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 andrew.r.johnson@dowjones.com
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