Structured Finance in the Courts

Legal advocacy is a key component of our mission of protecting the structured finance market.

Briefing

Occasionally a case in the judicial system raises issues of foundational significance to the structured finance market. In those instances, the Structured Finance Association will submit an amicus brief to attempt to protect against precedent setting ruling that will upset long-standing contractual doctrine, reasonable market expectations and a healthy functioning market.

In some cases, we partner with other trade groups, but the matters always relate to topics of great importance for the structured finance market. A few of the key legal matters that we have weighed in on are:

“This case has uniformly raised serious concerns across the industry as the CFPB’s proposed consent order challenges certain sacrosanct contractual rights of transaction parties. We strongly support an appropriate and transparent servicing standard for consumers; however, we believe it’s inappropriate to shift the burden of remedying any alleged third party’s misconduct to another party in contradiction with the agreed contractual arrangement.” – Kristi Leo, Structured Finance Association 

One of the many-cited contributors to the failure of the private-label RMBS market to rebound from its crisis-driven lows is contractual ambiguity, concern around the inviolability of the contract, and a general lack of trust that trust cash flows will be allocated as dictated by the transaction documents. The CFPB v NCSLT case has aggravated these concerns among market participants, and without intervention, the lack of confidence might extend to other asset classes such as credit cards, student loans, and auto loans.

While neither appropriate nor acceptable, the extra-legal re-ordering of legacy RMBS contracts, in retrospect, can at least be attributed to a crisis situation, the Great Financial Crisis. That is not the case in this NCSLT matter.

At the heart of our concerns is the rule of law as it applies to negotiated contracts – a bedrock tenet to the stability of financial markets. The CFPB’s proposed consent order effectively rewrites contractual provisions that parties agreed to and penalizes the underlying investors, who are not accused of any wrongdoing, for the alleged actions of the third-party services. Moreover, the CFPB’s proposed consent order was negotiated without the involvement of any of the transaction parties who have interest, rights and obligations that would be modified by that order.

The ramifications of this lawsuit will have a chilling effect on the broader securitization market if the proposed consent order moves forward. The securitization market provides essential credit to more students and consumers at a lower cost than would be available otherwise. For example, $171 billion of student loans, $223 billion of auto loans, and $206 billion of other consumer loans are currently funded through the securitization markets as of year-end 2018.

The Structured Finance Association took immediate action to submit an amicus brief.  Additionally, the Association arranged an Investor D.C. Fly-In to relay the industry’s concerns to Capitol Hill and the CFPB. This multi-pronged approach of addressing the court, legislators, and the CFPB has already shown some impact. Various statements made in a recent court decision granting multiple parties’ motions to intervene where sympathetic to the positions argued by the Structured Finance Association. Likewise, letters sent by Members of Congress to the CFPB outlined the Association’s members’ concerns.

Lehman Brothers brought action against 250 noteholders, issuers, and indenture trustees seeking to recover approximately $1 billion that was distributed to securitization trusts in connection with 44 swap transactions following the declaration of bankruptcy by Lehman Brothers in September 2008.

Impact on Structured Finance. The case involves the treatment of a so-called “flip clause” in a securitization waterfall in the event of a bankruptcy of a swap counter-party.  The flip clause is a provision, very common in securitization agreements, that redirects or reprioritizes cash flow upon bankruptcy, and is often included in securitizations that incorporate swaps.  This case is important for the securitization market in that a decision favorable to Lehman may call into question the scope of the safe harbor provisions of the Bankruptcy Code applicable to swaps and other protected contracts. The Association’s position in this matter is that the agreed-upon terms which dictate how cash flows should be allocated in the event of a bankruptcy should be followed for the protection of all transaction parties.

Action taken by the Structured Finance Association. The Association filed an amicus brief to the US Bankruptcy Court supporting the Noteholder Defendants’ motion to dismiss the Lehman Brothers Special Financing complaint (LBSF), in which LBSF argues that certain payment priority provisions are unenforceable and are not protected by the Bankruptcy Code’s safe harbor provisions. In June 2017, the Association sought leave to file an amicus brief in that appeal in support of the defendants. In March 2018, New York federal judge affirmed a bankruptcy court’s dismissal of Lehman’s bid to claw back $1 billion in the transactions.  Lehman again appealed that decision to the Second Circuit Court of Appeals.  The Association filed a third amicus brief to the US Court of Appeals for the Second Circuit on November 1 2018, again in support of the defendants.

The Madden v. Midland case centers on a plaintiff, Saliha Madden, a New York resident who had defaulted on $5,000 under a credit card she opened with Bank of America (now doing business as FIA Card Services).  As is very common FIA Card Services later sold Madden’s defaulted debt to Midland Funding LLC, a California-based company specializing in the collection of past due loans. Midland Funding sought repayment from Madden for the principal outstanding along with an interest rate of 27% consistent with the terms of the credit card agreement governed by Delaware law. In 2011 the plaintiff filed suit alleging that Midland violated the Fair Debt Collection Practices Act by falsely representing the amount of interest it was entitled to collect on the basis Midland is not a national bank and therefore must adhere to the applicable state usury laws regardless of the fact the loan was originated by a national bank under which the interest rate terms were valid.

