ResCap Bankruptcy Report Erodes Some Creditor Arguments

   By Andrew R. Johnson 
 

Mortgage lender Residential Capital LLC had a rocky relationship with parent company Ally Financial Inc., though dealings between the two firms don't adequately support claims that Ally intentionally set ResCap up for failure, an independent examiner has determined.

But while the examiner concluded that several potential claims that Ally harmed ResCap financially and defrauded the subsidiary's creditors would likely fail, he also said an initial settlement Ally reached last year with ResCap and its creditors was unlikely to have gained court approval because the proposed amount was too small.

The findings were made public in a highly anticipated report released Wednesday after U.S. Bankruptcy Judge Martin Glenn ordered that the report be unsealed during a hearing over a subsequent $2.1 billion settlement Ally reached last month with ResCap and its creditors.

The report, totaling more than 2,200 pages and costing ResCap's bankruptcy estate an estimated $80 million, was scheduled for release last month, but Judge Glenn agreed to allow the report to be filed and kept under seal while ResCap, creditors and Ally put the finishing touches on the settlement. The settlement, which Judge Glenn approved, is seen as crucial to moving the case along.

Conducted by former U.S. Bankruptcy Judge Arthur J. Gonzalez and championed by creditors including Berkshire Hathaway Inc. (BRKA, BRKB), the examination was intended to address questions surrounding the activities of ResCap and Ally in the years leading up to the mortgage subsidiary's Chapter 11 bankruptcy filing in May 2012.

Creditors of ResCap, including mortgage insurers and bondholders, alleged Ally exerted full control over ResCap throughout their existence, fueling arguments that the parent company should be on the hook for an estimated $25 billion of ResCap mortgage liabilities.

Ally, which is 74% owned by the U.S. government after receiving a $17.2 billion bailout during the financial crisis, long maintained that it and ResCap operated independently of each other, conducting transactions at "arm's length."

Judge Gonzalez found several problematic aspects of the Ally's and ResCap's relationship, questioning whether Ally's board fully informed its subsidiary's directors of key details about various restructuring moves taken in 2005 and the ensuing years to protect Ally's financial position. Ally at the time was owned by General Motors Co. (GM), which was facing intense financial difficulties that threatened the credit ratings of Ally.

But the examiner determined it would difficult for parties to prove Ally fraudulently transferred assets, including an ownership in Ally's bank subsidiary, from ResCap. He also concluded that arguments that Ally "pierced the corporate veil," meaning Ally and ResCap acted as "a single economic entity," were unlikely to succeed.

"The evidence supports the proposition that ResCap became unable to satisfy its creditors because of the billions of dollars in operating losses it recorded beginning in the fourth quarter of 2006--not because of an abuse of the corporate form by" Ally, the report said.

It is unclear how the findings may affect ResCap's bankruptcy case going forward. Examiners' reports are not binding on the bankruptcy court, though creditors could use details to support arguments in the future.

A spokeswoman for Ally did not immediately respond to a request for comment about the report, nor did attorneys for Berkshire Hathaway, which was pushing for the report's release.

The report is the result of one of the largest bankruptcy examinations ever conducted. Professionals retained by Judge Gonzalez reviewed nearly nine million pages of documents provided by 23 different parties, according to the report. They also conducted nearly 100 interviews of 83 witnesses, including executives with ResCap, Ally and Cerberus Capital Management LP, a minority owner of Ally.

"We're pleased that the report has been released and we're hopeful that we'll assist the parties in resolving" their claims, Howard Seife, an attorney with the law firm Chadbourne & Parke LLP who represents Judge Gonzalez, said Wednesday.

The release of the report was seen as a crucial driver to getting ResCap, its creditors and Ally to agree to the settlement Judge Glenn approved Wednesday. Under the deal, Ally agreed to pay $2.1 billion to ResCap's bankruptcy estate to be distributed to creditors. The agreement prevents parties from backing out of the deal based on findings in the examiner's report.

The settlement replaced the earlier agreement under which Ally proposed paying $750 million to the bankruptcy estate. ResCap's creditors balked at the amount, arguing it was too small compared with the size of ResCap's liabilities.

Judge Gonzalez said in the report it was "unlikely" that a court would have approved the prior settlement with Ally because the liability releases that deal afforded Ally were worth more than its $750 million price tag.

ResCap, once the country's fifth-largest mortgage servicer and 10th-largest mortgage lender, filed for Chapter 11 bankruptcy in May 2012 as litigation over soured mortgage securities mounted and bond payments loomed. The move was intended to help Ally, which is not part of the bankruptcy, to sever itself from those issues so it can focus on repaying the bailout it received during the financial crisis.

--Marie Beaudette, Patrick Fitzgerald and Jacqueline Palank contributed to this story.

Write to Andrew R. Johnson at [e-mail]

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