$9 Billion in Toxic Loans and Counting

I.                   BACKGROUND

The Court has previously addressed the complex background and unique legal issues involved in this contractual indemnification lawsuit in numerous orders and opinions, most notably in its 210-page Findings of Fact and Conclusions of Law (“FOF & COL”) following the parties’ 13-day bench trial in this case.

In re ResCap Liquidating Tr. Litig., No. 13-cv- 3451 (SRN/HB), 2020 WL 4728109 (D. Minn. Aug. 14, 2020); (ResCap Consol. Liquid. Tr.Litig., 13-cv-3451 [Doc. No. 5527].)

While the Court will not reiterate its past findings in detail here, to provide the necessary context for Plaintiff’s motion, the Court will briefly describe the origins of this case, the underlying relationship between Plaintiff’s predecessor, Residential Funding Corporation (“RFC”), and Defendant Primary Residential Mortgage, Inc. (“PRMI”), and the procedural history of this action, including the relationship of this case with similar cases filed in this District.

RFC’s Bankruptcy

This lawsuit stems from the 2012 bankruptcy (the “Bankruptcy”) of the Minnesota company known as RFC. (FOF & COL ¶ 1.) Following the 2008 collapse of the housing market, RFC was sued by various “Trusts” and “Monoline Insurers” for breaching the “representations” and “warranties” (“R&Ws”) RFC had made to those entities, or their insureds, when selling them bundles of home mortgages pooled together into residential mortgage-backed securities (“RMBS”).

In re RFC & ResCap Liquid. Tr. Action, 399 F. Supp. 3d 827, 831 (D. Minn. 2019) (“HLC Fee Award”).

Facing billions of dollars of liability, RFC filed for bankruptcy in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”).

In the Bankruptcy Court, after much negotiation, RFC reached a series of settlements, totaling approximately $9 billion, with the RMBS Trusts and several of the Monoline Insurers. HLC Fee Award, 399 F. Supp. 3d at 831.

In December 2013, the Bankruptcy Court Judge, the Honorable Martin Glenn, approved the settlements as “fair and reasonable” in a 134-page order. (FOF & COL ¶ 111); HLC Fee Award, 399 F. Supp. 3d at 831.

At the hearing in which Judge Glenn approved the settlements, he further observed that “this case is certainly the most legally and factually complicated case that I’ve presided over in my seven years on the bench,” and that “ResCap presented more unsettled legal issues than I’ve seen in one case before, whether during my seven years on the bench or thirty-four years in law practice before that.” HLC Fee Award, 399 F. Supp. 3d at 831.

 Indemnification and Fee-Shifting Provisions

As part of RFC’s Bankruptcy, RFC’s creditors formed ResCap, a trust authorized to sue the dozens of banks and mortgage lenders that had sold RFC the loans that were subsequently bundled into RMBS…

on grounds that those lenders breached their (corresponding) R&Ws to RFC, and thus directly caused RFC to breach its R&Ws to the Trusts and Monoline Insurers, which, in turn, contributed to RFC’s $9 billion in Bankruptcy liabilities. Id. ResCap’s legal claims against the lenders were rooted in the “Client Contract” that those lenders had signed with RFC, which itself incorporated a lengthier agreement called the “Client Guide,” or in PRMI’s case, both the Client Guide and a similar agreement called the “AlterNet Guide” (collectively, “the Guides”). Id.

In addition to the R&Ws that the lenders made to RFC, such as a promise that all of the borrower information the lender provided RFC was accurate, (FOF & COL ¶¶ 20–21), both the Guides contained broad indemnification provisions requiring the originating lenders to indemnify RFC from “all losses, damages, penalties, fines, forfeitures, court costs and reasonable attorneys’ fees, judgments, and any other costs, fees and expenses resulting from any Event of Default.” (Id. ¶¶ 26, 28) (citing PTX-001 § 274; PTX-032 § A223; PTX-1055 A212; In re ResCap Liquid. Tr. Litig., 428 F. Supp. 3d 53, 67 (D. Minn. 2019) (“PRMI Summ. J. Order”) (emphasis added)).

Litigation in Minnesota

Based on this broad indemnification language, and the $9 billion in “losses and liabilities” incurred in RFC’s Bankruptcy settlements, in late 2013, ResCap began filing dozens of materially identical lawsuits in the District of Minnesota against a wide range of mortgage lenders, all asserting claims for breach of contract and contractual indemnification.

