bac appellate brief

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New York County Clerks Index No. 602825/08

New York Supreme CourtAPPELLATE DIVISIONFIRST DEPARTMENT

MBIA INSURA NCE CORPORATION,

Plaintif f-Respondent-Appellant,against

COUNTRYWIDE HOME LOANS, INC., COUNTRYWIDE SECURITIES CORP.,

COUNTRYWIDE FINANCIAL CORP., COUNTRYWIDE HOME LOANS SERVICING, L.P.,

Defendants-Appellants-Respondents,and

BANK OF AMERICA CORP.,Defendant-Respondent.

!! !!

To Be Argued By:

Mark Holland

CONFIDENTIAL

BRIEF FOR DEFENDANTS-APPELLANTS-RESPONDENTS

Mark HollandLarkin M. MortonMeghan K. SpillaneGOODWIN PROCTER LLPThe New York Times Building620 Eighth AvenueNew York, New York 10018

[email protected]@[email protected]

Paul F. Ware, Jr.David J. ApfelSarah Heaton ConcannonAbigail K. HemaniGOODWIN PROCTER LLPExchange Place, 53 State StreetBoston, Massachusetts 02109

[email protected]@[email protected]@goodwinprocter.com

Of Counsel:

David M. Wells

William E. Adams, Jr.

GUNSTER, YOAKLEY & STEWART, P.A.

One Enterprise Center

225 Water Street, Suite 1750

Jacksonville, Florida 32202

904-354-1980

[email protected]

[email protected]

Attorneys for Defendants-Appellants-Respondents

Countrywide Home Loans, Inc., Countrywide Securities Corp., and

Countrywide Financial Corp., and Bank of America, N.A., solely in its

capacity as successor by July 2, 2011 de jure merger to BAC Home Loans

Servicing, L.P. (f/k/a Countrywide Home Loans Servicing, L.P.)

Printed on Recycled Paper


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TABLE OF CONTENTS

Page

QUESTIONS PRESENTED ............................................................................................1

PRELIMINARY STATEMENT.......................................................................................2

NATURE OF THE CASE ...............................................................................................7

A. Factual Background. ..................................................................................7

B. MBIAs Motion For Partial Summary Judgment .................................... 13

C. The IAS Courts Decision .......................................................................15

ARGUMENT ..............................................................................................................18

I. POINT I: THE IAS COURT ERRED BY EXEMPTING INSURANCE COMPANIESSEEKING TO RECOVER DAMAGES FOR FRAUD AND BREACH OF CONTRACT

FROM HAVING TO PROVE LOSS CAUSATION..................................................18

A. All Plaintiffs Seeking Damages for Common Law FraudClaims Must Prove Loss Causation. ........................................................18

B. All Plaintiffs Seeking Damages for Breach of Contract ClaimsMust Prove Proximate Causation. ........................................................... 26

II. POINT II: THE IAS COURT ERRED BY HOLDING THAT MBIA MAY RECOVER

RESCISSORY DAMAGES................................................................................27

A. The IAS Court Erred By Holding That Insurance Law Sections3105 And 3106 Inform[] MBIAs Claim For RescissoryDamages. ................................................................................................ 29

B. There Is No Basis For The IAS Courts Recognition Of ThePossibility Of Rescissory Damages In Favor Of An InsuranceCompany That Has Made The Voluntary Choice Not To Seek

To Rescind An Insurance Contract. .........................................................37


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C. MBIA Has Waived Its Entitlement To The Relief It Seeks HereBy Continuing To Accept Premiums After Learning Of The BasisFor Its Claims. ......................................................................................... 47

D. The IAS Court Erred In Failing To Consider Whether MBIA Has

An Adequate Remedy At Law. ................................................................ 50

E. That MBIA Has An Adequate Remedy At Law Is FurtherDemonstrated By The Contractual Sole Remedy To WhichMBIA Agreed To Be Bound. ..................................................................51

CONCLUSION............................................................................................................55


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TABLE OF AUTHORITIES

Page(s)CASES

Abbott v. Prudential Ins. Co. of Am.,281 N.Y . 375 (1939) ........................................................................................... 33

ABN AMRO Bank, N.V. v. MBIA Inc.,17 N.Y.3d 208 (2011) ..................................................................................... 7, 11

Aetna Cas. & Sur. Co.v.OConnor,8 N.Y .2d 359 (1960) ........................................................................................... 44

Alper v.Seavey,9 A.D.3d 263 (1st Dept 2004) ........................................................................... 50

Assured Guar. Mun. Corp.v.DLJ Mortg. Capital, Inc.,No. 652837/11, 2012 WL 5192752(Sup. Ct. N.Y. Cnty. Oct. 11, 2012) ....................................................... 47, 48, 49

Assured Guar. Mun. Corp.v.Flagstar Bank, FSB,No. 11 Civ. 23475(JSR), 2011 WL 5335566 (S.D.N.Y. Oct. 31, 2011) ............ 52

Bible v.J ohn Hancock Mut. Life Ins. Co. of Bos.,256 N.Y . 458 (1931) ........................................................................................... 47

BW Sportswear, Inc. v.Those Certain Underwriters at Lloyds of London,32 Misc. 3d 1245(A) (Table; text at 2011 WL 4357674 (Sup. Ct. N.Y .Cnty. 2011)) ........................................................................................................ 35

Centro Empresarial Cempresa S.A. v. Amrica Mvil, S.A.B. de C.V.,17 N.Y .3d 269 (2011) ......................................................................................... 18

Cinerama, Inc.v.Technicolor, Inc.,663 A.2d 1134 (Del. Ch. 1994) .................................................................... 39, 40

Christiania Gen. Ins. Corp. v. Great Am. Ins. Co.,979 F.2d 268 (2d Cir. 1992) ............................................................................... 33

Dress Shirt Sales, Inc. v. Hotel Martinique Assocs.,12 N.Y .2d 339 (1963) ......................................................................................... 36


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Ellington v. Stony/ATV Music Publg LLC,85 A.D.3d 438 (1st Dept 2011) ......................................................................... 50

Equitable Life Assurance Socy of U.S. v.Kushman,276 N.Y. 178 (1937) ..................................................................................... 41, 42

First Nationwide Bank v. Gelt Funding Corp.,27 F.3d 763 (2d Cir. 1994) ................................................................................. 24

Fruition, Inc. v. Rhoda Lee, Inc.,1 A.D.3d 124 (1st Dept 2003) ........................................................................... 26

Geer v.Union Mut. Life Ins. Co.,273 N.Y. 261, 273 (1937) ................................................................................... 35

Ginsburg v. Pac. Mut. Life Ins. Co. of Cal.,89 F.2d 158 (2d Cir. 1937) ................................................................................. 33

