Win for MBIA in Ruling Against Countrywide (Updated: Maybe Not Really)

Bloomberg reports that Countrywide took a major setback in a suit against it by bond insurer MBIA. MBIA has alleged (quelle surprise!) that Country misrepresented the quality of loans it had MBIA guarantee. From Bloomberg:

Bank of America Corp. (BAC) lost a court fight against MBIA Inc. (MBI) over the hurdles the bond insurer will have to clear in a lawsuit seeking to force the bank to buy back faulty home loans made by its Countrywide Financial unit.

MBIA, which says it was duped into guaranteeing payment on Countrywide mortgage bonds, need only show the lender made misrepresentations about the loans backing the bonds, instead of having to prove they caused the losses the insurer is seeking to recover, New York state Judge Eileen Bransten said in a decision.

“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,” she wrote.

I’m no lawyer, but I find this ruling puzzling, and I expect Bank of America to appeal it. If you are suing someone, you not only have to establish that you did something wrong, but you also need to establish that you were damaged and come up with some sort of basis for arguing how badly you were damaged. If your dry cleaner destroyed a suit, you can’t assert, “This was a custom made Saville Row suit that cost me $5000 and would now cost $7500 to replace,” you need to produce some evidence that you really were damaged to that degree. How otherwise do you have a basis for determining damages? Perhaps this MBIA agreement has some language that provides for specified damages in the event of rep and warranty breaches, but if so, you’d think the matter would not take a judicial ruling.

Our colleague and former monoline executive Tom Adams drafted the claim for one of the very early rep and warranty suits (he sees his language picked up in most of the current suits) and has deemed the need to prove that the rep breach actually led to a loss to be a major hurdle (as it imposed very serious costs on the party suing to prove that the losses resulted from the loan being less than it was promised to be, as opposed to normal underwriting losses, such as the borrower losing his job). The judge may be trying to reduce that buredn, but I am not sure this approach would withstand an appeal. And the language of her ruling also implies that her logic applies only to monolines, and may not be generalizable to rep and warranty suits brought by investors. But if my doubts prove to be ill informed, that means the so called Bank of America settlement, in which investors were to get $8.5 billion to settle claims against 530 Countrywide trusts, looks even more wildly underpriced that we said it was when it was announced.

And this illustrates, yet again, that the legal liabilities facing Bank of America are putting in on a terminal path, unless it can successfully put Countrywide into bankruptcy. We’ve heard some pretty persuasive arguments as to why it probably can’t (the AIG objection to the $8.5 billion settlement makes a very persuasive case). And given how the liability is weighing on the stock, we imagine BofA would have put Countrywide in bankruptcy by now if it thought that was a workable solution.

Update: I will be getting more information when I get my hands on the decision, but an opposite ruling was issued today on a Countrywide case in New York on a case filed by another bond insurer, Syncora, that the claimant (Syncora) has not established as a matter of law that there does not have to be a direct causal link between a rep breach and a loss. So this MBIA ruling may not be as significant as the initial media reactions suggest.

MBS Guy also tells me that the language of the monoline agreements is clear, that the language of the monoline contracts is that the breach has to be material and adverse. He wonders if the breach did not lead to the loss, then how is the breach material?

Update 6:40 PM: Reader MBS Guy has read both rulings, and I will turn the mike over to him:

Have read this through finally, and I would conclude it is not the victory it is made out to be. Unfortunately, I can’t cut and paste language from the decision because the pdf is locked. However, here’s how I see it:

with respect to MBIA’s common law and NY State Insurance Law fraud claims, the judge rules that MBIA does not need to prove that a direct causal link between the alleged misrepresentations and the loss MBIA suffered. However, the judge notes that MBIA’s burden remains quite high: (1) MBIA must prove that the misrepresentations were material to MBIA’s decision to enter the policies (and that the misrepresentations occurred), (2) that MBIA relied on the information misrepresented, (3) that it would not have issued the policy if not for the alleged misrepresentations, (4) that the alleged misrepresentations materially increased MBIA’s risk, and (5) that MBIA was damaged as a direct result of the material misrepresentations. Then MBIA must prove the amount of its damages.

Here’s a quote from this part of the decision:

MBIA must then prove that it was damaged as a direct result of the material misrepresentations. As has been aptly pointed out by Countrywide, this will not be an easy task.”

