On February 5, 2016, the Bank of New York Mellon (“BNY Mellon”), in its capacity as trustee of 530 RMBS trusts, filed an Article 77 petition with the Supreme Court of the State of New York requesting instruction as to how it should distribute proceeds from an upcoming $8.5 billion settlement payment from Bank of America Corporation. The settlement payment relates to a 2011 settlement of claims arising from representations and warranties made by Countrywide Financial Corporation and Countrywide Home Loans, Inc. in connection with the 530 RMBS trusts at issue.

The petition highlights a dispute among Certificateholders in the 530 trusts regarding how settlement proceeds should most fairly be disseminated to investors. Among other consideration, the petition concerns the application of “write up” provisions—by which the principal balance on previously written-down certificates is increased—and how these provisions could affect the allocation of proceeds in over-collateralized trusts.  The petition states that the distribution process may create the artificial appearance that a trust’s overcollateralization target was hit, resulting in the unintended “leakage” of settlement proceeds to subordinated Certificateholders, at the expense of the senior tranches.

Petitioners request the court clarify whether BNY Mellon must: (a) pay disbursements first and subsequently adjust the overcollateralization calculation to prevent leakage; (b) pay disbursements first and make no adjustment to the overcollateralization calculation, thereby permitting leakage; or (c) change its settlement disbursement operations to “write up first and pay second.” As BNY Mellon puts it: “the resolution of this question has significant consequences . . . affecting the distribution of potentially billions of dollars.” Verified Petition.