Wells Fargo Bank, National Association, as Trustee v. Margate Funding I, Ltd.

Background

Wells Fargo Bank, National Association, acting as trustee of the Margate Funding I, Ltd. securitization trust, filed an interpleader action to have the court determine the competing rights to trust funds. An interpleader action allows a holder of disputed property to deposit or retain the property while the court decides which claimants are entitled to it. Wells Fargo had already been discharged from liability and held $20,845,308.25 in an interest-bearing account.

The trust held residential mortgage-backed securities and had issued senior and junior notes. Under the trust indenture, income was distributed through a priority system, or “waterfall”: interest owed to the senior note-holders was paid first, followed by interest to the junior note-holders, then principal on the senior debt, and finally principal on the junior debt. Pacific Investment Management Company LLC (PIMCO) was the real party in interest for the senior note-holders. Angelo Gordon Management, LLC and Bracebridge Capital, LLC were the real parties in interest for the junior note-holders.

The trust’s collateral manager determined that nine securities were defaulted securities and arranged an intraday auction on March 18, 2021. More than thirty potential bidders were notified, twelve participants submitted at least thirty-five bids, and all nine sales were completed that day. Five securities met the indenture’s definition of defaulted securities because their credit ratings had fallen substantially; the other four qualified as credit-risk securities because their credit spreads had increased. The indenture required the sale of defaulted securities within specified periods and allowed the collateral manager to sell credit-risk securities at its discretion. It also required commercially reasonable conduct.

Parties’ Positions and Proceedings

The junior note-holders later challenged the classification and sale of four securities. The collateral manager acknowledged that failure to pay interest, standing alone, was not enough to classify the securities as defaulted, but stated that the sales could not be undone. The manager also explained that it sold the securities because of their distressed condition and uncertainty surrounding the expected cessation of LIBOR, the interest-rate benchmark used in the indenture.

PIMCO and the junior note-holders filed cross-motions for summary judgment. Summary judgment is a decision without a trial when the material facts do not require a credibility determination and the law can be applied to those facts. With the parties’ agreement, the court converted the proceeding into a hearing under Federal Rule of Civil Procedure 52 because there were no credibility issues. After oral arguments on January 22, 2025, the court granted PIMCO’s motion and denied the junior note-holders’ cross-motion, while stating that the relief needed to be reduced to account for interest overpayments.

Findings and Ruling

Judge Alvin K. Hellerstein found that the collateral manager was authorized to sell all nine securities. The court found that all nine were distressed and met the indenture’s criteria for either credit-risk or defaulted securities. It further found that the manager’s decision to sell was commercially reasonable, including because the manager had sought to sell the securities for some time and faced uncertainty related to LIBOR’s expected cessation.

The court also found that the auction itself was commercially reasonable. The number of bidders and bids, along with the prices received, supported that conclusion. The court rejected the junior note-holders’ argument that a longer sale period would have produced better prices as speculative. The court noted that any better prices would have benefited the senior, rather than junior, note-holders.

The court concluded that PIMCO was entitled to the escrowed proceeds plus interest at the New York statutory rate, subject to an adjustment. Because the quarterly interest payments had already been paid in full to both classes when the securities were sold, the sale proceeds should have reduced the senior notes’ principal. Instead, interest continued to be paid to PIMCO without accounting for the reduced principal balance. The court found that PIMCO had received total interest overpayments of $409,102 from September 2021 through December 2022.

The resulting award was to be calculated as the escrow amount, with interest at nine percent from March 22, 2021 through February 14, 2025, less interest accumulated in the escrow, and less the $409,102 in overpayments with nine-percent interest calculated from the dates of those overpayments. The parties were ordered to provide the necessary calculations by February 21, 2025 so that judgment could be entered. The court also ruled that PIMCO would have judgment for costs as taxed by the Clerk and directed the Clerk to terminate all open matters.