Ending months of speculation, U.S. District Judge Jed Rakoff in Manhattan has become the latest judge to side with bond insurers on a crucial issue in a crush of mortgage repurchase suits against banks that issued toxic mortgage-backed securities.
The ruling came in a case Assured Guaranty Ltd. and its lawyers at Susman Godfrey brought against Flagstar Bank over $1 billion in MBS that Assured insured and that tanked in value in the subprime meltdown. In a 24-page summary judgment ruling issued on Tuesday, Rakoff ruled that, to force Flagstar to repurchase (or “put-back”) faulty home loans pooled into residential MBS, Assured doesn’t need to show that misrepresentations by the bank directly caused the loans to default. Instead, Assured just has to show that the bank’s alleged misrepresentations increased its odds of sustaining losses.
Assured Guaranty and Flagstar contractually agreed that breaches of representations or warranties concerning the risks of the underlying RMBS loans would trigger Flagstar’s repurchase obligations, provided that the breaches “materially” or “adversely” impacted the value of the loans. Flagstar’s lawyers at Arnold & Porter moved for summary judgment in January, arguing that to show it was “adversely impacted” Assured must establish a direct causal link between misrepresentations and its losses. Assured’s lawyers at Susman took the position that “adverse” just means “opposed to one’s interests,” so to trigger the put-back provisions they only have to show that Assured was harmed by Flagstar’s alleged misrepresentations.
Rakoff issued a one-page order in late February rejecting Flagstar’s motion, as we reported here. We inferred that the judge was siding with the more lax causation standard proposed by Assured’s lawyers at Susman Godfrey, but we couldn’t know for sure.
Rakoff has now confirmed that assumption, ruling that Assured’s stance on loss causation “fully accords with New York law.” He based his decision on a long-held principle of New York insurance law holding that an insurer can rescind a policy if it later learns about a material misrepresentation that would have led it to a refuse to offer the policy. Rakoff also noted that Assured’s contract with Flagstar makes no mention of the words like “cause” or “loss.”
“If the sophisticated parties had intended that the plaintiff be required to show direct loss causation, they could have included that in the contract,” he wrote.
Including Rakoff, all three New York judges that have heard arguments on the loss causation issue have sided with bond insurers. As we previously reported, the first was New York Supreme Court justice Eileen Bransten, who in January rejected a closely watched bid by Bank of America Corporation to scuttle a put-back case brought by MBIA Inc. The other is Rakoff’s Southern District colleague Paul Crotty, who is overseeing a case Syncora Guarantee brought against now-defunct EMC Mortgage Corporation, a Bear Stearns subsidiary. Rakoff relied heavily on Crotty’s analysis in Tuesday’s decision, though, as Reuters’s Alison Frankel reports, Rakoff’s ruling seems to bode even more poorly for MBS-issuing banks.
Neither Susman partner Jacob Buchdahl, who represents Assured, nor Flagstar counsel Veronica Rendon of Arnold & Porter immediately returned calls seeking comment.
