Wells Fargo v. Bear Stearns Co Inc ( 2019 )

PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
_____________
No. 18-2887
_____________
In re: HOMEBANC MORTGAGE CORP., et al,
Debtors
WELLS FARGO, N.A., in its capacity as Securities
Administrator
v.
BEAR STEARNS & CO., INC.;
BEAR STEARNS INTERNATIONAL LIMITED;
HOMEBANC CORP.;
STRATEGIC MORTGAGE OPPORTUNITIES REIT, INC.
GEORGE L. MILLER, Chapter 7 Trustee for the Estate of
HomeBanc Corp.,
Appellant
_____________
On Appeal from the United States District Court
for the District of Delaware
District Court No. 1-17-cv-00797
District Judge: The Honorable Richard G. Andrews
Argued September 26, 2019
Before: SMITH, Chief Judge, McKEE, and PHIPPS,
Circuit Judges
(Opinion Filed: December 24, 2019)
Francesca E. Brody
Sidley Austin
787 Seventh Avenue
New York, NY 10019
James O. Heyworth [ARGUED]
Sidley Austin
787 Seventh Avenue
New York, NY 10019
Andrew W. Stern
Sidley Austin
787 Seventh Avenue
New York, NY 10019
Counsel for Bear Stearns Co., Inc.
Bear Stearns International Ltd.
Strategic Mortgage Opportunities REIT,
Inc.
2
John T. Carroll, III
Cozen O’Connor
1201 North Market Street
Suite 1001
Wilmington, DE 19801
Steven M. Coren [ARGUED]
Kaufman Coren & Ress
2001 Market Street
Two Commerce Square, Suite 3900
Philadelphia, PA 19103
John W. Morris
Kaufman Coren & Ress
2001 Market Street
Two Commerce Square
Philadelphia, PA 19103
Counsel for George L. Miller, Chapter 7 Trustee for
the Estate of HomeBanc Corp.
________________
OPINION
________________
SMITH, Chief Judge.
This appeal revolves around the liquidation of defaulted
mortgage-backed securities that were subject to two repurchase
3
agreements. Following multiple rounds of litigation before the
Bankruptcy and District Courts, George E. Miller, Chapter 7
trustee for the estate of HomeBanc Corp., seeks our review.
On appeal, we address these questions: (1) whether a
Bankruptcy Court’s determination of good faith regarding an
obligatory post-default valuation of mortgage-backed
securities subject to a repurchase agreement receives plenary
review as a question of law or clear-error review as a question
of fact; (2) whether “damages,” as described in 11 U.S.C.
§ 101(47)(A)(v), requires a non-breaching party to bring a
legal claim for damages or merely experience a post-
liquidation loss for the conditions of 11 U.S.C. § 562 to apply;
(3) whether the safe harbor protections of 11 U.S.C. § 559 can
apply to a non-breaching party that has no excess proceeds
after exercising the contractual right to liquidate a repurchase
agreement; and (4) whether Bear Stearns liquidated the
securities at issue in compliance with the terms of the parties’
repurchase agreements. Because we agree with the disposition
of the District Court, we will affirm.
I
HomeBanc Corp. (“HomeBanc”) was in the business of
originating, securitizing, and servicing residential mortgage
loans. From 2005 through 2007, HomeBanc obtained
financing from Bear Stearns & Co., Inc. and Bear Stearns
International Ltd. (jointly referred to as “Bear Stearns”)
pursuant to two repurchase agreements:1 a Master Repurchase
1
A repurchase agreement, typically referred to as a “repo,” is
“[a] short-term loan agreement by which one party sells a
security to another party but promises to buy back the security
4
Agreement (“MRA”) dated September 19, 2005 and a Global
Master Repurchasing Agreement (“GMRA”) dated October 4,
2005.2 Transactions were accompanied by a confirmation that
included the purchase date, purchase price, repurchase date,
and pricing rate. HomeBanc transferred to Bear Stearns
multiple securities in June 2006, June 2007, and July 2007;
however, nine of the securities—the securities at issue
(“SAI”)—were accompanied by confirmations showing a
purchase price of zero and open repurchase dates.3
On Tuesday, August 7, 2007, HomeBanc’s repo
transactions became due, requiring HomeBanc to buy back
thirty-seven outstanding securities, including the nine SAI, at
an aggregate price of approximately $64 million. Bear Stearns,
concerned about HomeBanc’s liquidity, offered to roll (extend)
the repurchase deadline for an immediate payment of roughly
$27 million. Bear Stearns alternatively offered to purchase
thirty-six of the securities outright for approximately $60.5
million, but HomeBanc rejected this proposal. HomeBanc
failed to repurchase the securities or pay for an extension of the
due date by the close of business on August 7. The following
afternoon, Bear Stearns issued a notice of default that gave
HomeBanc until the close of business on Thursday, August 9,
2007, to make payment in full. No funds were forthcoming.
Consequently, Bear Stearns sent formal default notices to
on a specified date at a specified price.” Repurchase
Agreement, BLACK’S LAW DICTIONARY (11th ed. 2019).
2
Bear Stearns held the nine securities at issue (“SAI”) in this
case under the GMRA.
3
An “open repurchase date” means that the security is payable
on demand.
5
HomeBanc on August 9, 2007, and later that day, HomeBanc
filed voluntary petitions for relief under Chapter 11 of the U.S.