Glickv.Campagna,613 F.2d 31 (3d Cir. 1979) ................................................................................. 39

Glickman v. N.Y. Life Ins. Co.,291 N.Y. 45 (1943) ............................................................................................. 33

Gluck v. Exec. Risk Indem., Inc.,680 F. Supp. 2d 406 (E.D.N.Y. 2010) ................................................................ 32

Gozanv.Mut. Life Ins. Co. of N.Y.,40 N.Y .2d 707 (1976) ......................................................................................... 32

Grace v. Rosenstock,228 F.3d 40 (2d Cir. 2000) ................................................................................. 41

Greenev.United Mut. Life Ins. Co.,38 Misc. 2d 728 (Sup. Ct. Bronx Cnty. 1963) .................................................... 35

GuideOne Specialty Mut. Ins. Co.v. Congregation Adas Yereim,593 F. Supp. 2d 471 (E.D.N.Y. 2009) ................................................................ 34

Hechter v. N.Y. Life Ins. Co.,46 N.Y .2d 34 (1978) ........................................................................................... 31

Hotaling v. A.B. Leach & Co.,247 N.Y . 84, 87 (1928) ....................................................................................... 24


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In re Transkaryotic Therapies, Inc.,954 A.2d 346 (Del. Ch. 2008) ............................................................................ 40

Interested Underwriters at Lloydsv.H.D.I. III Assocs.,213 A.D.2d 246 (1st Dept 1995) ....................................................................... 35

Kenford Co. v. County of Erie,73 N.Y .2d 312 (1989) ......................................................................................... 26

Kiss Constr. NY, Inc.v.Rutgers Cas. Ins. Co.,61 A.D.3d 412 (1st Dept 2009) ......................................................................... 35

Laub v. Faessel,297 A.D.2d 28 (1st Dept 2002) ..................................................................passim

Losei Realty Corp. v. City of N.Y.,254 N.Y. 41 (1930) ............................................................................................. 26

Majestic Export Co., Inc.v.Katz & Greenfield, Inc.,248 A.D. 205 (1st Dept 1936) ........................................................................... 31

MBIA Ins. Corp. v. Countrywide Home Loans, Inc.,87 A.D. 3d 287 (1st Dept 2011) .................................................................passim

MBIA Ins. Corp. v.Merrill Lynch,81 A.D.3d 419 (1st Dept 2011) ......................................................................... 50

Mecca v.Gibraltar Corp. of Am.,746 F. Supp. 338 (S.D.N.Y. 1990) ..................................................................... 40

Megaris Furs, Inc. v. Gimbel Bros., Inc.,172 A.D.2d 209 (1st Dept 1991) ....................................................................... 18

Mooneyv. Nationwide Mut. Ins. Co.,172 A.D.2d 144 (3d Dept 1991) .................................................................. 44, 45

Natl Union Fire Ins. Co. v. Christopher Assocs.,257 A.D.2d 1 (1st Dept 1999) ........................................................................... 20

New Paradigm Software Corp.v.New Era of Networks, Inc.,107 F. Supp. 2d 325 (S.D.N.Y. 2000) ................................................................ 50

Outdoor Life Network, LLC v.EMTA Corp.,No. 2:06-cv-00463 JWS, 2006 WL 3834287 (D. Ariz. Dec. 29, 2006) ............. 38


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Randall v.Loftsgaarden,478 U.S. 647, 656 (1986) .................................................................................... 40

Reisv.Hazelett Strip-Casting Corp.,28 A.3d 442 (Del. Ch. 2011) .............................................................................. 39

Reliance Ins. Cos. v. Daly,38 A.D.2d 715 (2d Dept 1972) .................................................................... 44, 45

Rives v. Am. Ry. Express Co.,227 A.D. 375 (1st Dept 1929) ........................................................................... 31

Rudman v. Cowles Commcns, Inc.,30 N.Y.2d 1 (1972) ............................................................................................. 50

Small v. Lorillard Tobacco Co.,94 N.Y . 2d 43 (1999) ...................................................................................... 3, 20

St. Clair Shores Gen. Emps. Ret. Sys. v.Eibeler,745 F. Supp. 2d 303 (S.D.N.Y. 2010) ................................................................ 42

Star City Sportswear, Inc.v.Yasuda Fire & Marine Ins. Co. of Am.,1 A.D.3d 58 (1st Dept 2003) ............................................................................. 35

Starr Found. v. Am. Intl Grp., Inc.,76 A.D.3d 25 (1st Dept 2010) ........................................................................... 23

Stein v. Security Mutual Insurance Co.,38 A.D.3d 977 (3d Dept 2007) .......................................................................... 36

Stutman v. Chem. Bank,95 N.Y.2d 24 (2000) ..................................................................................... 18, 20

Sun Ins. Co. of N.Y. v. Hercules Sec. Unlimited,195 A.D.2d 24 (2d Dept 1993) .......................................................................... 33

Telstra Corp. v. Dynegy, Inc.,No. Civ. A 19369,2003 WL 1016984 (Del. Ch. March 4, 2003) ...................... 40

Tudor v. Riposanu,93 A.D.2d 718 (1st Dept 1983) ......................................................................... 34

U.S. Life Ins. Co. v.Blumenfeld,92 A.D.3d 487 (1st Dept 2012) ......................................................................... 48


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U.S. Life Ins. Co.v.Grunhut,83 A.D.3d 528 (1st Dept 2011) ......................................................................... 47

Weinbergerv.UOP, Inc.,457 A.2d 701 (Del. 1983) ................................................................................... 40

STATUTES,RULES,REGULATIONS,CONSTITUTIONAL PROVISIONS

N.Y. Ins. Law 3105 ........................................................................................passim

N.Y. Ins. Law 3106 ........................................................................................passim

N.Y. Stat. Law 301(b) ..................................................................................... 34, 38

N.Y . Veh. & Traf. Law 313 .................................................................................. 47

OTHER AUTHORITIES

Bogert, George G., et al.,The Law of Trusts and Trustees 862 (3d ed.2012) ................................................................................................................... 40

Dobbs, Dan B., et al.,The Law of Torts 693 (2d ed. 1991) .................................. 21

Insurance Department of New York, Insurance Law Revision of the State ofNew York (Tentative Draft) 63 (1937) ............................................................ 33

N.Y. Ins. Law 58 (McKinney 1926) ............................................................... 32, 33

N.Y. Ins. Law 150, Ins. Dept Revision Note (McKinney 1949) ......................... 32

Report of the Joint Legislative Committee on Revision of Insurance Laws,1938 N.Y . Legis. Doc. No. 77 (1938) ................................................................ 32

Restatement (Second) of Torts 546 ....................................................................... 19

Restatement (Second) of Torts 548A .............................................................passim

Statement of Hon. Edwin W. Patterson, Chairman, Comm. on InsuranceLaw Revision, Proceedings of Joint Legislative Comm. forRecodification of Insurance Law(Nov. 16, 1938) ............................................ 32

Wolfe, J r., Donald J. & Pittenger, Michael A., Corporate & CommercialPractice in the Delaware Court of Chancery 12.04 (2012) ............................ 40


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QUESTIONS PRESENTED

1. The IAS Court held that an insurance company seeking to recovermoney damages for fraud need not establish a direct causal link between the

alleged misrepresentations and claims the insurance company paid under the

policies. Did the IAS Court err in exempting insurance companies from the

requirement that plaintiffs seeking to recover damages for fraud must establish

that the alleged misrepresentations or other misconduct were the direct and

proximate cause of the losses claimed? Laub v. Faessel, 297 A.D.2d 28, 30-31

(1st Dept 2002). Answer: Yes.

