Official Committee of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC)
Docket: Case No. 12-12020(MG); Adv. Proc. 13-01277(MG)
Court: United States Bankruptcy Court, S.D. New York; August 13, 2013; Us Bankruptcy; United States Bankruptcy Court
UMB Bank, N.A. filed a Partial Motion to Dismiss in response to an Adversary Proceeding initiated by the Official Committee of Unsecured Creditors of Residential Capital, LLC, concerning claims against UMB as the successor indenture trustee and Wells Fargo as the collateral control agent. The Committee's case, initiated on February 28, 2013, included fourteen counts, with UMB seeking dismissal of ten. Following objections from the Committee and a supporting declaration, UMB withdrew its motion regarding five counts, including Count XIV. After a hearing on July 26, 2013, the Court denied the motion without prejudice for Counts I, IV, and XIII, while granting it with prejudice for Count V.
Background context includes the Debtors' chapter 11 filing on May 14, 2012, and subsequent approval of postpetition financing from Ally Financial, Inc., which involved stipulations regarding liens and security interests. The Committee investigated a $1.1 billion discrepancy related to the collateral securing the Junior Secured Notes and the AFI Revolver, noting that the Debtors' internal records indicated a lack of verification regarding certain pledged assets and their status as "Excluded Assets" under the Notes Security Agreement.
On December 26, 2012, the Court granted the Committee's motion for standing to pursue claims in the adversary complaint. Key facts include the issuance of approximately $4 billion in 9.625% Junior Secured Guaranteed Notes (Junior Secured Notes) by ResCap on June 6, 2008, as part of an Exchange Offer to swap outstanding notes maturing from 2010 to 2015. This transaction resulted in the exchange of about $6 billion in Old Notes for roughly $4 billion in Junior Secured Notes and approximately $862 million in cash. By the Petition Date, about $2.12 billion in Junior Secured Notes remained outstanding, with an unaccreted original issue discount of at least $377 million.
The Junior Secured Notes were issued under an Indenture involving multiple guarantors and U.S. Bank N.A. as the indenture trustee. On the same date, certain Debtors executed a Third Priority Pledge and Security Agreement with the Indenture Trustee. This agreement was subsequently amended to the Notes Security Agreement, which granted liens on specific assets (Notes Collateral) to secure payment obligations under the Indenture. The Committee alleges that at least $350 million in assets, identified as Preference Assets, were added to the Notes Collateral within 90 days before the Petition Date, characterizing these as Preferential Transfers.
Additionally, on June 4, 2008, AFI entered into a loan agreement with the Debtors, later amended to the AFI Revolver on December 30, 2009, with approximately $747 million in principal outstanding at the Petition Date. Concurrently, a First Priority Pledge and Security Agreement was established to secure the AFI Revolver Obligations, granting the Collateral Agent liens on the Notes Collateral.
On June 6, 2008, an Intercreditor Agreement was executed involving the Collateral Agent, AFI, the Original Trustee, and certain Debtors, establishing the rights regarding collateral for the Indenture Trustee and AFI. Section 2.1(b) states that liens under the Revolver Security Agreement take priority over those under the Notes Security Agreement. However, the Debtors acknowledged that the Secured Parties hold “first priority” liens on the Notes Collateral, which are also subordinate to other liens.
In relation to the AFI DIP Order, the Debtors made Stipulations confirming the validity of the Notes Obligations, detailing that the outstanding principal under the Junior Secured Notes is at least $2,120,452,000, alongside accrued interest and fees. The Debtors affirmed that the Secured Parties have first priority, perfected, and enforceable liens on the Notes Collateral, which includes assets from the Pre-Petition Ally Repo Facility and items listed in the AFI DIP Order.
The Stipulations also release the Secured Parties from any claims related to the Junior Secured Notes and their liens, facilitating the allowance of the Notes Obligations without the need for a proof of claim. The AFI DIP Order provides the Secured Parties with adequate protection, including replacement liens and administrative expense claims to address any value loss in the Notes Collateral. Specifically, they received liens on the equity interests of the Barclays DIP Borrowers, conditioned on the validity of prior liens on the BMMZ Facility.
Additionally, the Released Mortgage Loans, owned by ResCap, RFC, or GMACM and pledged under May 2010 repurchase agreements, may have been previously subject to Secured Parties' liens. On May 17, 2010, the Collateral Agent released certain mortgage loans from collateral obligations and filed UCC-8 termination statements to nullify prior financing statements on the Released Mortgage Loans.
