MBIA's principal argument is that on the facts of the case, BAC has successor liability for Countrywide's liabilities based on the New York law of de facto merger. De Facto merger is one of the few exceptions to the corporate law principle that an acquiror of assets (BAC) doesn't thereby also acquire the transferor's (Countrywide's) liabilities. Another separate and distinct exception to this corporate law principle of non-successor liability is the theory of fraudulent conveyance.
BAC's counsel misstated the legal parameters of the de facto merger doctrine and emphasized irrelevant facts in its argument before Justice Bransten by trying to conflate the theory of de facto merger (which requires no analysis of the consideration received in connection with a transfer of assets) with the separate theory of fraudulent conveyance (which is all about whether assets were transferred for less than full value). Since the facts of the case don't support the theory of fraudulent conveyance as easily and neatly as they support the theory of de facto merger, BAC essentially defended against MBIA's claim of de facto merger by arguing that there was no fraudulent conveyance. This may be true, but it is quite beside the point.
I do not believe that Justice Bransten will be confused by BAC's attempt to conjure lemonade from lemons. I use this euphemism because it appeared that BAC went to great length to conduct its acquisition of Countrywide in a way such that it would acquire all of the operating assets and business (including management) of Countrywide (the Countrywide mortgage platform), and insulate itself from liabilities it did not want to assume (or which BAC would agree to assume only on its own terms), but would not contravene applicable fraudulent conveyance law. However, BAC was blind in its execution of this transaction plan to the applicabiity of de facto merger law, which is an alternative and well-developed theory that applies irrespective of BAC's attempt to avoid a fraudulent conveyance claim. So, in having to defend a case whose facts squarely present a strong case of de facto merger, BAC's counsel tried to show how the facts don't satisfy the fraudulent conveyance theory, and hope the judge doesn't get it. Lemons to lemonade legal advocacy.
To appreciate why I think Justice Bransten will get it and grant MBIA's SJ motion on BAC successor liability, we will first address the facts of the case, almost all of which are uncontested, analyze the New York doctrine of de facto merger and why it's application is especially well-suited to the facts of the case, and consider whether Justice Bransten is likely to apply the law of any jurisdiction other than the New York law of de facto merger.
BAC acquired Countrywide in a triangular merger in early 2008. If you took a snapshot immediately after the acquisition, Countrywide was a wholly-owned subsidiary of BAC. Had BAC done no further transactions with Countrywide, it would be clear that BAC would have no successor liability for the liabilities of Countrywide, as is the standard case in corporate law.
Even if BAC had engaged in contributions to capital to, or received dividend distributions from Countrywide, or if Countrywide and BAC engaged in asset transfers and liability payments with each other that did not constitute the wholesale transfer of an integrated operating business, there would still have been no BAC successor liability. Again the standard case in corporate law. But those are not the facts of the case.
In the lemons to lemonade legal advocacy mode, BAC counsel tries to contort the facts of the case and asserts misleadingly: "if transactions between a parent as a subsidiary or between two subsidiaries were thought to allow creditors of the subsidiary to reach all of the assets of the parent company, it would have a very deleterious social consequence of discouraging very efficient activities; that is the ability to move assets around within a corporate structure, to invest money in one of the subsidiaries without taking on its liability, when it would, in fact, deter companies from coming in and helping to rescue a company if they couldn't make that investment without having a limitless liability for risk known and unknown."
So let's see if this is simply a case of moving some assets around in a holding company structure, or whether BAC pulled out a corporate vacuum cleaner and sucked up all of Countrywide's mortgage platform in a manner that merged Countrywide's mortgage business with BAC's mortgage business, but which left Countrywide's contingent liabilities behind with a shell company.
The question of whether BAC has successor liability turns on exactly that factual distinction...and don't let the notion that leaving behind contingent liabilities is somehow permitted or innocuous: those Countrywide contingent liabilities have matured into settlement payments by BAC (because Countrywide has no substantial assets) of in excess of $20 billion.
So picking up from that snapshot when Countrywide became a wholly-owned subsidiary of BAC, BAC did not leave well-enough alone. Countrywide transferred to BAC its entire mortgage platform, consisting of substantially all of its assets, as well as all of Countrywide's business liabilities that the Countrywide mortgage platform would incur in the ordinary course of business (e.g. vendor and supply relationships), together will all of Countrywide's senior management...at least those executives who weren't subject to SEC enforcement investigations (which investigations led to SEC-imposed fines and disbarment from holding future corporate executive positions for the three highest Countrywide executives).