2. The IAS Court held that an insurance company seeking to recovermoney damages for contractual breaches of representations and warranties in an

insurance agreement need not prove a causal link between the alleged breaches and

claims the insurance company paid under the policies. Did the IAS Court err in

exempting insurance companies from the requirement that plaintiffs suing for

breach of contract may recover only the direct and proximate damages which result

from the alleged breach? Answer: Yes.

3. The IAS Court held that an insurance company suing for fraud andbreach of contract may recoverrescissory damages, in the amount of all past and

future claims paid under its insurance policies less premiums received, without

demonstrating any loss causation, even though, among other things, the insurance


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company (i) expressly waived its right to rescission in the insurance policies, and

has not sought to rescind or avoid those policies, (ii) continued to accept premiums

after learning of the alleged misconduct, and (iii) has a complete and adequate

remedy at law in the form of monetary damages for claims it may have paid due to

the defendants alleged misconduct, including a remedy that it agreed would be its

sole remedy. Did the IAS Court err in so holding? Answer: Yes.

PRELIMINARY STATEMENT

This is an appeal from a decision by the IAS Court holding, for the first

time, that an insurance company asserting common law fraud and breach of

contract claims may recover what the Court called rescissory damages

measured as all past and future claims payments, less premiums receivedwithout

actually seeking rescission and withouthaving to prove the bedrock element of loss

causation. Not only is this ruling contrary to fundamental common law principles

requiring a plaintiff to prove loss causation to recover damages, it turns the

business relationship between the parties upside down.

In exchange for substantial premiums, MBIA, a financial guaranty insurance

company, agreed to insure the 15 residential mortgage-backed securitizations (the

Securitizations) at issue in this litigation against the risk that the loans in the

Securitizations would not generate the expected principal and interest, including

because of adverse macroeconomic conditions. The rescissory damages that the


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IAS Court entertained would relieve MBIA entirely of its insurance obligation,

shifting the cost of all past and future claims payments, regardless of cause, to

Countrywide. In essence, Countrywide would be transformed into the insurer,

without MBIA having to prove that any of the payments it has made or will make

under the policies are the result of Countrywides actions as opposed to the

macroeconomic risks against which MBIA agreed to insure, or even that the

payments were made on loans that breached any representation or warranty. This

result finds no support in New York law, common sense, or the parties contracts.

The IAS Courts decision ignores settled New York law requiring all

plaintiffs seeking to recover damages for fraud or breach of contract to prove that a

defendants alleged misrepresentations or breach of contract directly caused the

loss about which the plaintiff complains. See, e.g., Small v. Lorillard Tobacco Co.,

94 N.Y. 2d 43, 57 (1999). In derogation of these settled principles, and

analogizing from inapt circumstances in which an insurer seeks to rescindoravoid

an insurance policywhich MBIA has not done herethe IAS Court held that 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. [See R83, Memorandum Decision and Order of the Supreme Court of the

State of New York, New York County, I.A.S. Part 3 (Bransten, J.) entered on

January 3, 2012 (Ord.) at 14.] At bottom, the IAS Court held that MBIA could


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satisfy its burden of proving causation for its common law damages claims merely

by showing transaction causation, i.e., that it would not have issued the policies (or

would have issued them on different terms) if the alleged misrepresentations had

not been made. [R84, Ord. 15.] The IAS Courts ruling effectively eviscerates the

requirement under New York law (and general common law principles) that

plaintiffs must also prove loss causation to recoverdamages for fraud or breach of

contract.

The IAS Court compounded its error by ruling that MBIA is entitled to

recover so-called rescissory damages. There is no dispute, as the IAS Court

recognized, [R86, Ord. 17], that MBIA knowingly and irrevocably bargained

away its right to seek rescission of the insurance policies, and it does not even

purport to seek that remedy in this litigation. But even though MBIA does not and

could not seek actual rescission, the IAS Court fashioned out of whole cloth a new,

unprecedented equitable remedy ofrescissory damagesi.e., all past and future

claims payments made less premiums receivedthat, in effect, allows MBIA both

to avoid its obligations under the policies withoutactually having to rescind those

policies and to recover money damages withouthaving to prove loss causation.

There is no support for such an extraordinary remedy under New York (or any

other) law. Moreover, the IAS Courts ruling disregards the fact that MBIA (1)

negotiated a full and adequate remedy at law for breaches of Countrywides


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representations and warranties, and (2) has ratified the policies by continuing to

accept premiums to this day, and therefore is estopped from seeking rescissory

relief.

MBIAs position, endorsed by the IAS Court, is not just a litigation tactic;

MBIA is forced to that position by its extremely aggressive (if not reckless)

business model. MBIA insured highly complex and obviously risky securitizations

using a business model that it called no loss underwriting, that is, its entire

financial structure was built on the assumption that MBIA would structure and

underwrite transactions in such a way that it would neverhave to pay a claim. Its

minimal reserves are based on that assumption. When MBIA decided to become a

major player in the structured finance business and insure billions of dollars in

residential mortgage-backed securities, it ignored the possibility of a national real

estate bubble that could burstwith catastrophic consequences for MBIA. And

MBIA did so knowing that Countrywide couldand wasmaking loans on a

stated income basis, with little or no documentation from the borrower, and with

exceptions to its underwriting guidelines if it considered (in its sole judgment) that

compensating factors warranted the credit.

