Zero Purchase Price Repo Transactions Held to Qualify Under the Catchall Provision of Section 101(47)(A)(v); Liquidation of Disputed Securities Remanded to Bankruptcy Court for Further Review

George L. Miller, Chapter 7 Trustee for the Estate of HomeBanc Corp. v. Bear Stearns & Co., Inc. (In re HomeBanc Mortgage Corp.), No. 13-1064 (RGA) (D. Del. March 27, 2014)

[Update – On remand and after trial, the Delaware Bankruptcy Court found that Bear Stearns acted rationally, in good faith, and in accordance with the governing GMRA when it conducted an auction of the Securities at Issue in August 2007. While the market was difficult, it was functioning, and Bear Stearns complied with usual and customary standards for holding the auction.]

In this Memorandum Opinion issued by the Honorable Richard G. Andrews of the Delaware District Court, an issue of first impression was tackled – whether certain transactions (the “Disputed Transactions”) for the sale and repurchase of mortgage-backed securities (the “Disputed Securities”) fell within the definition of a “repurchase agreement” under section 101(47) of the Bankruptcy Code when the Disputed Securities had a purchase price of zero.  Because the Disputed Transactions were “part and parcel” of other undisputed repurchase transactions, the Court held that the Disputed Securities qualified under the Bankruptcy Code’s catchall provision for repurchase agreements as “credit enhancements.”

Non-debtor parties to “repurchase agreements” are afforded special treatment by Congress under section 559 of the Bankruptcy Code as, among other things, they are entitled to exercise their contractual rights postpetition “to cause the liquidation, termination or acceleration of a repurchase agreement” without first seeking relief from the automatic stay.  Pursuant to section 101(47)(A)(i) of the Bankruptcy Code, the term “repurchase agreement” means, among other things, “an agreement . . . which provides for the transfer of one or more . . . mortgage-related securities . . . against the transfer of funds by the transferee . . ., with a simultaneous agreement by such transferee to transfer to the transferor [the securities] . . . against the transfer of funds.”  In addition, “any security agreement or arrangement or other credit enhancement related to” a repurchase agreement under section 101(47)(A)(i) also qualifies.  See 11 U.S.C. § 101(47)(A)(v).  Repurchase agreements, and the transactions made thereunder, are often called “repos.”

In the case at hand, the Appellees, certain Bear Stearns entities, believing that they qualified under section 559 of the Bankruptcy Code, exercised their contractual rights under a global master repurchase agreement (the “GMRA”) with Appellant, HomeBanc Corp. (“HomeBanc”), following HomeBanc’s default thereunder and subsequent bankruptcy filing, to liquidate the Disputed Securities.  The Disputed Securities were auctioned and, ultimately, sold to certain of the Appellees.  During its bankruptcy proceedings, HomeBanc challenged the propriety of the auction as well as the Appellees’ actions under section 559, arguing that the Disputed Transactions did not qualify as repos because the Disputed Securities had a purchase price of zero and thus, could not be transferred back to HomeBanc “against the transfer of funds” as required under section 101(47)(A)(i).

The Bankruptcy Court disagreed, holding on summary judgment that the GMRA contained a contractual provision allowing for all repo transactions made between the parties under the GMRA to be deemed made in consideration of any other transaction under the GMRA.  Under this “bucket theory,” any transaction under the GMRA for a purchase price greater than zero was consideration for the Disputed Transactions and thus, the “transfer of funds” requirement under the Bankruptcy Code was satisfied.  The Bankruptcy Court also determined that, even if its “bucket theory” was incorrect, the Disputed Securities qualified under the catchall provision of section 101(47)(A)(v) as credit enhancements related to other non-disputed repo transactions made under the GMRA.

The District Court – “with considerable doubt” – disagreed that the Bankruptcy Court’s “bucket theory” satisfied the “transfer of funds” requirement of section 101(47)(A)(i). According to the Court, there was no dispute that the Disputed Securities were transferred as part of other non-disputed repo transactions made under the GMRA.  Importantly, however, there was equally no dispute that the Disputed Securities “could have been transferred back [to HomeBanc] without being ‘against the transfer of funds.’”  Accordingly, the Court held that the Disputed Transactions did not fall within the plain meaning of section 101(47)(A)(i).  Notwithstanding the foregoing, the Court found that the Disputed Transactions, as “part and parcel” of other undisputed GMRA repo transactions, were repurchase agreements pursuant to section 101(47)(A)(v) as credit enhancements.

With respect to the propriety of the Disputed Securities’ auction, the District Court remanded to the Bankruptcy Court the issue of whether it was conducted in good faith.  Although the Bankruptcy Court granted summary judgment in favor of the Appellees on this issue, the District Court determined that a material issue of disputed fact existed. Given that the auction resulted in only one bid, and that the bid was from the Appellees, the Court held it possible that “something . . . [was] wrong with the auction process.”  Accordingly, the Court determined that good faith could not be determined conclusively on summary judgment.