Bankruptcy Code.4
Upon HomeBanc’s default, the MRA and GMRA
required Bear Stearns to determine the value of the thirty-seven
remaining repo securities. This meant that Bear Stearns, within
its broad discretion, had to reach a “reasonable opinion”
regarding the securities’ “fair market value, having regard to
such pricing sources and methods . . . as [it] . . . consider[ed]
appropriate.” J.A. 1038.
Bear Stearns, claiming outright ownership of the
securities, decided to auction them to determine their fair
market value. Auction solicitations were distributed between
the morning of Friday, August 10 and Tuesday, August 14,
stating that Bear Stearns intended to auction thirty-six of the
securities on August 14, 2017.5 The bid solicitations listed the
available securities, including their unique CUSIP identifiers,
4
The bankruptcy was later converted to a Chapter 7 proceeding
in February 2009.
5
One of the thirty-seven remaining securities was excluded
from the August 14, 2007 auction because J.P. Morgan had
agreed with HomeBanc to purchase the security for $1 million.
Ultimately, J.P. Morgan did not buy the security, and as a
result, it was subsequently auctioned on August 17, 2007. Bear
Stearns’s mortgage trading desk submitted the highest bid,
purchasing the security for $1,256,000.
6
original face values, and current factors.6 Bear Stearns’s
finance desk sent the bid solicitation to approximately 200
different entities, including investment banks and advisors,
pension and hedge funds, asset managers, and real estate
investment trusts. In some cases, multiple individuals within a
single entity were solicited. The finance desk also sought bids
from Bear Stearns’s mortgage trading desk, implementing
extra safeguards to prevent any insider advantage.
The auction yielded two bids. Tricadia Capital, LLC
submitted a bid of approximately $2.2 million for two
securities, and Bear Stearns’s mortgage trading desk placed an
“all or nothing” bid of $60.5 million, the same amount Bear
Stearns had offered before HomeBanc’s default. After the
auction closed, Bear Stearns’s finance desk determined that
Bear Stearns’s mortgage trading desk had won. Bear Stearns
allocated the bid across the thirty-six securities on August 15:
$52.4 million to twenty-seven securities and $8.1 million
divided evenly among the nine SAI ($900,000 apiece).
Despite its default and the results of the auction,
HomeBanc believed itself entitled to the August 2007 principal
and interest payments from the thirty-seven securities; Bear
Stearns disagreed. Wells Fargo Bank, administratively holding
the securities, commenced this adversary proceeding by filing
an interpleader complaint on October 25, 2007. HomeBanc
and Bear Stearns asserted cross-claims against each other.
After depositing the August 2007 payment with the
6
A CUSIP is a nine-digit numeric or alphanumeric code that
identifies financial securities to facilitate clearing and
settlement of trades.
7
Bankruptcy Court, Wells Fargo was subsequently dismissed
from the proceedings. The cross-claims between HomeBanc
and Bear Stearns remained.
A. HomeBanc I7
After HomeBanc’s bankruptcy was converted to a
Chapter 7 proceeding, George Miller was appointed as trustee
for the estate. Miller brought several claims against Bear
Stearns, including (1) conversion (for selling the SAI via
auction when HomeBanc asserted that it had superior title and
interest), (2) violation of the automatic bankruptcy stay (by
auctioning the SAI), and (3) breach of contract (for improperly
valuing the SAI in violation of the GMRA).
With respect to these three claims, the Bankruptcy
Court granted Bear Stearns’s motion for summary judgment.
When a bankruptcy petition is filed, an automatic stay halts any
actions by creditors. 11 U.S.C. § 362. However, § 559
generally allows repo participants to exercise a contractual
right to liquidate securities without judicial interference. 11
U.S.C. § 559. The Bankruptcy Court held that the transactions
underlying the nine SAI constituted repurchase agreements
under 11 U.S.C. § 101(47)(A)(i) and (v), bringing the SAI
within the safe harbor protections of § 559. Thus, Bear Stearns
had the right to liquidate the securities: it did not violate the
automatic bankruptcy stay or convert the securities. See J.A.
7
There are four decisions relevant to this appeal that the parties
denote as HomeBanc I, Home Banc II, HomeBanc III, and
HomeBanc IV. We make reference to those decisions in like
manner.
8
44-45 (“Bankruptcy Code § 559 permits liquidation of
securities in accordance with a party’s contractual rights, and
the GMRA permits the Bear Stearns defendants to act within
their discretion” to sell the securities upon default.).
The Bankruptcy Court also entered summary judgment
against HomeBanc on the breach of contract claim.
Interpreting the GMRA, which is governed by English contract
law, the Bankruptcy Court noted that while the agreement
required Bear Stearns to rationally appraise the SAI in good
faith, Bear Stearns had sizeable discretion in coming to a fair
market valuation. Due to this broad discretion, the Court held
that there was no dispute of material fact as to whether Bear
Stearns complied with the GMRA since using a bidding
process to value securities was typical practice in the industry
at the time.
B. HomeBanc II
HomeBanc appealed to the District Court, arguing that
the Bankruptcy Court erred by (1) determining that the
transactions involving the SAI qualified as repurchase
agreements entitled to the safe harbor protections of § 559; (2)
interpreting the GMRA to impose a nonexistent subjective
rationality standard for Bear Stearns to value the securities
upon HomeBanc’s default; and (3) deciding that the sale of the
SAI was rational and in good faith.
