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The Metropolitan Corporate Counsel: When Is a Repurchase Agreement Not a Repurchase Agreement? Testing the Limits of Bankruptcy

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The Metropolitan Corporate Counsel: When Is a Repurchase Agreement Not a Repurchase Agreement? Testing the Limits of Bankruptcy CorporateThe Metropolitan Counsel® www.metrocorpcounsel.com Volume 16, No. 3 © 2008 The Metropolitan Corporate Counsel, Inc. March 2008 Subprime – Law Firms & Corporate Counsel When Is A Repurchase Agreement Not A Repurchase Agreement? Testing The Limits Of Bankruptcy Protections Afforded Mortgage Loan Warehouse Providers Joseph Cioffi broadened repo participants’ safe-harbored activities to include the exercise of contrac- DAVIS & GILBERT LLP tual rights to accelerate or terminate repur- Joseph Falcone chase agreements. Mortgage loan originators typically NATIXIS CAPITAL MARKETS INC. finance their origination activities through short-term financing facilities known as The title of this article may sound like a “warehouse facilities,” which, in many trick question, but American Home Mort- cases, are provided by banks and other capi- gage Corp. (“American Home”), a residen- Joseph Joseph tal markets participants. Prior to the enact- tial mortgage loan originator and Chapter 11 Cioffi Falcone ment of BAPCPA, many warehouse debtor in Delaware Bankruptcy Court, insolvency of one participant is allowed to providers, and particularly Wall Street firms, became the first originator to seriously pose spread to other players. In particular, the eschewed secured lending facilities and this question and challenge the safe harbor viability and stability of the repo market instead entered into mortgage loan repos provisions of the Bankruptcy Code (the was a key concern addressed in the 1984 with originators on the theory that their con- “Code”) that were specifically broadened in amendments to the Code and, then again, as tracts could, at a minimum, be covered recent years to include mortgage loan repur- part of the Bankruptcy Abuse Prevention under the safe harbor provisions of section chase agreements (otherwise known as and Consumer Protection Act of 2005 555 as “securities contracts.” “mortgage loan repos”). American Home’s (“BAPCPA”). In 1984, section 559 was In the post-BAPCPA world today, ware- opposition to certain financial institutions added in order to protect the exercise by house financing arrangements are typically which helped finance its mortgage loan repo participants of contractual rights to liq- documented as “master repurchase agree- originations to consumers serves as both a uidate repurchase agreements from stays, ments” under which an originator, as seller, cautionary tale for mortgage loan repo par- avoidance and other limitations that would transfers newly-originated mortgage loans ticipants and an affirmation by the Bank- otherwise be imposed by the Code. Without against payment by the warehouse provider, ruptcy Court of the broad protections such protection, a party to a repo with a as purchaser, with a simultaneous agreement intended by Congress to be granted to such debtor in bankruptcy would be vulnerable to by the originator to repurchase from the participants. loss of, or interference with, its rights and warehouse provider the same mortgage As evidenced throughout the Code, sub- remedies under the repo by reason of the loans, by no later than a date certain, at a sequent amendments and legislative history, commencement of the bankruptcy proceed- designated repurchase price. During the Congress has long recognized the impor- ing. BAPCPA specifically expanded the interim period, the originator tries to arrange tance of protecting financial markets from protections of section 559 to participants in for the sale of the mortgage loans to a take- the disastrous effect that may occur if the repo agreements involving “mortgage out purchaser. Simultaneously with the sale related securities” (as defined in section 3 of to the take-out purchaser, the repurchase is Joseph Cioffi is a Partner at Davis & the Securities Exchange Act of 1934), consummated by the originator under the Gilbert LLP and heads the firm’s mortgage “mortgage loans,” or “interests in mortgage repurchase agreement, as the purchase price banking practice. Joseph Falcone is Direc- related securities or mortgage loans” by is transferred, on the originator’s behalf, tor, Counsel at Natixis Capital Markets Inc. expanding the definition of “repurchase directly from the take-out purchaser to the Craig Gold, an Associate at Davis & agreements” contained in section 101(47). warehouse provider in exchange for the Gilbert LLP, contributed to this article. In addition, among other things, BAPCPA mortgage loans. Please email the authors at jcioffi@dglaw.com or joseph.falcone@cm.natixis.com with any questions regarding this article. Volume 16, No. 3 © 2008 The Metropolitan Corporate Counsel, Inc. March 