This transfer of the Countrywide mortgage platform, its entire operating business, is an important transaction for purposes of application of de facto merger doctrine. Before the Countrywide mortgage platform transfer, Countrywide could conduct a mortgage banking business at Countrywide. After the Countrywide mortgage platform transfer, Countrywide could conduct no business whatsoever. After the transfer, Countrywide's remaining assets could not generate even sufficient income to pay the legal fees necessary to defend against Countrywide's claims, let alone the $20 billion required to actually pay those claims in settlement.
This was not a subtle corporate transaction. All of Countrywide's 19,000 employees at the time became employees of BAC, because they followed the transferred Countrywide mortgage platform. (In another piece of lemons to lemonade legal advocacy, BAC counsel did note that at one time, Countrywide employed 40,000 people. This indicates only that Countrywide's business declined during the financial crisis). MBIA replayed video testimony of BAC executives making it clear that the objective of the Countrywide acquisition was to combine the mortgage banking operations of BAC and Countrywide to become the market leading mortgage banking operation.
Could BAC have integrated Countrywide's and BAC's own mortgage banking businesses on a functional basis, and still leave the respective businesses' assets and liabilities in separate subsidiaries? Yes.
Did BAC do this? No.
Does this have legal ramifications for purposes of BAC's successor liability for Countrywide's liabilities? To answer this question, we turn to the de facto merger doctrine.
The de facto merger doctrine is one of four exceptions to the standard rule that an asset purchaser is not liable for the seller’s debts. These exceptions are: (1) a purchaser who formally or impliedly assumes a seller’s debts; (2) transactions undertaken to defraud creditors; (3) a purchaser who de facto merges with a seller; and (4) a purchaser that is a mere continuation of a seller. See Cargo Partner AG, v. Albatrans, Inc. Notice that fraudulent converyance (2 above) and de facto merger (3 above) are considered separate and distinct exceptions.
The de facto merger doctrine under New York law (I will discuss why Justice Bransten will apply New York law later in this post) “applies when the acquiring corporation has not purchased another corporation merely for the purpose of holding it as a subsidiary, but rather has effectively merged with the acquired corporation.” See Fitzgerald v. Fahnestock & Co., Inc. As discussed above, BAC did not buy Countrywide to hold and to run as a subsidiary; rather, it bought Countrywide to divest it of all of its valuable business operations, to merge those operations into BAC’s own operations, and to exploit Countrywide’s subsidiary shell status to provide separation between Countrywide’s valuable assets and business operations and Countrywide’s contingent creditors. The de facto merger doctrine ensures that “a successor that effectively takes over a company in its entirety should carry the predecessor’s liabilities as concomitant to the benefits it derives from the good will purchased.” Id. See also In the Matter of New York City Asbestos Litigation and Sweatland v. Park Corporation
There is a reasonably well-developed body of caselaw relating to de facto merger in New York, and the four "hallmarks" of a de facto" merger are clear: (1) continuity of ownership, (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible, (3) assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation, and (4) continuity of management, personnel, physical location, assets, and general business operations. “These factors are analyzed in a flexible manner that disregards mere questions of form and asks whether, in substance, it was the intent of the successor to absorb and continue the operation of the predecessor.” Matter of AT&S Transportation, LLC v. Odyssey Logistics & Technology Corp.
Much of the briefing and oral argument made by MBIA with respect to Countrywide's de facto merger with BAC goes to point out how the facts of the case fit neatly and precisely within these four "hallmark" elements of de facto merger law. Much of the briefing and oral argument made by BAC goes to how Countrywide received fair value for the transfer to BAC of Countrywide's mortgage platform (by BAC's estimation, $45 billion). Of course, all of this money flew out the door to pay Countrywide creditors, most of whom were lending institutions that BAC needed to be "on board" to continue the combined mortgage banking businesses of BAC and Countrywide....and approximately $5 billion of this consideration actually went to BAC itself.
But the salient point is there is no adequacy of consideration element to the theory of de facto merger. All of this argumentation by BAC is without legal effect for purposes of de facto merger.
So what explains BAC's argumentation about the $45 billion payment if it is legally irrelevant? Well, part is lemons to lemonade legal advocacy, which also might be understood by fans of CSN&Y as the "if you can't be with the one you love, love the one your with" mode of argument.
But also, there is the notion that no judge is a legal decision-making automaton, ignoring arguments that sound more in appeals to conscience than reason. BAC's appeal to Justice Bransten's conscience is essentially, "Hey, we paid $45 billion for this pile. Haven't we paid enough? Doesn't this offend your sense of fairness, even decency, if we have to pay more?"
In rebuttal to this appeal to judicial realism, MBIA has a ready answer: the facts that MBIA marshalled in connection with its claim of implied assumption of liability, a separate additional theory of successor liability (1 above, in the listing of the four exceptions).
