April 2013: Complete Appellate Victory for Swiss Re in Synthetic CDO Action

The firm recently secured appellate endorsement by the New York Appellate Division, First Department, of the complete dismissal of fraud and contract claims against client Swiss Re brought by plaintiff noteholders. In 2003, plaintiffs invested in subordinate notes issued by a special purpose vehicle, Breithorn CDO. The synthetic CDO (the protection seller) was counterparty to a credit default swap with our client Swiss Re written against a pool of reference securities selected by Swiss Re (the protection buyer). After the notes declined in value, plaintiffs sued Swiss Re (along with the trustee for the notes) alleging, inter alia, causes of action for breach of contract and fraud, based on Swiss Re’s substitution of certain reference obligations and issuance of broker quotes on the notes to plaintiffs. The trial court held that plaintiffs as noteholders could not sue as third-party beneficiaries to the underlying CDS as they were not named as third-party beneficiaries and any benefit to them as noteholders was purely incidental. The court also rejected plaintiff’s fraud claims as it enforced the express disclaimers contained in the broker quotes and found the plaintiffs had the ability to assess the notes’ value for themselves. The New York Appellate Division, First Department, agreed with the trial court and affirmed the dismissal of all claims against Swiss Re.

The case holds that where the contract expressly permits certain conduct—here, free substitution of reference swaps even against the interest of the CDS counterparty—the investor has no redress. The case reinforces the importance of disclosed contract terms for sophisticated investors. Importantly, the plaintiffs had alleged a convoluted theory of post-closing fraud and contract breaches, but no claim of fraud in the inducement, thus distinguishing the case from our typical CDO case on the plaintiffs’ side. The time for plaintiffs to appeal to the N.Y. Court of Appeals has run, thus securing total victory in this case.