When the national real estate market collapsed, all of MBIAs insured

residential mortgage-backed securitizations, not just the Countrywide deals at issue


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here, suffered catastrophic losses and MBIA was caught.1

MBIA had chosen, for

competitive reasons, to contract that under no circumstances could it rescind the

insurance it had writteni.e., that its obligation to provide that insurance is

unconditional[] and irrevocabl[e]. [See, e.g., R2343, 2006-E Note Guaranty

Insurance Policy, at 1.] MBIA had bargained for representations and warranties

from Countrywide covering the loans, but in return it had agreed in unequivocal

contractual language that its sole remedy for any breach would be Countrywides

obligation to either cure the breach or repurchase the breaching loan from the trust

if the breach materially and adversely affected MBIA.2 That loan-by-loan remedy

no longer meets MBIAs business needs, however, because MBIA has no right to

seek compensation from Countrywide for the claims MBIA was obliged to pay on

fully-compliant loans that defaulted as a result of the financial crisis rather than

any breach of a representation or warranty by Countrywide. Faced with the

imperative of its model that it suffer no losseven as a financial guarantee

insurer stuck in the worst financial crisis since the Great DepressionMBIA was

1 See, e.g.,Complaint,MBIA Ins. Co. v. J.P. Morgan Securities LLC, No 64676/2012 (Sup Ct.

Westchester Cnty. filed Sept. 14, 2012); Complaint,MBIA Ins. Co. v. IndyMac, F.S.B., 1:09-cv1011-ABJ (D.D.C. filed May 29, 2009); Complaint, MBIA Ins. Co. v. Credit SuisseSecurities (USA) LLC, No. 603751/2009 (Sup. Ct. N.Y. Cnty. filed Dec. 14, 2009);Complaint,MBIA Ins Co. v. Residential Funding Co., No. 603552/2008 (Sup. Ct. N.Y. Cnty.filed Dec. 4, 2008); Complaint, MBIA Ins. Co. v. GMAC Mortg., LLC, No. 600837/2010(Sup. Ct. N.Y. Cnty. filed Apr. 1, 2010).

2 [R4144-45, Countrywides Rule 19-a Counter-Statement of Material Facts (CSOF) 12.]


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forced to craft the unprecedented and (we submit) entirely unwarranted theory that,

even though it does not seek rescission, it is entitled to recover rescissory

damages without having to prove loss causation. Only by that course could

MBIA claim to be entitled to payment from Countrywide forallclaims MBIA has

paid under its insurance policiesincluding on loans that fully complied with

Countrywides representations and warranties.

The IAS Courts decision therefore should be reversed.

NATURE OF THE CASE

A. Factual Background.During the relevant period, MBIA was in the business of providing financial

guarantee insurance and other forms of credit protection on financial obligations.

MBIA exclusively wrote financial guarantee insurance policies and did not offer

other forms of insurance. It is therefore referred to as a monoline insurer.3 Until

2008, MBIA touted its expertise and its underwriting standards, which anticipated

no losses even under a worst probable case scenario. [R4243; see also

R4633.]

Defendant Countrywide Financial Corporation, itself or through subsidiaries

(collectively, Countrywide), engaged in mortgage lending and other real estate

financial related business. Defendant Countrywide Home Loans, Inc. (CHL)

3 See ABN AMRO Bank, N.V. v. MBIA Inc., 17 N.Y.3d 208, 216-17 (2011).


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originated residential home mortgage loans. Other Countrywide entities serviced

those loans and underwrote offerings of mortgage-backed securities.4

MBIA sued Countrywide in 2008 for, inter alia, fraudulent inducement,

breach of contract, and indemnification in connection with financial guarantee

insurance policies that MBIA issued between 2004 and 2007 on 15 Securitizations

with a face value at origination of $21 billion. Countrywide sponsored the

Securitizations and originated many of the approximately 390,000 mortgage loans

(the Mortgage Loans) in the Securitization pools. MBIA alleges that

Countrywide made material misrepresentations and breached representations and

warranties concerning the quality of the Mortgage Loans underlying the

Securitizations.

For each Securitization, CHL sold to a Trust a pool of second-lien residential

Mortgage Loans, consisting of either closed-end second liens (CES) or revolving

home equity lines of credit (HELOCs). Each Trust, in turn, issued securities that

were sold to investors (the Securities). The Securities promised to pay the

investors interest and principal via the Trusts using the payments that borrowers

make on the Mortgage Loans. [R4141-42, Countrywides Rule 19-a Counter-

Statement of Material Facts (CSOF) 3-4.]

4 After the events set forth in the amended complaint, defendant Bank of America acquiredCountrywide. See MBIA Ins. Corp. v. Countrywide Home Loans, Inc. , 87 A.D. 3d 287, 290n.1. (1st Dept 2011).


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MBIA guaranteed that the payments due to Securities investors would be

made. In exchange for substantial premiums paid by the Trusts, MBIA issued

Note or Certificate Guaranty Insurance Policies to the Trusts (the Insurance

Policies), in which it promised that if the payments received from the Mortgage

Loans were insufficient to cover the payments due under the Securities, MBIA

would pay the shortfall to the Trusts. [R4142, CSOF 5.] MBIA unconditionally

and irrevocably guaranteed the Insurance Policies. [See, e.g., R2343, 2006-E

Note Guaranty Insurance Policy, at 1.] Countrywide is not a party to the Insurance

Policies. [R4142, CSOF 6.]

Before MBIA issued the insurance on each Securitization, Countrywide

provided MBIA with extensive information about the underlying mortgage loans.

This included loan data tapes, third-party due diligence results, underwriting

guidelines, shadow ratings from credit rating agencies, prospectuses, and

prospectus supplements. MBIA also had the opportunity to request any additional

information that it wanted from Countrywide before deciding to insure the

Securitizations. [R4430-32.]

The rights and obligations of all of the parties to the Securitizations are set

forth in a set of contracts (the Transaction Documents). The Mortgage Loans

were conveyed to the Trusts through a Purchase Agreement (Purchase Agmt.)

and a Sale and Servicing Agreement (SSA) for the HELOC transactions and a


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Pooling and Servicing Agreement (PSA) for the CES transactions. The Trusts

issued the Securities through an Indenture and sold the Securities pursuant to a

Prospectus and Prospectus Supplement. [R4142-43, CSOF 7-9.]5

For each Securitization, MBIA and CHL entered into a contract that governs

their respective rights and obligations, called an Insurance Agreement. The

Insurance Agreements incorporate many of the provisions contained in the other

Transaction Documents. Each Insurance Agreement incorporates loan-level

representations and warranties CHL made about the individual Mortgage Loans

that CHL sold to the Trust, including a representation that each Mortgage Loan

was originated in accordance with CHLs underwriting guidelines.6

The

Transaction Documents provide that, if a Mortgage Loan breaches such loan-

level representations or warranties, MBIAs sole remedy is to request that CHL

cure the defect, substitute a new loan for the defective loan, or repurchase the

noncompliant loan. [See, e.g., R1912, 2006-E Purchase Agmt. 3.02 (b), (c).]

