On May 18, 2012, Judge Rosemary M. Collyer of the District Court for the District of Columbia held that a group of Washington Mutual Bank’s (WaMu) noteholders could not intervene as defendants in a breach of contract lawsuit brought against WaMu’s receiver and JPMorgan Chase Bank.  The noteholders sought to intervene solely on the basis that the lawsuit could exhaust funds in the receivership and, in turn, diminish the noteholders’ recovery.  The District Court held that regardless of whether the lawsuit would exhaust funds in the receivership, the noteholders could not intervene because they lacked a present and direct interest in the lawsuit, particularly because their interests were contingent on the resolution of a contractual issue under the applicable securitization agreements that had not yet been determined.  Deutsche Bank National Trust Company v. Federal Deposit Insurance Corporation, Civil Action No. 09-1656 (RMC) (D. D.C. May 18, 2012).

Background

Deutsche Bank National Trust and WaMu entered into various securitization agreements for pools of residential mortgages, for which Deutsche Bank acted as trustee and WaMu served as the servicer and sponsor for the trusts.  After WaMu suffered large hits from mortgage loan losses, on September 25, 2008, federal regulators shut down WaMu due to its insufficient liquidity, appointed the FDIC as WaMu’s receiver, and commenced a receivership proceeding for WaMu in the District Court of the District of Columbia.  On the same day the receivership was commenced, JPMorgan and the FDIC entered into a purchase and assumption agreement whereby JPMorgan agreed to purchase and assume all of WaMu’s assets and certain of its liabilities.

Subsequently, Deutsche Bank filed a proof of claim in the receivership proceeding based on alleged breaches by WaMu of certain securitization agreements, including WaMu’s failure to repurchase certain defaulting loans in the mortgage pools.  Several months after filing its proof of claim, Deutsche Bank filed suit in the District Court for the District of Columbia.  Deutsche Bank sought $10 billion in damages from the FDIC, as receiver, and JPMorgan, WaMu’s successor, arising out of alleged breaches of warranties and representations made in securitization agreements by WaMu.  Deutsche Bank also contended that its claim against the receiver should be entitled to administrative expense priority and given seniority over all of WaMu’s senior creditors.

JPMorgan maintained that it did not assume the obligations under the securitization agreements and that even if it did assume those obligations under the purchase and assumption agreement, it should be entitled to indemnification from the FDIC.  If the Court were to find the receiver liable for the obligations under the securitization agreements, then the potential for a recovery by WaMu’s other creditors, including the noteholders, would be significantly diminished.

On March 12, 2012, approximately three years after Deutsche Bank commenced its lawsuit against the receiver and JPMorgan, an ad hoc group of WaMu’s senior noteholders moved for the first time to intervene as defendants in the suit pursuant to Rule 24(a) and (b) of the Federal Rules of Civil Procedure.  The ad hoc group maintained that a judgment in favor of Deutsche Bank against the FDIC would reduce, or potentially eliminate, any funds in the receivership, and that those funds would be the only source of payment to the ad hoc group.  Based on the potential for the exhaustion of funds in the receivership, the ad hoc group contended that they had a right to intervene in the case because they had a substantial interest in the property at issue in the litigation.  The ad hoc group also maintained that the FDIC did not adequately represent the ad hoc group’s interests because the FDIC’s obligation to serve the public interest did not coincide with the private, economic interests of WaMu’s noteholders.

Although the FDIC acknowledged the ad hoc group’s notes as legitimate liabilities of the WaMu receivership, it urged the District Court to reject the noteholders’ motion to intervene because the noteholders did not, at the time, have a direct interest in the pools of residential mortgages or the underlying securitization documents subject to Deutsche Bank’s lawsuit.

District Court’s Decision

The District Court ultimately held that the ad hoc noteholder group did not have a right to intervene in the Deutsche Bank litigation as a matter of right because its members lacked a direct interest in the suit.  Under Federal Rule of Civil Procedure 24(a)(2), a party may intervene as a matter of right in a lawsuit if (i) the application to intervene is timely, (ii) the party has an interest relating to the property or transaction which is the subject of the action, (iii) the party is situated such that the disposition of the action would impair the party’s ability to protect that interest, and (iv) the party’s interest must not be adequately represented by existing parties to the action.  Fed R. Civ. P. 24(a)(2).  A party may also move for permissive intervention under Rule 24(b) when the party’s claim or defense shares a common question of law or fact with the case.  Fed. R. Civ. P. 24(b).

The District Court denied the ad hoc group’s motion and held that they did not have a right to intervene as a matter of right.  The District Court found that the noteholders lacked a direct interest in the lawsuit because the noteholders’ interests, if any, were still contingent on a determination of whether, under the purchase and assumption agreement, JPMorgan assumed WaMu’s obligations under the securitization agreements and whether JPMorgan would be entitled to indemnification from the FDIC.  If JPMorgan assumed those obligations, then the funds in the receivership would not be exhausted and consequently, the noteholders’ interests would not be affected.  The District Court held that once those contractual issues are determined, the noteholders’ interests may become cognizable.  In addition, the District Court held that permissive intervention was not appropriate because the ad hoc group did not have a question of law or fact in common with the litigation.

On May 25, 2012, the ad hoc group of noteholders filed a notice of appeal with the Court of Appeals for the D.C. Circuit, arguing that they will suffer irreparable harm if they are not permitted to intervene to immediately protect their interests in the property subject to the Deutsche Bank action.  There have been no further developments with the ad hoc group’s appeal.

Conclusion

While the District Court decided this case in the context of an FDIC receivership, a bankruptcy court in a chapter 11 bankruptcy would likely reach the same conclusion with respect to noteholders lacking a direct interest in ancillary litigation pending between a debtor and a third party.  Federal Rule 24 applies to adversary proceedings in bankruptcy, as Federal Bankruptcy Rule 7024 expressly incorporates the provisions of Rule 24 of the FRCP.  Consequently, an intervening creditor must demonstrate that it will be injured by the outcome of the case and that it has a present and direct interest in the property subject to the litigation.  Non-litigation parties whose recovery will be diminished by a pending lawsuit likely lack the cognizable claims required to intervene.