Impact on structured finance: Madden v. Midland calls into question whether the terms of a bank loan originated pursuant to the National Bank Act are still valid following the sale or assignment of the loan to a non-bank third party. A ruling in favor of Madden would have a significant impact on the valuation of certain loans originated by depository institutions as well as those previously sold by banks to non-bank, including securitizations trusts.  The ability to ‘export’ rates is critical to loan market including the current securitization market. In fact, there is evidence that the lower court decision has already impacted consumer lending activity in Second Circuit states (NY, VT and CT) including decreasing the number of loans that are originated by banks and/or financed by or sold to non-banks.

Action taken by the Structured Finance Association.

While the Southern District Court for New York ruled in favor of Midland, the Second Circuit Court of Appeals reversed its ruling finding that the National Bank Act pre-emption did not apply to Midland because Midland was not a national bank.  In 2016, the Association filed an amicus brief in support of Midland petition to be heard by the Supreme Court, however, the Supreme Court ultimately denied the petition.  The Association continues to seek legislative or regulatory action with respect to the valid-when-made doctrine– see current efforts here

Two lawsuits in New York currently threaten the credit card ABS market. Seeking to leverage the Second Circuit’s decision in the Madden v. Midland case, plaintiffs filed punitive class actions in the Eastern District of New York against Capital One Funding LLC, Capital One Master Trust, and Capital One Multi-Asset Execution Trust (Cohen v. Capital One) and in the Western District of New York against Chase Card Funding LLC and Chase Card Issuance Trust with Wilmington Trust named as sole trustee (Petersen v. Chase). Plaintiffs in both cases allege that the two banks violated New York state laws by setting an interest rate over New York’s current cap of 16%, and seek to recoup the interest payments in excess of that rate and cap rates going forward.

Impact on structured finance: While both cases focus on credit card debt, SFA members warn that the outcome of these cases has the potential to impact all forms of securitized debt by potentially subjecting national banks to overburdensome state-by-state regulation. A favorable outcome for either Plaintiff could have several negative and long-lasting effects on the U.S. securitization and lending market by limiting funding sources and forcing banks to seek more financing away from securitization, thereby impacting their ability to extend credit.

Action taken by the Structured Finance Association: SFA, in partnership with the Bank Policy Institute, filed a motion on August 13th supporting the defendants’ motion to dismiss in Petersen v. Chase, and filed a brief in support of defendants in the Cohen v. Capital One case on October 4th. In both cases, SFA highlights the potential negative impact on lending markets and the cost and availability of credit for U.S. consumers and businesses.

In June 2017, an involuntary chapter 11 petition was filed against Taberna Preferred Funding IV Ltd. by HH Holdco, which, at the time, were holders of all the senior priority Class A-1 notes and a significant percentage of Class A-2 notes.

Impact on structured finance: The dismissal of the petition is very important in that it reinforces a fundamental and universally accepted principle that non-recourse securitizations should only be liquidated by the terms set forth in governing documents.

Action taken by the Structured Finance Association.  In September 2017, the Association submitted an amicus curiae brief to the US Bankruptcy Court for the Southern District of New York where we argued that the attempt by the senior note holders to put Taberna in bankruptcy was counter to the fundamental principle of securitization and Taberna’s contractual agreements, and an attempt to abuse the reorganization process. In November 2018, the Court issued an opinion, consistent with the Association’s arguments, dismissing the case. 

Summary: Four different Maryland trial courts dismissed foreclosure actions where the owner of the defaulted mortgage debt was a foreign statutory trust that was not licensed as a debt collector under the Maryland Collection Agency Licensing Act (MCALA). In so finding, the trial courts stated that the trusts were “in the business of collection consumer debt”, and thus subject to MCALA. An intermediate court of appeals upheld that ruling of those consolidated cases. However, the Maryland Court of Appeals reversed the lower courts’ rulings, resolving the questions on appeal by determining that the Maryland legislature did not intend to require foreign statutory trusts to become licensed debt collectors pursuant to MCALA.

Impact on structured finance: Requiring foreign statutory trusts to be licensed debt collectors—when the relevant subservicers operating on behalf of the trust are duly licensed debt collectors—serves no public policy purpose, and would simply increase transaction costs for future securitizations and introduce uncertainty for legacy securitizations. Doing so would adversely affect securitization of loans in Maryland, and potentially other jurisdictions.

Action taken by the Structured Finance Association. The Court of Appeals ruling, for which the Association filed an amicus brief, affirms the role of trusts in securitization, correctly finding that MCALA should not require to foreign statutory securitization trusts to become licensed debt collectors.

Summary: In the aftermath of the financial crisis, state and local level governments considered proposals that would utilize their eminent domain powers to seize underwater mortgage loans from owners and private securitization trusts, and refinance them on terms more favorable to the underwater borrowers.

Impact on structured finance: Eminent domain risks violating the sanctity of contract that will results long-term uncertainty and increased costs in the future. Investors would have to price in the risk of having their investments written down by state and local governments, and those prices would ultimately be borne by homeowners in the form of higher rates and reduced access to credit. Rate and term modifications are among the suite of tools that have proven to be a more effective means of assisting underwater or distressed borrowers while protecting investor interests.

Action taken by the Structured Finance Association. Such proposals were widely criticized by private investors through the Association and other industry groups, as well as regulators at the FHFA and FHA.

Contact

Jennifer Wolfe

Director, ABS and Investor Policy

Jennifer.Wolfe@structuredfinance.org