In March thousands of foreclosed mortgage holders began receiving relief checks for subprime loans originated by Calabasas-based Countrywide Financial Corp., acquired by Bank of America in July 2008. The money flows from an $8.68 billion settlement of the predatory lending class action brought against Countrywide by the attorneys general of seven states. The settlement, brokered in October 2008 by California AG Jerry Brown and the office of the Illinois Attorney General, called for BofA to modify the loans of nearly 400,000 homeowners nationwide, suspend foreclosures for eligible borrowers, and eliminate certain fees. Borrowers who had been displaced due to foreclosure prior to the settlement were to receive direct payments for relocation. If all eligible California borrowers participate, their savings from loan modifications could total $3.5 billion (People v. Countrywide Fin. Corp., No. LC083076 (Los Angeles Super. Ct. judgment entered Oct. 20, 2008)). When the settlement was signed it looked like a perfect deal - so good that 45 states and the District of Columbia eventually joined the agreement. "Tragically, California and the other states have had to step in because federal authorities shamelessly failed to even minimally regulate mortgage lending," Brown said as he announced the deal. The settlement wasn't bad for BofA, either. Countrywide admitted no wrongdoing, and the AGs either dismissed pending lawsuits or dropped ongoing investigations. But there was a problem: Nobody bothered to guarantee that investors in Countrywide's mortgage-backed securities - sold to investors in a variety of trusts - would go along with the deal. Those investors owned 88 percent of Countrywide's subprime mortgages. Isaac M. Gradman, a securities litigator at Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco, calls the failure to include investor cooperation in the pact "unsophisticated." Says Gradman, "It's easy to agree on a settlement when it involves other people's money." In an article he wrote, Gradman called the deal "one of the largest and potentially most ill-conceived legal settlements in history." Michael Aguirre, a principal in San Diego's Aguirre, Morris & Severson, says, "Brown recognized the settlement would give him big, big press and he would not have to fight to the death in court." In 2008 Aguirre - then city attorney of San Diego - sued Countrywide separately and included fraud allegations. But Aguirre lost a reelection bid later that year, and the new city attorney - working with Brown - dropped the suit. Brown rejects criticism of the settlement. "By requiring lenders to evaluate consumers for modifications, our office has effectively required Countrywide to consult with investors and bondholders," says Evan Westrup, a spokesman for Brown's office. But David J. Grais, name partner in New York's Grais & Ellsworth who represents trust investors in a class action against Countrywide, contends that BofA neglected to seek approval from the buyers of its securitized mortgages. "I've never met an investor who was asked," Grais says. The loan modifications specified in the settlement had the effect of reducing cash flow to investors through lower principal and interest payments. According to Grais's suit, this could depress the value of the plaintiffs' certificates by billions (Greenwich Fin. Serv. Distressed Mortgage Fund 3, LLC v. Countrywide Fin. Corp., No. 650474/2008 (N.Y. Sup. Ct. (N.Y. County) complaint filed Dec. 1, 2008)). The class action seeks a declaratory judgment that, under agreements governing Countrywide's mortgage-backed trusts, BofA must repurchase every mortgage loan for which it cut the payments by at least the amount of the unpaid principal and accrued interest. Grais stipulates in his pleadings that the plaintiffs have no beef with the settlement between the AGs and Countrywide, "nor do plaintiffs take any position about whether the cost of reducing payments on loans [other than those Countrywide sold to plaintiffs] may be passed to the trusts that purchased those loans." He simply wants the court to declare that "Countrywide must fulfill this contractual obligation" and buy back certain modified loans from the trust. Rick Simon, spokesman for Bank of America Home Loans, declined to comment on the litigation. "The settlement came just months after Bank of America acquired Countrywide," he says. "The bank moved very quickly to come to a settlement, which has been a model for the federal government in announcing its affordable home program." At the end of 2008 Countrywide removed the class action to federal court, but the case was remanded to the Supreme Court of New York (Greenwich Fin. Serv. Distressed Mortgage Fund 3, LLC v. Countrywide Fin. Corp., 654 F. Supp. 2d 192 (S.D.N.Y. 2009)). The thrift appealed the remand and also moved to dismiss the suit in state court - and that's when the case got really interesting. Rather than wait for the courts to determine whether it had to buy back what may be $80 billion in toxic mortgages, BofA lobbied Congress to provide a safe harbor for lenders that agree to modify home loans or enter workouts with borrowers. In May 2009 President Obama signed the Helping Families Save Their Homes Act (P.L. 111-22). Last October, Countrywide's lawyers argued that the act rendered ineffective contract provisions that Countrywide must get investor approval to modify loans. Howard Rice's Gradman says that if the defense argument succeeds, trust investors could challenge the safe harbor provision under the Fifth Amendment's takings clause. "Now the government doesn't just have a dog in the fight," he says. "For constitutional reasons and also because of the government's interest in enforcing the sanctity of contracts, it's got a very big dog in it." Meanwhile, the bank has other Countrywide-related litigation to worry about. At least three insurers that guaranteed Countrywide's mortgage-backed securities have asked New York's supreme court to hold BofA vicariously liable for its subsidiary's shoddy loan practices. "There are a lot of investors lying awake at night wondering whether Bank of America is liable," Grais says. Even in states where claimants have begun to receive payments, the shine is now off the Countrywide settlement. "Modifying loans is taking longer than we expected, and we're getting complaints from homeowners," says Kristin Alexander, a spokeswoman for Washington's attorney general. "But we're still working with Bank of America." The bank has an uphill battle. A record number of U.S. homeowners - more than 900,000 of them - dropped into foreclosure between January and March 2010. Nearly a quarter of those were in California. In June, BofA announced that it would extend its three-year loan modification program through 2012. Pamela A. MacLean, a Bay Area freelance writer, has reported on state and federal courts for 25 years.