As part of RFC’s Bankruptcy, RFC’s creditors formed ResCap, a trust authorized to sue the dozens of banks and mortgage lenders that had sold RFC the loans that were subsequently bundled into RMBS…

on grounds that those lenders breached their (corresponding) R&Ws to RFC, and thus directly caused RFC to breach its R&Ws to the Trusts and Monoline Insurers, which, in turn, contributed to RFC’s $9 billion in Bankruptcy liabilities. Id. ResCap’s legal claims against the lenders were rooted in the “Client Contract” that those lenders had signed with RFC, which itself incorporated a lengthier agreement called the “Client Guide,” or in PRMI’s case, both the Client Guide and a similar agreement called the “AlterNet Guide” (collectively, “the Guides”). Id.

In addition to the R&Ws that the lenders made to RFC, such as a promise that all of the borrower information the lender provided RFC was accurate, (FOF & COL ¶¶ 20–21), both the Guides contained broad indemnification provisions requiring the originating lenders to indemnify RFC from “all losses, damages, penalties, fines, forfeitures, court costs and reasonable attorneys’ fees, judgments, and any other costs, fees and expenses resulting from any Event of Default.” (Id. ¶¶ 26, 28) (citing PTX-001 § 274; PTX-032 § A223; PTX-1055 A212; In re ResCap Liquid. Tr. Litig., 428 F. Supp. 3d 53, 67 (D. Minn. 2019) (“PRMI Summ. J. Order”) (emphasis added)).

A.    Litigation in Minnesota

Based on this broad indemnification language, and the $9 billion in “losses and liabilities” incurred in RFC’s Bankruptcy settlements, in late 2013, ResCap began filing dozens of materially identical lawsuits in the District of Minnesota against a wide range of mortgage lenders, all asserting claims for breach of contract and contractual indemnification.

At the outset of the litigation, ResCap was represented solely by attorneys at the Minneapolis firm of Felhaber Larson, (“Felhaber”), RFC’s longstanding counsel, as well as attorneys at the Columbus, Ohio law firm of Carpenter, Lipps & Leland LLP (“Carpenter Lipps”), RFC’s Bankruptcy counsel. HLC Fee Award, 399 F. Supp. 3d at 832.

Early in the proceedings, ResCap and counsel at Felhaber determined that ResCap also “needed to obtain national counsel with significant RMBS litigation and RMBS-related bankruptcy expertise to represent [it].” (Heeman Decl. [Doc. No. 26] ¶ 9.)

However, “[ResCap] could not locate counsel in Minneapolis/St. Paul with the requisite expertise who were capable and able to litigate the cases, particularly in light of the many conflicts that law firms in this market had due to their ongoing representation of many of the defendant-originators in these cases.” (Id.)

Plaintiff was not alone in seeking national counsel, as “the overwhelming majority of Defendants in these cases, including PRMI, hired lead counsel from outside of Minnesota,” (id.), often from some of the most prestigious law firms in the country (noting that defense counsel included Williams & Connolly, Jones Day, Munger, Tolles & Olson, Orrick, Herrington & Sutcliffe, Ropes & Gray, Simpson Thatcher & Bartlett, Sullivan & Cromwell, and Wachtell, Lipton, Rosen & Katz).

Ultimately, ResCap obtained the services of national counsel at the firm of Quinn Emanuel Urquhart & Sullivan, LLP, due to Quinn Emanuel’s well-regarded RMBS, bankruptcy, and insurance litigation experience, including its success in recovering over $25 million for the Federal Housing Finance Agency in RMBS litigation.

Plaintiff also continued to be represented by local counsel, attorneys at Felhaber, with those attorneys subsequently moving to Spencer Fane LLP, and by RFC’s Bankruptcy counsel, Carpenter Lipps.

As of January 2015, 68 of ResCap’s cases were consolidated for pretrial purposes before the undersigned judge as part of the ResCap RMBS Litigation. (Horner Decl. ¶ 3.) Of these 68 cases, five involved default, three were “loan-level cases” distinct from the other consolidated cases, and one settled shortly after consolidation. (Id.) As of February 2015, 59 cases remained part of the consolidated ResCap RMBS Litigation.

