January 8, 2008 A Delaware bankruptcy court decided on Friday that mortgage servicing rights could be severed from a mortgage loan repurchase agreement that fell within applicable safe harbors of the Bankruptcy Code, at least where the loans were transferred “servicing retained.” The decision is Calyon New York Branch v. American Home Mortgage Corp., et al. (In re American Home Mortgage Corp.), Bankr. Case No. 07-51704 (CSS) (Bankr. D. Del. Jan. 4, 2008).

Prior to American Home’s bankruptcy, Calyon New York Branch (“Calyon”), as administrative agent, and American Home Mortgage Corp. and certain affiliates (“American Home”) entered into a whole loan repurchase agreement. The agreement expressly provided that the loans were transferred to Calyon “servicing retained.” The agreement also provided that American Home would be paid a servicing fee during the term of the repurchase agreement. However, the agreement also provided that Calyon could designate a new servicer on a default under the repurchase agreement.

The Court decided three issues. The first was whether the repurchase agreement fell under either the Bankruptcy Code’s repurchase agreement safe harbor provision, section 559, or the Bankruptcy Code’s securities contract safe harbor, section 555. (These safe harbor provisions, among other things, permit the non-debtor party to terminate and close out covered agreements, notwithstanding the automatic stay.) The second – and most significant – question decided was whether the portion of the agreement providing for servicing of the mortgages was covered by the safe harbor provisions, or constituted a separate, severable contract. The third question was whether the Court should order specific performance of American Home’s obligation to transfer servicing to a newly designated servicer.

In determining that the repurchase agreement was covered by section 559, the Court concluded that it needed only to apply the plain meaning of section 101(47) of the Bankruptcy Code, which defines “repurchase agreement.” Under that section, an “agreement, including related terms,” is a repurchase agreement if it (i) provides for the transfer of one or more mortgage loans or interest in mortgage related securities or mortgage loans; (ii) against the transfer of funds by the transferee of such mortgage loans or interest in mortgage related securities or mortgage loans; (iii) with a simultaneous agreement by such transferee to transfer to the transferor thereof mortgage loans or interest in mortgage related securities or mortgage loans; (iv) at a date certain not later than 1 year after such transfer on demand and (v) against the transfer of funds. See id. at 19 (citing 11 U.S.C. § 101(47)). The Court concluded that the Calyon agreement met each of these requirements on its face, and, as a result section 559 of the Bankruptcy Code applied. The Court rejected American Home’s assertion that the additional criteria of liquidity and alienability were essential to qualification of an agreement as a repurchase agreement for purposes of section 559. The Court applied a similar plain language analysis to find that section 555 applied to the Calyon agreement, as well.

The Court rejected, however, Calyon’s argument that the right to service the mortgages subject to the repurchase agreement was included in the safe harbor of either section 559 or section 555. Applying New York law, the Court concluded that the servicing rights were severable from the contract under state law. The Court stressed that mortgage loans are commonly sold both “servicing released” and “servicing retained,” and that loans sold “servicing released” command a premium. In the Court’s view, Calyon had not paid the “servicing released” premium as part of the initial transaction, and, thus, would receive a windfall if permitted to change the servicer. Moreover, the windfall would be at American Home’s expense, since servicing rights are valuable and, to the extent in existence, constitute an asset of the estate.

Finally, the court declined to order American Home to transfer servicing to a new servicer designated by Calyon. The Court reasoned that, absent applicability of a safe harbor to the servicing portion of the agreement, Calyon was not entitled to specific performance.

While this decision is clearly important in many respects, the holding concerning servicing rights may be of limited applicability. At a minimum, a different result might well be obtained under a repurchase agreement providing that the loans were transferred “servicing released.” A more indepth discussion of this case, and any subsequent developments, will follow in the next issue of our newsletter.