On June 26, 2013, US Bankruptcy Judge Martin Glenn, overseeing the chapter 11 case of Residential Capital, LLC (ResCap), unsealed a 1,900-page report produced by court-appointed examiner, Arthur J. Gonzalez, and his professionals, Chadbourne & Parke LLP and Mesirow Financial Consulting, LLC. The Examiner Report was the culmination of a ten-month investigation that identified amyriad of causes of action, potentially worth billions of dollars, arising fromdozens of transactions involving ResCap's parent, Ally Financial Inc., its subsidiary Ally Bank, and Cerberus. At the June 26th hearing, Judge Glenn praised the Examiner Report as a “masterful job.”
The Examiner and his professionals found thatmany of the claims initially identified by creditors and their representatives were unlikely to lead to valuable causes of action for ResCap or its creditors. However, the Examiner and his teamindependently discovered a number of valuable causes of action— including claims related to themisallocation of net revenues on loans brokered by GMAC Mortgage (a ResCap subsidiary), the use and allocation of ResCap’s tax attributes, and claims under theMinnesota insider preference statute—that could potentially provide substantial recoveries for the estate. Specifically, the Examiner found that ResCap’s bankruptcy estates could bring potentially-viable causes of action asserting up to US$5.5 billion in damages. The Report also noted that the Ally entities have significant potential liability to third-party claimants.
The chair of Chadbourne’s bankruptcy and financial restructuring practice, Howard Seife, called the release of the Examiner Report “a significant event in the ResCap chapter 11 case—one that we hope will assist the court and the parties in resolving the case.”
A summary of the background related to the Report and the findings of the Report can be found below. A full copy of the Examiner Report is available at www.chadbourne.com/rescap.
Background on the Examiner Report
ResCap and certain of its subsidiaries filed for bankruptcy on May 14, 2012. Prior to its bankruptcy, ResCap was the fifth largest servicer of residentialmortgage loans in the United States, servicing approximately US$374 billion of residential mortgage loans. ResCap anticipated a short stay in bankruptcy that would culminate in prearranged sales of itsmortgage lending and origination business platformand accelerated confirmation of a liquidating chapter 11 plan. The centerpiece of ResCap’s proposed plan was a settlement of all estate causes of action and third-party claims against ResCap’s parent, Ally Financial Inc., in exchange for a cash payment of US$750 million and certain non-cash contributions.
ResCap's proposed settlement with Ally was immediately criticized bymany of its creditors. One unhappy creditor, Berkshire Hathaway,moved for the appointment of an examiner to conduct a broad ranging review of ResCap’s prepetition transactions with Ally and the proposed settlements underlying ResCap's reorganization plan. The Bankruptcy Court granted thatmotion and Arthur J. Gonzalez, former Chief Judge of the United States Bankruptcy Court for the Southern District of New York, was appointed as Examiner. The Examiner was tasked with investigating the wide array of causes of action that could be asserted by ResCap or third parties against Ally or others, and evaluating whether Ally's proposed settlement contribution, including the cash payment of US$750 million, was sufficient to justify the releases it desired. The Examiner retained Chadbourne & Parke LLP as his counsel to conduct the investigation.
The Magnitude of the Examiner's Investigation
As requested by the parties in interest, the scope of the Examiner's investigation was exceptionally broad. The Examiner was asked to investigate the entire course of conduct and all material intercompany dealings involving ResCap, Ally, Ally Bank, and Cerberus over a period of almost a decade. This was no small undertaking. In the years preceding the chapter 11 cases, there were dozens of affiliate transactions between those parties, including discrete, one-time transactions, ongoing intercompany business arrangements, and various types of capital support. These transactions included transfers involvingmany billions of dollars of value. The Examiner investigated the activities of ResCap’s directors and officers in connection with all of those transactions.
