MBIA Inc.’s attempt to shield its public finance business from its more toxic structured finance guarantees hit a roadblock Thursday as the U.S. District Court for the Southern District of New York denied a motion to dismiss a lawsuit charging MBIA with fraud and breach of good faith.

A number of hedge funds, led by Aurelius Capital Master Inc., sued bond insurer subsidiary MBIA Insurance Corp. last March after the company transferred $5.4 billion of capital to a new domestic public finance insurer. The plaintiffs argued the transfer of capital was a fraudulent conveyance and “a breach of the implied covenant of good faith and fair dealing,” according to the court ruling.

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