The District Court affirmed on the first two issues but
remanded for further proceedings as to whether Bear Stearns
complied with the GMRA in good faith. First, the District
Court decided that the transactions underlying the SAI did not
9
qualify as repos under § 101(47)(A)(i) because the
confirmations accompanying the transactions showed that the
securities had a purchase price of zero, allowing the SAI to
“have been transferred back . . . without being ‘against the
transfer of funds . . . .’” 8 J.A. 59-60. Instead, they were credit
enhancements under § 101(47)(A)(v).9 “There is no doubt that
8
11 U.S.C. § 101(47)(A)(i), (v) (“The term ‘repurchase
agreement’ (which definition also applies to a reverse
repurchase agreement)-- (A) means--
(i) an agreement . . . which provides for the transfer of one or
more . . . mortgage related securities . . . against the transfer
of funds . . . with a simultaneous agreement by such transferee
to transfer to the transferor thereof . . . interests of the kind
described in this clause, at a date certain not later than 1 year
after such transfer or on demand, against the transfer of funds
...;
(v) any security agreement or arrangement or other credit
enhancement related to any agreement or transaction referred
to in clause (i), (ii), (iii), or (iv) . . . .) (emphasis added).
9
Although the Bankruptcy Code does not define “credit
enhancement,” the term encompasses various ways that a
borrower may improve its credit standing and reassure lenders
that it will honor its debt obligations. See Credit Enhancement,
OXFORD DICTIONARY OF FINANCE AND BANKING (2014).
Here, the District Court held that HomeBanc engaged in
“credit enhancement” by providing additional collateral to
Bear Stearns with a purchase price of zero. See
Overcollateralization, THE PALGRAVE MACMILLAN
DICTIONARY OF FINANCE, INVESTMENT AND BANKING (1st ed.
2010).
10
the disputed transactions were part and parcel of their
undisputed repo transactions. It therefore seems to me that the
extra securities were plainly within the umbrella of ‘credit
enhancements.’” J.A. 60 (quoting 11 U.S.C. § 101(47)(A)(v)).
While the nine SAI were credit enhancements rather than
traditional repos,10 the District Court still held that they
received the protections of § 559.
As to HomeBanc’s second claim, the District Court
decided that the Bankruptcy Court correctly discerned the
relevant English law, finding that the GMRA’s “reasonable
opinion” language equated to a “good faith” requirement.
The Court, responding to HomeBanc’s last argument,
held that the record created a fact question as to whether Bear
Stearns acted in good faith by auctioning the SAI. Two
concerns led to this decision. First, only Bear Stearns
submitted a bid that included the nine SAI. J.A. 62 (“When . .
. Bear Stearns was the winning bidder because it was the only
bidder, I think that is indisputable evidence that the market was
not working, or that there was something else wrong with the
auction process.”). Second, the District Court believed that the
Bankruptcy Judge erroneously discounted the opinion of
HomeBanc’s expert witness, who stated that Bear Stearns
designed the auction to dissuade outside bidders. Because of
these issues, the case was remanded for further proceedings to
determine if the auction complied with the GMRA.
10
The District Court concluded that the other twenty-eight of
the thirty-seven securities were traditional repos under 11
U.S.C. § 101(47)(A)(i).
11
C. HomeBanc III
Upon remand and after a six-day trial, the Bankruptcy
Court ruled that the auction was fair and customary, and
therefore, Bear Stearns acted in good faith accepting the
auction results as the fair market value of the thirty-seven
securities. In reaching this holding, the Bankruptcy Court
divided the question of good faith compliance with the GMRA
into “three parts: (i) whether Bear Stearns’[s] decision to
determine the Net Value of the Securities at Issue by auction
in August 2007 was rational or in good faith; (ii) whether the
auction process utilized by Bear Stearns was in accordance
with industry standards; and (iii) whether Bear Stearns’[s]
acceptance of the value obtained through the auction was
rational or in good faith.” J.A. 76.
The Court, in addressing the first sub-question,
concluded that Bear Stearns acted in good faith by determining
the securities’ value via an auction, despite the turbulent
condition of the residential mortgage-backed securities market
in August 2007. HomeBanc argued that an auction cannot
provide accurate price discovery when a market is
dysfunctional, and while HomeBanc presented testimony that
the residential mortgage-backed securities market was non-
functional in August 2007, there was substantial opposing
testimony that the market, though troubled, was functioning.
“[T]here was [also] no evidence of other factors that might be
considered indicia of market dysfunction: asymmetrical
information between buyers and sellers, inadequate
information in general . . . , market panic . . . , high transaction
costs, the absence of any creditworthy market participants or
fraud.” J.A. 86. Moreover, “there was no indication . . . when
12
or if market prices would stabilize.” J.A. 85-87. It was
therefore reasonable for Bear Stearns to quickly liquidate the
collateral via a sale. Because the Court found that the market
was functioning in August 2007, it concluded that the auction
was a commercially reasonable determinant of value.
Bear Stearns’s auction process was also found to be
reasonable: the procedures provided possible bidders with
sufficient information to formulate a bid; the 4.5 days to place
bids was more than what was typically given to sophisticated
purchasers of residential mortgage-backed securities; Bear
Stearns solicited many potential buyers, including its main
competitors; and the rules prevented a Bear Stearns affiliate
from gaining an unfair advantage in formulating its bid.
