Why Bank of America Might Lose at This Important Hearing

This is the week that the fate of a distinctly unsettled prior settlement between Bank of America (NYSE: BAC  ) and 22 institutional investors gets put to the test in the courtroom of New York State Supreme Court Justice Barbara Kapnick. At issue is a New York law called Article 77, which will be used to answer the question of whether or not Bank of New York Mellon (NYSE: BNY  ) , as trustee for the settlement, acted reasonably in accepting the terms on behalf of the complainants.

Certainly, the $8.5 billion settlement amount is big enough to worry about all on its own, but there is another issue here, and for Bank of America, it's huge: Does B of A have successor liability for the bad behavior of Countrywide?

Intertwined with the Article 77 matter
It's a valid question, and it is considered germane to whether BONY acted in a reasonable manner pursuant to the settlement. As BTIG's Mark Palmer has noted, the pact was based upon the notion that B of A did not have successor liability, so revisiting that particular point might throw the whole deal out the window, and cause B of A lots of anguish -- both now and in the future.

Of course, as Alison Frankel muses, Kapnick could take the path of least resistance and endorse the settlement. This would save both B of A and BONY a big hassle, and prevent everybody from having to go back to the starting gate.

But, it probably won't be that easy. The question of successor liability by B of A for Countrywide has come up before, in the recently settled battle between the bank and monoline insurer MBIA (NYSE: MBI  ) . Earlier this year, the insurer filed with the New York courts a very long and colorful presentation in its bid to win summary judgment on this very issue. Despite its effort, however, New York State Supreme Court Justice Eileen Bransten wouldn't rule either for or against the question, citing disputed facts that needed more scrutiny. But, in a blow to Bank of America, she did decide that the successor liability issue should be heard in New York, rather than Delaware, which was B of A's preferred venue.

NY AG's case seems to favor a loss for B of A
Kapnick could still decide that there is no such liability on Bank of America's part toward Countrywide, but she would be going up against the Attorney General of New York, who last year filed suit against B of A for $1 billion in damages regarding substandard loans Countrywide sold Fannie Mae and Freddie Mac several years ago.

In the complaint filed in the so-called "Hustle" case, U.S. Attorney Preet Bharara outlines how the state of New York considers Bank of America to be liable for this shoddy behavior -- both as a direct participant, and as the successor to Countrywide. Preet alleges that the two entities engaged in a de facto merger, much as MBIA had -- at least, according to New York law. And, that's what counts at this point.

Will Kapnick approve the settlement without going into all these issues? In its motion to have the Hustle suit dismissed, B of A argued only that the AG's office hadn't proved fraud. For obvious reasons, the question of the bank's responsibility for Countrywide's abuses is one can of worms that B of A would rather not open.

Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges -- like the $8.5 billion settlement issue -- still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, Financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.