Residential Capital, LLC

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UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK 	FOR PUBLICATION
In re:
RESIDENTIAL CAPITAL, LLC, et al.,
Debtors.
Case No. 12-12020 (MG)
Jointly Administered
MEMORANDUM OPINION AND ORDER DENYING THE MOTIONS OF THE
FEDERAL HOUSING FINANCE AGENCY AND UNDERWRITER DEFENDANTS TO
COMPEL DOCUMENT DISCOVERY FROM THE DEBTORS
A P P E A R A N C E S:
KASOWITZ BENSON TORRES &
FRIEDMAN LLP
Counsel for the Federal Housing Finance
Agency
1633 Broadway
New York, New York 10019
By: 	Andrew K. Glenn, Esq.
Matthew B. Stein, Esq.
Daniel A. Fliman, Esq.
MORRISON & FOERSTER LLP
Counsel for the Debtors
1290 Avenue of the Americas
New York, New York 10104
By: 	Gary S. Lee, Esq.
Joel C. Haims, Esq.
CRAVATH, SWAINE & MOORE LLP
Counsel for Credit Suisse Securities (USA)
LLC
Worldwide Plaza
825 Eighth Avenue
New York, New York 10019
By: 	Richard W. Clary, Esq.
Michael T. Reynolds, Esq.
SULLIVAN & CROMWELL LLP
Counsel for J.P. Morgan Securities LLC
125 Broad Street
New York, New York 10004
By: 	Penny Shane, Esq.
Sharon L. Nelles, Esq.
Jonathan M. Sedlak, Esq.
SKADDEN, ARPS, SLATE MEAGHER &
FLOM LLP
Counsel for UBS Securities LLC
Four Times Square
New York, New York 10036
By: 	Jay B. Kasner, Esq.
Scott Musoff, Esq.
Robert A. Fumerton, Esq.
SULLIVAN & CROMWELL LLP
Counsel for Goldman, Sachs & Co.
125 Broad Street
New York, New York 10004
By: 	Richard H. Klapper, Esq.
Theodore Edelman, Esq.
Michael T. Tomaino, Jr., Esq.
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PAUL, WEISS, RIFKIND, WHARTON &
GARRISON LLP
Counsel for Citigroup Global Markets, Inc.
1285 Avenue of the Americas
New York, New York 10019
By: 	Brad S. Karp, Esq.
Bruce Birenboim, Esq.
Susanna M. Buergel, Esq.
SULLIVAN & CROMWELL LLP
Counsel for Barclays Capital, Inc.
125 Broad Street
New York, New York 10004
By: 	David H. Braff, Esq.
Brian T. Frawley, Esq.
Jeffrey T. Scott, Esq.
Joshua Fritsch, Esq.
SIMPSON THACHER & BARTLETT LLP
Counsel for RBS Securities, Inc.
425 Lexington Avenue
New York, New York 10017
By: 	Thomas C. Rice, Esq.
David J. Woll, Esq.
Alan Turner, Esq.
MARTIN GLENN
UNITED STATES BANKRUPTCY JUDGE:
“For more than three centuries it has now been recognized as a fundamental maxim that
the public . . . has a right to every man’s evidence.” Jaffee v. Redmond, 518 U.S. 1, 9 (1996)
(internal quotation marks and citations omitted). The two pending motions seeking immediate
discovery from the chapter 11 Debtors in these cases raise the important question whether the
policy reflected in this maxim must give way, at least temporarily, to the demonstrated needs of
these chapter 11 cases. The Court concludes that section 105 of the Bankruptcy Code permits
the Court to extend the protection of section 362(a) to preclude any discovery from the Debtors
in these cases for a reasonable period of time absent further order of the Court. Therefore, the
two pending motions are denied.
I. 	BACKGROUND
The two pending motions are the Supplement to July 17, 2012 Motion of the Federal
Housing Finance Agency Pursuant to the July 11, 2012 Order of the Honorable Denise L. Cote
Seeking Limited Discovery from the Debtors and, if Necessary to that Purpose, Relief from the
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Automatic Stay, filed on July 17, 2012 (the “Supplemental Motion,” ECF Doc. # 859); and the
Motion in Support of Loan File Discovery from the Debtors and, if Necessary to that Purpose,
Relief from the Automatic Stay (the “Underwriters Motion,” ECF Doc. # 1293). Discovery is
sought from the Debtors in connection with a case originally filed in state court and then
removed to the U.S. District Court for the Southern District of New York—Federal Housing
Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation v. Ally
Financial Inc. f/k/a GMAC, LLC et al., Case No. 11 Civ. 7010 (Cote, J.) (the “FHFA Case”).
In its amended complaint in the FHFA Case, FHFA, as conservator for the Federal Home
Loan Mortgage Corporation (“Freddie Mac”), asserts seven claims against the Debtors’ affiliates
Ally Financial, Inc. (“AFI”), Ally Securities, LLC (“Ally Securities”), and GMAC Mortgage
Group, Inc. (“GMACM,” and together with AFI and Ally Securities, the “Non-Debtor
Affiliates”), and seven other underwriters not affiliated with the Debtors (the “Underwriter
Defendants”). The claims stem from allegedly false and misleading statements and omissions
made in registration statements, prospectuses and other offering materials relating to $6 billion of
residential mortgage-backed securities (“Certificates”) purchased by Freddie Mac from twenty-
one securitization trusts (the “Securitizations”) between September 23, 2005 and May 30, 2007.
The amended complaint alleges, inter alia, that the Certificates’ offering documents
misrepresented that the underlying mortgage loans complied with underwriting standards and
presented a false picture of the characteristics and riskiness of those loans.
FHFA’s Supplemental Motion, as further modified during a hearing on September 11,
2012 (the “September 11 Hearing”) in this Court, seeks to require the Debtors to produce 2,500
loan files (“Loan Files”); 1 the Underwriters Motion filed by the Underwriter Defendants seeks to
1 	FHFA originally requested production of an unspecified number of Loan Files. 	See FHFA Reply to
Debtors’ Objection, dated August 10, 2012 (ECF Doc. # 1086). At a hearing in this Court on August 14, 2012 (the
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require the Debtors to produce 43,000 Loan Files. All of the Loan Files relate to the mortgage
loans in the securitization trusts at issue in the FHFA Case. The Debtors oppose both motions. 2
On May 15, 2012, the district court entered a scheduling order requiring that document
discovery be completed by September 30, 2012, with depositions beginning in January 2013.
The order also set a deadline of May 17, 2013 for briefing on summary judgment motions and a
tentative trial period to begin in the fall of 2013. See Order dated May 15, 2012 (Case No. 11
Civ. 7010) (Dkt. # 99).
Concurrent with this discovery dispute, the Debtors commenced an adversary proceeding
in this Court—Residential Capital LLC et al. v. Allstate Ins. Co. et al, Adv. Proc. No. 12-01671
(the “Residential Capital Adversary Proceeding”). FHFA was one of twenty-seven defendants in
the adversary proceeding. On May 25, 2012, Debtors filed a Motion to Extend Automatic Stay
or, in the Alternative, for Injunctive Relief Enjoining Prosecution of Certain Pending Litigation
“August 14 Hearing”), FHFA limited its request to 5,000 loan files; it memorialized its revised request in the
Supplemental Memorandum of Law of the Federal Housing Finance Agency in Further Support of Request for
Limited Discovery from the Debtors and, if Necessary to that Purpose, Relief from the Automatic Stay, filed on
August 28, 2012. (ECF Doc. # 1297.) At the September 11 Hearing, FHFA further reduced its request to 2,500 loan
files. Counsel for the Underwriter Defendants argued at the September 11 Hearing that all 43,000 loan files, and not
a subset of either 2,500 or 5,000, must be produced.
