A New York trial court recently granted partial summary judgment in favor of MBIA Insurance Corporation (“MBIA”) on fraud and breach of warranty claims it had brought against Countrywide Home Loans, Inc. and various affiliates (collectively, “Countrywide”) concerning certain financial guaranty insurance policies that MBIA had issued in connection with residential mortgage-backed securitizations originated by Countrywide. MBIA Ins. Corp. v. Countrywide Home Loans, Inc., Index No. 602825/08, 2012 N.Y. Misc. LEXIS 2 (N.Y. Sup. Ct. 2012). The court concluded that, to succeed on its fraud and breach of contract claims, MBIA was not required to prove a direct causal link between its payment of claims under those policies and the alleged misrepresentations by Countrywide concerning the risks of the securitizations.
Between 2004 and 2007, MBIA entered into 15 separate insurance contracts with Countrywide whereby MBIA agreed to insure payments to investors with respect to the securitization of certain pools of residential mortgages. That securitization process involved packaging numerous mortgage loans into a trust, issuing securities in the trust and selling those notes, known as residential mortgage-backed securities, to investors. The homeowners’ payments of principal and interest on their mortgage loans would be used to pay the investors who purchased the securities. Pursuant to its contracts with Countrywide, and in exchange for premium payments received, MBIA was obligated to make up any shortfalls in the scheduled payments to the investors from the trust.
MBIA alleged that, beginning in 2007, during the U.S. housing market collapse and related financial crisis, defaults and nonpayments by the homeowners whose mortgages were included in the relevant securitization pools materially increased, and the trusts became unable to make the scheduled payments to investors in the notes. As of August 29, 2009, MBIA claims, it had paid $1.4 billion on its insurance policies and faced hundreds of millions of dollars in additional future claims.
On September 30, 2008, MBIA commenced the instant action against Countrywide, asserting a number of causes of action including fraud, negligent misrepresentation, breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnification. In essence, MBIA alleged that Countrywide made material misrepresentations and breached warranties concerning the creditworthiness of the borrowers of the home loans included in the securitization pools and Countrywide’s compliance with proper underwriting and loan origination standards. According to MBIA, Countrywide knowingly made loans to borrowers that could not afford to repay them and/or who committed fraud in their loan applications. Moreover, Countrywide allegedly falsely represented that home appraisals were conducted by independent appraisers while, in truth, the appraisers were beholden to Countrywide, thereby increasing the risk of inflated appraisals. MBIA alleges that if it had known that Countrywide’s representations were false, MBIA would never have guaranteed the notes and suffered the losses alleged.
Countrywide moved to dismiss the complaint for failure to state a claim and, in an April 29, 2010 decision, that motion was granted in part and denied in part. Specifically, the court dismissed the negligent misrepresentation claim in its entirety and the implied covenant of good faith and fair dealing claim in part, while denying the motion to dismiss the fraud claim. On appeal, the Appellate Division modified that decision to dismiss the implied covenant of good faith and fair dealing claim in its entirety, but otherwise affirmed. MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287, 928 N.Y.S.2d 229 (1st Dep’t 2011).
The Parties’ Positions
Having in large part survived Countrywide’s challenge to the legal sufficiency of the allegations in its complaint, MBIA thereafter filed a motion for partial summary judgment in its favor concerning its fraud and breach of contract claims.
MBIA’s motion effectively sought a declaration by the court concerning the degree of causal connection that MBIA would need to demonstrate in order to prove its fraud and breach of contract claims. With respect to its fraud claim, MBIA requested a judgment from the court that MBIA need establish only that Countrywide’s alleged misrepresentations induced MBIA to issue insurance policies on terms it would not have agreed to had MBIA known of the alleged misrepresentations, and that MBIA need not show a causal connection between Countrywide’s alleged misrepresentations and MBIA’s claims payments. Similarly, with respect to its breach of contract claim, MBIA sought a judgment that it need establish only that the mortgage loans in the securitization pools breached a representation or warranty in a way that materially affects MBIA’s interests, and need not show that the loan was nonperforming or that the nonperformance was caused by Countrywide’s breaches of representations and warranties.
Countrywide opposed MBIA’s motions, arguing that MBIA should instead be required to prove that the claims payments it made were directly caused by Countrywide’s alleged misrepresentations and not by the meltdown of the U.S. housing market and financial crisis that began in 2007. Countrywide further argued that, in any event, MBIA could only be entitled to rescission of the challenged insurance policies and not, as it demands, damages in the amount that it has paid out under the insurance policies (less premiums MBIA received under the policies).
In deciding MBIA’s motion for partial summary judgment, the court framed the “base issue before the court” as “when causation occurs in claims for insurance fraud and breach of representations and warranties.” Relying in part on Sections 3105 and 3106 of the New York Insurance Law, the court concluded that “it is well-settled that it is upon the misrepresentation that induces action resulting in damages that fraud or breach occurs.” As such, “no basis in law exists to mandate that MBIA establish a direct causal link between the misrepresentations allegedly made by Countrywide and claims made under the policy.”
Following from this conclusion, the court explained the standard of proof moving forward in the litigation as follows:
MBIA must prove for its fraud claim that it issued the Insurance Policies on representations made in the policies’ applications, and that it would not have done so or would have issued the policies on different terms had the alleged misrepresentations not been made. Similarly, MBIA must prove for its breach of warranty claim that Countrywide’s alleged misrepresentations materially increased MBIA’s risk of loss.
Moreover, the court disagreed with Countrywide’s position that MBIA may only seek to rescind or avoid the insurance policies and could not seek damages. The court concluded that, although “rescission may be warranted should MBIA prove its claims,” it would be “impractical” because rescinding the insurance policies would harm the innocent investors in the notes. And, where rescission is impractical, the court has the discretion to instead award “rescissory damages.” Here, according to the court, “should MBIA prove its case, rescissory damages [in the amount paid by MBIA under the insurance policies] minus premiums received will make MBIA whole without providing a windfall.”
The court cautioned, however, that MBIA must still prove all the elements of its claims, including “that it was damaged as a direct result of the material misrepresentations” and “the amount of [those] damages,” which “will not be an easy task.”
The court’s recent decision in MBIA Ins. Corp. v. Countrywide Home Loans, Inc. settled in favor of financial guaranty insurance companies an important question concerning the standard of proof necessary to establish causation on certain fraud and breach of contract claims. That decision did not, however, decide the ultimate merits of MBIA’s claims. A decision on whether MBIA can prove its essential allegations by a preponderance of the evidence, including its reliance on and damages suffered from Countrywide’s alleged misrepresentations, awaits another day