In a recent decision, the Supreme Court of New York’s Appellate Division (First Department) (Appellate Court) approved a settlement agreement (Settlement) between a large group of certificate holders for mortgage-backed securities (Institutional Investors), for which Bank of New York Mellon (BNYM) serves as Trustee (Trustee), and Countrywide Home Loans (Countrywide) and Bank of America (BofA). In its ruling, the Appellate Court partially reversed the lower court’s limited approval of the Settlement by finding that the lower court improperly seconded-guessed the judgment of the Trustee and did not accord that judgment proper deference when considering approval of the Settlement.
BNYM served as Trustee for certain residential mortgage-securitization trusts. After the housing market collapsed, and the value of mortgage-backed securities declined, a Notice of Non-Performance was issued to Countrywide [and Bank of New York] by the Institutional Investors, who represented 24 percent of the face value of the related certificates. The Institutional Investors, with the assistance of the Trustee, entered into the Settlement with BofA and Countrywide. Under the terms of the Settlement, BofA and Countrywide agreed to do the following:
- Pay $8.5 billion into the Trusts;
- Implement improvements in mortgage servicing procedures, which improvements were valued at $3 billion; and
- Indemnify the Trusts against certain losses caused by an alleged failure by the seller to deliver mortgage loan files in the proper form.
The Trustee commenced a proceeding seeking court approval of the Settlement. In opposition, a group of certificate holders who opposed the Settlement (Objectors) argued that the Trustee had acted unreasonably, in bad faith, and outside its discretion by:
- Failing to represent the certificate holders’ interests during settlement negotiations and elevating its own interests, by focusing on its own liability exposure;
- Retaining conflicted counsel who immediately focused on a settlement without properly investigating the loans or evaluating the strengths and weaknesses of the various claims;
- Relying on faulty assumptions to estimate a low settlement range for the claims; and
- Failing to insist on a loan file review.
Some of the Objectors also argued that the seller or servicer of the Trusts’ loans had breached their obligation to repurchase modified loans from the Trusts, and that the Settlement improperly released those claims without the necessary scrutiny or assessment of their value.
Lower Court Ruling
The New York Supreme Court, New York County (Lower Court) approved the bulk of the Settlement and did not find fault with the Trustee’s conduct; however, the Lower Court sustained the objection relating to the Settlement’s release of claims arising out of the alleged failure to repurchase modified loans. Specifically, the Lower Court held that the Trustee had acted “unreasonably or beyond the bounds of reasonable judgment” by failing to investigate the potential worth or strength of those claims before releasing them.
Appellate Court Ruling
In reviewing the Lower Court decision, the Appellate Court reversed and found that the Trustee did not act unreasonably. The Appellate Court began its opinion by setting forth the general principal that a trustee’s discretionary acts are generally reasonable absent findings of bad faith or abuse of discretion. The Appellate Court said that while reliance on the advice of counsel may not always be the end of the analysis regarding a breach of trust claim, such as the one at issue, “a party challenging the decisions of a trustee who relied on the advice of a highly-regarded specialist in the relevant area of law can prevail only upon a showing that, based on the particular circumstances, the reliance on such counsel’s assessment was unreasonable and in bad faith.” Indeed, the decision provides that a court need not agree with counsel’s judgment or assessment in order to approve the Settlement; rather, a court need only determine that it was reasonable for a trustee to rely on counsel’s expert judgment.
Here, the Appellate Court found that the Trustee did appropriately rely on advice of experienced counsel. The Trustee, upon advice of counsel, employed a negotiation strategy that did not specifically seek recovery for the claimed failure to repurchase modified loans and that sought to release or not pursue weaker claims. In reviewing these actions, the Appellate Court said that the Trustee properly obtained and considered the opinions of several outside experts, including counsel, and that nothing in the Trustee’s retention (or non-retention) of experts warrant rejecting counsel’s advice or the Trustee’s decision to follow the proposed strategy and accept the terms of the negotiated settlement. Moreover, the Appellate Court said that it would have been unreasonable to decline entering into a settlement and expect to do better after years of litigation.
As a result, the Appellate Court found that the lower court “... disregarded the standard of deference due to a trustee’s exercise of discretionary judgment. Indeed, in doing so the court was, in effect, improperly imposing a stricter and far less deferential standard, one that allows a court to micromanage and second guess the reasoned, and reasonable, decisions of a Trustee.” Therefore, the Trustee did not abuse its discretion in releasing the claims at issue, and the Appellate Court approved the Settlement in its entirety.
This decision, which affirms that courts should give deference to the Trustee’s decision to enter into a settlement, is a win for trustees. The decision reinforces that a trustee’s discretionary acts should not be second-guessed provided that the trustee acted in good faith, reasonably and prudently. Indeed, the analysis employed by the courts to determine if a trustee’s discretionary acts were appropriate focuses more on process. Thus, trustees should take the necessary steps to ensure that a proper process is created and followed.