2 FHFA initially filed a Motion Pursuant to the July 11, 2012 Order of the Honorable Denise L. Cote
Seeking Limited Discovery from the Debtors and, if Necessary to that Purpose, Relief from the Automatic Stay (the
“Initial Motion,” ECF Doc. # 810). In its Initial Motion, FHFA sought discovery of loan tapes (“Loan Tapes”) and
loan originator information (“Originator Information”) containing data regarding the mortgage loans in the
securitization trusts at issue in the FHFA Case. In May 2012, Judge Cote ordered all defendants in the FHFA Case
to produce the Loan Tapes to FHFA by June 8, 2012. Over the next month, several defendants produced some of
the tapes, covering sixteen out of the twenty-one Securitizations. However, the majority of the produced Loan
Tapes allegedly contained data deficiencies that made them insufficient for FHFA’s sampling expert to develop a
reliable sampling protocol. The Non-Debtor Affiliates did not comply with the order, arguing that they did not have
custody or control over the documents, as the documents were the property of the Debtors’ estates and the automatic
stay precluded them from obtaining the documents from the Debtors. Before the August 14 Hearing, the Debtors
and FHFA agreed that the Debtors would produce the Loan Tapes and Originator Information as requested in the
Initial Motion. The parties later submitted a stipulation to that effect. (ECF Doc. # 1444.)
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Against Debtors’ Directors and Officers and Non-Debtor Corporate Affiliates (the “Injunction
Motion”).3 (Adv. Proc. No. 12-01671, ECF Doc. # 4.)
On June 28, 2012, FHFA filed its Motion to Withdraw the Reference of the Above-
Captioned Adversary Proceeding to the Bankruptcy Court (Adv. Proc. No. 12-01671, ECF Doc.
# 44). On July 9, 2012, the district court entered an order granting FHFA’s motion, withdrawing
the reference solely as to FHFA. Shortly thereafter, by an order dated July 11, 2012, the district
court directed FHFA to seek permission from this Court to obtain the documents it requested
from the Non-Debtor Affiliates because the documents were in the possession of the Debtors.
About one week later, at a case conference held on July 17, 2012 (the “July 17 Case
Conference”), the district court denied the Debtors’ Injunction Motion, finding that the anti-
injunction provision of the Housing and Economic Recovery Act (“HERA”), 12 U.S.C. §
4617(f), which governed actions brought by FHFA, prevented the district court from enjoining
FHFA from proceeding with its action against the Non-Debtor Affiliates. See July 17 Case
Conference Tr. 6:13-15 (ECF Doc. # 859, Ex. A). The district court also found that it did not
have the authority to extend the automatic stay under section 105 of the Bankruptcy Code and
directed FHFA to seek relief with respect to discovery from this Court. See id. at 23:11-17 (“I
don’t need to reach [the issue of whether Bankruptcy Code section 105 allows the court to extend
the stay] because I wouldn’t have jurisdiction to extend the stay, but I don’t find that ResCap has
made a strong enough showing even if it were within my jurisdiction to consider the Section 105
3 	The Injunction Motion sought an order staying lawsuits (including all discovery) against the Non-Debtor
Affiliates. Before the Court heard the Injunction Motion, the Debtors entered into stipulations with most of the
defendants in the case partially staying the pending actions against the Non-Debtor Affiliates until October 31, 2012,
without prejudice to applications to extend the stay beyond that date. 	Motions addressed to the pleadings were
permitted to be litigated, and discovery directed to the Non-Debtor Affiliates was also permitted, but any discovery
from the Debtors was stayed. See Stipulation and Order with Respect to Debtors’ Motion to Extend the Automatic
Stay or, in the Alternative, for Injunctive Relief (Adv. Proc. No. 12-01671, ECF Doc. # 84). 	The preliminary
injunction hearing went forward on July 10, 2012 against Western & Southern Life Insurance Company. At the
conclusion of the hearing, the Court granted the motion for a preliminary injunction on terms substantially similar to
the terms in the stipulations. July 10, 2012 Hearing Tr. 123:6-139:18 (ECF Doc. # 750).
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argument.”). The district court observed that “[t]here is no dispute that the stay that ResCap
seeks cannot be obtained through mere application of the statutory automatic stay provided in
Section 362 . . . . Such an extension may only be obtained through a court’s exercise of its
equitable powers through Section 105 of the Bankruptcy Code.” Id. at 9:22-24, 10:3-5 (emphasis
added).
II. 	DISCUSSION
FHFA filed its Initial and Supplemental Motions in this Court requesting that the Debtors
be required to produce Loan Tapes, Originator Information and Loan Files. FHFA asserted that
section 362(a) of the Bankruptcy Code does not apply to its discovery requests to the Debtors,
and even if it did, under the twelve-factor test enumerated in Sonnax Indus., Inc. v. Tri
Component Prods. Corp. (In re Sonnax Indus., Inc.), 907 F.2d 1280, 1285-87 (2d Cir. 1990),
cause exists to lift the stay.4 FHFA also argued that “[c]ourts have consistently held that the
automatic stay does not preclude a party from seeking third-party discovery against a debtor,”
citing the Ninth Circuit Bankruptcy Appellate Panel’s decision in Groner v. Miller (In re Miller),
262 B.R. 499 (9th Cir. B.A.P. 2001), holding that section 362(a) of the Bankruptcy Code does
not protect an individual debtor from having her deposition taken as a third-party witness in a
case in which both she and her husband were defendants. Id. at 503-05.
4 	Bankruptcy Code section 362(d)(1) states that “the court shall grant relief from the stay provided under
subsection (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay – (1) for cause,
including the lack of adequate protection of an interest in property of such party in interest[.]” The Sonnax factors
apply when a court is faced with the decision whether to grant relief from the stay “for cause” under section
362(d)(1). See Sonnax, 907 F.2d at 1285-86 (in analyzing section 362(d)(1), noting that “[n]either the statute nor the
legislative history defines the term ‘for cause’” and adopting the twelve factors outlined in In re Curtis, 40 B.R. 795
(Bankr. D.Utah 1984)). An in-depth analysis of the Sonnax factors is unnecessary here because the issue in this case
is not whether the stay applies to FHFA’s request under Bankruptcy Code section 362(a) alone, and therefore should
be lifted “for cause” under section 362(d)(1), but rather, whether the Court can use its section 105(a) authority to
regulate third-party discovery requested from the Debtors. Nonetheless, even if the Court were to consider whether
to grant relief under section 362(a) and (d) “for cause,” the Sonnax factors weigh heavily against lifting the stay.
Specifically, factors two (“lack of any connection with or interference with the bankruptcy case”), six (“whether the
action primarily involves third parties”), and twelve (“impact of the stay on the parties and the balance of harms”)
weigh heavily in favor of denying FHFA’s request to lift the stay “for cause.” See section II.E infra.
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In their objection to FHFA’s motions, Debtors argued that the automatic stay applies to
the discovery sought by FHFA. The Debtors rely, among other cases, on Johns-Manville Corp.
v. Asbestos Litig. Grp. (In re Johns-Manville), 40 B.R. 219 (S.D.N.Y. Jan. 9, 1984). In Manville,
a co-defendant of the debtor in a separate litigation sought document production and depositions
from officers, directors, and employees of the debtor (but not from the debtor). The district court
affirmed the bankruptcy court’s decision denying a motion to lift the stay to allow the discovery
to proceed. Id. at 231.
The Debtors also rely on a statement by this Court during the July 10, 2012 evidentiary
hearing on the Debtors’ Motion for Preliminary Injunction Notice of Motion and Debtors Motion
to Extend Automatic Stay or, in the Alternative, for Injunctive Relief Enjoining Prosecution of
Certain Pending Litigation Against Debtors Directors and Officers and Non-Debtor Corporate
Affiliates (transcript at ECF Doc. # 750), that “[t]here is an automatic stay in place with respect
to discovery from the debtors . . . if you make the motion to vacate the stay, you’re going to carry
the burden . . . you or anyone else who is seeking to lift the stay to launch discovery against the
debtors is going to carry a very heavy burden.” July 10, 2012 Hearing Tr. 99:8–100:2.
The Debtors argue that the discovery sought by the FHFA and the Underwriter
Defendants would be extremely costly and burdensome to the Debtors. According to the
Debtors, the collection and production of the documents sought by FHFA would distract the
Debtors’ employees from key tasks related to the restructuring and preservation of their business,
and the costs associated with producing these files would adversely affect the value of the
Debtors’ estate and prejudice their creditors.
At the August 14 Hearing, the Court determined that the Supplemental Motion and the
Underwriters Motion raise a contested matter under FED. R. BANKR. P. 9014. Therefore, the
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Court scheduled an evidentiary hearing for September 11, 2012. The Court directed the parties
to submit additional briefs before the September 11 Hearing on the following issues: (1) whether
the use of the word “process” in section 362(a) applies to third-party subpoenas or requests for
discovery; (2) whether, and to what extent, producing the Loan Files would be burdensome and
costly to the Debtors; and (3) whether the Shared Services Agreement 5 between the Debtors and
AFI requires the Debtors to provide the Loan Files to AFI, and if so, who would have to pay for
such a request. See August 14 Hearing Tr. (ECF Doc. # 1215). Each of these issues is discussed
below.
