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Bank of New York v. Federal Deposit Insurance Co.

September 28, 2006

THE BANK OF NEW YORK, PLAINTIFF,
v.
FEDERAL DEPOSIT INSURANCE COMPANY, DEFENDANT.



MEMORANDUM OPINION

The Bank of New York ("BNY"), indenture trustee for the interests of investors who purchased asset-backedsecuritiesfrom a trust established by the now-defunct NextBank, N.A. ("NextBank"), is suing the Federal Deposit Insurance Corporation ("FDIC") for conversion based on actions the agency took as NextBank's receiver. Five of BNY's original six counts have been dismissed. Count VI, the sole remaining claim, concerns a contract provision promising the investors ("Noteholders") recovery of their investments at an accelerated rate upon the appointment of a receiver for NextBank. BNY contends that, in declining to honor this early amortization or "ipso facto" clause, the FDIC acted without authority under the Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA), Pub. L. No. 101-73, 103 Stat. 183.

The issue before the Court is one of first impression. Essentially, BNY argues that the structure of the NextBank securitization transaction was crafted so that NextBank was not a party to the contract (the "Master Indenture") containing the ipso facto clause and that, as a result, the FDIC exceeded its powers under 12 U.S.C. § 1821(e)(12)(A)*fn1 -- --and thereby converted millions of dollars belonging to the Noteholders-- --when it refused to honor the ipso facto clause upon NextBank's failure. The FDIC counters that BNY'ssecuritization transaction is not immune from the FDIC's statutory powers providingthat the FDIC as receiver may exercise its power to enforce an agreement notwithstanding an early amortization clause triggered by the appointment of a receiver, because NextBank "entered into" the agreement within the meaning of Section 1821(e)(12)(A). For the reasons set forth herein, the Court concludes that the early amortization clause is unenforceable against the FDIC and that, therefore, judgment will be entered for the FDIC on Count VI.*fn2

BACKGROUND

I. NextBank and the Parties

NextBankwas a national banking association established in 1999 to issue consumer credit cards, primarily through the internet. (Pl.'s Mot. for J. as to Liability ["Pl.'s Mot."] Ex. A at 4, 11.) By February 2002, NextBank had 1.2 million credit card holders and accounts totaling approximately $1.9 billion. (Christensen Decl. Ex. 3 ["Ltr. 2/12/02"] at 1187; Wigand Dep. Ex. 4 at 2.)

NextBank maintained the vast majority of its accounts-- --approximately $1.7 billion-- --in a "securitized" portfolio. (Id.) In other words, instead of financing this portfolio with money borrowed in its own name, NextBank created a trust, transferred its receivables to this trust, ordered the trust to sell notes to investors, and used the proceeds to pay merchants for charges by credit card holders. (Def.'s Statement of Material Facts ["Def.'s Stmt."] ¶ 5; see, e.g., Christensen Decl. Ex. 1 ["Offering Mem. 12/6/00"] at 390--91 (highlighting information about the trust for prospective investors).) Generally accepted accounting principles permitted NextBank to remove the securitized accounts from its balance sheets. (Pl.'s Mot. Ex. B at 6.) By doing so, NextBank was able to reduce its required capital reserves. (See id.)

The FDIC learned in September or October of 2001 that NextBank's undercapitalization and practice of extending credit to subprime borrowers had put the bank at risk for failure. (See Wigand Dep. at 20:7--8; Pl.'s Mot. Ex. A at 5--8.) In late 2001, the Office of the Comptroller of the Currency ("OCC") determined that NextBank was improperly accounting for poor credit quality on delinquent accounts. (See id.) On February 7, 2002, the OCC appointed the FDIC to become NextBank's receiver. (See id. Ex. A at 46.) As receiver, the FDIC succeeded to "all [NextBank's] rights, titles, powers, and privileges." 12 U.S.C. § 1821(d)(2)(A)(I) (2006). Further, the FDIC's appointment obligated it to "preserve and conserve [NextBank's] assets and property." Id. § 1821(d)(2)(B)(iv).

BNY is the indenture trustee for the trust NextBank established to securitize its accounts. (Christensen Decl. Ex. 4 ["MI"] at 140, 205.) As indenture trustee, BNY represents the interests of the Noteholders, who are large, institutional investors, including Credit Suisse, Goldman Sachs, J.P. Morgan, Deutsche Bank, and Barclays Capital. (Id. Ex. 2 ["Offering Mem. 4/20/01"] at 937--38; Offering Mem. 12/6/00 at 460--61, 593; see Wigand Dep. Ex. 4 at 3.)

II. Principles and Benefits of Securitization

In order to address the parties' dispute, one must first have a basic understanding of NextBank's method of financing. "Securitization has grown from an emerging practice involving mortgage receivables more than 25 years ago to one of the most widely used forms of commercial funding across a broad range of businesses, both in the U.S. and worldwide." (Pl.'s Mot. Ex. B at 6.) Although securitization can take various forms, most securitization arrangements involve certain basic players: a "transferor," the initial owner of the assets; a "special purpose vehicle" ("SPV"), which the transferor creates to purchase and hold the assets; and investors, who purchase securities issued by the SPV. (Id. Ex. B at 6, 9.)