Lastly, the Court held that Bear Stearns acted in good
faith when it accepted the outcome of the auction as the fair
market value of the SAI. HomeBanc maintained that the
auction results were egregious. Using its own discounted cash
flow model, HomeBanc valued the nine SAI at $124.6 million.
HomeBanc’s Chief Investment Officer, however, estimated the
value of the SAI at approximately $18.5 million on August 5,
2007—nine days before the auction closed—a value much
closer to Bear Stearns’s $8.1 million assessment on August 15,
2017. The Bankruptcy Court also highlighted that (1)
HomeBanc tried and failed to find an alternative purchaser who
would pay more for the thirty-seven securities, and (2) Bear
Stearns paid a higher price for the thirty-seventh security than
HomeBanc bargained for with J.P. Morgan.
D. HomeBanc IV
13
HomeBanc appealed again, initially contending that
Bear Stearns did not act in good faith because the auction was
held in a non-functioning market, failed to produce an actual
sale, and resulted in an inexplicable valuation of the SAI.
Finding that the Bankruptcy Court’s good faith determination
was one of historical fact and not clearly erroneous, the District
Court upheld the judgment. The Court faulted HomeBanc for
failing to demonstrate that the mortgage-backed securities
market was dysfunctional in August 2007 or that the auction
was carried out in bad faith.
HomeBanc alternatively asserted that the Bankruptcy
Court erred by ignoring the safe harbor limits for credit
enhancements under 11 U.S.C. § 101(47)(A)(v). Unlike the
broad protections of § 559 that are available for
§ 101(47)(A)(i) repos, HomeBanc believed that credit
enhancements under § 101(47)(A)(v) receive fewer protections
under § 562. “The extent to which credit enhancements qualify
as repurchase agreements entitled to bankruptcy safe harbor
protection is ‘not to exceed the damages in connection with any
such agreement or transaction,’” which must be measured by
“‘commercially reasonable determinants of value.’” J.A. 116-
17 (quoting 11 U.S.C. §§ 101(47)(A)(v), 562).
Based on the connection between §§ 101(47)(A)(v) and
562, HomeBanc claimed that the Bankruptcy Court failed to
(1) recognize that Bear Stearns had violated the automatic
bankruptcy stay and converted the securities, and (2) determine
whether the auction was a “commercially reasonable
determinant” of the securities’ value. The District Court
disagreed, holding that § 562 was inapplicable. Since Bear
Stearns’s liquidation of HomeBanc securities resulted in
14
excess proceeds and Bear Stearns never asserted a claim for
damages, the District Court reasoned that the broad safe harbor
protections of § 559, not § 562, were relevant. HomeBanc
timely appealed to this Court.
II
The Bankruptcy Court had jurisdiction over this matter
pursuant to 28 U.S.C. §§ 157 and 1334, and the District Court
exercised its jurisdiction under 28 U.S.C. § 158(a)(1). 28
U.S.C. § 158(d)(1) provides this Court with jurisdiction to
review the District Court’s final order.
This Court’s “review of the [D]istrict [C]ourt’s decision
effectively amounts to review of the [B]ankruptcy [C]ourt’s
opinion in the first instance.” In re Segal, 57 F.3d 342, 345 (3d
Cir. 1995) (quoting In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989) (internal quotation marks omitted)). We
exercise plenary review of the Bankruptcy Court’s
interpretation of the Bankruptcy Code and clear-error review
of its factual findings. See In re J & S Properties, LLC, 872
F.3d 138, 142 (3d Cir. 2017); In re Abbotts Dairies of Pa., Inc.,
788 F.2d 143, 147 (3d Cir. 1986).
The parties dispute the standard of review that applies
to the Bankruptcy Court’s determination of good faith.
HomeBanc asserts that a good faith determination constitutes
a mixed question of law and fact that is subject to clear-error
review for the underlying factual findings and plenary review
for the Bankruptcy Court’s “choice and interpretation of legal
precepts and its application of those precepts to historical
facts.” In re Trans World Airlines, Inc., 134 F.3d 188, 193 (3d
15
Cir. 1998). Bear Stearns responds that only clear-error review
applies because HomeBanc “sets forth ‘no choice and
interpretation of legal precepts’ of the Bankruptcy Court to
which plenary review would be appropriate.” Appellee Br. at
29 (quoting In re Montgomery Ward Holding Corp., 242 B.R.
147, 152 (D. Del. 1999)).
As a general matter, this Court has long considered the
determination of good faith to be an “ultimate fact.” Hickey v.
Ritz-Carlton Rest. & Hotel Co. of Atlantic City, 96 F.2d 748,
750-51 (3d Cir. 1938). An ultimate fact is commonly
expressed in a standard enunciated by statute or by a caselaw
rule, like negligence or reasonableness, and “[t]he ultimate
finding is a conclusion of law or at least a determination of a
mixed question of law and fact.” Universal Minerals v. C.A.
Hughes & Co., 669 F.2d 98, 102 (3d Cir. 1981). Consequently,
factual findings are reviewed for clear-error while “the trial
court’s choice and interpretation of legal precepts and its
application of those precepts to the historical facts” receive
plenary review. Id. at 103.
Despite these general precepts, determining the
applicable standard of review here is not so straightforward.
We have previously held that whether a party filed a Chapter
11 bankruptcy petition in good faith is an ultimate fact subject
to review as a mixed question of law and fact. In re 15375
Memorial Corp. v. Bepco, 589 F.3d 605, 616 (3d Cir. 2009).