At the September 11 Hearing (transcript at ECF Doc. # 1428), FHFA introduced into
evidence two declarations by Kanchana Wangkeo Leung, Esq. (one of FHFA’s outside counsel)
(ECF Doc. ## 808, 1296). FHFA’s counsel did not call or cross-exam any witnesses during the
hearing. The Debtors introduced into evidence the declarations of Jeffrey A. Lipps (ECF Doc. #
1023-1), Mary Fahy Woehr (ECF Doc. # 1295-1), and Philip M. Scheipe (filed as an exhibit to
AFI’s statement on the Shared Services Agreement at ECF Doc. # 1299), as well as two
declarations of John G. Mongelluzzo (ECF Doc. ## 1023-2, 1295-1).6 The Debtors also
introduced into evidence eight exhibits. Debtors’ counsel did not call or cross-exam any
witnesses during the hearing.
5 	The Shared Services Agreement is an Exhibit to the Court’s Final Order Under Bankruptcy Code Sections
105(a) and 363(b) Authorizing Residential Capital, LLC to Enter into a Shared Services Agreement with Ally
Financial Inc. Nunc Pro Tunc to the Petition Date for the Continued Receipt and Provision of Shared Services
Necessary for the Operation of the Debtors’ Businesses (ECF Doc. # 387). The Shared Services Agreement is an
agreement entered into between Residential Capital LLC and AFI to allow for the continued sharing of services
post-bankruptcy that they had shared pre-bankruptcy.
6 	FHFA’s counsel made a general objection to the paragraphs in the Mongelluzzo, Woehr and Scheipe
declarations “that purport to speak as to the intent of the parties when they negotiated and entered into the Shared
Services Agreement. There has been no argument by any party that the agreement is ambiguous and that there is a
need for any parol evidence as to intent.” September 11 Hearing Tr. 89:6-15. The Court admitted all declarations
into evidence and reserved decision on FHFA’s objection. In light of the Court’s disposition of the pending motions
it is unnecessary to rule on FHFA’s objections.
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A. The Meaning of “Process” in Section 362(a) of the Bankruptcy Code
FHFA argues that the plain language of the Bankruptcy Code and its legislative history
demonstrate that the word “process” in section 362(a) was not meant to protect debtors from
discovery in a third-party action. The Court asked the parties to address the issue in
supplemental briefs. FHFA did so, but the Debtors disingenuously argued that, based on the
Court’s statements during the August 14 Hearing, the Court already decided that the automatic
stay under section 362(a) applies in this case because the word “process” includes any process
seeking to compel discovery even in actions in which the Debtors are not parties. But the Court
asked the question whether section 362(a)(1) applies to the use of judicial process to obtain
discovery from a debtor; the Court did not decide the issue. See August 14 Hearing Tr. 70:8-9;
see also September 11 Hearing Tr. 86:18-87:5 (“I asked a question whether the use of the term
‘process’ in 362(a) applied to subpoenas – third-party subpoenas . . . . Kasowitz addressed it and
your brief just simply recites the Court has already determined that 362(a) applies. I did no such
thing.”).
Section 362(a) of the Bankruptcy Code provides an automatic stay against the following:
(1) the commencement or continuation, including the issuance or
employment of process, of a judicial, administrative, or other
action or proceeding against the debtor that was or could have
been commenced before the commencement of the case under
this title, or to recover a claim against the debtor that arose
before the commencement of the case under this title; [or] . . . .
(2) . . . .
(3) any act to obtain possession of property of the estate or of
property from the estate or to exercise control over property of
the estate[.]
11 U.S.C. § 362(a) (emphasis added).
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The automatic stay affords “one of the fundamental debtor protections provided by the
bankruptcy laws.” Midlantic Nat’l Bank v. N.J. Dep’t of Envtl. Prot., 474 U.S. 494, 503 (1986)
(citations omitted). But by its terms, section 362(a) does not protect debtors in all circumstances.
FHFA argues that the words “including the issuance or employment of process” do not cover
third-party subpoenas, because the phrase modifies the operative phrase “the commencement or
continuation . . . of a judicial, administrative, or other action or proceeding against the debtor”
(emphasis added). Thus, the argument goes, section 362(a) does not apply to this case because
the discovery is not being requested in a proceeding against the Debtors.
There is surprisingly little authority whether the automatic stay applies to discovery from
a debtor in a third-party action in which the debtor is not a party. FHFA’s argument is supported
by the holding in Miller, 262 B.R. 499, where the Ninth Circuit Bankruptcy Appellate Panel
concluded that the automatic stay does not apply to discovery from a debtor in a third-party
action:
In this case, Groner issued the subpoenas to Debtor in an effort to
continue her prosecution of her claims against Henry, a non-
debtor. 	Section 	362(a) 	prohibits 	the 	commencement 	or
continuation of an action against the debtor; to the extent that
Groner was eliciting Debtor’s testimony for purposes other than to
continue 	the 	prosecution 	of 	her 	claims 	against 	Debtor, 	the
proposed discovery did not violate the automatic stay, unless the
issuance of subpoenas itself constitutes “issuance or employment
of process” against Debtor or a “judicial proceeding” against
Debtor. 	If this were true, a debtor could never be called as a
witness (even in actions where the debtor is not a party) without
relief from the stay. Such an interpretation of section 362(a) defies
common 	sense 	and 	the 	spirit 	of 	the 	Code. 	Information 	is
information, and we believe the discovery of it as part of the
development of a case against non-debtor parties is permissible,
even if that information could later be used against the party
protected by the automatic stay.
Id. at 505.
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The Debtors offered no support for their position that section 362(a) precludes discovery,
erroneously relying on statements by this Court in granting a preliminary injunction staying
litigation against the Non-Debtor Affiliates. The Court accepts FHFA’s argument that section
362(a) does not, standing alone, protect the Debtors from discovery in third-party actions. But
the Court concludes that section 105 provides the Court with the necessary authority to extend
the protection of the automatic stay to discovery from the Debtors. On the evidentiary record
here, the Court concludes that the Debtors have established that section 105 should be applied to
limit or restrict third-party discovery from the Debtors absent further order of the Court. 7 To be
clear, this Court is not issuing an injunction against FHFA; rather, the Court is extending the
protection of the stay pursuant to section 105(a) to anyone seeking discovery from the Debtors
absent further order of the Court.
The provisions of the Bankruptcy Code are intended to marshal and protect the assets and
the property of the estate throughout the administration of the case. See 11 U.S.C. § 541. See
also 5 COLLIER ON BANKRUPTCY ¶ 541.01 (Alan N. Resnick & Henry J. Sommer, eds. 16th rev.
ed. 2012) (“Property belonging to the estate is protected from piecemeal dismantling by creditors
by the automatic stay of section 362. It is this central aggregation of property that promotes the
fundamental purposes of the Bankruptcy Code: the breathing room given to a debtor that
attempts to make a fresh start, and the equality of distribution of assets among similarly situated
creditors, according to the priorities set forth within the Code. It is from this central core of
estate property that the debtor’s creditors will be paid.”) Requiring the Debtors to provide
discovery in a manner that threatens the Debtors’ ability to reorganize cannot be sanctioned
under the Bankruptcy Code.
7 	The standards applicable to discovery from the Debtors is discussed in section II.E below.
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B. Section 105 of the Bankruptcy Code
Section 105(a) of the Bankruptcy Code provides:
The court may issue any order, process, or judgment that is
necessary or appropriate to carry out the provisions of this title.
No provision of this title providing for the raising of an issue by a
party in interest shall be construed to preclude the court from, sua
sponte, taking any action or making any determination necessary
or appropriate to enforce or implement court orders or rules, or to
prevent an abuse of process.
