UBS AG and its lawyers at Skadden, Arps, Slate, Meagher & Flom got a dose of bad news Thursday in a fight with mortgage-backed securities investors.

A federal judge in Manhattan refused to dismiss breach of contract claims brought by three trusts that issued about $1.5 billion in securities backed by UBS-sponsored mortgages. And, the judge ruled, UBS may have to pay money damages for failing to repurchase faulty loans.

The ruling comes three months after UBS agreed to pay $358 million to settle parallel claims brought by Assured Guaranty, which issued insurance on the securitization deals.

Lawyers at Quinn Emanuel Urquhart & Sullivan sued UBS unit UBS Real Estate Securities Inc. on behalf of the trusts last September. They alleged that UBS failed to police the quality of loans pooled into the three securitization trusts, which paved the way for about half the loans to wind up delinquent. When bond insurer Assured alerted UBS to the defective loans, the plaintiffs claimed, UBS shirked its contractual duty to buy them back. The trusts sought damages for UBS's alleged breach, including payment beyond the purchase price of the loans.

A Skadden team led by Jay Kasner countered that the trusts had no business seeking money damages, and that the case should therefore be dismissed, since UBS agreed only to repurchase faulty loans. UBS also argued that the complaint failed to state a viable claim for breach of contract, and that UBS's settlement with Assured—which was also represented by Quinn Emanuel—required dismissal.

U.S. District Judge Harold Baer Jr. shot down Skadden's arguments one by one in Thursday's opinion. The judge rejected UBS's motion to dismiss, and he refused "to foreclose the possibility of awarding damages in lieu of specific performance." Baer did, however, ruled that the trusts can't seek money damages above the purchase price of the allegedly faulty loans.

Skadden's Kasner was out of the office and unavailable for comment on Thursday. Philippe Selendy of Quinn Emanuel did not immediately respond to our call. Robins, Kaplan, Miller & Ciresi represents the securitization trustee, U.S Bank National Association.

Also on Thursday, Judge Baer reaffirmed an earlier decision not to allow a group of investors to intervene in the case. The investors had challenged Quinn Emanuel's role as counsel to the trusts at the same time that it was representing Assured Guaranty and the Federal Housing Finance Agency, which reached its own $885 million settlement with UBS last month.

"While the motion is denied, I can't help but note that some aspects of this litigation provide, at least for me, an odor of concern and should Proposed Intervenors recognize a problem as we move forward, they are invited to bring it to my attention," Baer wrote.