On March 4, 2013, the New York State Supreme Court rendered its long-awaited decision in respect of the actions of the New York Insurance Department (now the Department of Financial Services, the "Department") in approving the restructuring of MBIA. That restructuring created an alleged "good bank/bad bank" in which MBIA Corp.'s public finance policyholders were transferred into a new, well capitalized insurer while the structured finance policyholders were left behind to suffer MBIA Corp.'s financial difficulties. A group of banks holding structured finance policies brought two suits, one against the Department, seeking to void and annul the Department's approval of the restructuring (the "Article 78 Proceeding"), and another against MBIA and its affiliates, seeking to void the restructuring as nothing more than a fraudulent transfer (the "Plenary Proceeding"). The March 4 decision absolves the Department for its part in the MBIA restructuring, based on the very high hurdle that the Department's actions only need not be "arbitrary and capricious." However, the Court expressly held that its decision did not extinguish the banks' causes of action in the Plenary Proceeding. While over twenty banks joined the original litigation, only two remain. Those banks have stated that they will appeal the March 4 decision, and the litigation may continue in the Plenary Action. It remains to be seen, however, whether the March 4 decision will bring the parties to the settlement table.
In February 2009, MBIA Inc. restructured its principal insurance subsidiary, MBIA Corp., resulting in the separation of its municipal bond insurance business from its structured finance business. MBIA Inc. established a new U.S. public finance financial guarantee insurance company by transferring the stock of a dormant subsidiary of MBIA Corp. ("National") to a newly-established intermediate holding company that was a subsidiary of MBIA Inc. MBIA Corp. transferred all of its U.S. public finance business to National through quota share reinsurance. MBIA Corp. retained all of its international and structured finance business. As a result of the transaction, MBIA Corp. retained approximately twice the claim paying resources National received, but MBIA Corp.'s retained portfolio was seen as far more risky than National's portfolio. Moreover, MBIA Corp. remained on the hook for the portfolio ceded to National.
The Department provided regulatory approval to MBIA's restructuring through a letter detailing the individual steps required to achieve the restructuring. After the restructuring took place, MBIA Corp. ceased writing new business. National was eventually redomesticated to New York, which placed it under the Department's direct supervision, but did not get much traction with its attempts to write new business.
In May 2009, a large group of banks commenced the Plenary Proceeding against MBIA. Two months later, the same group commenced Article 78 Proceeding in response to MBIA's assertion that its restructuring was shielded by the Department's approval. Due to an extensive appeal of MBIA's motion to dismiss in the Plenary Proceeding on the point of the Department's approval, as well as the accelerated procedural process for an Article 78 action, the Article 78 Proceeding was heard in June 2012 while the Plenary Proceeding was held in abeyance.
The Court held that the issue before it in the Article 78 Proceeding was whether there was a rational basis for the Department's approval or whether it was an arbitrary decision. In discussing that standard, the Court said that the Department should be left to interpret how the laws worked, provided that the interpretation was not irrational or unreasonable. The Court also stated that a determination whether the Department acted arbitrarily or capriciously must be based on the evidence at the time of the approval rather than looking at the later result. Finally, the Court declared that it was not intended to oversee the Department's practices.
In applying the above standards to the Department's approval, the Court considered as rational the Department's goals of assessing MBIA Corp.'s ability to pay claims as they became due and preserving capacity in the municipal bond market. The Court pointed to the lack of statutes or regulations prescribing an approval process the Department had to follow. When addressing several technical arguments involving sections of the New York Insurance Law, the Court also pointed to the lack of explicit language prohibiting the Department's actions. Where a section of the law did contain explicit language regarding solvency tests, the Court disregarded that language with a finding that no determination of insolvency had been made, notwithstanding that the Department's approval specifically considered MBIA Corp.'s financial condition. Ultimately, the Court's decision that the Department's approval was not irrational or arbitrary might be characterized as relying heavily on the notion that the Department is best placed to determine the best course of action under the circumstances at the time.
The Court did allow the structured finance policyholders that the decision did not extinguish their causes of action against MBIA in the Plenary Proceeding. That was no large gift, however, because the Court of Appeals had made that determination earlier in the Plenary Proceeding. Accordingly, the opportunity remains for the structured finance policyholders to prosecute their claims in the Plenary Proceeding.
The structured finance policyholders face decisions whether to appeal, prosecute the Plenary Proceeding, press to settle or take some other tack. Indeed, analysts have been watching to see if a larger settlement could materialize involving MBIA's attempt to put back mortgage defaults covered by MBIA Corp. policies due to alleged misrepresentations on the loans. The decision as to the course of action will be made in a very dynamic period for MBIA. On the back of the decision, its stock price shot up. However, Standard & Poor's stated that the decision would not affect its downgrade of National to BB from BBB, and MBIA Corp. to CCC from B to reflect an expectation that MBIA Corp. would likely soon be taken over by the Department.