Berkshire Hathaway yesterday offered to serve as a stalking-horse bidder to purchase the assets of Residential Capital under better terms than under the company’s current deals with Fortress Investment Group’s Nationstar Mortgage and Ally Financial.

ResCap had filed for Chapter 11 on May 14 with the agreement that it would sell its mortgage origination and servicing businesses to Nationstar for about $2.3 billion, and sell its legacy portfolio, consisting mainly of mortgage loans and other residual financial assets, to its parent company, Ally, for $1.4 billion. But those deals were always subject to higher bids, and the company is expected to attract interest from several possible purchasers.

A hearing to set the ground rules for the sales process is scheduled for June 18 at the bankruptcy court in Manhattan.

With yesterday’s filing, Berkshire sought to get a jump on potential rivals by stepping into the role of stalking horse bidder – an initial bidder who agrees to purchase assets subject to higher and better offers, thus setting a price floor — saying it would offer to purchase the mortgage origination and servicing businesses on the same terms as Nationstar, but with a breakup fee of only $24 million and no expense reimbursement. The Nationstar deal includes a breakup fee of $72 million, plus reimbursement of expenses of up to $10 million.

The smaller breakup fee potentially benefits Residential Capital by leaving more money for the company in case the stalking horse bidder is ultimately outbid. In addition, an excessive breakup fee can chill bidding by driving up the minimum level of acceptable bids.

With respect to the loan portfolio, Berkshire’s offer was more straightforward, saying simply that it would beat Ally’s purchase price by $50 million.

Whether the purchase of ResCap assets is a good or bad bet for Berkshire (and, for the record, we’ll give Buffett the benefit of the doubt on this issue), from a bankruptcy perspective the more interesting issue is deciphering how a confusing series of moves by Buffett in the bankruptcy case over the past week play into his strategy, according to sources. Professionals universally acknowledge Buffett’s savvy and the proficiency of his legal counsel, as well as that of the Berkshire investment manager involved, but many remain baffled by the sequence of events.

Earlier this month, the unsecured creditors’ committee appointed in ResCap’s bankruptcy sought and won court permission to investigate whether certain ResCap transactions with Ally and other affiliates could be avoided as so-called fraudulent conveyances under the Bankruptcy Code. The committee contended, in effect, that the transactions – the committee identified more than 20 candidates is says are worthy of a closer look — stripped ResCap of valuable assets ahead of the bankruptcy filing so that creditors could not lay claim to them. Such creditor committee investigations are commonplace in Chapter 11 cases, as unsecured creditors seek to improve their prospects for recoveries by either voiding liens held by secured creditors or, if possible, returning assets to the bankrupt company that can be used to pay claims.

But on June 4, Berkshire requested an independent examiner to look into the very same transactions, questioning the committee’s ability to conduct an independent investigation because its members “have disparate and potentially conflicting interests with respect to the matters that require investigation.” Among other things, the committee includes trustees of ResCap’s mortgage backed securitized trusts who have already signed a plan support agreement with ResCap, the Berkshire motion said.

In its motion, Berkshire noted that it held more than one-half of ResCap’s outstanding unsecured bonds, in addition to more than 40% of the company’s junior secured debt.

Strategically, Berkshire seemed to be taking its cues from some recent higher profile Chapter 11 cases, most notably Tribune and Dynegy Holdings, in which independent examiner findings of fraudulent conveyance led to settlements that enhanced unsecured creditor recoveries, a far superior result to uncertain, protracted and expensive litigation.

Indeed, several sources following the credit interpreted Berkshire’s examiner motion as a possible move to get more recovery for the 8.5% unsecured notes, which were languishing in the teens. And sure enough, upon news of Berkshire’s examiner motion the notes traded up several points on June 5 and June 6, reaching 21.5, which is the level sources say Berkshire decided to dump its position over those two days.

The credit-event auction held last Wednesday to settle CDS contracts referencing ResCap may have eventually set a final price of 17.625 cents on the dollar, according to Markit and Creditex, but during the auction, Citi came to market with a big block of the bonds – presumably Berkshire’s – while Goldman Sachs had a long thesis that gave them more recovery, using Berkshire’s own call for an examiner as support for the possibility that this allocation could somehow be renegotiated to get more recovery.