Similarly, we have concluded that whether a debtor is insolvent
is an ultimate fact requiring mixed review. See Trans World
Airlines, 134 F.3d at 193. Some District Courts, however, have
held that good faith determinations under § 363(m) of the
Bankruptcy Code receive clear-error review. See In re
16
Polaroid Corp., No. 03-1168-JJF, 2004 WL 2223301, at *2 (D.
Del. Sept. 30, 2004); In re Prosser, Bankr. L. Rep. 82, 437
(D.V.I. Mar. 8, 2013).
A determination of good faith necessarily flows from
consideration of an array of underlying basic facts, making it
an ultimate fact. See Universal Minerals, 669 F.2d at 102;
Hickey, 96 F.2d at 750-51. Yet, the distinction between basic
and ultimate facts can be murky; sometimes, there are
intermediate steps on the path to an ultimate fact. See In re
15375 Memorial Corp., 589 F.3d at 616 (referring to basic,
inferred, and ultimate facts). This opacity gives us some pause,
but no intermediate steps are currently before us for review.
We therefore hold that a bankruptcy court’s determination of
good faith regarding a mandatory post-default valuation of
collateral subject to a repurchase agreement is an ultimate fact
subject to mixed review.11 A bankruptcy court’s basic factual
findings are examined for clear-error while the ultimate fact of
good faith receives plenary review.
III
On appeal, HomeBanc challenges the District Court’s
decision that § 559, not § 562, was controlling and that Bear
Stearns did not violate the automatic bankruptcy stay. Section
559 gives parties to a repurchase agreement a safe harbor from
the automatic bankruptcy stay, which normally prevents
creditors from collecting, recovering, or offsetting debts
11
We do not (and need not) decide whether good faith is
always an ultimate fact requiring mixed review.
17
without court approval.12 Thus, § 559 generally permits a non-
defaulting party to liquidate collateral, according to the terms
of the relevant repurchase agreement, without seeking court
approval. Section 562 also provides a safe harbor, though it is
more limited. For instance, § 562 requires that “damages” be
measured at a certain time and using a “commercially
reasonable determinant of value.” 11 U.S.C. § 562.
As to whether § 559 or § 562 applies here, the text of
§ 101(47)(A)(v) is dispositive. Subparagraph (v) specifies that
repos include credit enhancements, but such credit
enhancements are “not to exceed the damages in connection
with any such agreement or transaction, measured in
accordance with section 562 of this title.” 11 U.S.C.
§ 101(47)(a)(v) (emphasis added). While the protections of
§ 559 are generally available, the safe harbor does not
encompass a recovery beyond the “damages” claimed. We
therefore must define “damages,” as found in 11 U.S.C.
§ 101(47)(A)(v), to determine if § 562 applies to the nine
SAI—each of which is a credit enhancement.
12
Section 559 states in part: “The exercise of a contractual
right of a repo participant or financial participant to cause
the liquidation . . . of a repurchase agreement . . . shall not be
stayed, avoided, or otherwise limited by . . . order of a court or
administrative agency . . . [and] any excess of the market
prices received on liquidation of such assets . . . over the sum
of the stated repurchase prices and all expenses in connection
with the liquidation of such repurchase agreements shall be
deemed property of the estate . . . .” 11 U.S.C. § 559(emphasis added).
18
HomeBanc asks this Court to interpret “damages” as
meaning a “shortfall,” “loss,” “deficiency,” or “debt.” This
would mean that when a repo participant liquidates a credit
enhancement after default, any amount obtained in excess of
the actual deficiency suffered, as measured according to § 562,
is subject to the automatic bankruptcy stay, even if the surplus
took years to develop. Conversely, Bear Stearns argues that if
there is no claim for damages, then § 562 is inapplicable: The
definition of “damages” must include a legal claim.
“Damages” is not defined within Title 11, but we hold
for several reasons that the term refers to a legal claim for
damages rather than a “loss,” “shortfall,” “deficiency,” or
“debt.” First, “damages” is a term of art. Although probably
not obvious to the layperson, every first-year law student learns
to automatically connect “damages” with what is potentially
recoverable in court, and not necessarily an underlying loss or
injury.13 Damages are “[m]oney claimed by, or ordered to be
paid to, a person as compensation for loss or injury.”
Damages, BLACK’S LAW DICTIONARY (11th ed. 2019); 1 DAN
B. DOBBS, DOBBS LAW OF REMEDIES: DAMAGES-EQUITY-
RESTITUTION § 3.1 (2d ed. 1993) (“The damages remedy is a
judicial award in money, payable as compensation to one who
has suffered a legally recognized injury or harm.”). This is a
plain term, and as a result, defining “damages” as a “debt” or
13
At oral argument, counsel for HomeBanc inadvertently
showed how “damages” are inextricably tied to a legal claim.
He stated, “I think the damages are the - the recovery to which
you may be entitled, if you prove some liability.” Transcript
of Oral Argument at 14, In re HomeBanc Mortgage Corp. (3d
Cir. Sept. 26, 2019) (No. 19-2887).
19
“loss” without any associated legal claim would contradict
common understanding within the legal profession.