The Committee claims that while the Debtors did not provide the Secured Parties with a lien on or security interest in the Released Mortgage Loans, the assets listed under the “Ally Revolver” and/or “Blanket” columns in Exhibit A to the AFI DIP Order, which are deemed Notes Collateral, include these Released Mortgage Loans. On December 21, 2011, BMMZ Holdings LLC (BMMZ), ResCap, GMACM, and RFC entered into a Master Repurchase Agreement (MRA) known as the BMMZ Agreement. Under this agreement, GMACM and RFC purportedly "sold" mortgage loans valued at $371 million (excluding the Released Mortgage Loans) to BMMZ for $250 million, with an agreement to "repurchase" them at a price that includes a Price Differential of LIBOR plus 4.75. The Committee argues that despite the terminology of "sale" and "repurchase," the arrangement was effectively secured financing. UMB notes that Ally agreed that the mortgage loans subject to the Pre-Petition Ally Repo Facility were transferred free of liens or claims. The Debtors similarly agreed to this transfer condition. The Barclays DIP facilitated the unwinding of the BMMZ Facility, with the Released Mortgage Loans pledged as collateral.
The Notes Security Agreement defines Excluded Assets as those pledged under any “Bilateral Facility,” which restricts the Debtors from granting liens to the Secured Parties on such assets. The term “Bilateral Facility” encompasses around 53 financing arrangements in which certain Debtors were involved as of June 6, 2008. The Committee believes that the Debtors pledged assets to other creditors under these Bilateral Facilities, with some collateral later released from liens and remaining part of the estate as of the Petition Date. Although the Debtors did not grant the Secured Parties a lien on the Released Bilateral Facilities Collateral, the assets listed in the “Ally Revolver” and/or “Blanket” columns are claimed to include this collateral.
Additionally, the Committee identifies certain Debtors as Non-Obligor Debtors, including EPRE LLC, ETS of Washington, Inc., and Residential Funding Mortgage Exchange, LLC. They assert that the “Cash and Cash Equivalents” and “Other Assets” in the “Blanket” column on Exhibit A include assets owned by these Non-Obligor Debtors, which have not guaranteed the Junior Secured Notes, have not provided liens to the Secured Parties, and are not obligated under the Indenture or JSNs.
The Complaint includes fourteen counts against the defendants, with UMB seeking dismissal of four specific counts. Key counts include:
- **Count I**: Seeks a declaratory judgment affirming that no Secured Parties possess a lien or security interest in the Released Bilateral Facilities Collateral.
- **Count IV**: Requests a declaratory judgment stating that no Secured Parties have a lien or security interest in the Released Mortgage Loans.
- **Count V**: A declaratory judgment addressing multiple aspects related to the BMMZ Facility, including its classification as secured financing, the Debtors' lack of residual value rights, ownership of BMMZ Mortgage Loans, and the status of any liens or security interests held by Secured Parties as either excluded or released prior to the Petition Date. It also asserts that Secured Parties are not entitled to Adequate Protection Liens concerning the equity of Barclays DIP Borrowers.
- **Count XIII**: Requests disallowance of Secured Parties' claims for unmatured interest or Original Issue Discount (OID) under relevant sections of the Bankruptcy Code and Federal Rules of Bankruptcy Procedure.
The legal standard for dismissal under Rule 12(b)(6) requires a complaint to provide sufficient facts to state a plausible claim for relief, with courts accepting all factual allegations as true and drawing reasonable inferences in favor of the nonmoving party. The complaint must contain a clear statement demonstrating entitlement to relief, and courts evaluate the plausibility of claims based on well-pleaded factual allegations, using a context-specific approach.
To meet the plausibility standard, a complaint must allege facts indicating more than a mere possibility of unlawful action by a defendant. It must go beyond merely consistent allegations and avoid conclusory statements or formulaic recitations of legal elements. The Committee's attempt to obtain a declaratory judgment regarding the BMMZ Facility is insufficient, as it seeks recharacterization of a repurchase agreement as a secured financing, which UMB argues is legally flawed. The Committee's acknowledgment that the BMMZ Facility is a Repurchase Agreement under the Bankruptcy Code, subject to safe harbor provisions, undermines its claim. UMB contends that the Committee's action would disrupt the rights of Secured Parties without a legitimate basis. If the Committee's claim succeeded, it could create an illogical scenario where both the Debtors and BMMZ would hold ownership of the same assets. Furthermore, UMB claims that the Released Mortgage Loans were transferred under a previous agreement and asserts that the Secured Parties maintained a security interest in the Debtors’ rights concerning these loans as of the Petition Date. The Committee argues that, if true, the BMMZ Facility should be treated as a secured financing, but acknowledges that the relevant statutes do not clarify the characterization of repurchase agreements.