At the CDS auction, Citi offered $520 million of the bonds for sale, and Goldman bid on $345 million of those, according to data from Markit and Creditex.

The Berkshire moves in the unsecured debt were disclosed on June 7 when Berkshire investment manager Ted Weschler filed a terse affidavit with the bankruptcy court stating that he had “been informed” that those trades were executed.

The Berkshire moves in the unsecured debt were disclosed on June 7 when Berkshire investment manager Ted Weschler filed a terse affidavit with the bankruptcy court stating that he had “been informed” that those trades were executed.

The sale of the position, coming on the heels of an examiner motion clearly intended to enhance unsecured recovery in the case, was confusing. On the one hand, it raised the inference that Berkshire used the court filing simply to drive the price of the debt up ahead of a planned sale – speculation arguably supported by Weschler’s stilted and passive language, sources say. But other observers dismissed Weschler’s language as insignificant and merely typical legalese, speculating that it reflected the fact that Weschler and the trading unit had perhaps not fully communicated. In this view, the examiner motion’s intent was not to drive up the price of the debt, but rather that the sale was simply the result of having an automatic level at which Berkshire was willing to part with those bonds, as they weren’t important to Buffett’s overall strategy of acquiring the company’s assets.

Weschler’s office and Berkshire’s attorneys with Munger, Tolles & Olson did not respond to repeated requests for comment.

In any event, Berkshire has not yet withdrawn its motion for the examiner, although its interest in pursuing an investigation, in light of the fact that it is no longer an unsecured creditor, is less clear. “Berkshire’s choice to bring this motion notwithstanding its apparent support for the committee’s investigation was initially puzzling,” the unsecured creditors’ committee said in a response to Berkshire’s examiner motion filed June 11 with the bankruptcy court, adding that it “now seems even more questionable.” Noting that Berkshire’s interest is now solely as a secured creditor, the panel argued, “The examiner motion now represents an effort by the largest secured creditor to interfere with an investigation by the committee – the entity best situated to protect the interests of unsecured creditors – into the fairness of a series of transactions that includes, among other things, the Debtors’ settlements with secured creditors.”

In the meantime, however, several other unsecured creditors – including the New Jersey Carpenters Health Fund, along with The Union Central Life Insurance Company, Ameritas Life Insurance Corp. and Acacia Life Insurance Company – have piled onto Berkshire’s original request, so the concept of an independent examiner has arguably taken on a life of its own, independent of any motivation Berkshire may have had.

If Berkshire’s strategy is opaque, it is equally unclear at this point how all this maneuvering may ultimately affect the ResCap Chapter 11.

The funding to pay down exiting creditors was to consist of the $750 million cash contribution ResCap parent Ally Financial said it would make upon confirmation of the company’s reorganization plan, and the $1.6 billion stalking-horse bid Ally has offered for ResCap-owned mortgages currently marked at 45% of UPB (comprised of Ally’s $1.4 billion bid plus an additional $200 million to be provided under the proposed reorganization plan in exchange for legal liability releases).

Before Berkshire dumped his share of the unsecureds, some investors feared (or hoped) that Berkshire held enough of the 9.625% third-lien notes to prevent the company from cramming down the unsecureds (forcing them to accept the proposed reorganization plan), according to sources. But now, the new group of bondholders might not have this power, as some acquirors the Berkshire stake may be subject to the existing plan support agreements.

It is also unclear what effect Berkshire’s play may have upon Ally’s future actions. Whether or not Berkshire ultimately succeeds in acquiring the assets, the current plan consisting of the $750 million contribution and Ally’s stalking horse bid is likely to change, sources noted.

“This plan may be only the first step toward a plan [that will get approved],” according to a source following the credit. “It could be that Ally has to increase its contribution to gain support for a fast-track reorganization.”

And then there is also a problem given the allowed claims deal negotiated by Gibbs & Bruns LLP attorney Kathy Patrick and her team along with Ropes & Gray on behalf of 17 institutional investors holding RMBS, according to sources.

They negotiated that ResCap and the affiliated debtors would grant an $8.7 billion allowed claim to 392 residential mortgage backed securities trusts.

The RMBS holders have or manage investments more than $13 billion in outstanding RMBS securities issued by over 350 of the covered trusts, according to a press release detailing the agreement that took place shortly after ResCap filed for bankruptcy.