Second, “[C]ourts must presume that a legislature says
in a statute what it means and means in a statute what it says
there.” Am. Home Mortg., 637 F.3d at 255 (internal quotation
marks and citations omitted). If Congress had wanted to define
“damages” in a manner different from its commonly
understood meaning, such as a “loss,” “deficiency,” or “debt,”
it could have done so. These terms appear elsewhere in Title
11, yet Congress chose not to employ them here. See, e.g., 11
U.S.C. §§ 703(b), 726(a)(4), 727(a)(12)(B).
Third, other parts of Title 11 support a plain legal
interpretation of “damages.” “Damages” is used throughout
Title 11 to refer to a legal claim. See, e.g., 11 U.S.C.
§§ 110(h)(5)(i)(1)(A)-(i)(2), 362 (k)(1)-(2), 523
(a)(19)(B)(iii). Moreover, the text of § 502(g)(2) and the
section title of § 562 suggest that “damages” means a legal
claim for loss.14
Fourth, defining “damages” as a “loss,” “shortfall,” or
“debt” would create a problematic process for creditors
seeking to quickly liquidate collateral after a default. Under
HomeBanc’s proposed approach, a non-defaulting party would
14
See 11 U.S.C. § 502(g)(2) (“A claim for damages calculated
in accordance with section 562 . . . .”); 11 U.S.C. § 562(“Timing of damage measurement in connection with swap
agreements, securities contracts, forward contracts,
commodity contracts, repurchase agreements, and master
netting agreements”).
20
first determine which collateral constitutes a repurchase
agreement under § 101(47)(A)(i) versus a credit enhancement
under § 101(47)(A)(v): repurchase agreements would receive
the full protection of § 559 while credit enhancements would
be subject to the conditions of §§ 101(47)(A)(v) and 562. Once
the collateral was categorized, a creditor could liquidate only
the § 101(47)(A)(i) repos. Afterwards, the non-defaulting
party would determine if there was any remaining shortfall. If
so, then the § 101(47)(A)(v) credit enhancements could be
sold, one at a time, to fill the hole.
We consider HomeBanc’s approach impractical.
Whether a transaction is a repurchase agreement under
§ 101(47)(A)(i) or a credit enhancement under § 101(47)(A)(v)
is not always clear cut—the parties in this case litigated this
issue for almost a decade. Creditors often seek to liquidate
quickly, but a need to differentiate between repos and credit
enhancements would substantially slow this process. It is also
likely that repo participants would litigate this issue because of
the potential application of §§ 101(47)(A)(v) and 562.
Moreover, the need to differentiate between repurchase
agreements and credit enhancements could eliminate the
ability to buy or sell collateral via “all or nothing” bids. Bear
Stearns, in this case, would have had to conduct multiple
separate auctions: an initial auction to value the twenty-eight
traditional repos and subsequent auctions to individually value
the nine credit enhancements to cover any shortfall. Bear
Stearns could not have made an “all or nothing” bid for the
remaining securities. Such an approach is unduly
cumbersome. The literal application of the statute, in contrast,
does not produce “an absurd result.” See Douglass v.
Convergent Outsourcing, 765 F.3d 299, 302 (3d Cir. 2014).
21
HomeBanc does raise one concern about our approach
which we consider valid: interpreting “damages” to require a
deficiency claim may incentivize bad behavior. A non-
defaulting party may seek to price the collateral at a level equal
to the debt owed by the defaulting party, keeping any upside
for itself and avoiding judicial scrutiny simply by not asserting
a deficiency claim. The nature of repos, however, provides
parties with the opportunity to address this issue contractually.
For example, the GMRA requires a good faith valuation, and
other agreements could do likewise. Furthermore, if a
creditor’s loss is sufficiently large, it will seek damages, even
if doing so invites judicial scrutiny. Because of the
aforementioned reasons, we hold that “damages” as described
in § 101(47)(A)(v) necessitates the filing of a deficiency claim.
IV
Though § 562 is inapplicable because Bear Stearns did
not initiate a damages action, it appears that the auction did not
yield excess proceeds. As this Court has explained, excess
proceeds result when “the market prices exceed the stated
repurchase prices.” Am. Home Mortg., 637 F.3d at 255-56. At
the time of HomeBanc’s default, the contractual repurchase
price for the thirty-seven securities was approximately $64
million, but the auction netted only $61.756 million. That is a
shortfall, not an excess.
Notwithstanding the lack of excess proceeds, we
conclude that the Bankruptcy Court appropriately applied
§ 559. Most importantly, the text of § 559 does not require
excess proceeds:
22
The exercise of a contractual right of a repo
participant or financial participant to cause the
liquidation . . . a repurchase agreement . . . shall
not be stayed, avoided, or otherwise limited by
operation of any provision of this title or by order
of a court or administrative agency . . . . In the
event that a repo participant or financial
participant liquidates one or more repurchase
agreements . . . and under the terms of one or
more such agreements has agreed to deliver
assets subject to repurchase agreements to the
debtor, any excess of the market prices
received on liquidation of such assets . . . over
the sum of the stated repurchase prices and all
expenses in connection with the liquidation of
such repurchase agreements shall be deemed
property of the estate . . . .
