MBIA on Winning Streak Heading into Trial on Restructuring Challenge

Monoline insurer MBIA, the most influential plaintiff in mortgage crisis litigation, has been on a roll lately in its lawsuits against Bank of America and other institutions over issues stemming from the subprime meltdown.  But MBIA will face its stiffest challenge yet next month, as a New York Superior Court judge has decided to hold a trial on the Article 78 challenge by three banks, including BofA, to the insurer’s 2009 restructuring.

With each passing month, MBIA has made progress in its RMBS lawsuits, putting it closer and closer to obtaining recoveries on its distressed portfolio of mortgage derivative insurance and ultimately emerging from the mortgage crisis as a viable entity.  But much of that may depend on the resolution of challenges to MBIA’s restructuring, including the upcoming proceeding under Article 78, a vehicle for challenging whether the decision of a body or officer was in excess of authority or an abuse of discretion.

The trial on that matter, which should focus primarily on the actions of New York’s insurance regulator rather than MBIA itself, is now set to go forward on May 14, 2012.  But if the trial results in the nullification of the 2009 restructuring, in which MBIA split its troubled structured finance business from its healthier municipal bond insurance business, MBIA could bear the brunt of the fallout.

Judge Barbara Kapnick, who should be a familiar name to readers of this blog as the jurist presiding over Bank of New York Mellon’s Article 77 proceeding to approve BofA’s $8.5 billion putback settlement, among others, will also preside over BofA’s Article 78 challenge.  At an April 20 hearing, Kapnick ruled that this challenge would proceed to a bench trial (meaning there is no jury and the judge acts as the factfinder), meaning that Her Honor will have sole authority to determine whether the New York Insurance Commissioner acted within its discretion in approving the restructuring.  Judging from the transcript of the hearing, Kapnick is seeking to hold a streamlined proceeding over a two-week period in which few experts will be introduced and the main focus is the decision-making process of the two primary players at the New York Insurance Department (NYID).  Read Alison Frankel’s excellent article comparing the similar standards of review in the Article 77 and 78 proceedings to see how Judge Kapnick may be hard-pressed to rule in favor of the banks under Article 78 by finding an abuse of discretion, without also finding an abuse of discretion in BNYM’s decision to settle Countrywide putback claims at a steep discount.

Regardless, MBIA heads into this trial riding high on a litigation winning streak that has put it in a strong negotiating position.  As plaintiff, MBIA has been scoring victory after victory in its suit against BofA and Countrywide over allegations that it was misled by the lender about the quality of loans MBIA was agreeing to insure.  As defendant, MBIA has managed to wrangle settlements with the vast majority of banks and funds that have challenged  its 2009 restructuring and the New York Insurance Commissioner’s decision to approve the same.  Just last week, MBIA settled one of the outstanding suits it faces concerning this overhaul, announcing that it had reached a deal with Aurelius Capital Management that resulted in the dismissal of the entire action.

As I’ve discussed, MBIA has been somewhat of a trailblazer for both monoline and investor plaintiffs wishing to sue the banks for deficient underwriting and for breaching their representations surrounding non-prime lending.  Having filed its suit against Countrywide (and later BofA) back in September 2008, MBIA was responsible for some of the earliest precedential ruling on key issues such as BofA’s successor liability, the use of statistical sampling to prove underwriting breaches and the propriety of the banks’ loss causation defenses.

More recently, MBIA has garnered a slew of victories on discovery issues, including winning permission from Judge Eileen Bransten to depose BofA CEO Brian Moynihan, to obtain BofA’s repurchase review documents, and to press ahead with discovery and trial on claims that BofA is on the hook for Countrywide’s liabilities as its successor-in-interest (the last two rulings were recently upheld by the First Department on appeal, see here and here).  Judge Bransten’s Order on the Moynihan deposition in particular demonstrates that Her Honor is tiring of BofA’s heel dragging on discovery, and is giving short shrift to its defenses regarding relevance and burden in favor of giving MBIA broad access to discovery.  I liked this line from Her Honor’s Order in particular: “Moynihan therefore has unique knowledge regarding his intentions and state of mind when he made statements about BAC’s responsibility for Countrywide’s liabilities, which are undoubtedly relevant to MBIA’s claim for successor liability.” (Order at 14.)