MBIAs right to such a remedy only arises, however, if it has been materially and

adversely affect[ed] by the breach of the particular representation or warranty.

[See, e.g.,R2138, 2006-S8 PSA 2.03(f); R3501, 2006-E SSA 2.04(b), (c).]

5 The Securities are registered with the Securities and Exchange Commission under theSecurities Act of 1933. [See, e.g., R3696, CWHEQ, Inc., Form S-3 (Registration Statement)(Mar. 12, 2006).]

6 [See, e.g., R1905, 2006-E Purchase Agmt. 3.02(a)(37).]


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Beginning in late 2007, the United States suffered a historic economic crisis,

and an unprecedented number of borrowers began to default on their mortgages. 7

Despite the worst economic recession since the 1930s, approximately 80% of the

Mortgage Loans in the Securitizations have been paid in full or continue to

perform. [R153.] Nevertheless, some borrowers were unable to pay their

mortgages, and the Trusts could not make all the payments due to the Securities

holdersin other words, the very risk against which MBIA insured came to pass.

The Trusts therefore filed claims with MBIA, in accordance with the terms of the

Insurance Policies. At the time it filed its Amended Complaint in 2009, MBIA had

paid approximately $1.4 billion in claims to the Trusts on the Insurance Policies.8

[R4149, CSOF 21-22.]

The impact of the economic crisis and recession on MBIA is well-

documented. As the Court of Appeals recently observed:

Beginning in 2007 and continuing through 2008, thehealth of the real estate market deteriorated. In turn, therisks associated with certain financial products tied toreal estate, such as structured-finance products, increasedconcomitantly. Not surprisingly, MBIA Insurancesexposure to liability with respect to its structured-finance

policy portfolio grew exponentially as the real estate

market crumbled during this period.

ABN AMRO Bank, 17 N.Y.3d at 217.

7 See ABN AMRO Bank, 17 N.Y.3d at 216-17.

8 [R300, Am. Compl. 3.] As of July 15, 2011, more than $12.8 billion of the $21 billion


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MBIA has admitted in discovery in this case that the economic crisis, rather

than breaches of any of Countrywides representations and warranties, caused a

significant portion of its losses on the Insurance Policies. Carl Webb, the former

head of MBIAs Structured Finance Division for Mortgage Backed Securities,

testified at his deposition that 60% of the defaults and delinquencies on Mortgage

Loans in the Securitizations were caused by the recession, and not anything

Countrywide did. [R4151, CSOF 28.] Other MBIA witnesses agree that

MBIAs losses were caused, at least in part, by the recession and not by

Countrywide. David Glehan, a Managing Director of MBIA, told his supervisors:

[A] portion of the current delinquencies are the result ofmacro economic issues. The ability to refinance isvirtually impossible for all but a small percentage of the

population. Prior to the meltdown of the mortgagemarket, a borrower had several options prior to not

paying on a loan. The borrower had the option torefinance with the lender at a lower rate or the borrowercould rely on significant housing price appreciation tosell the home and prepay the loan. Because these optionsno longer exist, the only option for many borrowers is tonot to pay on the loan . . . .

[See R4350 (emphasis added).] Stacey Terezakis, a senior analyst in MBIAs

Structured Finance Division and a team member on many of the Countrywide

Securitizations, testified that there were many factors that contributed to the[se]

losses, including macroeconomic issues. [R5368.]

worth of Mortgage Loans already had been paid-in-full. [Id., Abdou Aff. 8.]


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MBIA undertook its own retrospective analyses in 2008 that concluded that

its own poor risk controls contributed significantly to MBIAs losses. MBIAs

internal documents acknowledge that MBIA failed to: (1) take account of changes

in the macroeconomic environment, including the risk of a housing bubble, an

increased supply of homes in the market, and diminishing job growth; (2) provide

adequate resources, oversight, and limits to its underwriting of structured products;

and (3) consider adequately the information that Countrywide had provided about

the Mortgage Loans. [See R5792-859; R5860-84.]

In this action, MBIA nevertheless has sought to have Countrywide pay for

allof the claims payments it has had to make under the Insurance Policies, even

those having nothing to do with breaches of Countrywides representations and

warranties. MBIA alleges, inter alia, that Countrywide falsely represented that it

had originated the Mortgage Loans in compliance with its underwriting standards

and guidelines; systematically abandoned its underwriting guidelines in pursuit of

market share; and knowingly issued loans to borrowers who could not afford to

repay the loans, who committed fraud in loan applications, or who otherwise did

not meet Countrywides guidelines.

B. MBIAs Motion For Partial Summary Judgment.On May 25, 2011, in the midst of fact discovery, MBIA filed a motion for

partial summary judgment. In its motion, MBIA requested a ruling that it can


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recover on its damages claims for fraud and breach of the Insurance Agreements

without having to show any causal connection between Countrywides alleged

misrepresentations and MBIAs losses. More specifically, MBIA requested

judgment that to prevail on its fraud cause of action, MBIA need establish only that

Countrywides alleged misrepresentations induced MBIA to issue the Insurance

Policies on terms to which it would not otherwise have agreed; and it need not

prove that Countrywides alleged misrepresentations caused MBIAs claims

payments under the Insurance Policies. Similarly, MBIA requested judgment that

to prevail on its cause of action for breach of the Insurance Agreements, MBIA

need only establish that CHLs alleged warranty breaches materially increased

MBIAs risk of loss, and need not prove that any warranty breach caused any

actual claims payments under the policy. [R448, Pl.s Mem. of Law in Supp. of

Mot. for Partial Summ. J. & Mot. to Strike Defenses at 10 (MBIA Mem.); R457,

MBIA Mem. at 19.] MBIA further argued that once it had established these

elements, it was entitled to be returned to the position it would have occupied had

it not issued the Insurance Policies, by recovering an award of what it termed

rescissory damages,i.e., allclaim payments MBIA has made or will make under

the policies (less premiums received), including payments on perfectly compliant

loans that defaulted.9

9 [R452-53, MBIA Mem. at 14-15.]


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In support of its motion, MBIA relied on two provisions of the New York

Insurance Law, Sections 3105 and 3106, that it had never before cited or even

mentioned in the case and that, on their face, do nothing more than govern the

circumstances in which an insurance policy may be rescinded or declared void ab

initio. MBIA argued that, despite the fact that it seeks damages and notrescission,

these provisions supersede New Yorks general common law requirements for

fraud and breach of contract and, thus, MBIA is not required to make any

showing of a causal link between Countrywides misrepresentations and warranty

breaches, on the one hand, and MBIAs claims payments under the policies, on the

other. [R456, MBIA Mem. at 18.]C. The IAS Courts Decision.

