Earlier this year, the United States Bankruptcy Court for the District of Delaware issued an important decision in American Home Mortgage, Inc. regarding the scope of the recently amended definition of a “repurchase agreement”. Under the Bankruptcy Abuse Prevention Consumer Protection Act of 2005, Congress broadened the Bankruptcy Code’s definition of "repurchase agreement" to include the transfer of "mortgage related securities, mortgage loans [and] interests in mortgage related securities or mortgage loans." A review of the opinion in Calyon New York Branch v. American Home Mortgage Corp., 379 B.R. 503 (Bankr.D.Del. 2008) provides guidance regarding how courts apply the revised definition going forward. Furthermore, given the increase in mortgage related bankruptcies, Judge Christopher S. Sontchi’s decison In American Home Mortgage, Inc. addresses an important issue which is likely to arise again in future bankruptcy proceedings.
American Home Mortgage originated, sold and serviced subprime loans. Prior to filing for bankruptcy, Calyon New York Branch issued a notice of default to American Home, demanding that it repurchase the loans in Calyon’s possession. Soon after American Home filed for bankruptcy, Calyon sought a declaratory judgment finding that the agreement between the parties was a “repurchase agreement” as defined under the Bankruptcy Code. Calyon also asked the court to find that the entire contract was a repurchase agreement, including the portion of the agreement governing loan servicing.
The court agreed with Calyon that the terms of the agreement rendered it a “repurchase agreement,” however, the court rejected Calyon’s argument that the loan servicing portion was a repurchase agreement. The court based its decision on the plain meaning of the contract. Applying the definition of “repurchase agreement” to the terms of the contract, the court found that American Home Mortgage agreed to transfer the originated loans to Calyon in exchange for funds, Calyon agreed to transfer the loans back to American Home Mortgage, also for funds, and the second transfer by Calyon was made within 180 days of the first.
By finding that the parties entered into a repurchase agreement, Calyon could proceed with its rights under the contract despite the automatic stay’s injunction against actions arising from a pre-bankruptcy default. However, Calyon did not receive such “safe harbor” protection for the loan servicing portion of the contract. Instead, the court found that the servicing component was an asset of American Home Mortgage that could be severed from the repurchase portion of the agreement.
In order to find that loan servicing could be severed from the repurchase agreement, the court considered several factors, most important of which was the language of the agreement. The loans were sold on a “servicing retained” basis, instead of “servicing released.” Had the parties intended to transfer the servicing rights to Calyon, the loan would have been structured as a servicing released agreement, resulting in Calyon paying a higher premium for the loans.
American Home Mortgage sheds light on how parties to a loan repurchase agreement can receive the protections provided under the Bankruptcy Code by satisfying the Code’s definition of “repurchase agreement.” It is the language of the agreement, not the economics of the transaction, that determine whether a contract is a repurchase agreement. Additionally, whether the servicing portion of the contract remains with the loan originator, versus the loan purchaser, also depends on the terms of the contract. By clarifying what constitutes a repurchase agreement under the Bankruptcy Code, American Home Mortgage provides guidance and certainty to parties drafting repurchase agreements, or those seeking to enforce their rights under an agreement with a lender in bankruptcy.