11 U.S.C. § 559 (emphasis added). Section 559 states that “any
excess . . . shall be deemed property of the estate.” It does not
say “the excess.” “Any” is commonly used to refer to
indefinite or unknown quantities.15 For instance, is there any
money left in the bank account? In § 559, the indefinite or
unknown quantity is the excess. There may be an excess, but
the text does not demand that one exists. Rather, it establishes
a condition—transferring the property to the estate—if there
15
See Any, MERRIAM-WEBSTER DICTIONARY,
https://www.merriam-webster.com/dictionary/any#learn-
more; Any, OXFORD ENGLISH DICTIONARY,
https://www.oed.com/
view/Entry/8973?redirectedFrom=any#eid.
23
are excess proceeds. The text reveals that § 559 can apply
when there is an excess, shortfall, or break-even amount.
We recognize that in American Home Mortgage we
stated that “[s]ections 559 and 562 address different situations.
Section 559 applies only in the event that a . . . liquidation
results in excess proceeds. . . . § 562 . . . applies when the
contract is liquidated, terminated, or accelerated, and results in
damages rather than excess proceeds.” 637 F.3d at 255-56
(emphasis added). Taken out of context, this dictum could be
wrongly interpreted to suggest that § 559’s authorization of a
repo participant to liquidate collateral applies “only” if the
liquidation results in excess proceeds. This Court used the
word “only” to contrast the ordinary division between § 559
with § 562, not to create a binding either/or proposition. Am.
Home Mortg., 637 F.3d at 255-56. Judge Rendell’s
concurrence implicitly supports this narrow comparative
interpretation, stating that a liquidation of a repurchase
agreement is exempt from automatic stay provisions, making
no mention of whether an excess is necessary for the
protections of § 559. Id. at 258 (Rendell, J., concurring). Our
reading avoids any conflict with the plain text of § 559.
Furthermore, the case before us involves a “loss” or “shortfall”
without a claim for “damages,” presenting unique
circumstances not addressed in American Home Mortgage.
The few cases and treatises that explore this issue show
that a repo participant can liquidate a repurchase agreement
regardless of whether the sale results in an excess, shortfall, or
a break-even amount. See Matter of Bevill, Bresler &
Schulman Asset Mgmt. Corp., 67 B.R. 557, 596 (D.N.J. 1986)
(“Any proceeds from the sale of the securities in excess of the
24
agreed repurchase price are deemed property of the estate.”);
In re TMST, Inc., No. 09-17787-DK, 2014 WL 6390312, at *4
(Bankr. D. Md. Nov. 14, 2014) (“Concomitant to those rights
granted to the repurchase creditor to liquidate with finality the
pledged securities, in Sections 559 and 562 Congress
vouchsafed to the bankruptcy estate the right to any excess
market value of such securities.”); 5 COLLIER ON
BANKRUPTCY § 559.04 (16th ed. 2019) (“Section 559
specifies, however, that any excess proceeds or value
remaining after the nondefaulting party has recovered the
amounts owed to it by the debtor must be paid to the debtor . .
. .”); 1 JOAN N. FEENEY ET AL., BANKRUPTCY LAW MANUAL
§ 7:19 (5th ed. 2019) (a repo “participant is free to offset or net
out any termination value . . . .”); 4 WILLIAM L. NORTON, JR.
AND WILLIAM L. NORTON, III, NORTON BANKRUPTCY LAW
AND PRACTICE § 75:4 (3d ed. 2019) (“Code § 559 also contains
a provision dealing with excess proceeds in the event that a
repo participant liquidates . . . and the repo participant has
agreed to deliver any surplus assets to the debtor. In this event,
any excess . . . shall be deemed property of the estate . . . .”).
Although the auction yielded no excess proceeds, the
protections of § 559 were appropriately applied.
V
Section 559 generally provides an exemption from the
automatic bankruptcy stay to the extent that a liquidation
accords with the relevant repurchase agreement. Thus, Bear
Stearns’s safe harbor is contingent on its adherence to the
GMRA—upon default, to honestly and rationally value the
remaining securities for purposes of crediting HomeBanc’s
debt. The Bankruptcy Court held that Bear Stearns valued the
25
SAI in good faith compliance with the GMRA, but HomeBanc
claims otherwise.16 We exercise plenary review over this
determination of good faith and agree with the Bankruptcy
Court that Bear Stearns complied with the GMRA.
First, HomeBanc contends that the auction did not
provide the fair market value of the SAI because a sale never
occurred. Bear Stearns simply shifted the SAI from the finance
desk to the mortgage trading desk and made an internal
accounting adjustment. The GMRA required that Bear Stearns
reach a “reasonable opinion” regarding the securities’ “fair
market value, having regard to such pricing sources and
methods . . . as . . . [it] consider[ed] appropriate.” J.A. 1038.
There was no clause that required Bear Stearns to sell the
securities to an outside party. Moreover, whether an exchange
of funds occurred is immaterial to establishing the securities’
fair market value.17
HomeBanc also asserts that Bear Stearns acted in bad
faith because it knew or should have known that, given the
dysfunctional market for mortgage-backed securities in August
2007, an auction would not identify the fair market value of the
16
On appeal, neither party contests the Bankruptcy Court’s
conclusion that the GMRA includes a “good faith” standard:
Bear Stearns was required to act in “good faith” when
determining the fair market value of the securities at issue. The
parties dispute whether Bear Stearns’s actions met that
standard.
17
A discount cash flow model, for example, is another way to
determine fair market value without an actual “sale.”