Defendants argue that a transaction classified as a "repurchase agreement" under Bankruptcy Code section 101(47) should be treated as a true sale rather than a financing arrangement. The Committee contends that UMB misinterprets the ruling in American Home, emphasizing that the definition of 'transfer' in section 101(54) includes the creation of a lien, meaning that even if a contract only creates a lien, it qualifies as a "transfer." A subsequent ruling in the American Home case analyzed whether a transaction should be viewed as a financing or a true sale, despite its classification under sections 555 and 559. The Committee asserts that the BMMZ Facility being classified as a repurchase agreement does not prevent the court from determining it as a financing rather than a true sale, and disputes UMB's claim that all affected parties must have the same characterization of the transaction. The Committee refers to case law indicating that a transaction's structure can differ for third parties versus the direct parties involved. Additionally, the BMMZ Facility has been refinanced and unwound, which limits the Committee's claims to the Defendants alone. UMB counters that the agreement clearly indicates the parties intended the transaction to be treated as a sale, as reflected in the explicit language of the MRA. Courts in similar cases have dismissed recharacterization claims where the agreements' terms were unambiguous in establishing true sales. Ultimately, the Court concludes that the Committee has not sufficiently pleaded a claim asserting that the BMMZ Repo Facility is a "secured financing" instead of a repurchase sale, rejecting the Committee's argument for recharacterization.
The Master Repurchase Agreement (MRA) indicates that the parties intended to create a repurchase agreement, as evidenced by their designation as “Buyer” and “Seller” instead of lender/borrower. Definitions such as “Purchased Mortgage Loans,” “Purchase Date,” and “Purchase Price” further affirm that the MRA transactions are sales, not loans. The Committee acknowledges this repurchase agreement status in relation to sections 555 and 559 of the Bankruptcy Code, maintaining the rights of BMMZ. Consequently, the Court refuses to recharacterize the BMMZ Repo Facility as “secured financing” for evaluating any liens or security interests, thereby dismissing Count V of the Complaint with prejudice.
Additionally, the Committee has adequately asserted a claim for declaratory judgments regarding the Released Bilateral Facilities Collateral (Count I) and the Released Mortgage Loans (Count IV). They seek a declaration that Secured Parties lack liens on these assets. The Notes Security Agreement contains a broad all-assets granting clause that pledges all assets of the Company and Guarantors to the Secured Parties. UMB acknowledges that the Notes Security Agreement excludes Bilateral Facilities Collateral but argues that once such collateral is released, it should no longer be considered an “Excluded Asset,” thus becoming part of the Secured Parties' collateral under the all-assets clause. UMB also contends that any claim to avoid the Indenture Trustee’s liens on proceeds from the Released Bilateral Facilities Collateral contradicts the Notes Security Agreement's language, which does not exclude these proceeds from the collateral package. The Committee counters that the all-assets clause excludes any “Excluded Assets,” asserting that the grant of security interest applies broadly but does not include these Excluded Assets.
The exclusion of Excluded Assets from the collateral description in the Notes Security Agreement indicates that all collateral granted to the JSNs explicitly omits these assets, both existing and future acquisitions. The Agreement lacks a savings clause that would automatically subject previously excluded property to a lien if the exclusion reason is eliminated. The Committee contests UMB’s claim that proceeds from Excluded Assets are not considered Excluded Assets; it argues that certain collateral was unencumbered by Defendants’ liens as of the Petition Date, meaning proceeds from such collateral, identified as Released Bilateral Facilities Collateral, are also free from liens.
In response to Count IV, UMB asserts its security interest in the Debtors’ rights to repurchase Released Mortgage Loans under the BMMZ Facility, post their release for sale. The Committee counters that Defendants have not demonstrated reacquisition of liens on the Released Mortgage Loans that are not part of the BMMZ Facility, thus Count IV should not be dismissed. The ambiguity regarding whether an Excluded Asset can become collateral under the All-Asset Granting Clause necessitates a more comprehensive evidentiary examination, leading to the denial of the Motion without prejudice for Counts I and IV.
Additionally, the Committee has sufficiently claimed to disallow $377 million of the JSNs’ claim due to it being Original Issue Discount (OID). The Second Circuit defines OID as the difference between a bond's face value and the proceeds received, amortized over the bond's life. In bankruptcy, under Section 502 of the Bankruptcy Code, claims for unmatured interest, including unamortized OID, are disallowed, as interest ceases to accrue upon filing for bankruptcy.
Interest disallowed under section 502(b) includes postpetition interest that is not yet due and any prepaid interest representing an original discount on the claim, which would not have been earned at bankruptcy. For instance, a claim on a $1,000 note issued before bankruptcy would only be recognized for the cash actually advanced. If the note had a 10% original issue discount, only $900 would be allowed. Any interest component after the bankruptcy filing must be pro-rated and disallowed.
