Bank of America bought Countrywide in 2008.
Bank of America bought Countrywide in 2008. (Landov)

An insurer who underwrote mortgage-backed securities that failed during the 2008 housing crisis must prove all the elements of common-law fraud in its suit against Countrywide Home Loans, a Manhattan appeals court has ruled.

Ambac Assurance Corp., a financial guaranty insurer, sued Countrywide in 2010 after underwriting 17 residential mortgage-backed securitizations. But Ambac may not point to New York Insurance Law §3105 as a reason for bypassing the need to prove certain fraud elements, an Appellate Division, First Department, panel said Tuesday.

Moreover, the statute, which addresses material misrepresentations in insurance contracts, cannot be used by Ambac as an affirmative basis for recovering money damages, Justice Rosalyn Richter wrote for the panel.

“There is no merit to Ambac’s contention that Insurance Law §3105 dispenses with the common-law requirement of proving justifiable reliance and loss causation,” Richter said. “This court recently observed that Insurance Law §3105 does not, by its terms, ‘create a cause of action, but merely codifies common law [insurance] principles,’” she noted, citing CIFG Assurance North America v. JPMorgan Securities.

The suit against Countrywide and several related defendants said Ambac issued unconditional and irrevocable insurance policies guaranteeing payments of principal and interest to investors in Countrywide’s residential mortgage-backed securitizations.

Ambac contends that Countrywide breached various contractual representations and warranties related to the securitizations and its business practices, according to the panel. In addition, the insurer alleges Countrywide fraudulently induced it to issue policies by making false statements about its operations and the loans.

Both Ambac and the Countrywide defendants sought summary judgment on “a number of issues,” Richter wrote. In 2015, Manhattan Supreme Court Justice Eileen Bransten granted in part and denied in part their respective motions.

In Ambac Assurance v. Countrywide Home Loans, 651612/10, Richter modified parts of Bransten’s decision.

The largest portion of the panel’s ruling focused on §3105′s effect, or lack thereof, on Ambac’s efforts to prove fraud and recover damages. Richter pointed out that §3105, which Ambac argued had “informed” its fraud claim, had “no applicability” to the case before her.

“Cases applying Insurance Law §3105 arise in the context of either a declaratory judgment action by an insurer seeking rescission … or an insurer asserting a defense to an insured’s claim for payment under the policy,” she wrote. “Here, Ambac seeks neither to rescind the policies, which are unconditional and irrevocable, nor to defeat a claim by an insured for payment.”

Instead, she said Ambac “seeks to assert Insurance Law §3105 as an affirmative claim seeking monetary damages.”

Richter also said that “although Ambac describes the relief it seeks as compensatory damages, it is no different from rescissory damages to which Ambac is not entitled.”

Both organizations representing financial guaranty insurers, the Association of Financial Guaranty Insurers, and representing the securities industry, Securities Industry and Financial Markets Association, weighed in with amicus briefs in the appeal.

Richter noted that the court found arguments from the Securities Industry and Financial Markets Association to be persuasive.

“Ruling otherwise would inequitably allow Ambac to recoup the money it paid out for loans that complied with all warranties, and for which there were no misrepresentations, but which resulted in default due to the housing market collapse or other risks Ambac insured against,” she said. “By issuing the irrevocable insurance policies, Ambac accepted the risk that an economic downturn could cause the loans to default and trigger its obligation to pay.”

Justices Sallie Manzanet-Daniels, Judith Gische, Troy Webber and Marcy Kahn joined in the ruling.

Peter Tomlinson, a partner at Patterson Belknap Webb & Tyler representing Ambac, did not return a call seeking comment Tuesday.

Joseph M. McLaughlin, a Simpson Thacher & Bartlett partner representing Countrywide, declined to comment Tuesday.