To some degree, this seems like a rather fine parsing of distinctions: MBIA doesn’t have to prove a direct causal link between misrepresentations and loss incurred, but must still prove that it was damaged by misrepresentations that were material.

The court did lower the standard from what Countrywide wanted for the proof of damages – but not in any way that I think is important.

With respect to breach of reps and warrants portion of MBIA’s motion, the court denied MBIA’s motion. This means the court denied MBIA’s motion that (1) it does not have to prove that the alleged breach of reps and warrants caused the non-performance of the loans and (2) that it is not limited to non-performing loans.

Put another way, the court did not agree that, as a matter of law, MBIA had proved its case on these issues. This is, I think, the real causation issue that people were concerned about: Do allegations of breaches of reps and warrants have have to prove that the breach caused the loss?

Countrywide argued that the plain language of the contracts states that no breach occurs unless the breach materially and adversely affects the interest of the insurer. MBIA disagreed. The court ruled that MBIA was not entitled to a summary judgment on this issue. Therefore, MBIA has the burden of proof to show that this is the case in arguments down the road, including issues of interpretation of what the contract means.

The Syncora decision argues basically the same thing, but in a different order. In this decision, the judge holds on the rep and warrant issue first, and denies Syncora’s motion for summary judgment.

On the rep and warrant issue, Syncora sought to prove that it only needed to prove that a rep breach was material and adverse, but it did not need to prove that the loan was non-performing or the cause of the loan’s non-performance.

The court denied Syncora’s motion because it said that the contract was open to different interpretations. The court noted that it was not holding that Syncora must show that a breach caused the loss or must be for a loan that defaulted. Rather, the court was only holding that Syncora had the burden of proof to make this argument more fully, based on the facts and terms of the contracts (i.e. it is not a “matter of law” issue when there are facts or terms open to interpretation).

With respect to Syncora’s fraud claims (that, under NY State Insurance Law and common law, Syncora was fraudulently induced to enter the insurance policies based on misrepresentations by Countrywide), the court basically reaches the same conclusion as in the MBIA case – Syncora does not have to prove a direct causal link between the alleged misrepresentation and the loss, but it still has a high burden of proof to prove the misrepresentation occurred, that it relied on the misrepresentation, and that it was damaged as a result.

Note – it was the same judge on both cases.

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    1. Brett

      I could think of one point myself reading that prediction.

      The top 6 financial firms are forecasted to contribute 26% to S&P Earnings growth, with BAC at the top with 14%.

      Seems like a major argument for breaking these mega-banks up. If they are making all the profits, it’s a sign there is no competition in this field and they are using their market power to drive up their profits at the expense of every other industry.

  1. TimmyB

    In this instance, an apt analogy to bond insurance is health insurance. If, prior to Obamacare, you came down with an expensive to treat illness, health insurance companies would go over your application with a fine tooth comb looking for something to hang a claim of application fraud on.

    In some instances with insurance, it doesn’t matter that the so-called fraud is completely unrelated to the illness. This example, from

    When her insurance application asked for “anything else relevant to your health that we should know about,” Katy forgot to mention two visits to a psychologist she had 6 years earlier. Katy was later diagnosed with breast cancer, and submitted claims to her insurance company for breast cancer treatment. After receiving Katy’s claim, her plan discovered the two psychologist visits. Before [Obamacare] Katy’s mistake might have prompted her health insurer to rescind, or retroactively cancel, her coverage. But under the health care law, Katy’s insurance plan cannot rescind her coverage, because Katy did not intentionally misrepresent significant information.

    With bond insurance, it seems that the insurers are rescinding the contract based upon application fraud. I imagine that the insurance contract gives the insurance company the right to rescind if there is any fraud in the application, even if the fraud does not cause the company damages.

    1. Yves Smith Post author

      No, there is no analogy. Read the update. The contract that the BOND INSURERS devised provides that rep breaches have to be “material and adverse”. These cases hinge on the interpretation of specific contractual provisions.

      1. weinerdog43

        If the misrepresentation is ‘material’, then I would hazard a guess that MBIA’s argument was “We would not have written this policy but for Countrywide’s lie.” If the underwriter’s testimony confirms this along with MBIA’s underwriting guidelines, I think this is a pretty strong argument.