11 U.S.C. § 105(a) (emphasis added).
The cases the parties have cited have largely concerned the application of section 105 to
litigation or discovery requests made upon non-debtors (for example, employees of the debtor,
officers or directors of the debtor, or non-debtor affiliates). See, e.g., Manville, 40 B.R. 219 (co-
defendant in other litigation sought document production and depositions from officers,
directors, and employees of the debtor); Lane v. Philadelphia Newspapers, LLC (In re
Philadelphia Newspapers, LLC), 423 B.R. 98, 100 (E.D. Pa. 2010) (third party sought discovery
against non-debtor co-defendants of the debtor); In re Richard B. Vance & Co., 289 B.R. 692,
697 (Bankr. C.D. Ill. 2003) (third party issued subpoenas to the debtor’s non-debtor parent
company and its bank); In re Mahurkar Double Lumen Hemodialysis Catheter Patent Litig., 140
B.R. 969, 977 (N.D. Ill. 1992) (third party sought depositions of debtor’s employee); In re
Hillsborough Holdings Corp., 130 B.R. 603, 605 (Bankr. M.D. Fl. 1991) (third party sought
depositions of present or former employees of the debtor).8
8 	In one case cited by the Debtors, the discovery being sought (customer lists and other document
production) was directed against the debtor itself—however, unlike this case, the debtor had been named as a party
in the pending litigation. Named Plaintiffs and the Certified Classes they Represent in the Cement Antitrust Litig. v.
Penn-Dixie Indus., Inc. (In re Penn-Dixie Indus., Inc.), 6 B.R. 832, 833-34 (Bankr. S.D.N.Y. 1980). Judge Liflind
did not lift the stay to allow discovery to go forward. Id. at 837. Debtors also cite to Teledyne Indus., Inc. v. Eon
Corp., 373 F. Supp. 191 (S.D.N.Y. 1974). In Teledyne, the following documents were sought by a third party from
the debtor: “Eon’s Certificate of Incorporation; (2) Eon’s By-Laws; (5) Minutes of Eon board meetings; (6) minutes
of Eon executive committee meetings; (33) documents, including bank accounts, showing disbursements of funds
received under the generator set contract; and (39) liquidation payments for deliveries made under the contract.” Id.
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Where an injunction is sought by a debtor under section 105 to stay actions against non-
debtors, the relief must be sought through an adversary proceeding under FED. R. BANKR. P.
7001. See, e.g., Signature Bank v. Ahava Food Corp., No. Civ. 3893, 2008 WL 4126248, at *1
(S.D.N.Y. Aug. 19, 2008) (stating that “to seek [injunctive relief under 105(a)] the debtor must
file an adversary proceeding in the Bankruptcy Court”); Hillsborough, 130 B.R. at 606 (“On the
other hand, if the debtor seeks protection under section 105 of the Code, the debtor must
commence an adversary proceeding”). The reason an adversary proceeding is required to obtain
an injunction against a third-party is clear: “While § 105(a) of the Bankruptcy Code allows a
bankruptcy court to issue any order necessary to carry out the provisions of the Code, it ‘does not
provide an independent source of federal subject matter jurisdiction.’” Philadelphia
Newspapers, 423 B.R. at 103. Jurisdiction over third parties may be properly exercised under
“related to” jurisdiction provided by 28 U.S.C. § 1334(b) due to the impact of the litigation on
the Debtors’ reorganization efforts. Id.
Here, the Debtors followed that procedure by filing an adversary proceeding against the
plaintiffs (including FHFA) in actions naming the Debtors’ Non-Debtor Affiliates as defendants,
seeking an injunction staying litigation (and not just discovery) against the Non-Debtor
Affiliates. The district court withdrew the reference of the adversary proceeding with respect to
FHFA and denied injunctive relief. But that result does not mean that FHFA or any other party
at 202-03. The court declined to extend the stay, and stated that “11 U.S.C. § 714, it is true, enables the bankruptcy
court to stay all actions against the debtor pending a final decree in the arrangement proceeding . . . . The purpose of
the stay is to prevent interference with, or diminution of, the debtor’s property during the pendency of the Chapter
XI proceeding . . . . It is intended to prevent a creditor from defeating the jurisdiction of the bankruptcy court over
the debtor’s property by instituting another action in a different forum . . . . It is obvious, I submit, that none of
these purposes would be defeated by requiring Eon to submit copies of the documents requested by plaintiff.” Id. at
203. Teledyne was notably distinguished in Manville, in which Judge Brieant held that “Teledyne should not be read
as indicating that discovery requests against the bankrupt will invariably be granted. In fact, Teledyne suggests that
such requests should be upheld only when such discovery will not interfere significantly with the Debtor’s
reorganization efforts.” Manville, 40 B.R. at 223.
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can compel discovery by the Debtors during the pendency of the bankruptcy case if such
discovery would substantially interfere with the Debtors’ efforts to reorganize.
FHFA acknowledged during the September 11 Hearing that no case has apparently
addressed the question whether section 105 allows a bankruptcy court to extend the stay to
protect the debtor itself, and not just a non-debtor party, from third-party discovery, and whether
an adversary proceeding is required to grant such relief. See September 11 Hearing Tr. 115:12-
15. This appears to be an issue of first impression. The Court concludes that the power to stay
discovery against the debtor is an essential attribute of the Court’s power to administer a
bankruptcy proceeding and carry out other enumerated powers under the Bankruptcy Code for
the benefit of all parties in interest.
The order extending the stay to discovery from the Debtors absent further court order is
one that relates to the administration of the bankruptcy case itself; like other case administration
orders, it does not require filing an adversary proceeding.9 An adversary proceeding is not
required to obtain jurisdiction; the bankruptcy court has jurisdiction over the main case under 28
U.S.C. §§ 1334(a) and the referral from the district court under 28 U.S.C. § 157(a). The power
to stay discovery against a debtor must be exercised cautiously, particularly where a stay of
discovery may interfere with the prosecution or defense of third-party litigation pending in other
courts. The uncontrolled burden and expense of discovery in third-party actions has the potential
to destroy a debtor’s ability to reorganize, to the substantial detriment of all creditors and other
9 	In most cases, the issue of third-party discovery is likely to arise infrequently so that it is unnecessary or
inappropriate to include a stay of discovery in case management or administration orders. In the absence of such a
provision in an order, the debtor may move to obtain such relief when the issue arises. Here, on the other hand, in
light of the large number of lawsuits involving the Debtors and the Non-Debtor Affiliates, it is appropriate to include
a blanket prohibition of third-party discovery absent further order of the Court.
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parties in interest in a bankruptcy case. 10 In a case like this, where the Debtors are faced with
tens or hundreds or even thousands of lawsuits in which discovery from the Debtors may be
relevant to the issues in the pending suits, the issue is not whether to stay discovery, but what
factors the Court should consider in determining the conditions or limitations to place on
discovery. In the absence of controlling provisions in the Bankruptcy Code or the Federal Rules
of Bankruptcy Procedure, the Court looks for guidance to cases dealing with analogous issues.
As the discussion below suggests, the Court concludes that the following six factors
should be considered by bankruptcy courts in deciding whether to limit or permit discovery, and
on what conditions to do so: (1) the scope of requested discovery; (2) the context in which the
request arises; (3) the need for the discovery; (4) the timing of the discovery; (5) the burden on
the debtors from the requested discovery; and (6) the expense of discovery and who should bear
the cost. No one factor is determinative, the six factors are interrelated, and they may overlap.
With respect to the FHFA Motion, the Court will discuss each factor in turn. Before discussing
these specific factors, the Court will first address other contexts in which discovery has been
restricted.
C. Case Law on Extending the Automatic Stay to Non-Debtor Parties is Instructive
The case law extending the stay to litigation against non-debtor parties is instructive. The
Second Circuit recently reaffirmed the power of the bankruptcy court to stay litigation against
third-parties: “[T]he stay of litigation during the pendency of . . . bankruptcy . . . has historically
10 	FHFA’s counsel argued at the September 11 Hearing that the Court has no power to restrict or limit
FHFA’s discovery from the Debtors no matter what the consequences. See September 11 Hearing Tr. at 95:8–
115:13. FHFA’s counsel took the position that even if requiring the debtor to produce documents would cost $10
million and would guarantee that “this case is derailed and converts to a Chapter 7 liquidation,” the bankruptcy court
has no power to do anything to limit discovery because of HERA. Id. at 107:5–108:14.
