Vol 5 (2008) - Issue 2

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Calyon New York Branch v American Home Mortgage, Corp. (In re American Home Mortgage, Inc.): Bankruptcy Court Identifies Limits of Safe Harbour Provisions Applicable to Mortgage Loan Repurchase Agreements

Introduction

In a recent ruling, the US Bankruptcy Court for the District of Delaware (the 'Court') held that mortgage servicing rights and mortgage loan repurchase obligations contained in a single agreement could be severed for purposes of applying the 'safe harbour' provisions of the Bankruptcy Code. The Court concluded that while the repurchase obligations fell within the safe harbour
provisions of Bankruptcy Code sections 555 and 559, which permit the liquidation, termination or acceleration of repurchase agreements upon the bankruptcy filing of the counterparty, the mortgage servicing rights did not. As a result, while the non-debtor counterparty to the contract was permitted to exercise rights and
remedies in respect of the repurchase obligations that would have been prohibited but for the safe harbour, it was not permitted to take action to reclaim the servicing rights. In a case of first impression, the Court's ruling in In re American Home Mortgage, Inc. adheres to the plain meaning of the applicable Bankruptcy Code provisions, and reaches a conclusion that should guide other courts during the rising wave of mortgage-related insolvencies.

The automatic stay and safe harbours

The automatic stay is one of the fundamental protections afforded to debtors under the Bankruptcy Code. The stay arises immediately upon the filing of a bankruptcy petition and generally applies to any act to obtain possession
of, or exercise control over, property of a debtor's bankruptcy estate, as well as to the commencement or continuation of most legal and administrative proceedings against the debtor. The automatic stay is subject to a number of exceptions, as set forth in Bankruptcy Code section 362(b). For example, the automatic stay does not apply to the exercise by a governmental unit of its police or regulatory powers, such as the commencement or continuation of criminal proceedings.

In enacting the Bankruptcy Code, Congress also recognised the specialised needs of the financial markets and created certain 'safe harbours' for enforcing rights under, or terminating, certain types of financial contracts notwithstanding the automatic stay. Specifically,Congress excepted these contracts from the automatic stay restrictions on setting off mutual claims. In addition,although Bankruptcy Code section 365(e)(1) generally prohibits the termination or modification of a contract based upon a provision that is conditioned on the solvency or financial condition of the debtor, or the occurrence of an insolvency event such as a bankruptcy filing (such provisions being generally referred to as ipso facto provisions), the safe harbour provisions expressly permit certain protected persons to exercise ipso facto rights with respect to certain financial contracts.

These safe harbours, which were first added to the Bankruptcy Code in 1982 and expanded as part of extensive amendments in 2005, are currently found in Bankruptcy Code sections 555 (applicable to securities contracts), 556 (commodities contracts and forward contracts), 559 (repurchase agreements), 560 (swap agreements) and 561 (master netting agreements). In addition, Bankruptcy Code section 562 sets forth procedures for determining the measure of damages
under a financial contract that has been liquidated, terminated or accelerated by the non-debtor party under the safe harbour provisions, or that has been rejected by the debtor.