MBIA litigation presses ahead

The banks involved in the fraudulent conveyance case against MBIA Insurance yesterday filed their Notice of Appeal of the First Department of the New York State Supreme Court Appellate Division's recent ruling (see SCI 19 January). In addition, they requested that the Court of Appeals grant an expedited briefing and argument schedule, thereby bringing some clarity around the timing of the litigation.

The plaintiffs are seeking an expedited hearing by the New York Court of Appeals on whether their common law action under the Debtor and Creditor Law can proceed. They believe the appeal should be expedited because: its prompt resolution is of "substantial public importance"; policyholders will be prejudiced as MBIA Insurance's financial condition deteriorates; and MBIA's ceo has publicly urged the expedited resolution of the litigation. Robert Giuffra, partner in Sullivan & Cromwell's litigation group and lead counsel for the 12 banks involved in the case, says he hopes the hearing can take place in the spring.

Meanwhile, the plaintiffs aim to get the Article 78 proceeding to trial by the summer. Sullivan & Cromwell will be submitting further papers at the end of February, in which several former New York insurance superintendents will testify - including James Corcoran, who was the superintendent from 1983-1990.

His affidavit states that the record clearly reflects that the New York Insurance Department (NYID) approved the MBIA transformation transactions, even though the transactions were "not fair and equitable" to the structured finance policyholders. It also notes that the NYID's stated public policy reason for approving the transformation - the reinvigoration of the municipal bond market - was "not within the statutory mission of the department" and did not justify the department's violation of its duty to protect and treat fairly the interests of all policyholders.

Further, according to the affidavit, the record reflects that - in rushing to achieve a public policy objective not specified in the New York Insurance Law - the department engaged in a "deficient, expedited review" of MBIA Insurance's financing condition, including of its ability to pay claims of all policyholders following the transformation.

The broadest implication for the structured finance industry from the Article 78 and fraudulent conveyance cases is that they raise questions about whether buying monoline protection makes sense, according to Giuffra. The banks bought policies with the expectation of credit enhancement and coverage, yet MBIA's 'transformation' essentially meant that US$5bn of claims-paying assets backing those policies were stolen.

"Insurance companies can sometimes be overwhelmed by claims, but the expectation is always that the insurance company will protect policyholders first; this hasn't happened with MBIA," Giuffra explains. "It is a fundamental principle of insurance regulation is that the regulator protects the interests of all policyholders. In the MBIA case, the New York Insurance Department favoured one set of policyholders - the holders of municipal guarantees - over another, which violates the basic principles of the New York Insurance Law."

MBIA'S transformation was illegal and the NYID never should have approved it, Giuffra alleges. Adding to the sense that the regulator has something to hide, he says that the plaintiffs have for months been trying to get hold of correspondence between the then superintendent Eric Dinallo and other senior department officials about the basis for its decision - to no avail.

At issue is a concern that the policyholders won't be paid out if they make a claim in the future. Although MBIA is currently paying claims, the plaintiffs fear that the monoline will run out of money before many of the insured instruments mature.

Giving some credence to this is a 29 December S&P analysis, which predicts that MBIA Insurance will face US$36bn in claims under the rating agency's stress scenario, while it has only US$6.3bn in claims-paying assets. Further, S&P says it expects MBIA Insurance's claims-paying resources to remain well below projected stress-test losses for the foreseeable future.

But the plaintiffs are going further and alleging that MBIA Insurance was essentially insolvent after the restructuring. As well as damages, they are seeking the restoration of MBIA as it was before the split and the claims-paying assets to be returned.

Wins by the plaintiffs could result in a number of further cases being brought by other counterparties against MBIA. Indeed, a federal class action against the monoline has already been stayed, pending a decision in the appeals court.

CS