Master Repurchase Agreement Penetrates the Automatic Stay

By: Valerie Sokha

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

The derivatives provisions of the 2005 BAPCPA amendments greatly enlarged the scope of the financial contracts that are shielded from traditional bankruptcy limitations such as the automatic stay and the prohibition on ipso facto clauses.  Those exceptions were reaffirmed in a strong anti-debtor opinion in American Home Mortgage, Holdings, Inc. v. Lehman Brothers Inc.

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Although Lehman may now regret its victory since it is a debtor in its own bankruptcy case, it succeeded in defeating a number of theories that might have limited the scope of the exceptions.  In an opinion relying in part on the market protection policy reflected by the exceptions, the Delaware Bankruptcy Court adopted a liberal definition of “repurchase agreement” that turned mostly on the intention of the parties as stated in the four corners of their agreement.

 

Although financial derivative contracts were given special treatment under prior law, BAPCPA provided a greater shield for participants in such transactions with parties who file for bankruptcy protection. By expanding the definition of a repurchase agreement,

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BAPCPA extended protection to a much larger range of repurchase agreements by permitting ipso facto clauses that terminate the contract upon a bankruptcy filing

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and by exempting from the section 362 automatic stay the exercise of setoff remedies on default.

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The Court in American Home adopted a broad interpretation of the scope of repurchase agreements

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entitled to the safe harbor protections to include a master repurchase agreement (“MRA”).

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In this case, American Home Mortgage (“AHMIC”), the mortgage lender, and Lehman Brothers (“Lehman”), the brokerage, entered into a master repurchase agreement in which AHMIC purchased two Subordinated Notes (“Notes”) that were secured by mortgage loans from Lehman totaling at $84,125,000. In deciding if the MRA would be entitled to the safe harbor protections the Court looked at whether the MRA qualified as a repurchase agreement as defined in section 101(47) of the Bankruptcy Code

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and adopted a two part test for its application.

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First, the American Home Court determined whether the Notes qualified as “mortgage related securities, mortgage loans, interests in mortgage related securities or interests in mortgage loans.”

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Second, the Court determined whether “the structure of the MRA follows the structure of a “repurchase agreement” as defined by the Bankruptcy Code.”

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Although these notes did not qualify as mortgage related securities since they had not received a high enough rating by rating agencies, the Court held that the fact that the Notes were secured by mortgage loans meant that they qualified as “interests in mortgage loans.”

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  The Court reasoned that the term “interest” did not require that the Notes themselves be mortgage loans and that the lien on the underlying mortgage loans was an “interest” in mortgage loans to qualify.

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 The Court also rejected the argument that the agreement was a traditional UCC Article 9 security interest rather than a repurchase agreement.  Relying primarily on the intention of the parties as expressed in the four corners of their agreement, the Court found that the MRA was a repurchase agreement

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and thus entitled to the safe harbor provisions.

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In a similar case decided only four months prior to the American Home decision, the Delaware Bankruptcy Court also found that a contract for the sale and repurchase of mortgage loans was a repurchase agreement as defined under section 101(47) of the Bankruptcy Code.

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However, in that case, the Court severed the agreement into its component servicing rights and repurchase provisions and refused to extend the financial contract protections to the servicing rights aspects of the agreement. The Court focused largely on the economic implications that would ensue if these repurchase agreements are not excluded from the automatic stay provisions under the Bankruptcy Code.

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Discussing the impact that these repurchase agreements have on both US and global markets, the Court found it essential to enforce their liquidity and exclude them from the automatic stay provision in order to protect the financial markets from the risk that the debtor’s default might cause a cascading series of counter-party bankruptcies if the counter-parties were unable to promptly liquidate the contracts.

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