        1. Nathanael

          I’m pretty sure this is the basic argument. The argument MBIA is making is that the misrepresentations (fraud) by BoA are such that MBIA would never have entered into the contract absent the misrepresentations.

          Accordingly (MBIA will argue) the net loss on the contract is automatically due to the misrepresentations. Sounds right to me.

          It could be a pretty strong case, but MBIA will have to present factual evidence about its routine business practices to prove that it would never have entered into this contract but for the misrepresentations.

  2. John

    It’s about contract law. If the parties misrepresented the facts, there is no meeting of the minds and the contract is void.
    Your example is about damages, a very different story.

    1. Yves Smith Post author

      No, read the update. The Syncora ruling was the dismissal of a motion for summary judgment, and the judge ruled that “the claimant (Syncora) has not established as a matter of law that there does not have to be a direct causal link between a rep breach and a loss.”

      No one is arguing about voiding the contract.

      1. Ms G

        I haven’t read the complaints in either case.

        But I agree that it would be atypical that a contract between MBIA and BoFA would not require proof of actual damages. That said, if MBIA has not paid out on the failed bonds, it hasn’t suffered a loss (yet). If it has, then a reasonable measure of its damages is the amounts paid out. If voiding the contracts isn’t in dispute (i.e., agreed by both parties) the result is that the parties are restored to status quo ante, which (under this logic) would mean money damages equivalent to payouts (plus possibly interest) or zero dollar recovery if no payouts have been made yet.

        It is frustrating to see the fraud claims playing out in civil litigation between private parties suing each other under their limited agreements, which obscures the much bigger picture of the collective harms all of them caused on a national and worldwide scale.

        All the more reason to vociferously encourage and praise the few brave men and women (state AG’s only at this stage?) who are stepping into the deliberate breach left by the 1000 pound government gorillas who have the standing (but not the backbone) to bring wider cases that would more accurately reflect the economy-wide damage that all parties in the securitization chains caused.

    2. Blissex

      What the contract says, what Countrywide or MBIA want and whether the contract between them is in fact an insurance contract and is subject to “utmost good faith” standards is not clear from the reports.

      But a big deal is that essentially all MBS contracts contain language to the effect that if there is fraud the buyers can get a 100% refund of the price paid, and the MBSes revert to the seller. There is no issue of damages, but of course returning the securities for a 100% refund of the price paid involves a pretty large “damages” award if they are deeply impaired. That’s why various bills contain language against that, and any issue of fraud has been studiously avoided: it would undo a lot of massive transactions and sunk even further the originators of the securities based on fraudulent transactions.

      The question in the monoline cases may be whether the insurer is required to pay in the future or not, and whether there was fraud or misrepresentation.

  3. Publius

    I would agree that this ruling is not the clear cut victory that the monolines make it out to be. CW’s assertion that the monolines should have to prove causation was a weak argument in the first place – who is to say what causes a borrower to default? Was it the fact that their income was overstated? Or that house prices dropped 60% in Las Vegas from origination to default? Drawing that causation is too difficult for anyone, and besides was not part of the contract anyway. Note that with GSE putbacks, the GSEs have no such burden to prove causation. Nor do mortgage insurers with their rescissions. To hold monolines to a higher standard would have been bizarre.

    What is still extremely difficult is a)proving the misrep (e.g., for a stated income loan, did CW’s underwriters have a reasonable basis for believing the stated income?, was the appraisal at the time really inaccurate, and what validity does a retrospective appraisal have?), and b)proving the monoline relied on the misrep. I personally find it hard to believe that these monolines, who held themselves out at credit risk experts, and who attended all the same industry functions as CW, read all the same industry publications, etc., assumed all this risk blindly.

    1. James Cole

      I assure you they assumed this risk blindly, if by blindly you mean solely in reliance on the reps and warranties from the originators and underwriters that are now being litigated. Housing prices never go down in America! Also, the monolines have the same principal-agent issue as the banks, with the same poorly-designed compensation structure that compensates transactors for booking a deal that only earns out premium over a much longer period.

