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By Andrew Park
NEW YORK, Dec 11 (IFR) - A US court this week dealt investors a heavy blow in their battle with Lehman Brothers, the defunct US investment bank they claim breached representations and warranties made on bonds backed by shaky home mortgages.
Judge Shelley Chapman declined a motion on Wednesday for Lehman to increase the amount of reserves it must hold to make payments on 255 residential mortgage-backed securities (RMBS) from US$5bn to US$12.1bn.
Chapman also said all 209,000 mortgages underpinning the bonds must be reviewed one-by-one.
Judge Chapman ruled in favor of Lehman and against the trustees on the bonds, who are suing to get what remains of the bankruptcy estate to buy back the infringing loans.
Lehman produced two witnesses in court to say the review could be completed in a year - a claim the plaintiffs as well as observers of the case dismissed as absurd.
“There is absolutely no way in hell the process will take a year,” one RMBS analyst told IFR.
Lehman asserts that all the loans need to be reviewed on a case-by-case basis before any repurchase of the bonds can take place.
Lawyers for the trustees had pushed for statistical sampling to estimate the total damages for which Lehman could be held liable.
Witnesses called on behalf of the trustees said the loan-by-loan review would take decades.
The plaintiffs said that they tried to prepare a statistical sample of 5,000 of the underlying loans to a forensic underwriter to help bolster their case.
But they could only get hold of the paperwork for just under 4,600 of them - and even that, they said, took some 18 to 20 months to accomplish.
Charles Parekh, director of Duff & Phelps, a valuation and advisory firm, testified that the bankruptcy court, dedicating one week per month to the case, would take 21 years just to review the disputed loans.
But Chapman said long timelines for such comprehensive reviews was not unusual.
Pointing to the large number of claims in the Bernie Madoff bankruptcy and fraud case, she said: “They get done when they get done.”
If the process does drag on for years, it will reduce the pool of cash available to settle claims that R&W were breached, as payments will continue to be made to other unsecured Lehman creditors during this time.
Chapman said statistical sampling could not be used for the entire loan pool, though said it might be permissible at some point in the future on a small percentage of loans.
The two sides are now working on determining the logistics and mechanics of what happens next, according to one of the attorneys involved in the case.
The process includes engaging forensic underwriters, who would then re-underwrite the loans to determine whether they were in breach of R&W.
Loans that appear to require a repurchase would then be submitted to a claim negotiator. Loans in dispute between the trustee and Lehman would be argued back in court.
Parekh said the process could move faster if the bankruptcy court was willing to hear the disputed claims full-time.
“That’s not happening,” Chapman said. (Reporting by Andrew Park; Editing by Natalie Harrison and Marc Carnegie)