On January 3, 2012, the IAS Court (Bransten, J.) granted, in part, MBIAs

motion for partial summary judgment. The IAS Court stated that 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. [R83, Ord. 14.] The IAS Court held that MBIA could prevail claims for

fraud and breach of the Insurance Agreements without proving a direct causal

nexus between Countrywides alleged misrepresentations and the claims payments

that MBIA seeks to recover as damages. [R84, Ord. 15.] The IAS Court also

concluded that MBIA may recover what it called rescissory damages. [R87, Ord.


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18.] Relying on cases in which an insurer has sought to rescinda policy or have it

declared void ab initio, the IAS Court held that, to recover such damages on its

fraud and breach of contract claims, MBIA need only establish that an alleged

misrepresentation by Countrywide induced MBIA to issue insurance policies on

terms to which it otherwise would not have agreed. [R94, Ord. 25.]

To reach this result, the IAS Court relied upon New York Insurance Law

Sections 3105 and 3106, which, as noted above, address only the circumstances

under which an insurer may rescind or avoid an insurance policy based on

misrepresentations made by an insured. According to the IAS Court, in this

insurance context, with MBIA as an insurance company and Countrywide as an

applicant for insurance . . . [MBIAs] claims are informed by New York common

law and Insurance Law Sections 3105 and 3106. [R82, Ord. 13 (emphasis

added).] Therefore, despite the fact that MBIA does not seek rescissionand,

rather, advances common law damages claims for fraud and breach of contract

the IAS Court concluded that MBIA need only prove that any alleged

misrepresentations Countrywide made were material to MBIAs decision to insure

the Securitizations, and not that they caused MBIA to experience any losses.10

10 The IAS Court held that, to prove materiality, MBIA must show that it relied onCountrywides alleged misrepresentations in that the alleged statements induced MBIA totake action which MBIA might otherwise not have taken, or would have taken in a differentmanner. [R83, Ord. 14.]


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The IAS Court also held that MBIA may seek what it termed rescissory

damages, even though it has not sought to rescind the Insurance Policies and,

indeed, irrevocably bargained away its right to do so.. [R86-87, Ord. 17-18.]

Relying predominantly on inapplicable Delaware case law addressing a wholly

distinct form of damages unique to the corporate and securities law contexts, the

IAS Court stated:

While rescission will bring the parties back to base pointprior to contract formation, and in effect, unmake the

contract, as the Delaware Chancery Court stated in 2003:Rescissory damages are designed to be the economicequivalent of rescission in a circumstance in whichrescission is warranted, but not practicable.

[R85-86, Ord. 16-17 (citations omitted).] The IAS Court thus held that, should

MBIA successfully prove its case, it could recoverallamounts it has paid under

the Insurance Policies, less any premiums received, without demonstrating that any

of those payments were caused by Countrywides conduct.11

11 MBIA also moved for partial summary judgment on the contractual interpretation of certainlanguage in the governing Transaction Documents at issue in this litigation. The IAS Courtfound that the meaning of the repurchase provision of those documents is ambiguous andcannot be determined as a matter of law. [See R93, Memorandum Decision entered onJanuary 3, 2012 at 24.] MBIA filed a Notice of Cross-Appeal on this issue. 12 Othercommentators have offered the following example:


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ARGUMENT

POINT I

THE IAS COURT ERRED BY EXEMPTING INSURANCE

COMPANIES SEEKING TO RECOVER DAMAGES FOR

FRAUD AND BREACH OF CONTRACT FROM HAVING

TO PROVE LOSS CAUSATION.

A. All Plaintiffs Seeking Damages for Common Law FraudClaims Must Prove Loss Causation.

Until the IAS Courts decision, every plaintiff seeking to recover monetary

damages for fraud was required to prove loss causation. As the Court of Appeals

recently explained, to recover damages for fraudulent inducement, a plaintiffmust

establish the basic elements of fraud, namely a representation of material fact, the

falsity of that representation, knowledge by the party who made the representation

that it was false when made, justifiable reliance by the plaintiff, and resulting

injury. Centro Empresarial Cempresa S.A. v. Amrica Mvil, S.A.B. de C.V. ,

17 N.Y.3d 269, 276 (2011) (emphasis added) (quotation marks omitted). And as

this Court stated in a prior appeal in this case: [a] fraudulent misrepresentation is

a legal cause of a pecuniary loss resulting from action or inaction in reliance upon

it if, but only if, the loss might reasonably be expected to result from the reliance.

MBIA v. Countrywide, 87 A.D.3d at 295 (quoting Stutman v. Chem. Bank,

95 N.Y.2d 24, 30 (2000)); accordMegaris Furs, Inc. v. Gimbel Bros., Inc., 172

A.D.2d 209, 213 (1st Dept 1991) (affirming dismissal of fraud claim where


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[p]laintiffs pleadings are devoid of any attempt to demonstrate the requisite

nexus between the misrepresentation alleged to have been made and the injury said

to have been sustained).

Causation in the context of a fraud claim includes both transaction causation

and loss causation. This Court has made clear that a plaintiff asserting a cause of

action for fraud must prove both. To establish causation, plaintiff must show both

that defendants misrepresentation induced plaintiff to engage in the transaction in

question (transaction causation) and that the misrepresentations directly caused the

loss about which the plaintiff complains (loss causation).Laub, 297 A.D.2d at 31

(emphasis added). The IAS Courts decision erroneously conflates these two

distinct elements.

Transaction causation requires evidence that the plaintiff relied on the

alleged material misrepresentation in entering into the transaction. Laub, 297

A.D.2d at 31 (citing Restatement (Second) of Torts 546). A plaintiff must show

that he justifiably relie[d] upon the truth of the matter misrepresented, if his

reliance is a substantial factor in determining the course of conduct that results in

his loss. Restatement (Second) of Torts 546. The IAS Court recognized that

MBIA must prove this element:

Of particular[] importance here, MBIA must prove thatCountrywide made misrepresentations that were materialto its decisions to issue the Insurance Policies. In orderto show materiality, as defined by N.Y. Insurance Law


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3105(b) and case law, MBIA must show that it reliedon Countrywides alleged misrepresentations in that thealleged statements induced MBIA to take action whichMBIA might otherwise not have taken, or would havetaken in a different manner.

[R83-84, Ord. 14-15 (emphasis added).] This, of course, is a description of

transaction causationnot loss causation.