I haven't discussed MBIA's claim of implied assumption of liability because I don't expect Justice Bransten to discuss it; I expect she will rule in MBIA's favor on de facto merger. But the facts underlying MBIA's claim of implied assumption of liability should dissuade Justice Bransten from believing that she is being somehow "unfair" to BAC, and imposing on BAC liabilities that BAC never considered that it would have to bear.
MBIA played video testimony of BAC executives acknowledging that i) BAC understood Countrywide had contingent liability claims and that BAC factored those claims into the determination of the price paid for Countrywide, ii) BAC's earnings would have to be applied going forward to the payment of those legacy Countrywide claims, and iii) the now-famous reassurances to the market by BAC's CEO that BAC would “pay for the things that Countrywide did”.
Additional testimony confirmed that BAC has paid over $20 billion for Countrywide's contingent liabilities. These are not payments by a parent holding company in support of an operating subsidiary's business, but rather payments of a now-shell subsidiary's liabilities that arose from the conduct of the then-operating subsidiary's business.
While these are all relevant facts for MBIA's implied assumption of liability claim, they really serve an important secondary purpose, and that is to disavow any real-world notion that BAC would be somehow unfairly surprised, mistreated or blindsided by a successor liability holding.
In short, BAC fails at the indignity gambit.
Considering first things last, I now address the question as to whether it is likely that Justice Bransten will apply the law of a jurisdiction other than New York with respect to BAC successor liability.
This is a New York conflict of laws question. New York looks to see if there is an actual conflict among the jurisdictions involved. If a genuine conflict exists, New York’s choice-of-law framework applies an “interest analysis” to give effect to the law of the jurisdiction which, because of its relationship or contact with the occurrence or the parties, has the greatest concern with the specific issues in the litigation.
Before I proceed, let me emphasize that Judge Pfaezler's holding that Delaware law applies in a case asserting successor liability against BAC in federal district court in California has no precedential value with respect to whether or not Justice Bransten chooses New York law or Delaware law. The choice of law Justice Bransten will be making is a New York question that was not at issue before Judge Pfaezler in California.
If Justice Bransten decides to apply Delaware law to determine BAC's successor liability, Justice Bransten may wish to consider Juge Pfaezler's attempt to construe Delaware de facto merger law. But whether Justice Bransten chooses New York rather than Delaware law is a question for Justice Bransten to decide under New York law and with respect to which Judge Pfaezler's opinion has zero applicability.
Now, there are two reasons to believe that Justice Bransten will apply New York de facto merger law.
First, she has already issued strong signals that she would. At a preliminary hearing to dismiss MBIA's claim that BAC had successor liability, BAC referred Justice Bransten to Judge Pfaezler's holding. Justice Bransten said "You don't have to remind anyone again that my entire case should depend on a Central District California judge. I believe that, indeed, if you come to the commercial division in New York state, you have equal kind of judge and equal ability for this judge to reason and equally good appellate division to reverse if I'm wrong and a Court of Appeals that has equal amount of standing California. You constantly put in the Argent case from the Central District of California. Guess what? Where is a case from New York? Why isn't there a case from New York? Maybe because the Central District of California is wrong. And maybe I'm going to be making other kinds of law." [Hat Tip Alison Frankel]
Second, as a New York judge applying an interests analysis, it is hard to see how Justice Bransten applies Delaware rather than New York law. You have a New York state judge adjudicating a New York state law claim of breach of insurance agreement with respect to transaction documents that are governed by New York law, brought by a New York incorporated plaintiff with a principal place of business in New York, which is regulated by the New York Department of Financial Services, with respect to transactions that occurred principally in New York, and which even involves at the center of the dispute a New York incorporated BAC subsidiary. The only contact that Delaware has to the case is that BAC is incorporated in Delaware (it's principal place of business is North Carolina).
It might well be the case that a New York judge would apply Delaware law under the internal affairs doctrine in a case involving a Delaware corporation's rights and obligations to its shareholders, if for some reason that case was brought in New York. But MBIA's successor liability case is a debtor/creditor-focused claim, not an internal corporation/shareholder matter. Delaware has an exquisitely detailed body of law relating to internal corporate shareholder matters, and almost nothing involving de facto merger claims asserted by creditors, whereas the New York de facto law is well-developed. The balance of the interests clearly affects New York interests more than Delaware interests.
Now, I fully expect that BAC will, in fact, not lose on successor liability...because I believe BAC is rational and will settle with MBIA first. As discussed in my prior post, Bank of America Successor Liability, the Article 77 Case, and Settlement Game Theory , I believe that BAC's most rational course of action is to settle before an adverse successor liability decision is handed to them by Justice Bransten. Only time will tell.
NB: this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice. Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.
Disclosure: long MBI. Follow me on twitter.