In the Chateaugay case, the Second Circuit determined that a face value exchange of debt does not generate disallowable original issue discount (OID). The debtor had proposed exchanging new notes for old debentures at their face value, leading to a dispute about unamortized OID when bankruptcy was filed. The bankruptcy court initially ruled that the exchange resulted in disallowable OID, but this was contested. The Second Circuit reversed the bankruptcy court's decision, clarifying the distinction between fair value exchanges and face value exchanges. It emphasized that a face value exchange does not reduce overall debt, which is important in the context of bankruptcy policy favoring negotiated resolutions. The court argued that disallowing unamortized OID would deter creditors from cooperating in workouts that could prevent bankruptcy. The distinction made between the two types of exchanges highlighted that the bankruptcy court's reasoning was flawed in the context of face value exchanges.
LTV’s liability to holders of the New Notes remained equal to its previous liability to holders of the Old Debentures, despite the bankruptcy court’s finding that the exchange created new Original Issue Discount (OID). The court determined that this face value exchange did not reduce LTV's liabilities on its balance sheet and did not alter the nature of the underlying debt, but instead reaffirmed and modified it. The court distinguished tax treatment from bankruptcy treatment, noting that the realization events under tax law do not apply in bankruptcy contexts. Citing *In re Pengo Industries, Inc.*, the Fifth Circuit supported the Second Circuit's view that face value exchanges do not generate disallowable OID, emphasizing policy reasons that suggest exchanging holders would have a lower claim than non-exchanging holders, despite unchanged overall debt obligations.
Both parties agreed that the exchange creating the Junior Secured Notes was a fair market value exchange, and whether such exchanges generate disallowable OID is a novel issue. UMB contended that the concept of unmatured interest did not apply since ResCap extinguished $1,000 of unsecured bonds by issuing $800 of secured bonds, arguing that OID generation for tax purposes does not equate to unmatured interest in bankruptcy. Nonetheless, as established in *Chateaugay*, OID, if generated, is considered unmatured interest under section 502(b)(2) and must be disallowed. UMB further argued that the policy considerations from *Chateaugay* should preclude OID generation to avoid discouraging lenders from participating in restructuring offers with distressed companies. The Committee countered by asserting that, for the motion to dismiss, it must be accepted that at least $377 million of OID existed at the Petition Date, attributing this to the difference between the face amount and issue price of the notes under non-bankruptcy law.
The legal issue at hand is whether there is a clear legal basis to disregard the straightforward application of tax law and the Bankruptcy Code. The Committee contends there is none, distinguishing this case from Chateau-gay due to significant changes in the underlying debt, including extended maturities, reduced overall indebtedness, and the granting of collateral. The Old Notes became subordinated to the New Notes, and the Committee argues that holders of the new bonds, obtained through a fair market value exchange, should have claims equal only to the cash value of the old bonds tendered, adjusted for Original Issue Discount (OID).
The court found that the record does not provide sufficient grounds to conclude that the exchange could not have generated OID. Legal ambiguity exists regarding whether such an exchange produces OID, with the Chateau-gay case suggesting it may not, but the court emphasizes the absence of clear statutory direction. Notably, the case differs from Chateau-gay as the exchange resulted in a tangible reduction of the debtor’s liabilities, affecting the balance sheet. Unlike Chateau-gay, where creditors of old bonds could claim more in bankruptcy than those holding new bonds, this case presents a scenario where the Old Notes and Junior Secured Notes differ significantly, particularly since the Junior Secured Notes are secured and the exchange was voluntary with options available to Old Notes holders. Those who declined the exchange keep a lesser claim in bankruptcy compared to those who participated.
Ultimately, the court concludes that a more comprehensive evidentiary record is needed regarding specific counts, denying UMB’s motion without prejudice for Counts I, IV, and XIII, while granting it with prejudice for Count V.
Liens outlined in section 2 are granted by the "Recourse Obligors" on a wide range of assets including servicer advances, mortgage loans, trading securities, and various forms of personal property. Section 4 describes liens granted by the "FABS Grantors" on financial assets, trading securities, deposit accounts, and supporting assets. Section 5 involves liens from "Additional Account Parties" on deposit accounts and their proceeds.
Congress implemented amendments to the Bankruptcy Code aimed at maintaining liquidity in the repurchase agreement (repo) market by exempting these agreements from key provisions, such as the automatic stay. Significant sections include 555 and 559, which allow the liquidation and acceleration of repurchase agreements without interference from bankruptcy stays. Sections 362(b)(7) and 362(o) exempt setoffs and realizations against collateral for repos from automatic stays. Sections 546(f) and 548(d) provide exemptions from preference and fraudulent transfer avoidance related to settlement and margin payments. Certain sections also define essential terms related to repos. Notably, section 559 protects parties from ipso facto clauses triggered by bankruptcy defaults, enabling them to act on these clauses. Section 555 further allows non-defaulting repo participants to close out, terminate, or accelerate securities contracts.