2008 By 2007, the procession of bankruptcies BAPCPA amendments, which expressly respect to where to send their mortgage pay- of mortgage loan originators that flowed broadened the protections of section 559 to ments. Misdirected or untimely mortgage from declining housing prices, rising inter- mortgage loan repos, could, in fact, be a nul- payments often lead to impaired loan values. est rates and collapse of the sub-prime mort- lity. Accordingly, they argued, because the ser- gage industry created for the first time an American Home also relied on the Ware- vicing performed by the originator/seller opportunity to test the protections afforded house Providers’ failure to use the form of under a mortgage loan repo makes the trans- by the BAPCPA amendments. Generally, repurchase agreement developed by the action workable and avoids disruption, it is however, warehouse providers had been Bond Market Association and typically used an integral part of the repo and cannot be able to exercise their contractual rights to document securities repurchase transac- severed from the rest of the agreement. under mortgage loan repos without interfer- tions, and showed evidence that terms used Ultimately, the Court did not decide the ence from the Bankruptcy Court. American in sections 101(47) and 559 were merely repurchase agreement and servicing issues Home changed that at the end of 2007 when inserted into a form of secured loan agree- with respect to CSFB due to a settlement it challenged the rights of certain of its ment previously negotiated with Calyon in between the parties. However, by applying warehouse providers, Credit Suisse First an attempt to create a mortgage loan repo. the plain meaning of section 101(47), the Boston (“CSFB”) and Calyon, New York American Home maintained that the CSFB Court concluded that Calyon’s agreement Branch (“Calyon”), arguing that its mort- and Calyon agreements had features more did constitute a “repurchase agreement” and gage loan repos with CSFB and Calyon (the characteristic of a secured loan, including: that the safe harbor provisions of sections “Warehouse Providers”) were not truly (i) calculation of the price differential 555 and 559 were applicable. The Court “repurchase agreements,” but instead were (which operates like an interest rate on found that there was no need to consider secured financings cloaked in repurchase advances under the facility) without regard extrinsic evidence because there was no agreement parlance extracted from the to income generated by the underlying uncertainty regarding Congress’s intent in Bankruptcy Code. American Home further assets; (ii) extensive affirmative and nega- drafting the definition of “repurchase agree- argued that even if the Court concluded that tive covenants similar to those found in ment.” Based on several unique provisions the agreements were “repurchase agree- secured loan agreements; (iii) “conditions of Calyon’s agreement relative to more typi- ments” as defined under section 101(47), precedent” to funding; and (iv) “commit- cal mortgage loan repos, the Court also con- the servicing rights were severable and had ments” to fund. As demonstrated by the cluded that the servicing rights were been retained by American Home and there- Warehouse Providers, however, a survey of severable from the remainder of the Calyon fore, were not subject to control by the more than twenty publicly available mort- agreement and had been retained by Ameri- Warehouse Providers. gage loan repos showed none of them fol- can Home, and hence were not subject to ter- According to American Home, in order lowed the global form promulgated by the mination or control by Calyon under the safe for the safe harbor provisions of the Code to Bond Market Association, with all provid- harbor provisions of the Code. In determin- apply to a repurchase agreement (including a ing for the repurchase of the exact same ing that the loans were sold to Calyon on a mortgage loan repo) the contract must evi- mortgage loans initially sold under the repo, “servicing retained basis,” the Court cited dence (i) alienability or fluidity (i.e., the and most containing the same terms that the existence of a separate monthly servicing warehouse provider can dispose of the loans American Home claimed undermined the fee paid by Calyon under the agreement and to a third party) and (ii) substitutability (i.e., classification of the CSFB and Calyon the warehouse provider can return different agreements as “repurchase agreements” various other provisions of the agreement assets to the seller as part of the repurchase under the Code. which indicated that American Home transaction). Because the agreements in American Home further argued that even retained the right to designate the servicer of question did not expressly authorize the if the Court established that a true “repur- the loans. The Court also pointed to the Warehouse Providers
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