The settlement is subject to review and will not become effective unless accepted by an indenture trustee and approved by the bankruptcy court. If the amount of this allowed claim remains this high, this may leave little room for a big return on Berkshire’s investment, according to sources. This allowed claims at significantly higher numbers than people thought were going to be allowed, those sources said.

NEW YORK, Dec. 11, 2013 /PRNewswire/ — The Bankruptcy Court Judge overseeing Residential Capital’s (ResCap) Chapter 11 cases will enter an order confirming ResCap’s Chapter 11 Plan, marking the court’s formal approval of broad releases for all mortgage-related claims against Ally Financial Inc. and its subsidiaries (Ally), subject to certain limited exceptions.  The parties expect the Chapter 11 Plan to become effective within the next week.

“This marks a key milestone for Ally, and the ResCap chapter in our history is officially behind us,” said Chief Executive Officer Michael A. Carpenter.  “Confirmation of the ResCap Plan offers broad and permanent releases of substantially all past, present and future mortgage-related claims, which is a key point of progress for Ally in achieving nearly complete closure for mortgage liabilities.

“Ally is a fundamentally transformed company,” Carpenter continued.  “We have exited non-core operations globally, addressed legacy mortgage issues and returned more than 70 percent of the investment to the U.S. taxpayer.  Today, Ally has leading market positions in its core franchises, one of the strongest balance sheets in the industry, a highly regarded customer-centered philosophy, and a clear path to drive value for our shareholders.”

Ally is represented in ResCap’s Chapter 11 cases by Kirkland & Ellis LLP and Evercore Partners.

About Ally Financial Inc.
Ally Financial Inc. is a leading automotive financial services company powered by a top direct banking franchise. Ally’s automotive services business offers a full suite of financing products and services, including new and used vehicle inventory and consumer financing, leasing, inventory insurance, commercial loans and vehicle remarketing services. Ally Bank, the company’s direct banking subsidiary and member FDIC, offers an array of deposit products, including certificates of deposit, savings accounts, money market accounts, IRA deposit products and interest checking. Ally’s Commercial Finance unit provides financing to middle-market companies across a broad range of industries.

With approximately $150.6 billion in assets as of Sept. 30, 2013, Ally operates as a bank holding company. For more information, visit the Ally media site at http://media.ally.com or follow Ally on Twitter: @Ally.

Contact
Gina Proia
646-781-2692
gina.proia@ally.com

SOURCE Ally Financial

NEW YORK (Reuters) – A bankruptcy judge on Wednesday approved a settlement in which the U.S. government-owned Ally Financial Inc ALLY_pb.N, formerly the finance arm of General Motors Co., will pay $2.1 billion to its bankrupt unit Residential Capital LLC RESC.UL.

Judge Martin Glenn also said he will unseal a report by a bankruptcy examiner probing Ally’s role in ResCap’s collapse. The report had been sealed as the parties hashed out a settlement.

The deal is a key step in ResCap’s eventual exit from Chapter 11 protection. The settlement also will help Ally focus on its core business of auto lending and on repaying the U.S. government roughly $10 billion outstanding on a $17 billion loan for a bailout during the financial crisis.

The agreement still must be incorporated into a formal plan by ResCap charting its bankruptcy exit strategy, which will also need court approval.

“The standards applicable to this plan support agreement are not the same as the standards applicable to approving” a bankruptcy exit plan, Judge Glenn said during a hearing in U.S. Bankruptcy Court in Manhattan.

SEALED REPORT

Creditors had alleged that Ally had hastened ResCap’s collapse by stripping some choice assets. A report by former bankruptcy Judge Arthur Gonzalez, the examiner in ResCap’s bankruptcy, probed Ally’s role.

That hefty study, which cost ResCap’s estate about $80 million, has been kept under seal. Glenn said it will be released now that the sides have settled, although it was unclear exactly when the report would become available to the public.

Glenn said he planned to enter the order to unseal the report on Wednesday. “I hope you all enjoy reading the 2,235 pages,” he quipped.

The government still owns about three-quarters of Ally, formerly a GM GM.N unit known as General Motors Acceptance Corp. Mortgages made by ResCap led to huge losses for Ally, and it still owes the government $10 billion.

