The Top 5 RMBS Cases to Watch this Summer: No. 1 – MBIA v. Countrywide, BofA

After a week-long build-up (I’m sure the suspense is killing you), we’ve reached the No. 1 case in our countdown of RMBS Cases to Watch this Summer.  You may wish to catch up with parts I, II, III, and IV, if you haven’t already.  Though Case No. 2, Bank of New York’s Article 77 settlement, may have garnered more media attention thus far, another case gets my vote for No. 1 because it represents a true adversarial process, the best and only way, as far as I know, to establish any semblance of “proof” as to who is to blame for the massive losses associated with mortgage derivatives.  Read on to find out why the nation’s former No. 1 bank may want to stop the freight train that is our No. 1 case, before it’s too late.

No. 1 – MBIA v. Countrywide, Bank of America

Even relative newcomers to this blog should be well aware of the importance that I place on our No. 1 case, MBIA v. Countrywide, et al., No. 602825/2008 in New York State Supreme Court, presided over by Judge Eileen Bransten.  As one of the earliest-filed subprime RMBS cases, and one that has been skillfully and tenaciously litigated since the beginning by MBIA’s counsel, Quinn Emanuel, this case is one of the closest to resolution and to answering some of the tough legal questions hanging over this industry.  And based on what we’ve seen thus far, if and when this case begins producing final judgments, BofA is not going to like the answers.

As recently as April 24, I wrote about the progress MBIA was making in its case against Countrywide and BofA, in which it seeks compensation for the insurance payments it has made based on losses in 15 separate mortgage backed securities trusts.  Therein, I noted that MBIA was on a roll, having won several recent discovery and case management motions, providing the bond insurer with an ever-growing stockpile of ammunition to use in its forthcoming summary judgment motion.  But even since that time, there have been several developments that have only confirmed and continued this trend, as MBIA marches steadily toward a potentially crushing victory at trial.  I will run through those developments below, followed by a head’s up on what to watch for in this case going forward.

Motion to Compel Fraud-Related Documents

One of MBIA’s primary claims is that it was fraudulently induced to provide insurance for Countrywide’s securitizations based on misrepresentations by the lender regarding loan quality and the quality control procedures that it had in place.  Though common law fraud is typically difficult to prove, as it requires showings of knowledge, intent and reliance, a successful fraud claim could return to the aggrieved party the full amount of its loss plus punitive damages.  Usually, this requires some kind of smoking gun – emails or internal documents in which high-ranking corporate officers acknowledge a problem but cover it up and/or fail to disclose it to their business partners.

MBIA has been looking for just this type of smoking gun since the beginning of their case, and it appears they believe they’ve found it, in the form of internal Countrywide documents relating to its fraud hotline and internal fraud investigations.  If Countrywide knew there was widespread fraud in its loan origination processes, and covered up that information, it could certainly form the foundation for a finding that it intentionally misled MBIA into providing insurance coverage.  And Countrywide has certainly acted like MBIA is knocking on the door of a treasure trove of damaging evidence, as it has fought like crazy to avoid producing these documents.

But Judge Bransten is having none of it.  On May 25, Bransten issued her ruling (actually dated May 11 or May 15, depending on which version you pull up on the docket), in which she granted the bulk of MBIA’s discovery requests, and generally only limited the insurer’s requests when they extended to documents unrelated to the securitizations at issue in the case.  In particular, Bransten granted MBIA’s requests for:

  • Documents related to Countrywide’s “fraud hotline” (email, fax, mail and telephone hotline for complaints about illegal behavior by Countrywide employees) as to the loans at issue;
  • Documents related to loans at issue that were referred to Countrywide’s internal Fraud Risk Management Group and Fraud Prevention and Investigation Department;
  • All meeting minutes from 2004 to 2007 from three senior management committees (alleged to reveal Countrywide compliance and underwriting policies and its understanding of how its market share related to the same) and any other minutes that refer generally or specifically to materials relevant to securitizations at issue;
  • Countrywide internal modeling files on the securitizations at issue, if not already produced; and
  • Documents regarding two terminated employees and the fraud investigations  for which they were responsible at Countrywide, as well as documents regarding any fraud cover-up.

Whew!  That document dump should keep Quinn’s associates busy for awhile, and should reveal some very juicy details about what Countrywide knew about fraud and when, and what it did or didn’t do about it.  What might be even more significant about this ruling, however, is that Judge Bransten seems to have found her voice, emerging as a strident champion of the legal process while confronting head-on Countrywide/BofA’s complaints about the mounting burden of this litigation.  In the final paragraph of her Order, she writes:

the court acknowledges, and is sympathetic with, Countrywide’s statements regarding the volume of documents it has produced.  However, past production bears no relation to current and ongoing discovery obligations, and, while colorful, recitations of numbers of pages and volumes of documents produced is unpersuasive and is not considered.  Discovery, though expensive and exhaustive, must be completed in full. (May 25 Order at 16)

This trend only continues in the Judge’s next ruling, discussed below.

