A federal judge on Tuesday released details of a June court decision that requires XL Capital Assurance Inc. to honor seven credit default swaps with Merrill Lynch & Co.
U.S. federal Judge Jed Rakoff ruled that the swap agreements between Merrill and XLCA still granted the monoline voting rights on $3.1 billion of collateralized debt obligations - which the seven CDS provide protection on - even after Merrill entered into similar swap agreements with MBIA Insurance Corp.
Rakoff ruled in favor of Merrill on June 10, but released his reasoning on the case on Tuesday.
The XLCA contracts stipulate that any failure of Merrill's to follow the monoline's voting instructions would terminate the CDS transactions. Conversely, the MBIA swap agreement states that if Merrill does not follow MBIA's controlling rights, the monoline could then "declare" a termination event, according to the judge's opinion on the case.
"It is true that, as [XLCA] notes, nothing in the MBIA agreement purports to subordinate MBIA's claim to control of the voting rights to similar claims accorded to other parties (such as [XLCA]). However, the lack of a similar provision in the [XLCA] swaps suggests, if anything, that [Merrill] intended to abide by its agreement with [XLCA] in case of conflict," the opinion said.
Bond insurers often supply insurance on CDOs through CDS. Monolines prefer having voting rights and control of CDOs as that gives the bond insurers a say in what happens to the collateral backing the securities.
On Feb. 22, XLCA cancelled the seven contracts on the grounds that it believed that it no longer had controlling rights on the CDOs because Merrill extended voting rights to MBIA on the same securities. From Jan. 25, 2007 to Aug. 10, 2007, XLCA and Merrill entered into the swap agreements. Merrill began entering into six CDS with MBIA on Aug. 29 of that year.
XLCA spokesman Michael Gormley and Merrill spokesman Mark Herr both declined to comment on Rakoff's opinion.