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been the province of the bankruptcy courts.” Pfizer Inc. v. Law Offices of Peter G. Angelos (In
re Quigley Co., Inc.), 676 F.3d 45, 52 (2d Cir. 2012). In this district, bankruptcy courts have
extended the stay to non-debtor parties if the claims in question “threaten to thwart or frustrate
the debtor’s reorganization efforts . . . and that the injunction is important for effective
reorganization.” McHale v. Alvarez (In re The 1031 Tax Grp., LLC), 397 B.R. 670, 684 (Bankr.
S.D.N.Y. 2008) (citations and quotations omitted); Hawaii Structural Ironworkers Pension Trust
Fund v. Calpine Corp., No. 06 Civ. 5358, 2006 WL 3755175, at *4 (S.D.N.Y. Dec. 20, 2006)
(stating that section 105 can be used to extend the automatic stay to non-debtors “where the
action to be enjoined is one that threatens the reorganization process”). In Manville, Judge
Brieant noted that “the extensive contemplated pre-trial discovery and trial testimony in this case
would certainly have a serious adverse impact upon Manville’s reorganization proceedings,”
specifically because “Manville would have to divert personnel from its [various departments]”
even though it “faces more pressing obligations in the bankruptcy proceedings which have
commanded and will continue to command the attention of its officers, directors, counsel,
financial analysts and administrative personnel.” Manville, 40 B.R. at 224. The court also
observed that “to permit discovery to proceed in this instance would open the door to additional
requests of this nature from similarly situated defendants in literally thousands of other pending
asbestos-related cases and cases yet unfiled. The cumulative effect of this on the reorganization
can well be understood.” Id.
Courts outside of this district have also considered the extent to which the proposed
discovery would interfere with reorganization efforts. See Philadelphia Newspapers, 423 B.R. at
103-05; In re Dakotas’ Farm Mfg. Co., 31 B.R. 92, 94-95 (Bankr. S.D.S.D. 1983). Philadelphia
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Newspapers is particularly instructive because the court considered and rejected the application
of the Ninth Circuit Bankruptcy Appellate Panel’s decision in Miller:
The Court need not decide whether Miller states the applicable
principle, a matter that is far from certain, since, in any event,
Miller 	is 	distinguishable. 	In 	Miller, 	the 	discovery 	requests
involved “information” to be used in a lawsuit the outcome of
which would not affect the debtor or property of the debtor. Here,
as stated above, the “information” sought is to be used in the
prosecution of an action in which the employee of the Debtors is a
defendant, which if found liable, the Debtors could have an
obligation to indemnify. This obligation to indemnify, if triggered,
would affect the property of the Debtors’ estates. 	Thus, while in
Miller the discovery requests would under no circumstances affect
the property of the debtor, so much cannot be said here.
423 B.R. at 105. The court in Dakotas’ Farm explained that discovery would be permitted if it
did not interfere with the pending bankruptcy, but the party seeking the discovery had to bear all
of the costs:
While this Court has no jurisdiction over [the non-debtor party], it
certainly 	has 	jurisdiction 	over 	the 	property 	of 	the 	debtor
corporation. 	The Court may modify the automatic stay for cause
where there is a lack of interference with the pending bankruptcy
case. 	The Court will modify the stay provided there is no
interference with the debtor’s Chapter 11 proceeding resulting
from 	the 	plaintiff’s 	request 	for 	production 	of 	documents.
Balancing the plaintiff’s request and failure to pursue that request
at the meeting of creditors against the cost to the debtor dictates
that the plaintiff bear all copying expense and the salary of any
clerical assistance employed on behalf of the debtor in providing
the copies. This Court can see no basis for the debtor bearing such
expense 	when 	the 	unsecured 	creditors 	in 	the 	Chapter 	11
proceeding ultimately pay these costs. This cannot be justified in a
state court action to which the debtor is not a party. The automatic
stay will be modified to allow the plaintiff to acquire copies of the
documents required as conditioned herein.
31 B.R. at 94-95 (citations omitted). Collier also notes that, “[a]lthough an action against third
parties such as guarantors or codefendants is not stayed under Section 362(a), the court retains
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the power to enjoin the action if continuation of the action would interfere substantially with the
debtor’s reorganization.” 3 COLLIER ON BANKRUPTCY ¶ 362.03[3][d]. 11
In the Residential Capital Adversary Proceeding, this Court has already stayed discovery
against the Debtors. Because of the withdrawal of the reference, the stay does not apply to the
FHFA. By its terms, the stay is effective only until October 31, 2012, but the Court expressly
left open the possibility of extending the stay beyond that date.12 The Court specifically
permitted motion practice and discovery against the Non-Debtor Affiliates to continue, but
ordered that discovery against the Debtors remained stayed. During the July 10, 2012
evidentiary hearing on the motion, the Court noted the well-documented burden and expense of
discovery, particularly at this stage of the bankruptcy cases. July 10 Hearing Tr. 125:12-22
(“[T]he debtors will face very substantial and burdensome discovery if the action continues”),
136:24–137:3 (“We discussed the discovery burdens. The most significant factor favoring
extending the stay in this case is the substantial discovery burden and expense the debtors would
face if the Western & Southern action goes forward against Ally Securities.”).
The touchstone for granting injunctive relief against third-party actions is whether the
third-party action will “threaten to thwart or frustrate the debtor’s reorganization efforts.” 1031
Tax Grp., 397 B.R. at 684. This principle should be equally applicable to the issues raised by
discovery from a debtor in third-party actions. The scope, timing, burden and expense of the
11 	See also 3 COLLIER ON BANKRUPTCY ¶ 362.03[3] (“Litigation in which the debtor is not a party and that
only collaterally affects the debtor is not stayed.” (emphasis added)).
12 	The Debtors have now moved to extend the stay for a longer time period; that motion has not yet been
heard by the Court.
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proposed discovery are all factors in determining whether proposed discovery will thwart or
frustrate the debtor’s reorganization.13
D. The Federal Rules Governing Discovery and Subpoenas Provide Useful
Guidance
The Court also turns to Rules 26 and 45 of the Federal Rules of Civil Procedure for
guiding principles. These rules, by their terms, do not supply this Court with the power to limit
or restrict discovery from a debtor, at least in a case where the district court sits in the same
district as the bankruptcy court and any subpoena issued by the district court would be effective
to compel discovery. Rule 26 provides that “the court where the action is pending” or “the court
for the district where the deposition will be taken” may issue protective orders based, among
other things, on “undue burden or expense . . . .” F ED. R. CIV. P. 26(c)(1).
Rule 26(b)(2)(C)(iii) provides, in relevant part:
(b)(2)(C) When Required. On motion or on its own, the court must
limit the frequency or extent of discovery otherwise allowed by
these rules or by local rule if it determines that . . .
(iii) the burden or expense of the proposed discovery outweighs its
likely benefit, considering the needs of the case, the amount in
controversy, the parties’ resources, the importance of the issues at
stake in the action, and the importance 	of 	the 	discovery 	in
resolving the issues.
FED. R. CIV. P. 26(b)(2)(C)(iii).
In other words, Rule 26 requires the court to perform a balancing test when considering
whether a discovery request is particularly burdensome. Considerations include whether the
13 	This case is unusual in that FHFA argues and the district court decided that HERA prevents the court from
staying the FHFA Case against the Non-Debtor Affiliates. The same argument has been raised by the FDIC in
another case naming the Non-Debtor Affiliates as defendants. See Federal Deposit Insurance Corporation as
Receivers for Citizens National Bank and Strategic Capital Bank v. Bear Stearns Asset Backed Securities I LLC, et
al., No. 1:12-cv-04000-LTS. The district court has withdrawn the reference in the Residential Capital Adversary
Proceeding as to the FDIC, but the FDIC stipulated to a stay until October 31, 2012. Even if the FHFA Case was
stayed against the Non-Debtor Affiliates, the issues about regulating discovery from the Debtors would likely arise
in any event if the FHFA Case proceeded against the Underwriter Defendants.
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burden of the discovery “outweighs its likely benefit,” “the parties’ resources,” and “the
importance of the discovery in resolving the issues.” Id.
“Rule 26(b)(2) directs the court to limit or forbid unduly burdensome discovery.” 6 FED.