Motion to Compel Clawed Back Documents and Sanctions for Delay

On May 4, the parties appeared before Judge Bransten to argue about whether Countrywide had the right to “claw back” documents it had previously produced in the middle of depositions, and right when plaintiff’s counsel was about to use those documents to question opposing witnesses.  At the time, MBIA counsel Peter Calamari asked the Court to sanction Countrywide, stating

I do believe that they should be sanctioned. I also believe that additional depositions should, might need to take place once we get the documents. (May 4 Transcript at 57:11-14)

Yet, Calamari also made clear that he did not want the case schedule slowed down as a result of these issues.  In general, plaintiffs are already incentivized to try to propel their cases forward, both to put pressure on the opposition and to keep costs from spiraling out of control.  But in this case, there’s an additional factor: MBIA wants this case to reach trial before BofA’s separate plenary action against MBIA (alleging violations of debtor-creditor law in connection with MBIA’s restructuring) gets there first.

Though an unlikely scenario given the current state of the two cases, should BofA’s plenary action (pending before Judge Barbara Kapnick in New York Supreme Court) reach trial first, it would put MBIA in a precarious position.  On one hand, the monoline could go to trial and risk losing, meaning the restructuring could be invalidated and/or MBIA could be hit with massive damages and no longer have the financial wherewithal to prosecute its case; on the other hand, MBIA could settle with BofA out of a position of weakness and on unfavorable terms.  By far, MBIA would prefer to put BofA in that position by accelerating its MBS lawsuit to the point that it’s ready to go to trial first, thereby forcing BofA to make the tough decision from a weakened position.

Another reason that MBIA would like to accelerate its case is that it has an opportunity to score major victories against Countrywide/BofA on summary judgment.  Pursuant to the court’s Amended Pretrial Scheduling Order, opening summary judgment briefs are due by August 31 of this year, and the motions should be fully briefed by the end of October.  At any point thereafter, depending on what’s raised in MBIA’s motion, Bransten could rule on issues such as successor liability, loss causation and even on the merits of MBIA’s contractual arguments, should she find no genuine issue of fact exists.  Adverse rulings in this regard could be devastating for BofA’s proposed $8.5 billion settlement of Countrywide putback claims currently pending before Judge Kapnick, undermining the very assumptions on which the settlement figure is based (for detailed analysis of the loss causation issue and its impact, see my prior article here).

Thus, we have seen MBIA’s counsel emphasize at each turn that they want to keep the case on track, and decrying Countrywide and BofA’s apparent efforts to drag their heels.  At the May 4 hearing, in response to MBIA’s arguments, Judge Bransten also expressed frustration both with the parties’ conduct during discovery and with the overall pace of the litigation.  Though Bransten didn’t limit her comments solely to Countrywide, it’s hard to read the following comments, given the context of MBIA’s discovery motion, without concluding that she has the nation’s former No. 1 lender in her sights:

Really, just in general. We really have got to step up to the plate and take a big deep breath and grow up a bit. All right… Even I, I used to practice, too. But, it has been years. But, nevertheless, you’re practitioners… you don’t go around clawing back things in the middle of depositions. Particularly, when there has been prior notice given. It is just wrong.

Now, you may not get an answer you’re a hundred percent happy with. But, that is litigation. No one gets through this process liking everything that happens, no one.  Even The Judge (Smiles). It just doesn’t happen. So, of course, you’re going to get an answer that you wish you didn’t have. But, that is reality.

MBIA has the same problem. “God, that wasn’t the right answer.” You cannot stop it. Discovery is broad. It is complete. And frankly, I do think it has been, there has been a tendency of delay. Now, Mr. Calamari would want me to merely give sanctions. It is part of his motion, so I’ll be considering that. But, I am getting closer and closer. You don’t want me to get that annoyed that I really consider that what is happening is a tremendous delay, an unnecessary delay. If I do it is going to cost a substantial amount of money. And I don’t want to have that happen. It is humiliating. It is not right. It’s not right. And not professional. (May 4 Transcript at 60:26-62:26.)