26
SAI.18 HomeBanc highlights, among other things, that (1)
several witnesses testified that the mortgage-backed securities
market was in “turmoil” and “dysfunctional” in August 2007,19
(2) Bear Stearns’s American Home Mortgage auction, a week
prior, failed to produce an outside bidder, and (3) Bear Stearns
reduced its internal valuation of the thirty-seven securities
from roughly $119 million on Friday, August 3, 2007 to
approximately $68 million on Monday, August 6, 2007.
Despite this evidence, the Bankruptcy Court was correct
in determining that there was good faith where the market for
18
The parties have invoked the term “market dysfunction.”
Neither the briefs nor oral argument provided substantial
insight into this term and its meaning. Although there seems
to be no accepted definition, dysfunction likely includes low
liquidity and enough instability in a market such that the
routine price discovery process is not functioning properly.
Whether the securities market in August 2007 was
dysfunctional is a significant question because it bears on
whether Bear Stearns rationally valued the securities using an
auction. In American Home Mortgage, this Court endorsed the
view that “the market price should be used to determine an
asset’s value when the market is functioning properly. It is
only when the market is dysfunctional and the market price
does not reflect an asset’s worth should one turn to other
determinants of value.” 637 F.3d at 257.
19
A Bear Stearns securities trader testified that the market was
“dysfunctional” with “little to no liquidity,” and a former Bear
Stearns senior managing director testified that “we knew it was
a bad market” and that the market was “illiquid.” J.A. 870,
899, 1007-09.
27
mortgage-backed securities was sufficiently functional to
conduct an auction that complied with the GMRA. A Bear
Stearns employee, an economic consultant, and an outside
executive familiar with the repurchase market all testified that
the market was turbulent but not dysfunctional. The record
also contains substantial additional testimony to support this
characterization: other traders of mortgage-backed securities
stated that transactions were occurring in the summer of 2007.
There is also little evidence indicative of market dysfunction,
such as potential buyers lacking sufficient information to price
securities and the absence of any creditworthy market
participants. Here, HomeBanc mistakenly equates a declining
market with a dysfunctional one. The residual mortgage-
backed securities market was functioning adequately for Bear
Stearns, in good faith, to value the SAI via an auction.
Alternatively, HomeBanc argues that the auction
procedures were flawed, rendering the sale price inaccurate.
One academic witness testified that the information supplied to
potential bidders was inadequate, the time given to submit a
bid unreasonably short, and the bidding rules intentionally
designed to frighten away outside interest. This contrasted
with the testimony of several securities traders who opined that
the information provided in Bear Stearns’s bid solicitation was
sufficient to value the securities, the auction provided adequate
time to formulate a bid, and the bidding rules were attractive
rather than off-putting. Bear Stearns’s solicitation reached
many potential buyers, including several of its competitors.
Additionally, the auction rules were designed to prevent Bear
Stearns’s mortgage trading desk from obtaining any
objectionable advantage—(1) Bear Stearns affiliates had to
submit their bids thirty minutes before the deadline for outside
28
bids, and (2) Bear Stearns’s legal department, which was
located in a separate building from the mortgage trading desk,
collected all the bids. We will not disturb the Bankruptcy
Court’s finding that the auction process followed proper
industry practices.
HomeBanc also maintains that Bear Stearns did not
value the SAI in good faith compliance with the GMRA
because the post-auction value assigned to each of the nine
SAI, $900,000 a piece, was arbitrary—Bear Stearns never
justified why it valued each security at $900,000. The SAI
were diverse, having different collateral and cash flow rules,
and Bear Stearns valued each differently weeks before the
auction. Thus, HomeBanc insinuates that the allocated amount
had no relationship to what the securities were actually worth.
“[T]he $900,00 ‘price’ is simply what remained of Bear
Stearns’s total bid after subtracting the unchallenged
valuations attributed to the 27 securities not at issue, neatly
divided across the securities at issue.” J.A. at 38-39.
The GMRA required a rational, good faith
determination of the fair market value of the securities, and this
requirement could be met by a reasonable all-or-nothing bid
for the securities. A buyer may allocate the winning bid in a
variety of ways, but the defaulting party’s debt is always
credited the same amount: no matter how Bear Stearns divided
its bid of $60.5 million, HomeBanc’s debt only decreased by
that lump sum amount. We see no need to address this
argument further since the post-auction allocation to individual
securities says little about whether the all-or-nothing bid
constituted a fair market valuation.
29
In spite of HomeBanc’s attempts to show otherwise,
Bear Stearns acted in good faith compliance with the GMRA:
the market conditions were adequate to ascertain fair market
value via an auction, and the auction procedures were
adequate. Consequently, Bear Stearns rationally accepted the
auction results as providing the fair market value of the
remaining thirty-seven securities. Bear Stearns was obligated
to follow the GMRA, and it did so.
VI
In conclusion, we hold that (1) a Bankruptcy Court’s
determination of good faith regarding an obligatory post-
default valuation of collateral subject to a repurchase
agreement receives mixed review. Factual findings are
reviewed for clear-error while the ultimate issue of good faith
receives plenary review; (2) 11 U.S.C. § 101(47)(A)(v)
“damages,” which may trigger the requirements of § 562,
require a non-breaching party to bring a legal claim for
damages; (3) the safe harbor protections of 11 U.S.C. § 559 can
apply to a non-breaching party that has no excess proceeds; and
(4) Bear Stearns liquidated the securities at issue in good faith
compliance with the GMRA. Thus, we will affirm the
judgment.
30