PRAC. & PROC. § 2038 (Wright & Miller, eds., 2012). When this rule was amended in 1983, the
Reporter for the Advisory Committee observed:
Until last August, the last sentence in rule 26(a) said: “Unless the
court says otherwise, go ye forth and discover.” That had been the
message of the last sentence of rule 26(a). In 1983, we decided it
was a lousy message. 	That sentence has been stricken and
replaced, quite literally, by the reverse message, which you now
find in rule 26(b). Rule 26(b) now says that the frequency and
extent of use of discovery shall be limited by the court if certain
conditions become manifest. 	Just realize the 180–degree shift
between the last sentence of the old rule 26(a) and the new
sentence. Judges now have the obligation to limit discovery if
certain things become manifest.
See 6 FED. PRAC. & PROC. § 2008.1 (quoting A. Miller, The August 1983 Amendments to the
Federal Rules of Civil Procedure: Promoting Effective Case Management and Lawyer
Responsibility, 1984, at 32–33).
The Supreme Court has observed that “Rule 26 vests the trial judge with broad discretion
to tailor discovery narrowly and to dictate the sequence of discovery.” Crawford-El v. Britton,
523 U.S. 574, 598 (1998). And, as noted by Wright and Miller, “[j]udges relatively frequently
limit or forbid discovery when the cost and burden seem to outweigh the likely benefit in
producing evidence, as demonstrated by the plentitude of cases summarized in the margin.” 6
FED. PRAC. & PROC. § 2008.1. Moreover, “another method for regulating discovery requests that
infringe on the limitations of Rule 26(b)(2) is to condition orders that such discovery go forward
on the payment by the party seeking discovery of part or all of the resulting expense incurred by
the responding party.” Id.
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It would ordinarily be inappropriate for a bankruptcy court to determine the importance
of the requested discovery in resolving the issues in the underlying nonbankruptcy action. Issues
of scope, context and need for the discovery should ordinarily be the province of the trial court
where the underlying action is pending. Timing of the requested discovery is properly a concern
of both courts. Burden and expense (and their impact on the bankruptcy case) will especially be
of interest to the bankruptcy court; and the bankruptcy court will be in a far better position than
the trial court to assess those issues. Both sets of courts should, however, to the fullest extent
possible, try to accommodate the needs of the parallel proceedings.14 Court-to-court
communications may be a useful way to accomplish this goal.
Rule 45 likewise provides protection where a subpoena “subjects a person to undue
burden.” FED. R. CIV. P. 45(c)(3)(iv). Rule 45(c)(1) provides that “[a] party must take
reasonable steps to avoid imposing undue burden or expense on a person subject to the
subpoena.” Id. at 45(c)(1). Rule 45 also allows the issuing court to specify conditions as an
alternative to quashing a subpoena, if the serving party “ensures that the subpoenaed person will
be reasonably compensated.” Id. at 45(c)(3)(C)(ii). The emphasis on protecting non-parties
from “burdensome” discovery requests is of particular concern in bankruptcy cases.
Wright and Miller observe that “Rule 45(c)(1) makes explicit the principle of
accountability . . . . It requires those issuing or serving a subpoena to take reasonable steps to
avoid imposing undue burden or expense on the party subject to the subpoena. In addition, Rule
45(c)(1) places upon the issuing court a correlative duty to enforce those duties and impose
appropriate sanctions for the misuse of a subpoena.” F ED. PRAC. & PROC. § 2463. In addition,
14 	This case is a good example of efforts to accommodate the needs in parallel proceedings. The district court
in the FHFA Case directed FHFA to file a motion in the bankruptcy court to obtain discovery from the Debtors. The
district court explained the need for FHFA to obtain discovery from the Debtors. With respect to the scope of
requested discovery, particularly since FHFA has reduced its request to 2,500 Loan Files while the Underwriter
Defendants insist on 43,000 Loan Files, the district court has not yet clearly addressed the appropriate scope.
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Rule 45(c)(2)(B)(ii) requires that orders compelling persons who are neither parties nor officers
of parties to produce designated materials be protected from “significant expense.” See FED. R.
CIV. P. 45(c)(2)(B)(ii); see also FED. PRAC. & PROC. § 2463.
In the bankruptcy context, when the issue is whether a bankruptcy court should limit or
condition discovery from the debtor in a third-party action, the principles derived from Rules 26
and 45 provide useful guidance even though the rules are not specifically applicable. Rules 26
and 45 require balancing of burdens and benefits. Usually that balance will solely be in the
province of the trial court. When the overlay of a bankruptcy case is added to the mix, however,
both courts must necessarily play a role, hopefully with each court sensitive to the needs of the
other court.
E. Consideration of Scope, Context, Need, Timing, Burden and Expense
Based on the discussion above, the Court has distilled six factors relevant to a decision
whether a bankruptcy court should exercise its discretion to restrict or permit third-party
discovery during the pendency of a bankruptcy proceeding. But the starting point for the
analysis should in all cases be the long recognized policy that “the public has the right to every
man’s evidence.” Redmond, 518 U.S. at 9. Redmond goes on to state that “[w]hen we come to
examine the various claims of exemption, we start with the primary assumption that there is a
general duty to give what testimony one is capable of giving, and that any exemptions which
may exist are distinctly exceptional, being so many derogations from a positive general rule.” Id.
Exemptions from giving evidence generally arise from the assertion and recognition of privilege,
derived from statute or common law. See Trammel v. U.S., 445 U.S. 40, 50-51 (1980)
(“Testimonial exclusionary rules and privileges contravene the fundamental principle that ‘the
public . . . has a right to every man’s evidence’. . . As such, they must be strictly construed and
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accepted ‘only to the very limited extent that permitting a refusal to testify or excluding relevant
evidence has a public good transcending the normally predominant principle of utilizing all
rational means for ascertaining truth’” (quoting Elkins v. U.S., 364 U.S. 206, 234 (1960)
(Frankfurter, J., dissenting))).
A debtor is not entitled to an exemption from discovery in actions against non-debtors.
Rather, here, the issue is the limitations and conditions on providing evidence in third-party
actions that a bankruptcy judge should impose. The Court concludes that section 105 is a
statutory source of authority for the bankruptcy court in the exercise of discretion to impose
limitations and conditions on the duty to provide evidence. The Court may exercise its discretion
to limit or condition discovery from a debtor to protect a debtor from unreasonable burden or
expense that threatens administration of a bankruptcy case. While the Court may include a
prohibition on discovery from the debtor in a case management order—as the Court believes is
appropriate here—in the event a third party moves to lift the stay to permit discovery against the
debtor, the debtor must demonstrate why discovery should be limited or conditioned.
As explained below, with respect to the factors of scope, context and need, the burden of
coming forward with evidence is on the moving party since the moving party is in the best
position to produce evidence. With respect to burden and expense, the debtor has the burden of
coming forward with evidence since the debtor is in the best position to produce evidence. With
respect to timing, both the moving party and the debtor must come forward with evidence. In
light of “the primary assumption that there is a general duty to give what testimony one is
capable of giving,” Redmond, 518 U.S. at 9, the ultimate burden of persuasion rests with the
debtor. Not all factors will be relevant in each case; not all factors need to point in the same
direction. The greater the limitations or conditions the debtor seeks to impose on discovery, and
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the greater the interference that will result in the nonbankruptcy matter if limitations and
conditions are imposed, the stronger the debtor’s evidence and argument will need to be.
As explained below, the Court finds and concludes that the Debtors have met their
burden to prevent the FHFA and the Underwriter Defendants from obtaining additional
discovery of the Loan Files from the Debtors at this time. With respect to the production of
Loan Files, the Court concludes that someone other than the Debtors must bear the entire
expense of production. The Court will leave to the district court the issue of who (other than the
Debtors) pays. The Debtors can also produce 2,500 Loan Files sooner than they can produce
43,000 Loan Files. The district court must decide the scope of the production and whether FHFA
should get its 2,500 Loan Files substantially sooner than the Underwriter Defendants get their
43,000 Loan Files, if that is what the district court requires.
Assuming that someone other than the Debtors is paying for it, the timing of production
is directly tied to the burden of production. There are simply too many critical matters scheduled
in this case that will occur between now and the end of January 2013 to require the Debtors to
respond to the document production requests of the FHFA and the Underwriter Defendants.
This is truly a situation where the requested discovery must be stayed to protect a debtor from
unreasonable burden that threatens administration of these bankruptcy cases.
The Court will now review each of the six factors in turn.
