Courts faced with the task of unraveling the results of the recent credit crisis are being called upon to scrutinize lending agreements—many of which are complex and often previously uninterpreted. The review of these agreements is a reminder to signatory parties of the importance of fully understanding their obligations upfront.

The Bankruptcy Court for the District of Delaware recently examined various agreements involving the sale and repurchase of mortgage loans, and ultimately determined that such agreements constituted repurchase agreements that fell within the safe harbor protection of 11 U.S.C. §§555 and 559. The issue arose as part of the adversary proceeding styled Calyon New York Branch v. American Home Mortgage Corp (In re American Home Mortgage, Inc.)., No. 07-11047 (Bankr. D. Del. Jan. 4, 2008). The adversary proceeding was part of the complex bankruptcy cases of American Home Mortgage Corp. and its affiliates (“American Home” or the “Debtors”) pending before the Delaware bankruptcy court.

American Home and Calyon New York Branch (“Calyon”), as administrative agent, entered into a repurchase agreement (the “Agreement”). As part of the Agreement, the Debtors agreed to transfer mortgage loans to certain banks and security issuers (the “Counterparties”) in exchange for consideration. The Agreement then required the Counterparties to return the mortgage loans or interest therein to the Debtors within 180 days of the initial transfer in exchange for the transfer of funds from Debtors to the Purchasers.

As the credit contraction occurred in the summer of 2007, American Home found itself unable to originate loans as it was obligated to do under the Agreement. Calyon, as administrative agent, sent the Debtors a notice of default August 1, 2007, stating that the Debtors’ financial crisis constituted a default, and requiring the Debtors to repurchase all of the mortgage loans held by the Counterparties. The Debtors also had served as mortgage servicer, and following the default,Calyon sought to have JPMorgan Chase Bank, N.A. designated as the new mortgage servicer.

Rights in Bankruptcy

American Home filed for chapter 11 bankruptcy protection Aug. 6, 2007. Thereafter, Calyon filed a declaratory judgment action against the Debtors seeking a ruling that the Agreement constituted a repurchase agreement under section 101(47) of the Bankruptcy Code. Accordingly, Calyon maintained, the safe harbor provisions of §§555 and 559 applied, and excepted Calyon from the provisions of the automatic stay, thus permitting Calyon to pursue its rights under the Agreement during the bankruptcy case. Calyon also sought injunctive relief requiring the Debtors to transfer the rights and obligations in connection with servicing the mortgage loans to Calyon.

In opposition to the relief sought by Calyon, the Debtors argued that the Agreement was a secured financing, as opposed to a repurchase agreement, and also argued that the safe harbor provisions of §§555 and 559 did not apply to the servicing aspects of the Agreement.

In interpreting the Agreement, the court declined to hear industry standards or other extrinsic evidence in its determination of whether the Agreement constituted a repurchase agreement under the plain meaning of §101(47) of the Bankruptcy Code.

Section 101(47) states that a repurchase agreement is an agreement that: (1) provides for the transfer of mortgage loans or interest in mortgage loans; (2) against the transfer of funds by the purchase of such mortgage loans or interest in mortgage loans; (3) with a simultaneous agreement by the purchaser to transfer back the mortgage loans or interest in mortgage loans; (4) on a specific date that is not later than one year after the initial transfer; and (5) against the transfer of funds.

After analyzing the five elements set forth in §101(47) the court determined that the Agreement was a repurchase agreement.

Contractual Language

The court declined to adopt the Debtors’ reasoning urging the court to enforce the contractual language in the Agreement that weighed in favor of a determination that the Agreement was not a repurchase agreement.

After determining that the Agreement was a repurchase agreement, the court also determined that §§555 and 559 were applicable, finding that Calyon was a “financial institution” and the Agreement was a “securities contract,” as contemplated by §741 of the Bankruptcy Code. Section 555 excludes from the scope of the automatic stay the exercise of a financial institution’s contractual right to cause the liquidation, termination, or acceleration of a securities contract.

The court concluded that any claims, rights or obligations subject to the safe harbors provided by §§555 and 559 were not subject to the automatic stay. Then the court turned its analysis to the nature of the servicing obligations contained in the Agreement and whether such claims, rights or obligations were also subject to the safe harbors.

The court began its analysis of the servicing issues by determining that it could effectively sever the servicing of the mortgage loans from the part of the Agreement involving the sale and repurchase of the mortgage loans. Finding that the servicing rights could not be categorized as an interest in a mortgage loan, the court ruled that the servicing rights did not constitute a repurchase agreement under §101(47) or a securities contract under §741. As such, the court ruled that there was no basis to require the Debtors to transfer the servicing rights of the mortgages.

Looking Ahead

This case is instructive of the detailed analysis courts often employ when examining repurchase and other complex financing agreements. Often such analysis, on its face, may yield what appear to be inconsistent rulings.

In Calyon, the court first held that the contract was clear, and, as such, parol evidence was not required to interpret the four corners of the document. The court, however, later determined that it was not bound to follow contractual provisions that bore upon the determination of whether the Agreement was a repurchase agreement. Finally, the court determined that it could sever an entire part of the contract to determine that part of the contract was subject to the safe harbor provisions provided by §555 and 559 of the Bankruptcy Code, but another part – the servicing rights – did not benefit from such protections.

As the ramifications of the credit constriction in the summer of 2007 continue to expand, many complex financings will be subject to judicial scrutiny for the first time. There may not be much judicial precedent for how some of these instruments will be interpreted, and this case indicates that the Delaware Bankruptcy Court plans to examine such agreements line by line. Now, more than ever, parties to such contracts should carefully consider the rights, obligations and claims arising thereunder.