The United States Court of Appeals for the Third Circuit effectively overrode a repurchase agreement (“repo”) damages provision with its decision in Credit Agricole v. American Home Mortgage Holdings, Inc. in early 2011. The court affirmed a Bankruptcy Court ruling that attested to the valuation of deficiency claims in the event of bankruptcy on the “intrinsic value” of underlying assets at the time of acceleration, despite the fact that counterparties may not sell and markets may be frozen. As a result, counterparties had much less claim to damages. In this case, the counterparty argued that it was entitled to $478 million in damages, while the debtor argued that the claim was intrinsically valued at zero. The courts sided with the debtor. The decision marked the first time that a Circuit Court had issued a decision on this issue.
In this case, American Home argued that the Bankruptcy Code provides a “safe harbor” with provisions contained in section 562. The argument claimed that a repo counterparty’s deficiency claim should be fixed at the date of acceleration despite the fact that the counterparty did not sell underlying mortgage assets at that time. Typically, repo counterparties would declare defaults early and pair them with generous advance rates so that the mortgage values had fallen significantly by the date of disposal and the dollar amounts in question had skyrocketed.
The “safe harbor” provisions of the Bankruptcy Code give counterparties a number of rights in repo cases. However, they may also create major burdens on these parties and new requirements that are inconsistent with repo contracts. In the case in question, for example, the actual repo documentation clearly favored the argument of the counterparty. The Circuit Court overrode this documentation by pointing directly to the Bankruptcy Code. Other court decisions have created similar precedents by overthrowing provisions spelled out in secure loans and contracts due to the wording of the Bankruptcy Code.