Just over a month after that hearing, on June 7, Judge Bransten issued her ruling, which yielded few surprises based on those comments.  Her Honor granted almost every request in MBIA’s Motion to Compel, with the exception of its request for sanctions.  In that regard, she noted in her Order:

All parties in this action are represented by zealous advocates, as is proper and the court appreciates.  However, the court has taken note of conduct up to the present date, including continual allegations of as well as actual delay and apparent failure of both sides to substantively meet and confer.  Interruptions of depositions, inconvenient to the deponent and expensive to all sides, will not be tolerated.  Further interruption by any side will lead to an imposition of costs.

However, the court declines to impose sanctions at this time.  The conduct as related to the court is subject to interpretation, and the court does not find the conduct rises to a sanctionable level. This may change if BAC continues to conduct itself in a manner which may be interpreted as either deceptive or geared towards a goal of delay. (June 7 Order at 16 (internal citations omitted))

The long and short of this is that MBIA will get documents regarding BofA’s alleged de facto merger with, and assumption of liabilities of, Countrywide.  These include loss reserve accounting estimates and Countrywide acquisition-related documents, which should provide further ammunition for MBIA’s claims that BofA bears responsibility for Countrywide’s liabilities as its successor-in-interest.  MBIA also gets to hold the threat of sanctions over defendants’ heads should they play games with discovery going forward.  All-in-all, a big win for the monoline that allows it to continue to obtain damaging evidence while keeping its case on track.

The Track Ahead: What to Watch For

Having had little success before Judge Bransten, BofA has apparently decided that it stands a better chance before the New York Supreme Court’s Appellate Division for the First Department.  Though Bransten has a relatively successful track record on appeal, including in this case, BofA has continued to appeal nearly every meaningful ruling Bransten has made to the higher court.  Most recently, BofA appealed Bransten’s loss causation ruling as it applies to MBIA’s fraud and breach of insurance contract claims (background here), after which MBIA cross-appealed as to her ruling on the issue of loss causation for put-back claims.  The appeal and cross-appeal of the Partial Summary Judgment Order in MBIA v. Countrywide (and the virtually identical Order in the related case of Syncora v. Countrywide) is calendared for hearing before the Appellate Division during the October 2012 term, if the appeal is perfected.

Also up on appeal is Bransten’s Order denying Countrywide’s Motion to Compel discovery regarding MBIA’s practice of insuring similar risks.  Though Countrywide had argued that it was entitled to test whether MBIA followed its stated guidelines in practice, and therefore whether the insurer actually relied on Countrywide’s representations in deciding to insure the deals, Judge Bransten denied the motion.  She found that Countrywide could test that fact based on the documents already produced in this case relating to the securitizations at issue, MBIA’s guidelines or lack thereof, and relevant witness testimony.

While these appeals are being heard in the higher court, there will be no shortage of activity in Bransten’s trial court this summer.  MBIA will continue to plow through discovery, including trying to obtain and digest all of the new documents Countrywide has been compelled to produce, as well as squeeze in all of its fact depositions, prior to the August 31 deadline for submission of summary judgment motions.  This may include forcing BofA CEO Brian Moynihan to sit for deposition a second time, after Judge Bransten suggested that this would be the logical result of Moynihan’s statement that he couldn’t remember facts about certain meetings without having the meeting minutes in front of him (the same minutes Countrywide was trying to withhold and is now being forced to produce).  Does anyone doubt that Moynihan is sick of talking about, let alone participating in, legacy mortgage litigation?

Expert discovery will also continue throughout the summer, with August 1, 2012 being set as the deadline for expert depositions relating to primary liability against Countrywide.  In short, while this should be a long, hot summer for all parties to this litigation, I have a feeling that BofA is starting to feel the heat a bit more acutely, as the victories continue to pile up for MBIA.

Let’s be clear: BofA is relying heavily on the success of BNYM’s $8.5 billion settlement as part of its plan to put its legacy mortgage issues behind it. For the bank to allow this much smaller (by dollar amount at stake) but far less auspicious RMBS case to chug forward and potentially derail its settlement would be to make a tactical mistake of epic proportions.  With statutes of limitations windows closing, and the threat of additional litigation from MBS investors beginning to subside, BofA should become far more cognizant of the threat of litigation from its own shareholders if, after eating tens of billions of dollars in losses in mortgage liabilities, it stubbornly refuses to settle with MBIA for a few (billion) dollars more.

I hope you enjoyed this week-long rundown of the Top 5 RMBS Cases to Watch this Summer.  Keep an eye out for the epilogue to this series in the coming weeks, as I begin to evaluate end game scenarios and endeavor to tackle the big question on everyone’s mind – how will all this subprime madness ultimately shake out?

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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