MBIA’s fraud claim against Credit Suisse reinstated but court signals claim is fatally flawed

In 2009, MBIA, a company that insures financial products including financial risk, commenced an action against Credit Suisse Securities USA LLC (“Credit Suisse”), DLJ Mortgage Capital, Inc. (“DLJ”) and Select Portfolio Servicing, Inc. (“SPS”) claiming fraudulent inducement and breach of contract in connection with its insurance of a pool of mortgage-backed securities. The securities, insured by MBIA, were comprised of an aggregate of over 15,000 second lien residential mortgage loans, also referred to as HELOCs.  

The Dispute

MBIA’s insurance policy, issued pursuant to a contract it entered into with defendants DLJ and SPS, guaranteed certain payments on the securities. Credit Suisse was not a party to that contract, but served as the underwriter of the public offering of the securities, which it marketed to investors. MBIA’s fraud claim against Credit Suisse is premised on allegations of certain pre-contractual representations by Credit Suisse. Specifically, MBIA claims that Credit Suisse (1) provided a loan tape, which contained false and misleading disclosures about the HELOCs, (2) assured MBIA that the loans were underwritten to strict guidelines created or approved by Credit Suisse, (3) touted the due diligence it conducted on the loans, including depicting an individualized review of thousands of loans in the pool, (4) claimed that it was backing the loans originated by New Century, and (5) boasted that performance of its prior securitizations was far superior to other similarly structured transactions. Ambac Assurance Corporation (“Ambac”), another insurer of financial risk, commenced a parallel action against the same defendants (the “Ambac Action”).

The Earlier Dismissal of MBIA’s Fraudulent Inducement Claim

In August 2010, Judge Shirley Werner Kornreich of the Commercial Division of New York’s trial court in Manhattan denied Credit Suisse’s motion to dismiss MBIA’s fraud claim against it. In June 2011, Justice Kornreich reversed that decision and dismissed that claim (the “June Dismissal Order”). In the June Dismissal Order, the court found that MBIA’s fraudulent inducement claim was duplicative of its breach of contract claims because the fraud claim was based on representations made by Credit Suisse that were addressed by express contractual representations and warranties. The court’s reversal of its initial determination to allow MBIA’s fraud claim to proceed followed its decision to dismiss the fraudulent inducement claim against Credit Suisse in the Ambac Action on the same grounds, that Ambac’s fraudulent inducement claim was duplicative of its breach of contract claims.  

MBIA’s Fraud Claim Reinstated

A month later, in July 2011, in an unrelated case brought by MBIA against Bank of America Corporation’s Countrywide Financial Unit, New York’s Appellate Division issued a decision reversing the dismissal of MBIA’s fraud claims, MBIA v. Countrywide, 2011 NY App. Div. LEXIS 5509 (“Countrywide”). In that case, the Appellate Division held that MBIA’s fraud claims were not duplicative of its breach of contract claims merely because “some of the allegedly false representations are also contained in the agreements as warranties that form the basis of the breach of contract claim.”  

Under New York’s state procedural rules, where there is a change in the law that would change a court’s prior determination, a motion to renew or reargue may be brought. In light of the Appellate Division’s decision, which is binding on the trial court and which squarely addressed the legal issue on which Judge Kornreich had based her dismissal of MBIA’s fraud claim against Credit Suisse in June, MBIA sought leave to reargue the motion to dismiss. Upon reargument, Judge Kornreich granted MBIA’s motion, found that an application of the Countrywide decision to the facts of MBIA’s case against Credit Suisse mandated a determination that MBIA’s fraud claim did not duplicate its breach of contract claim, and allowed the fraud claim to proceed.  

Court Signals MBIA’s Fraud Claim Victory Is Temporary

While MBIA appears to have finally won the battle concerning its fraudulent inducement claim at the motion to dismiss stage of the litigation, the court left little doubt as to which party it believes will win the ultimate war. Indeed, after summarily granting reinstating MBIA’s fraudulent inducement claim with just two paragraphs of discussion, the court dedicated twenty-pages to analyzing “justifiable reliance,” a requisite element of MBIA’s fraud claim. The essence of the court’s analysis is that MBIA will not be able to establish justifiable reliance on Credit Suisse’s alleged misrepresentations when it could have requested and reviewed information that was material to the transaction, but chose not to. A failure to satisfy the justifiable reliance element would be fatal to MBIA’s fraud claim.  

Specifically, the court found that “MBIA’s reliance on [Credit Suisse’s] alleged representations . . . would be unreasonable as a matter of law” because MBIA did not request or review the loan files in the pool. According to the decision, MBIA’s failure to make use of the means of verification available to it prevents MBIA from arguing that it entered into the arm’s length transaction in justifiable reliance on the alleged misrepresentations. The court made abundantly clear that this is particularly true for sophisticated parties like MBIA whose primary business is insuring precisely the kind of financial risk in dispute in this case. Further, the court expressly rejected arguments by MBIA that the means of verification were not available to it because of the large number of loans and the limited amount of time available to complete the transaction. The court observed that MBIA’s time limitations were self-imposed and that it could have declined issuing the policy if it did not have enough time to conduct thorough due diligence.  

Following the extensive discussion of MBIA’s inability to demonstrate that it justifiably relied on the alleged misrepresentations underlying its fraud claim against Credit Suisse, the court concluded that “[i]t would benefit from a complete record created after the completion of the parties’ discovery.”  

Conclusion

In addition to reinstating MBIA’s fraudulent inducement claim, the court reinstated MBIA’s demand for consequential and punitive damages. The court, however, adhered to its decision granting defendants’ motion to strike MBIA’s demand for a jury trial in light of the express contractual waiver of that right by the parties, which means that Judge Kornreich will likely be the ultimately finder of fact in this case. While the trial court is bound to follow the Appellate Division’s decision and allow MBIA’s fraud claim to survive at the motion to dismiss stage, Judge Kornreich’s analysis strongly suggests that MBIA’s fraud claim will face other, more fatal, defenses.