But it is not enough for a plaintiff seeking damages for fraud to show that

the defendants misrepresentations induced it to enter into a transaction that

resulted in a loss. A fraud plaintiff also must prove loss causation. This requires

the plaintiff to establish that the alleged misrepresentations or other misconduct

were the direct and proximate cause of the losses claimed. Laub, 297 A.D.2d at

30-31 (emphasis added) (citing Restatement (Second) of Torts 548A); accord

Lorillard Tobacco Co., 94 N.Y.2d at 57 ([A]n act of deception, entirely

independent or separate from any injury, is not sufficient to state a cause of action

under a theory of fraudulent concealment.). Thus, the loss the plaintiff seeks to

recover must have been a reasonably foreseeable risk of harm resulting from the

misrepresentation. Stutman, 95 N.Y.2d at 30 (quoting Restatement (Second) of

Torts 548A). A fraudulent misrepresentation is a legal cause of a pecuniary loss

resulting from action or inaction in reliance upon it if, but only if, the loss might

reasonably be expected to result from the reliance.Restatement (Second) of Torts

548A; accord Natl Union Fire Ins. Co. v. Christopher Assocs., 257 A.D.2d 1, 9


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(1st Dept 1999) ([T]he fraudulent conduct must be related to the resultant

damages in order to satisfy the requirement of proximate causation.).

New York courts frequently refer to the Restatement (Second) of Torts

548A when addressing issues of loss causation. That section explains:

Causation, in relation to losses incurred by reason of amisrepresentation, is a matter of the recipients reliancein fact upon the misrepresentation in taking some actionor in refraining from it. . . . Not all losses that in factresult from reliance are however, legally caused by the

misrepresentation. In general, the misrepresentation is a

legal cause only of the pecuniary losses that are withinthe foreseeable risk of harm that it creates. . . . Pecuniarylosses that could not reasonably be expected to resultfrom the misrepresentation are, in general, not legallycaused by it and are beyond the scope of the makersliability.

Restatement (Second) of Torts 548A, cmts. a, b (emphasis added).12

The IAS Courts decision disregards this principle. Indeed, the IAS Court

never even discussed foreseeability, let alone found that borrower defaults caused

by the economic crisis were a foreseeable risk of harm from Countrywides alleged

12 Other commentators have offered the following example:

Suppose the plaintiff purchases shares in the X Rocket Company in reliance uponthe defendants fraudulent misrepresentations that the government has awarded ita valuable contract. No such contract exists, but the next day the companysentire rocket plant is demolished in an explosion and the plaintiffs shares becomeworthless. [T]he loss from the explosion is not the same kind of loss that wouldforeseeably result from the defendants misrepresentation. Under the Restatement[ 548A], the plaintiff cannot recover for unforeseeable losses, that is, thosedifferent from the losses risked by the misrepresentation.

3 Dan B. Dobbs et al., The Law of Torts 693, at 733-34 (2d ed. 1991) (emphasis added).


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misrepresentations. Instead, despite acknowledging that [i]t is . . . axiomatic that

proximate cause is inherent in causation, [R78, Ord. 9], the IAS Court held that

MBIA could satisfy the causation requirement of its fraud claim simply by proving

transaction causation, and that MBIA did not need to establish a direct causal link

between misrepresentations allegedly made by Countrywide and claims made

under the policy. [R83, Ord. 14.] According to the IAS Court, if MBIA can

prove that it relied upon material misrepresentations that Countrywide made about

the loans, then MBIA can recover for every claim payment it made under the

policies, regardless of whether the borrower defaulted as a result of the alleged

misrepresentation or for some other reason (e.g., job loss, illness, or other personal

circumstances). To the Court, simply exposing MBIA to the risk of having to

make claims payments sufficed to prove both transaction and loss causation.

The IAS Courts holding is contrary to numerous decisions of this Court. In

Laub, 297 A.D.2d at 31-32, for example, this Court affirmed the dismissal of a

fraud claim bought by an investor who sought to recoup investment losses on

technology stocks recommended by the defendant, an investment advisor who

allegedly misrepresented his training, expertise and experience. (The defendant

provided a second opinion regarding the investment advice the plaintiff was

receiving from this broker, Bear Stearns & Co.) Id. at 29-30. This Court held that

the plaintiff failed to show that the defendants alleged misrepresentations were


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the direct and proximate cause of the losses claimed,i.e., the drop in the prices of

the technology stocks the plaintiff purchased. Id. at 30-31. The Court explained

that [l]oss causation is the fundamental core of the common law concept of

proximate cause. . . . [T]here [must] be some reasonable connection between the

act or omission of the defendant and the damage which the plaintiff has suffered.

Id. at 31. Because the plaintiff did not produce any evidence that the defendants

misrepresentations about his background directly and proximately caused his

investment losses, his claims failed. Id. (citing Restatement (Second) of Torts

548A, cmt. b).

Similarly, in Starr Foundation v. American International Group, Inc., 76

A.D.3d 25, 26-27 (1st Dept 2010), this Court affirmed the dismissal of a

stockholders claim that it was induced to hold common stock of the defendant,

AIG, because AIG misrepresented the degree of risk in its credit default swap

(CDS) portfolio. This Court concluded that it was AIGs subsequent decision to

enter into certain CDS transactions, rather than any earlier misrepresentations

about the safety of its CDS portfolio, that was the proximate cause of the decline in

its stock price: [s]ince the CDS losses would have been incurred regardless of

any earlier misrepresentations AIG made concerning the risk of the CDS portfolio,

such alleged misrepresentations could not have been the cause of the decline of

AIGs stock price.Id. at 29 (emphasis added). The Court therefore held that the


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stockholders loss was not proximately caused by the alleged misrepresentations.

Id. at 31 (citingRestatement (Second) of Torts 548A).

Applying this settled law of proximate causation, New York courts

repeatedly have held that a plaintiff may not recover damages resulting from an

unforeseeable intervening cause. As the Court of Appeals explained long ago in

Hotaling v. A.B. Leach & Co., while [t]he plaintiff should be entitled to recover

from the defendants the loss which is the proximate result of the fraud that induced

the investment, the defendants should not be held liable for any part of plaintiffs

loss caused by subsequent events not connected with such fraud. 247 N.Y. 84, 87

(1928) (cited with approval inMBIA, 87 A.D.3d at 295).

Numerous courts have held that macroeconomic events, such as the recent

financial crisis, constitute just such an intervening cause. Accordingly, where, as

here, a plaintiff suffers losses that may have been caused by a market-wide

downturn or other macroeconomic event, that plaintiff cannot prevail on its fraud

claim unless it can prove that the asserted misrepresentationsrather than market

forcescaused plaintiffs alleged losses. Laub,297 A.D.2d at 32;see also First

Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 772 (2d Cir. 1994) ([W]hen

the plaintiffs loss coincides with a marketwide phenomenon causing comparable

losses to other investors, the prospect that the plaintiffs loss was caused by the

fraud decreases.).