A key principle underlying securitization is that quantifying the creditworthiness of pooled assets is often easier than quantifying the creditworthiness of the assets' owner. (Id.) Ease and accuracy of quantification makes it possible to bundle asset-backed securities for sale in classes, or "tranches," calibrated to varying investor preferences for income and risk. (See id. Ex. B(5) at 4 n.2.) Both investors and transferors benefit as a consequence. Investors can insulate themselves from the difficult-to-quantify risks of a transferor's business and make investments suited to their individual preferences for income and risk. (See id. Ex. B at 9; id. Ex. B(5) at 4 n.2.) Transferors can procure lower-cost financing and access to capital from institutional investors who might, absent securitization, be unable or unwilling to purchase the transferors' assets. (Id. Ex. B(5) at 3--4.)

A second important principle of securitization is the "legal isolation" of assets from their transferors. (Id. Ex. B(5) at 2, 4.) As defined by the Financial Accounting Standards Board ("FASB"), legal isolation means that an asset is "presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership." (Id. Ex. B(5) at 1(quoting Fin. Accounting Standards Bd., Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities 4 (1996), available at http://www.fasb.org/pdf/fas125.pdf).)Because the FASB's generally accepted accounting principles donot permit transferors to remove assets from their balance sheets absent legal isolation, legal isolation makes possible one of securitization's notable benefits for transferors--the ability to reduce their required capital reserves. (Id. Ex. B(5)at 1--3; see Pl.'s Mem. in Supp. at 2 ("The separation between NextBank and the Trust allowed NextBank to receive favorable accounting and regulatory treatment . . . .").)

III. Securitization of NextBank's Receivables

A. The Transaction Documents

All securitizations are based on documents that define the duties and obligations that transferors, SPVs, and investors owe one another. (Pl.'s Mot. Ex. B at 9.)NextBank securitized its assets using several interrelated "transaction documents." These included a "Trust Agreement" (Christensen Decl. Ex. 6 ["Trust"] at 1--28), an "Administration Agreement" (id. Ex. 7 ["Admin."] at 43--56), a "Transfer and Servicing Agreement" (id. Ex. 10 ["T&S"] at 58--115), and the Master Indenture (MI at 138--207).*fn3

In the Trust Agreement, dated December 1, 2000, NextBank created a trust to hold its credit card receivables and repay the Noteholders. (Trust at 1; Def.'s Stmt. ¶ 16.) The Trust Agreement designated NextBank the "owner" of the trust and, as such, accorded NextBank an "undivided beneficial interest" in the trust's assets. (Id.) Because NextBank owned the trust, the Trust Agreement provided that, "for income tax purposes, the [t]rust [would] be treated as a security device and disregarded as an entity." (Trust at 4.)

The trust depended on NextBank for its operation, because it lacked employees or infrastructure of its own. (Def.'s Stmt. ¶ 16.)The Administration Agreement, dated December 1, 2000, made NextBank responsible for carrying out the trust's duties under the other transaction documents. (Pl.'s Statement of Undisputed Facts ["Pl.'s Stmt."] ¶ 22; see Admin. at 46--47.)

In the Master Indenture, dated December 11, 2000, the trust authorized the issuance and sale of notes secured by and paid from the credit card receivables transferred to the trust. (MI at 138; Def.'s Stmt. ¶ 19.) Terms specific to particular series of notes would be set forth in series-specific "indenture supplements." (MI at 159.)

Notes issued by the trust would have three possible cash-flow periods. (Def.'s Stmt. ¶ 11; see Offering Mem. 12/6/00 at 391.) During an initial "revolving period," Noteholders would be paid only interest and no principal. (Id.) After the revolving period, there would be a "controlled amortization period" during which principal would be paid to Noteholders in fixed amounts at scheduled intervals. (Def.'s Stmt. ¶ 13; see Offering Mem. 12/6/00 at 391--92.) Finally, if there occurred a "redemption event" as defined in the Master Indenture, Noteholders would receive payments of principal and interest on an accelerated scheduledefined in their indenture supplements.(Def.'s Stmt. ¶ 14; see Offering Mem. 12/6/00 at 392.)

In particular, Article V, § 5.01 of the Master Indenture provided that, upon the appointment of a conservator, receiver, or liquidator of NextBank, "a [r]edemption [e]vent with respect to all [s]eries of [n]otes [would immediately] occur without any notice or other action on the part of the Indenture Trustee or the Noteholders." (MI at 173.)

The Transfer and Servicing Agreement, dated December 11, 2000, provided the procedure for transferring credit card receivables to the trust and servicing those receivables. (T&S at 58; Def.'s Stmt. ¶ 21.) NextBank was both "transferor" and "servicer" under the agreement. (T&S at 58.) As transferor, NextBank was responsible for transferring receivables to the trust. (See id. at 76.) As servicer, it was responsible for collecting payments on the receivables, depositing those collections in an account, keeping track of which collections were finance-charge receivables and which were principal receivables, and allocating the collections received among the Noteholders and the transferor pursuant to the Master Indenture, indenture supplements, and the Transfer and Servicing Agreement itself. (Def.'sStmt. ¶ 21.)

