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February 2017: New York Appellate Division Victory for Assured Guaranty

February 2017

The firm won an important appeal in the New York Appellate Division, First Department for client CIFG Assurance North America, Inc. (now known as Assured Guaranty) allowing it bring a claim for common law misrepresentation, as informed by Section 3105 of the New York Insurance law in a $100 million-plus case arising from CIFG’s insurance of two collateralized debt obligation vehicles (“CDOs”). The decision has been widely reported. See, e.g., Jason Grant, Insurer Gets Second Chance at Bank Accused of Dumping ‘Toxic’ Mortgage Securities, N.Y.L.J. (Nov. 30, 2016).

CIFG’s suit alleges that Bear Stearns, recognizing that it owned risky mortgage-backed securities, sought to off-load them onto unsuspecting innocent investors by repackaging the securities into two CDOs. To market the CDOs, Bear Stearns sought financial guaranty insurance concerning the senior-most tranche of the notes. CIFG agreed to provide the insurance based on certain representations, such as that the collateral in the CDO would be selected by an independent collateral manager, and not by Bear Stearns, which had an incentive to off-load its risky assets onto the CDO and the investors in the CDO.

However, at the request of Bear Stearns, CIFG did not directly insure the CDOs’ obligations to make payments on the notes. Instead, an affiliate of CIFG (known as a “transformer”) entered into a Credit Default Swap (“CDS”) with the noteholders, and CIFG issued a guaranty insurance on the transformer’s obligation to the noteholders.

The two CDOs ultimately defaulted and CIFG had to pay more than $100 million to discharge its obligations. CIFG brought suit in New York Supreme Court, alleging claims for misrepresentation, as informed by Insurance Law Section 3105, and another claim for fraud, on the grounds that, contrary to its representations, Bear Stearns was involved in selecting the collateral in the CDO. Unlike claims for fraud, claims for misrepresentation informed by Insurance Law 3105 do not require scienter or fraudulent intent; even an innocent misrepresentation can support liability.

The trial court dismissed CIFG’s misrepresentation claim with prejudice, reasoning, among other things, that Bear Stearns could not be an “applicant” within the meaning of Section 3105 given the transformer structure of the transaction. In an issue of first impression, the First Department held that the transformer structure could be sufficient “to show that Bear Stearns was an ‘applicant,’ within the meaning of Insurance Law Section 3105.” The First Department also rejected the argument that Insurance Law 3105 requires a written application for insurance.

The First Department also rejected Bear Stearns’ alternative claim that the misrepresentation claim is time-barred, holding that claims for misrepresentation sounding in Insurance Law 3105 are subject to a six year statute of limitation. The First Department noted that although a three-year statute of limitation applies to misrepresentation, if a misrepresentation claim alleges fraud, then a six year limitations period applies. The First Department also held that Insurance Law Section 3105 did not create a new cause of action, but rather codified common law principles, such that claims brought under the Section are not subject to three year limitations period for claims developed by statute.

Quinn Emanuel continues to represent Assured Guaranty in this and other matters.