Five of the six complaints bond insurer MBIA Insurance Corp. filed in April 2009 against Merrill Lynch were dismissed by the New York Supreme Court late Friday.
The case involves 11 credit default swaps that protect four collateralized debt obligations of asset-backed securities, which have a face value of $5.7 billion, according to Judge Bernard J. Fried’s 13-page statement.
MBIA, which sold the protection based on marketing materials published by Merrill between July 2006 and March 2007, entered the transaction under the impression that it was providing protection on “highly conservative” debt instruments. As such, it charged extremely low premiums averaging less than eight basis points annually, according to its complaint last year.
As the financial crisis took the market by storm, the quality of the underlying collateral deteriorated, and MBIA said it faced paying millions of dollars on the contracts.
MBIA alleged that Merrill deliberately sought to have its most toxic assets insured at a time when it had privileged knowledge of their deterioration. It called the transaction a scheme “to offload billions of dollars of deteriorating U.S. subprime mortgages and other collateral.”
The judge dismissed all allegations of fraud or misrepresentation, but he allowed a breach-of-contract claim to be pursued, meaning MBIA could still win monetary payment for damages incurred.
The claim rests on the contention that, while the credit quality of the assets in question was “nominally” triple-A, they were not of that value “in actuality ... that is, that the rating was, essentially, bogus,” Fried wrote, noting the gilt-edged ratings provided by Standard & Poor’s and Moody’s Investors Service
“Plaintiffs had a right to expect that the AAA ratings were backed by intelligence which could verify that the notes were actually of the credit quality an AAA rating implied,” the judge added. “Plaintiffs may claim that the wrapped notes were not qualified to be AAA rated, as promised, regardless of the label they carried, as a claim for breach of contract.”
Defendants have 20 days to respond to the amended complaint. As for the other allegations, Fried was convinced by the defendant’s evidence that the lawsuit was “a classic case of buyer’s remorse.”
The bank, which has since merged to become Bank of America Merrill Lynch, pointed to the marketing materials in question and noted such statements as: “Any investor ... should conduct its own investigation and analysis of the product and consult with its professional advisers as to the risks involved.”
Also, in the transactions, MBIA agreed to “unconditionally and irrevocably” guarantee the contracts “without the assertion of any defenses to payment, including fraud in the inducement or fact.” In addition, it signed a disclaimer agreeing it was capable of assessing, understanding, and assuming the risks of the policy.
In pointing to those statements, the judge added that among both parties, their “sophistication and business acumen and experience cannot be overstated.”
Jay Brown, chief executive officer of parent MBIA Inc., noted in a recent letter to shareholders that while many have claimed the company “should have known better,” he said the basis of commerce is trust, and blamed financial counterparties for not living up to their obligations.
“It’s a little like why you might choose to buy a Mercedes,” Brown said. “You want to deal with a company that has the highest reputation and standards for quality and service ... a company that, in the extremely rare case of a model being recalled, would share this information with you and right the situation immediately. In our case, we thought we were buying a Mercedes, not a used car where it’s 'buyer beware.’”