1. 	Scope
The FHFA has narrowed the scope of the requested document discovery at least for now,
limiting its current request to 2,500 Loan Files. That may not sound like a lot, but in connection
with expedited discovery sought by the Creditors Committee in connection with a contested
matter now scheduled for trial beginning on January 14, 2013 (the “RMBS Settlement Hearing”),
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the Committee sought production of 1,500 Loan Files for use by its experts using a sampling
methodology. The Court does not question the Debtors’ good faith in responding to the request
for production, but as of the September 11 Hearing, it had taken the Debtors nearly a month, if
not more, to produce approximately 1,450 Loan Files. See September 11 Hearing Tr. 34:3-4.15
The scope of the requested discovery is something that must be resolved by the district
court. The answers to the questions on scope will heavily influence this Court’s answers with
respect to timing, burden and expense. Until the issue of scope is clearly resolved, it is more
difficult to determine what, if any, conditions or limitations should be imposed on discovery.
Of course, at the same time that the Loan Files were being produced, substantial
additional electronic and paper discovery has been ongoing, with numerous deadlines missed by
the Debtors in their attempts to comply with the Court-ordered discovery schedule. This issue
will be discussed further in the discussion of burden. Discovery problems which, again, the
Court does not attribute to bad faith, has resulted in twice rescheduling the trial—originally
scheduled to begin on November 5, 2012, then rescheduled to begin on November 13, 2012, and
now rescheduled to begin on January 14, 2013.
2. 	Context
FHFA is seeking discovery that it hopes will advance its claims against the Non-Debtor
Affiliates and Underwriter Defendants. The FHFA Case is only one of many cases that FHFA
has brought against numerous defendants, raising claims similar to the claims raised in this case.
The district court established an expedited schedule applicable to all similar cases with a
discovery cut-off date of September 30, 2012. The district court has stressed that “without [the
requested materials], it will be very difficult for the litigation to proceed.” See July 11, 2012
15 	In the end, the Debtors simply could not locate some of the Loan Files. The Committee’s counsel reported
to the Court that the Committee’s expert was satisfied the files that were produced were a sufficient sample.
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Case Conference Tr. 9:3-10. While a uniform schedule in all of the similar cases pending before
the district judge may (and probably is) the most efficient manner of dealing with a large docket,
the uniform schedule with very tight time deadlines may simply not be compatible with the
extraordinary demands on the Debtors arising from these chapter 11 cases. Delay in the chapter
11 cases threatens the ability of these Debtors to reorganize. This is not, for example, a situation
where prompt discovery is required for a criminal case, police or regulatory action, or other
matter where the public interest requires an immediate trial in the district court. The Court does
not doubt the importance of the FHFA Case, or of the district court expeditiously dealing with its
docket, but the potential impact on hundreds or thousands of creditors will be severe if the
Debtors’ reorganization fails.16 On balance, the Court believes that the context supports
maintaining a stay on discovery at the present time.
3. 	Need
The district court has stated that the requested discovery “is the first cut that permits the
parties to evaluate the claims and to organize their other discovery requests and figure out
whether or not third-party discovery needs to take place and who would be involved in that.”
July 17 Case Conference Tr. 9:3-10. It appears that the district court believes that the lack of
production of the Loan Files in this case poses a significant hurdle to the advancement of the
litigation. Specifically, during the July 17 Case Conference, the district court stated that “Ally
and Res Cap should be producing the final closing loan tapes and the originator information so
that the rest of this litigation . . . can proceed.” Id. at 9:22-10:5. That issue has at least been
resolved. The district court also stated that the Loan Files must be produced. In assessing the six
16 	There is a certain irony here. AFI, the Debtors’ parent company, is 74% owned by the U.S. Treasury
because approximately $17 billion of TARP funds were advanced to prevent AFI from failing during the financial
crisis. FHFA, also a U.S. Government agency, as conservator of Freddie Mac, appears to be a creditor of the
Debtors.
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factors, a bankruptcy court should not question the trial court’s conclusion about the need for
specific discovery in the case pending before that court. Therefore, the Court concludes that
need weighs in favor of lifting the stay and ordering the requested discovery.
4. 	Timing
This factor weighs heavily in favor of maintaining the stay to protect Debtors from
FHFA’s and the Underwriter Defendants’ discovery requests until at least February 2013.
Debtors have a very difficult few months ahead. The Debtors are in the midst of document
review, document production and due diligence on at least three matters. In addition to their
day-to-day responsibilities, Debtors must prepare for the following events:
i. 	Auction of the Debtors’ Principal Assets. The Debtors are preparing for an
auction and sale hearing of its principal assets—the Loan Origination and
Servicing Platform and the Legacy Loan Portfolio—which is scheduled to occur
on October 23 and 24, 2012. Assuming the auction is successful, the Debtors’
focus must then be on successfully closing the sale transactions. Substantial due
diligence is underway by numerous qualified bidders, requiring the time and
attention of the Debtors’ employees and legal and financial professionals. The
hearing to approve the sales is currently scheduled for November 19, 2012, and it
will take at least several months to close any sale transactions, assuming Court
approval is granted.
ii. 	Hearing on Approval of Proposed $8.7 billion RMBS Settlement Agreement.
The proposed settlement, if approved and if it thereafter becomes effective, would
resolve potential breach of representation and warranty claims asserted by holders
and insurers of residential mortgage-backed securities originated and serviced by
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the Debtors. The expedited trial of this matter—which Debtors have frequently
described as a centerpiece of their efforts to reorganize—is now scheduled to
begin on January 14, 2013. The trial was originally scheduled to begin on
November 5, 2012, and was then rescheduled to begin on November 13, 2012.
The trial date was changed each time because the Debtors were unable to comply
with the expedited discovery schedule.17 Thirty hours of trial time (allocated
between supporters and opponents of the settlement) have been tentatively
scheduled over a four-day period.
iii. 	Examiner Investigation into the Propriety of Debtors’ Prepetition
Transactions. On June 20, 2012, the Court granted a motion for the appointment
of an examiner under section 1104(c)(1) of the Bankruptcy Code. See
Memorandum Opinion and Order Granting Berkshire Hathaway’s Motion to
Appoint an Examiner (ECF Doc. # 454). The U.S. Trustee selected Arthur J.
Gonzalez as the Examiner. The Examiner has retained and the Court has
approved the retention of legal counsel and a financial adviser for the Examiner.
The agreed scope of the investigation is very broad. The Examiner’s counsel has
requested document production, begun to prepare to interview a large number of
witnesses and is authorized to issue subpoenas and take testimony. Originally
projected to take six months to complete, the Examiner’s counsel advised the
Court on October 10, 2012 that the investigation and report may take more than
six months to complete, largely because of the conflicting demands placed on the
17 	Counsel have advised the Court that there may by testimony by eleven fact witnesses and thirteen expert
witnesses. Hopefully, these numbers will be pared down before the trial. None of these fact or expert witnesses
have been deposed yet because document production is not yet complete and many expert reports are still being
prepared.
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Debtors and other parties in interest by the expedited discovery in connection with
the upcoming RMBS Settlement Hearing. While the Court has insisted that the
case move forward while the Examiner completes the investigation and report,
there is little doubt that a reorganization plan cannot be confirmed until the
Examiner has completed his work.
iv. 	As Part of Their Day-to-Day Business, the Debtors Must Continue to Litigate
Foreclosure Cases and Related Litigation Across the Country. Debtors are the
fifth largest residential mortgage servicer in the country. The mortgage crisis that
has plagued the nation has resulted in numerous foreclosure actions across the
country. Many borrowers have asserted affirmative defenses which the Debtors
must actively litigate. As loan servicers, the Debtors are required to meet their
contractual obligations to mortgage holders for whom they service the loans.
These cases continue to place heavy litigation demands on the Debtors.
In light of all of the above, the Debtors simply cannot also undertake the very substantial
burden of producing the Loan Files requested by the FHFA and the Underwriter Defendants.
The factor of timing clearly and strongly favors continuing a stay on the discovery requested by
the FHFA and the Underwriter Defendants at least until February 2013.
5. 	Burden
The heavy burden that responding to FHFA’s and the Underwriter Defendants’ document
requests would impose at this time also strongly weighs in favor of maintaining the stay.
Debtors’ professionals and employees are already stretched thin responding to the many
demands described above.