As part of the investigation, the Examiner's professionals gathered and analyzed almost nine million pages of documents produced by twenty-three different parties. The Examiner’s professionals conducted ninety-nine formal interviews (one of which was under oath) of eightythree witnesses, including witnesses fromResCap, Ally, Ally Bank, Cerberus, and various counsel and advisors. In addition, the Examiner and/or his professionalsmet on approximately sixty-six occasions with various parties in interest. The Examiner’s professionals also had an ongoing dialogue with ResCap and its advisors and various other parties to address pertinent topics and information requests. Finally, the Examiner solicited and reviewedmultiple written submissions fromat least a dozen parties with respect to estate and third-party claims.
The Examiner was also asked to investigate the negotiation and entry into several proposed plan sponsor, plan support, and settlement agreements. The investigation of these proposed postpetition transactions was fact-intensive, and involved a review of the entire process underlying multiple complex settlement negotiations over a period of several months.
The Examiner considered and evaluated a wide array of potential state and federal law claims and causes of action that were proposed to be released by ResCap and Ally, including the proposed broad and nonconsensual release of claims against Ally and its affiliates held by third parties. The investigation required the Examiner's professionals to performdiscrete quantitative financial, accounting, tax, economic, and valuation analyses, as well as to formqualitative judgments regarding ResCap’s strategy, decisionmaking, and governance.
In short, as observed by Judge Glenn, the investigation was “an enormous undertaking.”
Overview of the Examiner’s Conclusions
The Examiner concluded that Ally's proposed US$750 million cash contribution would have been inadequate to justify a release of estate causes of action,much less a release of estate causes of action and third-party claims. The Examiner concluded that ResCap’s bankruptcy estates could assert up to approximately US$3.1 billion in damages with respect to claims the Examiner believed are either (1) likely to prevail, or (2) close questions, but likely to prevail. Themost significant causes of action the Examiner placed in those categories are:
- Up to US$1.77 billion in damages relating to the use and allocation of ResCap’s tax attributes;
- Up to US$566 million in damages relating to claims under the Minnesota insider preference statute; and
- Up to US$521 million in damages relating to themisallocation of net revenues on loans brokered by GMAC Mortgage.
In total, the Examiner found that ResCap’s bankruptcy estates could assert approximately US$5.5 billion in damages relating to potentially-viable estate causes of action (comprised of the US$3.1 billion in claims described above and an additional US$2.4 billion in potential damages with respect to claims that, while a close question, the Examiner concluded aremore likely than not to fail). Moreover, the Report concludes that Ally has significant potential liability to thirdparty claimants, including exposure related to the approximately US$221 billion in residential mortgage-backed securities issued by ResCap between 2004 and 2007.
As the Examiner advised in the Report, although a plan embodying a nonconsensual thirdparty release is not categorically prohibited in the Second Circuit, the best course for Ally to achieve a third-party release is to negotiate a plan that enjoys very broad creditor support. Without such support, and given that ResCap no longer has a substantial ongoing business to reorganize and operate, Second Circuit law wouldmake it quite difficult but not impossible to confirma nonconsensual plan that deprives third parties of their right to pursue their own claims in court.
On the eve of the release of the Examiner Report, ResCap, Ally, and certain key stakeholders announced that they had reached a comprehensive settlement, andmoved for the Examiner Report to be sealed. The temporary sealing of the Examiner Report was of critical importance to the parties. Indeed, several parties had the contractual right to terminate the plan support agreement entirely if the Examiner Report had been released prematurely. Under the proposed settlement, which was the result ofmediation by Bankruptcy Judge JamesM. Peck, Ally proposes tomake a contribution of US$2.1 billion in exchange for releases fromthe ResCap bankruptcy estates and third parties.
On June 26, 2013, Judge Glenn authorized ResCap to enter into the plan support agreement, thereby permitting ResCap to prosecute a plan of reorganization incorporating the proposed mediated settlement. It remains to be seen whether the Bankruptcy Court will approve the settlement. In any event, as the Bankruptcy Court and several parties in interest have recognized, the Examiner Report proved to be a principal driver of consensus. The Examiner's investigation and the Examiner's decision to allow the parties in interest to participate in the investigative process created powerfulmomentum towards settlement and provided significant value to ResCap and its creditors.