Bransten has scheduled another hearing for May 4 on whether to compel BofA to produce documents in two additional categories: 1) documents regarding BofA’s alleged assumption  of Countrywide liabilities and 2) documents BofA has withheld under an assertion of Bank Examiner privilege.  I expect the trend of discovery wins for MBIA to continue on both fronts.  With each additional win, MBIA is hoarding additional ammunition to use in summary judgment motions coming up in August and in ongoing settlement negotiations.

But MBIA’s strong position in its RMBS cases could be significantly undermined by the earlier resolution of the Article 78 proceeding in any manner that upsets the restructuring.  Though it can take solace in a favorable standard of review – essentially whether the NYID acted irrationally in approving the restructuring, given what it knew at the time – MBIA has a less favorable judge and some unpleasant evidence to contend with (including that it hid from the Insurance Commissioner a report by Lehman Bros. in the months prior to the restructuring, which suggested that MBIA had woefully insufficient reserves for losses on its CDO portfolio).  Though it’s uncertain how much of this evidence Judge Kapnick will consider when analyzing the NYID’s decision, what is certain is that an adverse judgment in the Article 78 proceeding, the first major civil trial stemming from the mortgage crisis, could raise questions about MBIA’s solvency and throw the company into turmoil.

Seemingly as a result, MBIA has adopted a tone of righteous indignation in its pleadings in the Article 78 proceedings.  The monoline can hardly contain its sense of outrage at having to defend its restructuring to the very banks that helped create the financial turmoil that necessitated the transaction.  This doozy of a final paragraph in the opening of its Sur-Reply brief has the distinct feel of being uttered by Jack Nicholson’s Colonel Nathan Jessup from A Few Good Men (at left), who scoffed at those who would rise and sleep under the blanket of the very freedom that he provides, and then question the manner in which he provides it.  See if you agree:

The Transformation was an effort in the public interest to ensure the availability of insurance in order to unfreeze the public finance markets.  It was accomplished without a dime of taxpayer funds.  It was reviewed for more than a year by dedicated professionals and approved by Superintendent Dinallo in the utmost good faith.  Contrary to the Banks’ egregiously false claims, no one “looted” anything or was enriched by it.  By contrast, the banking industry several years ago was bailed out with billions of dollars in taxpayer funds, after meetings over one weekend, to rescue it from the very financial crisis it played a major role in creating.  The Banks should not be heard to complain about what the NYID did here, and their Petition should be dismissed in its entirety.

Well, MBIA did not succeed in getting the plaintiffs’ petition dismissed, but neither did  plaintiffs succeed in getting Judge Kapnick to rule in their favor without a trial, despite a detailed and well-written brief by plaintiffs’ law firm, Sullivan & Cromwell.  So now it falls to Her Honor to listen to the evidence and decide whether to uphold or reverse the restructuring.  As I’ve said, Kapnick has indicated that she will take a narrow view of the evidence – focusing only on the reasonableness of the Insurance Commissioner’s conduct, and not that of MBIA.  As reported by Reuters, during the hearing to determine whether the case would go to trial, Her Honor said, “This case really addresses the actions of the insurance department in approving this transaction. It’s not a case about all these terrible intentional things, about concealing, [that MBIA is accused of having done].”

This certainly bodes well for MBIA – while also indicating that Kapnick may take the same deferential approach to BNYM in adjudicating the Trustee’s settlement under the restrictive guidelines of Article 77 (early returns on the hearing held today indicate that while Kapnick ruled the action will remain under Article 77, she will allow objections and may expand the scope of discovery).  I will keep you updated on developments in both actions as they arise, but suffice it to say that after almost four years of litigation, we are finally getting down to some significant merit-based determinations in this space, which will ultimately help to establish the allocation of losses from this monster of a crisis.

[Correction: a previous version of this story incorrectly identified the Article 78 plaintiffs’ law firm and the presiding judge in the second-to-last paragraph (hat tip reader C. Herzeca) – IMG]

About igradman

I am an attorney, consultant, book editor, and one of the nation's leading experts on mortgage backed securities litigation. I am the author of The Subprime Shakeout mortgage litigation blog, a partner at Northern California law firm Perry Johnson, Anderson, Miller & Moskowitz, LLP, and the editor of the critically-acclaimed book, "Way Too Big to Fail: How Government and Private Industry Can Build a Fail-Safe Mortgage System," by Bill Frey. Follow me on Twitter @isaacgradman
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