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In their supplemental briefing and with the evidence introduced during the September 11
Hearing, the Debtors addressed the financial and operational burden and expense if they are
required to produce 5,000 Loan Files or 43,000 Loan Files.18 Debtors initially estimated that
production of 43,000 Loan Files would take up to ten months to complete. According to the
Debtors, searching the Debtors’ databases would take over a week; the Debtors’ employees
would then spend one to two weeks clearing exceptions and resolving other errors. See
Mongelluzzo Supp. Decl. ¶¶ 17-18. Searches of electronically stored data would have to be run
at night due to their size, and because other searches critical to the Debtors’ day-to-day business
have to be run during the day. Id. Assuming that off-site records storage vendors retrieve files at
their contractually-agreed rate of 1,250 boxes a week, it would take approximately thirty weeks
for the Debtors’ vendors to pull all 43,000 files. Id. ¶ 19. While the files were being retrieved,
the Debtors’ imaging vendors would have to process and image the files, requiring still more
time. Id. ¶ 11. Debtors estimated the overall expense of producing 43,000 Loan Files to range
from $1,075,000 to $1,204,000, in the best-case scenario, and $3,225,000 to $4,300,000, in the
worst-case scenario. Id. ¶ 22.
During the September 11 Hearing, the Court told Debtors’ counsel that the Debtors’ time
estimate required to produce the requested files was completely unrealistic. September 11
Hearing Tr. 127:23-128:2. The Court directed Debtors’ counsel to obtain new time and cost
estimates assuming that production of the Loan Files would have to be completed within sixty
days, a time period that FHFA’s counsel acknowledged as reasonable. Id. at 132:17-133:1.
In response to the Court’s request, on September 21, 2012, the Debtors submitted a letter
with a cost estimate from one of its vendors, Iron Mountain, to retrieve 43,000 loan files within
18 	As already noted, during the September 11 Hearing, FHFA reduced its request for production to 2,500
Loan Files, while the Underwriter Defendants insisted that all 43,000 Loan Files should be produced. See n.1,
supra.
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sixty or 120 days. (the “September 21, 2012 Letter,” ECF Doc. # 1516.) Iron Mountain’s
proposal includes two options. In the first option, Iron Mountain estimates it would cost between
$182,680 to $304,800 for a sixty-day retrieval, and $127,158 to $244,278 for a 120-day retrieval,
to pull the Loan Files, ship them to the Debtors’ imaging vendor, and then retrieve and reshelf
the Loan Files after imaging. In the second option, which would cost the Debtors between
$811,200 to $931,680 for a sixty-day retrieval, and $621,158 to $741,278 for a 120-day retrieval,
Iron Mountain additionally assumes responsibility for imaging the Loan Files, although the
Debtors typically do not use Iron Mountain’s imaging services.
Debtors point out that these cost estimates do not include “any estimate for the time and
expense associated with identifying and locating the relevant loan files, negotiating statements of
work with Iron Mountain and other third party storage and imaging vendors, preparing the loan
files for production . . . and attorney review,” or “certain additional imaging costs, such as
adding search capabilities, which would increase the cost of production on a per page basis.” See
September 21, 2012 Letter at 2.
With respect to the production of 5,000 Loan Files, Debtors estimate that it would take
three days for two of the Debtors’ employees to identify the location of the files and two days to
resolve any “exceptions” that turn up in the searches. Mongelluzzo Supp. Decl. ¶¶ 6-7. The
Debtors then estimate that it would take approximately five weeks for all 5,000 Loan Files to be
pulled by the vendors. Id. ¶ 9. In all, Debtors estimate that the production of 5,000 Loan Files
would take between five to seven weeks, and the expense would range from $125,000 to
$140,000 on the low end, and $375,000 to $500,000 on the high end. Id. ¶ 12-14.
The financial burden is separately addressed below and can be eliminated by requiring
parties other than the Debtors to pay all of the costs. But the bigger problem for the Debtors in
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producing Loan Files at the present time is the Court-ordered information retrieval and
production requirements dictated by the critical stage of the Debtors’ chapter 11 cases and
discussed above. The Court therefore concludes that the factor of burden strongly weighs in
favor of maintaining the stay of discovery.
6. 	Expense
Debtors have provided estimates that the total costs of producing 5,000 Loan Files could
range from $125,000 to $500,000, and the total costs of producing 43,000 Loan Files could range
from $1,075,000 to $4,300,000. Debtors provided a more recent estimate that the costs of
pulling 43,000 Loan Files in sixty days could range from $182,680 to $304,800, notwithstanding
the additional costs that would be incurred for Debtors to locate the files, to have them scanned,
and to have them reviewed and reviewed by counsel and produced. The Debtors should not have
to bear the cost of discovery in third-party actions. This Court will condition discovery from the
Debtors on the payment of all costs of FHFA’s and the Underwriter Defendants’ discovery on
some party other than the Debtors, though precisely who must pay is an issue appropriately
decided by the district court.19
19 	As previously discussed, AFI and the Debtors are parties to a Shared Services Agreement. At the August
14 Hearing, the Court requested supplemental briefing whether the Shared Services Agreement requires the Debtors
to provide AFI with Loan Files it may request, and if it does, who must pay for it. AFI and the Debtors dispute
whether the Shared Services Agreement contemplated production by the Debtors to AFI of the volume of Loan Files
requested by FHFA and the Underwriter Defendants in this matter. The Court finds it unnecessary to resolve the
issue. This Court approved the Debtors entry into the Shared Services Agreement. See ECF Doc. # 387. The only
thing this Court decides now is that if the Debtors are required to provide AFI with the Loan Files, because the
district court orders AFI to make the request, the Debtors are not the ones who must bear the costs of doing so.
Whether AFI, FHFA, or the Underwriter Defendants should bear or share the costs is for the district court to decide.
There is authority, including an opinion by this Court, that under Rule 34, a party to litigation may be required to
produce documents in the custody or control of another. See In re Lozano, 392 B.R. 48 (Bankr. S.D.N.Y. 2007); see
also Shcherbakovskiy v. Da Capo Al Fine, Ltd., 490 F.3d 130 (2d Cir. 2007); JPMorgan Chase Bank v. Winnick,
228 F.R.D. 505 (S.D.N.Y. 2005) (“ Winnick I ”); JPMorgan Chase Bank v. Winnick, No. 03 Civ. 8535, 2006 WL
278192 (S.D.N.Y. Feb. 6, 2006) (“Winnick II”).
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7. 	Weighing All Relevant Factors, the Court Concludes the Stay should be Extended
to Protect Debtors from Producing the Loan Files at this Time
The Court must tread carefully when determining whether to maintain a stay on
discovery in third-party actions. While the precise question before the Court appears to be a
question of first impression, there are numerous parallels that support empowering a bankruptcy
court to limit or condition third-party discovery directed to debtors. The Court has endeavored to
identify and apply the factors that seem most relevant to the issues at hand. Having performed
this analysis, the Court concludes that the factors overwhelmingly support maintaining a stay
against discovery from the Debtors under section 105. The Debtors are entitled to a respite but
not an exemption from discovery. 	The Court recognizes that granting this relief imposes a
burden on the district court in the efficient handling of that court’s heavy docket and the orderly
administration of the large group of similar cases pending in that court. No disrespect to the
district court is intended in granting this relief, but the Court concludes that the evidence in the
record overwhelmingly supports granting this relief.
The Court directs the Debtors, the FHFA and the Underwriter Defendants to meet and
confer on a targeted schedule for production of documents, consistent with the demands of the
chapter 11 cases. The parties should also endeavor to resolve, if possible, the issues of allocation
of costs. To the extent appropriate, this Court is prepared to hold joint hearings with the district
court regarding the discovery issues. Other approaches, such as phased production, may be
possible and could lessen the burden on the Debtors.
III. 	CONCLUSION
For the reasons explained above, the Supplement to July 17, 2012 Motion of the Federal
Housing Finance Agency Pursuant to the July 11, 2012 Order of the Honorable Denise L. Cote
Seeking Limited Discovery from the Debtors and, if Necessary to that Purpose, Relief from the
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Automatic Stay, filed on July 17, 2012 (the “Supplemental Motion,” ECF Doc. # 859); and the
Motion in Support of Loan File Discovery from the Debtors and, if Necessary to that Purpose,
Relief from the Automatic Stay (“Underwriters Motion,” ECF Doc. #1293), are both DENIED.
IT IS SO ORDERED.
Dated: 	October 12, 2012
New York, New York
_____Martin Glenn____________
MARTIN GLENN
United States Bankruptcy Judge
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