Corporate headquarters of Bank of America in Charlotte, N.C.
Corporate headquarters of Bank of America in Charlotte, N.C. (AP/Chuck Burton)

Manhattan Supreme Court Justice Barbara Kapnick (See Profile) approved most of a $8.5 billion settlement Friday struck between Bank of America and investors exposed to major losses from troubled mortgage-backed securitizations prior to the financial crisis.

It was the final ruling issued by the Commercial Division judge before her appointment to the Appellate Division, First Department becomes effective today.

In a 54-page ruling, Kapnick said the settlement—reached in June 2011 with 22 investors after a year of discussion only to be challenged by a small contingent of investors led by insurance behemoth AIG for allegedly falling short of covering actual losses—was made in good faith and within the bounds of reasonableness.

The judge held that Bank of New York Mellon, as the trustee for these certificate holders, “did not abuse its discretion in entering into the settlement agreement and did not act in bad faith or outside the bounds of reasonable judgment.”

Kapnick, who presided over a nine-week evidentiary hearing in 2013 during an Article 77 proceeding initiated to approve the settlement, noted it was “clear” that BNYM placed “considerable weight” on the fact that the settlement had the backing of 22 institutional investors, including BlackRock, MetLife, Pa-cific Investment Management Company and the Federal Home Loan Mortgage Corporation.

The settlement, which involves 530 trusts comprised of loans that stemmed from subprime lender Countrywide Financial acquired by Bank of America in 2008, extinguishes potential claims arising from a failure to repurchase faulty loans and successor liability, among others.

Friday’s much-anticipated decision from the trial court was regarded as an opportunity to establish some precedent-setting groundwork as to what extent trustees have a duty in protecting the interests of investors of such securities.

Kapnick did reject one piece of the settlement in holding that the trustee had not acted in good faith in settling loan modification claims, which involves the repurchase of up to $31 billion worth of modified loans that are separate from the $8.5 billion figure.

“It is clear that the Trustee was aware of the issue and did include it in a list of settlement issues to discuss with Bank of America,” Kapnick wrote, adding that BNYM could have retained an expert to “opine on the contract interpretation of the various provisions of the PSAs that address the repurchase of modified loans.”

Kapnick stayed an entry of her judgment until Feb. 7.

“We are pleased that the Court refused to approve the proposed settlement in its entirety and found that the trustee acted unreasonably in agreeing to compromise billions of dollars of investor claims,” AIG said in a statement. “We respectfully disagree with the other aspects of the Court’s ruling, which are not supported by the record and which set a dangerous precedent that could eliminate important protections for investors.”

Mark Zauderer, partner at Flemming Zulack Williamson Zauderer who is among counsel representing AIG, said the case “will continue for years to come both at the trial and appellate levels.”

AIG and other investors who opposed the settlement—a list which at one point included four dozen entities but has since significantly narrowed—argued in court briefs that the discussion talks among investors, Bank of America and BNYM amounted to “a secret low-ball settlement” without the trustee “investigating or valuing any of the claims.”

Objectors furthermore argued that fairness in settlement was stymied due to the conflict of interest created by Mayer Brown’s representation of BNYM when it had counted among its clients Bank of America plus several of the institutional investors.

A waiver at the outset provided that should settlement negotiations fail, Mayer Brown would not bring action against Bank of America on behalf of BNYM.

AIG also argued there was no loan file review conducted prior to settlement and that investors’ losses are projected at $100 billion.

Kapnick’s opinion notes that amidst negotiations, conducted over the course of a year via face to face meetings, conference calls and “thousands of email exchanges,” the negotiated figure ranged from $1.5 billion on Bank of America’s end to $16 billion by the institutional investors.

In a statement, BNYM said it was “extremely pleased that the court has vindicated the trustee’s actions by overwhelmingly approving the settlement.” Matthew Ingber, a partner at Mayer Brown, declined to comment on the ruling.

AIG said it plans to file post-trial motions challenging aspects of the court’s ruling and to determine how losses per trust would be assessed along with the method of allocating the settlement amount among the trusts.

Were any issues to head to the First Department on appeal, Kapnick is automatically recused from serving on the presiding panel, said Office of Court Administration spokesman David Bookstaver.

The settlement is not consummated until all appeals are exhausted.