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MBIA v. Countrywide Ruling

posted by Adam Levitin

There's been a lot of media coverage of the recent ruling of the NY Supreme Court (that's the trial court, not the final Court of Appeals) in MBIA v. Countrywide, a suit by the monoline bond insurer against Countrywide for fraud, negligent misrepresentation, etc. that induced it to insure Countrywide's mortgage-backed securities. This and Syncora's similar suit are being carefully watched because they are the MBS litigation that is the farthest along and thus seen as a belleweather for other rep and warranty suits.  While the monolines are in a somewhat different position than MBS investors, they provide a good indicator of what to expect from investor suits.  

For all the discussion of the opinion, no one seems to have actually read the damn thing, so here it is.

To summarize:  MBIA is suing for insurance fraud and breach of reps and warranties in the insurance policy it issued at CW's request for some 15 MBS trusts. The main issue in this decision was whether MBIA had to prove that the alleged fraud and breach of warranty resulted in its losses.

CW argued that loss causation was necessary, which presented a real challenge in terms of sorting losses from the fraud vs. losses from market factors. The NY Supreme Court said that loss causation was not required here.  MBIA must merely prove that CW made a material misrepresentation, meaning that increased the risk that MBIA assumed.  Put differently, but for the misrepresentation MBIA would not have issued the policy on the same terms. The Court ruled for MBIA and says no loss causation is required. There's good policy for this ruling.  As late John Marshall (Chicago) Law School Professor John Dwight Ingram explained, requiring a causal connection may encourage fraud because "If [the rule were otherwise and] the cause of loss is not connected [to the misrepresentation], [it means that the insured] has coverage he otherwise couldn't have obtained.  Thus, [the insured] had nothing to lose by misrepresenting."  

What's puzzling, then is that having said that MBIA doesn't need to prove loss causation, the court states "MBIA must then prove that it was damaged as the direct result of the material misrepresentations. As has been aptly pointed out by Countrywide, this will not be an easy task." (p.15).  So no loss causation required, but damages must be shown to be linked to the direct result of the material representations?  Is it yes or no?  

I'm not sure how to square this.  My first thought was that the Court was making a technical distinction between not having to show loss causation to prove materiality of a misrepresentation (which goes to increased risk, not increased loss), and loss causation on the issue of damages. But I really don't see anything in the opinion or order to support such a reading.  Instead, the best way I can square these seemingly contradictory statements is that the court is saying that MBIA will have to prove its payouts on the policies, given what the court says is the proper remedy, namely "rescissory damages" (which might be better termed "reliance damages").  I think this means MBIA doesn't have to wade into what damages were from the financial crisis and what from the fraud, but there is still that reference on p. 15 to this not being "an easy task".  I really wish the court had been clearer on this point. 

The other interesting issue in this case relates to damages.  There is a dispute between the parties as to whether the damages should be rescission or rescissory (reliance) damages.  It's hard to tell the difference from the opinion:  it would appear that the difference between these remedies is whether the insurance policy remains in place going forward. In either scenario, MBIA would receive back its payouts on the policies and have to return  (or deduct) premiums already received.  

With rescission, the contract would no longer exist, meaning there would be no more insurance on the MBS, and MBIA wouldn't receive any future premiums.  That would leave the MBS investors kind of screwed, but with a suit against CW.  With rescissory damages it seems (but the court isn't clear on this) that the policy would remain in force, but--and here's the big point, but it's only apparent in MBIA's reply brief--with rescissory damages, the contract will remain in force and CW to repurchase the performing loans that do not conform to representations.  In other words, MBIA will continue to get premiums going forward for insuring the good loans.  So what MBIA is trying to do is to split the deal in half.  For the loans that have gone bad, to have CW cover the payouts minus the premiums and then for the loans that haven't gone bad, MBIA wants to keep doing the original deal as envisioned.  That's a very strange remedy.  Either the contract is rescinded or it isn't.  You can' t usually rescind the contract up until today and then honor it going forward.  It's a non-severable package deal.  I would have thought that the answer here for a fraud in the inducement type claim would just be plain old rescission and let the MBS holders have at CW on their own.  The court doesn't completely resolve this. It denied MBIA's motion for summary judgment on whether it could compel repurchases of perfoming, but non-conforming loans.  That doesn't mean that MBIA loses on that issue, just that it didn't win yet.  Reading this all together, though, it seems like MBIA is going to get partial rescission and partial selective repurchase of the bad loans.  

Final thought:  I'm kind of surprised that the MBS holders haven't intervened or been interpleaded given their interests in all of this.  

So to recap, I think this is a win for MBIA, quite possibly a very big win, but it's really hard to tell just given the lack of clarity in the opinion.  If you think they'll help decipher things, here is MBIA's original brief, the CW opposition brief, and the MBIA reply brief


That was excellent, thank you.

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