Ally would pay the Rescap estate $1.95 billion in cash and expects $150 million more to come from its insurers. The total proposed contribution is up from the $750 million it initially offered, which creditors lambasted as far too low.

BOON FOR BONDHOLDERS

The settlement could yield a profit for unsecured bondholders like Paulson & Co, which will receive $351 million or so, about 35 cents on the dollar for their roughly $1 billion in claims.

While Paulson has not disclosed what it paid for its stake, it likely acquired it at a discount, as the bonds were trading lower than 30 cents on the dollar last May, when ResCap filed for bankruptcy, according to bond tracking program TRACE.

MBIA MBI.N and FGIC FGIC.UL, which insured residential mortgage-backed securities issued by ResCap, stand to get a larger piece of the settlement pie, about $1 billion total. But they have had to pay billions of dollars in claims stemming from the failed securities and may have to pay more in the future.

Other bond insurers would get about $96 million.

Holders of residential mortgage-backed securities – of which there are more than 40,000 among 392 separate RMBS trusts – stand to recoup about $672 million.

The settlement also resolves litigation including a securities class action led by the New Jersey Carpenters Health Fund, which would receive $100 million. A trust created for the benefit of other private securities claimants would receive $226 million.

The case is In re Residential Capital LLC, U.S. Bankruptcy Court, Southern District of New York, No. 12-12020.

It appears that Residential Capital has decided not take its bankruptcy lying down. The company, which was once one of the largest mortgage servicers in the country, has filed lawsuits against 12 lenders that originated “poor quality” loans that ResCap purchased and securitized.

On Tuesday, the company filed lawsuits against the following in U.S. Bankruptcy Court in New York:

Bank of America
Summit Financial
Synovus Mortgage Corp.
Primary Capital Advisors
Cadence Bank
Mortgage Investors Group
Honor Bank
First Mariner Bank
CMG Mortgage
Citizens First Wholesale Mortgage
RBC Mortgage Company
PHH Mortgage Corp.

In each of the twelve lawsuits, ResCap alleges that the lenders are “legally and contractually responsible for the liabilities and losses caused by the poor quality of the mortgage loans in question.”

In the dozen nearly identical lawsuits, ResCap says that its business model was built on acquiring and securitizing residential mortgage loans from “correspondent lenders.”

ResCap would then “distribute those loans by either pooling them together with other similar mortgage loans to sell into residential mortgage-backed securities or selling them to whole loan purchasers.”

ResCap says that the quality of the loans was critical to the company’s success and it required its correspondent lenders to abide by “stringent loan-level contractual representations and warranties designed to protect (the company) from the risks of borrower fraud, appraisal fraud, failure to comply with state and federal law, and other credit and compliance factors that could negatively impact the performance and value of the loans it purchased.”

Eventually, ResCap was sued by “numerous counterparties and investors in its RMBSs, based on allegations that the loans contained numerous defects and were rife with fraud and compliance problems.”

The company is now suing the lenders because it says the lenders did not honor the contractual representations and warranties and misrepresented the quality of the loans.

ResCap is claiming breach of contract and indemnification.

In total, ResCap says that it purchased nearly 14,500 loans from the 12 lenders with an original principal balance of $1.5 billion.

ResCap claims that it was the lenders’ responsibility to collect information from the borrower, verify its accuracy and underwrite the loan. It claims that many of the loans it purchased included various defects, such as:

income misrepresentation, employment misrepresentation, owner occupancy misrepresentations, undisclosed debt, and missing or inaccurate documents.

Each lawsuit details specific examples of what the company calls “significant and material defects.” One example from the lawsuit against Primary Capital says,

“The stated income on the application was $95,000 in 2006, however, actual income in 2006 was only $828, as verified by the employer listed on the application.”

Another example of a loan defect from the lawsuit against Synovous:

“The borrower on this loan misrepresented his/her income. The borrower’s stated income was $12,000, whereas his/her actual average monthly income was $3,762. When actual income was used, the resulting debt-to-income ratio was 147%.”

In each lawsuit, ResCap seeks “contractual repurchase compensation and/or damages in excess of $75,000 and in an amount to be proven at trial, and an award of attorneys’ fees, interest, and costs” for each count of the lawsuit, one for breach of contract and one for indemnification.

Click here to read any or all of the 500-plus page lawsuits.