  4. izziets

    I think this is a pretty big win for MBIA with regard to what they have to prove, assuming that they successfully prove that fraudulent misrepresentations led them to issue the policy. BAC was arguing that MBIA had to prove that that the fraudulent misrepresentation caused the loss on an individual loan level. In other words, each loan that defaulted would have to have a determination regarding whether or not the misrepresentation led to the default, i.e., was the loan not as represented (badly underwritten, or higher LTV or lower credit score than represented) as opposed to the homeowner losing his/her job or dying or strategically defaulting due to being underwater. MBIA argued that, assuming they successfully prove that the fraudulent misrepresentation led them to issue the policy, then all losses incurred by MBIA on paying out on the policy (everything paid out to the trusts under the policy) less the premiums paid for the policy, are are legitimate damages regardless of why each homeowner defaulted, because MBIA wouldn’t have issued the policies in question but for the fraudulent misrepresentations and thus would have had no losses. Had BAC won, it would be a pretty daunting task to go about finding out the individual reasons for each particular loan ending up in default. If this decision stands, MBIA won’t have to spend the countless hours necessary to do this, nor will they end up recouping only a fraction of amounts paid out to the trusts under the policies. I would say this gives them more leverage to get a decent settlement from BAC, assuming BAC does’t go belly up before then.

    1. Ms G

      Do any of the knowledgeable readers/contributors know whether the argument that the securitized mortgage pools had been triple-A rated by one of the 3 ratings agencies [Moodys, Fitch, S&P] is being used by defendants in this and other breach of reps & warranties cases and, if so, how the argument is faring in the courts?

    2. Yves Smith Post author

      Reread what MBS Guy said, or go read the case. The judge DID NOT say what you are claiming. The media and other websites have way overstated what the ruling says:

      Countrywide argued that the plain language of the contracts states that no breach occurs unless the breach materially and adversely affects the interest of the insurer. MBIA disagreed. The court ruled that MBIA was not entitled to a summary judgment on this issue. Therefore, MBIA has the burden of proof to show that this is the case in arguments down the road, including issues of interpretation of what the contract means.

      This is the ruling:

      1. izziets

        With all due respect Yves, I did read the MBIA case and the only other coverage that I read prior to posting was Zerohedge’s post that mainly quoted directly from the decision. Perhaps the confusion stems from the fact that there are three separate claims being made by MBIA against Countrywide. 1) Fraud 2) breach of the insurance agreement and 3) breach of alleged repurchase obligations.

        My post pertains to MBIA’s claim for fraud against Countrywide and MBS Guy, who you quote, was speaking to MBIA’s claim for breach of Countrywide’s alleged repurchase obligations. The court clearly stated with regard to claims 1) & 2) “MBIA is not required to establish a direct causal link between defendent’s misrepresentation [and/or proven warranty breaches by CHL]and MBIA’s claims payments pursuant to the insurance policies at issue.”

        You are right that the court declines to state that no direct causal link is necessary with regard to claim 3)(breach of repurchase obligations) because it finds that the language relied upon, can be open to more than one interpretation and until further proceedings clear up how the language is to be interpreted the claim 3) is “unripe” for such a determination at the summary judgement level.

        However after denying summary judgement with regard to claim 3) the court goes out of its way to state “This court notes that it does not hold, by implication, that MBIA must show that a breach of a representation or warranty caused a loan’s non-performance, or that Countrywide is not contractually obligated to repurchase misrepresented loans. The holding is limited solely to MBIA’s burden of proof on its motion for summary judgement” In other words, this is not a win for Countrywide (at least not yet).

        I would also like to point out that the poster’s initial concern about the case was a misinterpretation of the court’s holding in that the poster expressed disbelief that the court would hold that the the Countrywide’s bad behavior wouldn’t have to be shown to have to have caused MBIA’s damages, as apparently the Bloomberg article suggested. That’s not what the court’s “not required to establish a direct causal link” language means. Assuming MBIA establishes either 1) fraud or 2) breach of the insurance agreement, the court is simply holding that MBIA need only show 1)in the case of fraud that it wouldn’t have issued the policies in question, therefor, whatever losses it incurred on the policies are its damages or 2) in the case of breach of the insurance agreement that the warranty breaches increased the risk of losses under the issued policies and that MBIA wouldn’t have issued the policies, or at least not on those terms, therefor whatever losses it incurred above that which would have been expected had there been no breaches of the warranties are its damages, in order to show that its damages were caused by Countrywide’s bad behavior. This is a less burdensome requirement than Countrywide was arguing for, i.e. that its fraud or breach of the insurance agreement had to be shown to be the proximate cause of the loans defaulting as opposed to the the economic downturn being the cause of the loans defaulting.