All of the transaction documents shared certain common characteristics. The documents repeatedly cross-referenced one another. (See, e.g., Trust at 8 (cross-referencing the Master Indenture and the Transfer and Servicing Agreement); Admin. at 45 (cross-referencing the Master Indenture, the Transfer and Servicing Agreement, and the Trust Agreement); MI at 166 (cross-referencing the Transfer and Servicing Agreement); T&S at 91 (cross-referencing the Trust Agreement).) NextBank had obligations under all of the documents, including under the Master Indenture. (See, e.g., MI at 1205 (obligating NextBank to pay BNY).) Notably, Next Bank signed all of the documents. (See Trust at 1; Admin. at 43; MI at 138; T&S at 58.)

As BNY has emphasized, however, the Mater Indenture was distinguishable from the other transaction documents in certain significant respects. Although NextBank signed the Master Indenture, it did so in a special signature block labeled "acknowledged and accepted." (MI at 1207.)*fn4 By contrast, NextBank signed the other documents in an ordinary signature block under a statement saying that "the parties" (or, in the case of the Transfer and Servicing Agreement, "the Transferor, the Servicer and the Trust") had "caused the Agreement to be duly executed." (Trust at 28; Admin. at 56; T&S at 114.)Also, whereas each of the other transaction documents listed NextBank on its cover sheet, the only entities listed on the Master Indenture's cover sheet were the trust and BNY. (Compare Trust at 1, Admin. at 43, and T&S at 58, with MI at 138.)

B. The Marketing of NextBank's Securitized Assets

In accordance with the four principal transaction documents (and relevant indenture supplements), NextBank marketed notes in various series, the properties of which it described in a standard "offering memorandum" and individualized "offering memorandum supplements" that were circulated to all prospective buyers. (Def.'s Stmt. ¶ 25.) The offering memorandum warned that, "[i]f a conservator or receiver were appointed for [NextBank], delays or deductions in payment of [their] notes could occur." (Offering Mem. 4/20/01 at 876; Offering Mem. 12/6/00 at 396.) More specifically, the memorandum warned, "[T]he FDIC may have the power . . . to prevent or require the commencement of an early amortization period." (Offering Mem. 4/20/01 at 876; Offering Mem. 12/6/00 at 396.)

In addition to NextBank's offering memoranda, BNY and prospective buyers received opinion letters from NextBank's outside counsel addressing whether BNY's interest in receivables could be enforced against the FDIC as receiver. (Def.'s Stmt. ¶ 25; see, e.g., Christensen Decl. Ex. 11 at 1038 (explaining the purpose of one such opinion letter).) In each of these letters, counsel warned that the proffered opinion depended on various assumptions. (See, e.g., id. ("We have assumed for purposes of this opinion, without investigation, that the following statements are correct.").) Among the assumptions contained in a majority of the opinion letters was that NextBank had entered into the Master Indenture. (See, e.g., id. Ex. 11 at 1040 ("The Documents resulted from arm's-length bona fide negotiations among the parties thereto, and were entered into by the Bank in the ordinary course of its business."); see also id. Ex. 11 at 1039 (coining "Bank" as shorthand for NextBank and "Documents" as shorthand for "The Transfer Agreement, the Assignment, and the Master Indenture").) A second assumption was that BNY would not attempt to foreclose on receivables solely because of the appointment of a receiver. (See, e.g., id. Ex. 11 at 1040 (listing as one of counsel's underlying assumptions that BNY "[would] not attempt to foreclose on the Receivables or the proceeds thereof after the appointment of the FDIC as conservator or receiver for [NextBank] . . . without the existence of an event of default other than the appointment of a conservator or receiver").)

Having received such warnings, the Noteholders whose interests BNY now represents purchased notes from "Series 2000-1" and "Series 2001-1."(Def.'s Stmt. ¶ 8.) Within each series, there were four classes of notes with differing levels of risk-- --the lowest being Class A, and the highest Class D. (Id.)Class A notes had priority for repayment over Class B, Class B over Class C, and Class C over Class D. (Offering Mem. 4/20/01 at 938; Offering Mem. 12/6/00 at 461.) Thus, as reflected in ratings provided by Moody's, the purchasers of Class C or D notes accepted a significantly higher risk that they would not "receive required interest and principal payments" as compared to the purchasers of Class A or B notes; therefore, the Class A notes were rated "Aaa," the Class B Notes "A1," the Class C Notes "Baa2," and the Class D Notes "Ba2."(Def.'s Stmt. ¶ 8; see Christensen Decl. Ex. 5 at 99 (listing the Moody's ratings for the Series 2000-1 notes).) In return for accepting greater risk, Class C and D Noteholders earned interest at higher rates.(See, ...


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