  5. indio007

    I also think this is a big win for MBIA. The thought they were insuring something else. All they have to do is show a material difference in what that thought they were insuring versus what they did insure and show that the difference was damaging. That should be quite easy considering the most accurate indicator of default is loan to value %. I’m sure this is the figure most often misrepresented.

    Then there is the issue that some of these mortgages might not even be in the trusts in the first instance so you have whole different can of worms i.e. false claim insurance fraud.

    The fact is they get to poke their nose around is going to be detrimental to the can kicking of the major banks and investment houses. The gig is up.

    1. Yves Smith Post author

      See comment above. YOU NEED TO READ THE DAMNED RULING.

      And this has nothing to do with loans not being in the trusts either. MBIA is not making that argument, so it is irrelevant.

      Look, I think BoA is in a whole heap of trouble, but the press is ahead of reality on this one.

      1. Th3T1ck

        I’m reading this ruling, and am not sure I understand it. It sounds like from the Syncora ruling that:
        1) They must prove misrepresentation
        2) Must show the material impact of that misrepresentation

        So, this sounds to me like the impact would likely have been a higher premium to insure, rather than a blanket refusal to insure (without really digging into MBIA or Syncora’s balance sheet). Is that your understanding? If so, that sounds like the damages would be the premium difference + some fractional punitive damage. Is that in line with your assessment, am I off base, or trying to oversimplify this? Thanks Yves!

      2. indio007

        I did read the ruling . I am aware that MBIA didn’t allege that fact, specifically saying loans aren’t in the trust. I still think a loan not being conveyed into the trust will still have consequences because of the broad view the court took.Of course, I’m talking about the first cause of action the court granted partial summary judgment over. The ruling is quite broad and is in reference to the insurance as a whole.

        My point really is this , if they compute loans one by one comparing and contrasting what they were represented to be versus what they are , they are ultimately going to run into fraudulent claims vis a vie insuring mortgages that were not actually in the trust.

        The insurance application is most likely based on the same faulty loan schedules that we are all aware of. It is no doubt material whether a loan listed on the schedule is legally in the trust or not in the trust.

        Like I said , I know it’s not specifically alleged but in the big picture view anything that is material that was omitted from the insurance application is fair game.

        1. Yves Smith Post author

          A judge is not going to bring in an issue like conveyance if neither side is arguing that, and neither is. Judges make findings of law and fact, and NO ONE in this case is presenting facts suggesting a failure to convey.

  6. someguy

    I think it’s pretty clear cut that MBIA suffered some amount of damage from the misrepresentation on underwriting, but it’s going to be hard to pin down a number on these cases. What they’re going to have to do is establish is how the pools would have performed if underwritten correctly instead of incorrectly. If I were working on this I would be looking at the performance of loan pools written to the specifications in the contract and comparing those to actual loss rates, seems to me the only way this will end up shaking out.

  7. Fíréan

    . . . you not only have to establish that you did something wrong . . . ? ? ?

    I’m no lawyer but . . . am i reading this wrong or is there a mistake in the text ? just wish to clarify.

    “If you are suing someone, you not only have to establish that you did something wrong, but you also need to establish that you were damaged and come up with some sort of basis for arguing how badly you were damaged.”
    Isn’t it that you were done wrong, by another party ?

    1. LucyLulu

      No, the latter contains three necessary criteria, the former is only the first of the three.

      Using another health example, suppose John is suing Dr. J for malpractice after being given a prescription for the wrong medicine. In order for John to prevail, first he must prove that Dr. J gave him the wrong prescription. Second, John must prove the wrong medicine caused him harm. Most medication mistakes, and medical errors, cause no appreciable ill effects (thank goodness). Third, he must assert a basis for the relief he is seeking. If he is suing for $10 million dollars, he must specify how the damages have merited him (for example) the equivalent of $10 million dollars of compensation for past and continued medical expenses, past and future income, and pain and suffering. (itemize the damages, like turning in an invoice).

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