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Indeed, this Court has already applied these principles in a prior ruling in

this case. Addressing Countrywides motion to dismiss MBIAs fraud claim for

failure to plead loss causation, this Court explained that it will be the job of the

fact-finder to determine which losses were proximately caused by

misrepresentations and which are due to extrinsic forces. See MBIA, 87 A.D. 3d

at 296 (quotation marks and citations omitted). The Court denied Countrywides

motion to dismiss, explaining that whether MBIAs losses were caused by

Countrywides alleged misrepresentations or the financial crisis involved a

question of fact. Yet the IAS Court made no such factual findings. Nor did the

IAS Court find that MBIAs losses from the largest recession since the Great

Depression were a foreseeable risk of harm from Countrywides alleged

misrepresentations. Disregarding this Courts prior decision, as well as the settled

law discussed above, the IAS Court instead ruled that [i]t is without basis in case

law to require MBIA to provide a causal link between the alleged

misrepresentations and payments made pursuant to the policies. [R87, Ord. 18.]13

The IAS Courts ruling is reversible error.

13 See also id.at 14 (The court therefore finds no basis in law exists to mandate that MBIAestablish a direct causal link between the misrepresentations allegedly made by Countrywideand claims made under the policy.)


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B. All Plaintiffs Seeking Damages for Breach of ContractClaims Must Prove Proximate Causation.

Similarly, it is hornbook law that a plaintiff suing for breach of contract may

recover only the direct and proximate damages which result from the violation.

Losei Realty Corp. v. City of N.Y., 254 N.Y. 41, 46 (1930) (quotation marks

omitted). Yet the IAS Court held, on the erroneous basis that MBIA may seek

what it termed rescissory damages,see pp. 22-23, supra, that MBIA is not

required to establish a direct causal connection between proven warranty breaches

by CHL and MBIAs claims payments made pursuant to the insurance policies at

issue. [R94, Ord. 25.]

Again, the IAS Court improperly departed from the common law by

removing the fundamental element of causation from MBIAs cause of action for

breach of contract. SeeKenford, 73 N.Y.2d at 319 ([I]t is well established that in

actions for breach of contract, the nonbreaching party may recover general

damages which are the natural and probable consequence of the breach.);

Fruition, Inc. v. Rhoda Lee, Inc., 1 A.D.3d 124, 125 (1st Dept 2003) (breach of

contract damages are such as ordinarily and naturally flow from the non-

performance and must be proximate and certain, or capable of certain

ascertainment, and not remote, speculative or contingent). As with its fraud

claim, in order to recover damages for breach of representations and warranties,

MBIA must prove that its losses were caused by Countrywides alleged


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misrepresentations, and not by the intervening economic crisis and recession. The

IAS Courts failure to require MBIA to do so is reversible error.

POINT II

THE IAS COURT ERRED BY HOLDING THAT MBIA

MAY RECOVERRESCISSORY DAMAGES

The IAS Court held that MBIA is entitled to recover what it termed

rescissory damagesthat is, damages for all payments [MBIA] has [made] or

will make pursuant to the Insurance Policies [R77, Ord. 8]without any need for

MBIA to provide a causal link between the alleged misrepresentations and

payments made pursuant to the policies. [R87, Ord. 18.] Not only is this ruling

contrary to fundamental common law principles, discussed above, requiring a

plaintiff to prove loss causation to recover damages; it also turns the business

relationship between the parties upside down. MBIA committed to insure the

Securitizations against the risk that the loans would not perform as expected,

including as a result of adverse macroeconomic conditions, and it agreed that its

sole remedy against Countrywide would be repurchase of loans that breach

representations and warranties and have a material and adverse effect on MBIA.

If MBIA is allowed to recover the rescissory damages it seeks, it will

effectively transform Countrywide into the insurer ofevery loaneven loans that

breached no representation and warranty whatsoever and defaulted only because


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the very macroeconomic risks against which MBIA insured came to pass. The

Insurance Policies would remain unrescinded, and the Trusts would receive all

insurance payments to which they have been or ever will be entitled, but

Countrywide would bear the cost of those payments while MBIA walks away scot-

free. And MBIA will achieve all of this withouthaving to prove a fundamental

element of its common law damages claims: loss causation. Such a result is

unprecedented. Before the IAS Courts ruling, no court anywhere had ever

sanctioned the concept of an insurance company being able to escape its financial

responsibility entirely by seeking relief in the form ofrescissory damages, with

the effect of foisting its insurance obligation onto another party.

As set forth below, the IAS Courts ruling cannot be permitted to stand for

several reasons. First, the Court erred in holding that Sections 3105 and 3106 of

the New York Insurance Law relieve MBIA of the need to demonstrate loss

causation. Those sections deal with rescission of an insurance contract by an

insurer, notcommon law damages claims of the sort MBIA asserts, and they do

nothing to change the loss-causation requirements for those claims. Second, the

case law the IAS Court cited in support ofrescissory damages does not support

the relief MBIA seeks. That case law was developed in a unique corporate-law

context to deal with circumstances that are inapplicable in this case. Third, and in

any event, MBIA has affirmatively waived its entitlement to rescissionand thus


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any relief that is the purported equivalent of rescissionby (i) continuing to

accept premiums for years after learning of the conduct that allegedly gives rise to

its claims, and (ii) negotiating a full and adequate remedy at law through the sole

remedy of repurchase for which it bargained.

A. The IAS Court Erred By Holding That Insurance LawSections 3105 And 3106 Inform[]MBIAs Claim For

Rescissory Damages.

The IAS Court concluded that MBIA did not have to prove the loss

causation element of the fraud and breach of contract claims it pleads because

those claims are informed and influenced by Sections 3105 and 3106 of the New

York Insurance Law. [R82, Ord. 13.] Neither section is even mentioned in

MBIAs Amended Complaint. Neither section lends any support to the notion of

rescissory damages or remotely suggests that an insurermay be relieved of the

burden of proving the elements of its claims.

Section 3105 provides in pertinent part:

(a) A representation is a statement as to past or presentfact, made to the insurer by, or by the authority of, theapplicant for insurance or the prospective insured, at or

before the making of the insurance contract as aninducement to the making thereof. A misrepresentation

is a false representation, and the facts misrepresented arethose facts which make the representation false.

(b)(1) No misrepresentation shall avoid any contract ofinsurance or defeat recovery thereunder unless suchmisrepresentation was material. No misrepresentationshall be deemed material unless knowledge by the insurer


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of the facts misrepresented would have led to a refusal bythe insurer to make such contract.

N.Y. Ins. Law 3105 (McKinney 2011). Section 3106 provides in pertinent part:

(a) In this section warranty means any provision of aninsurance contract which has the effect of requiring, as acondition precedent of the taking effect of such contractor as a condition precedent of the insurers liabilitythereunder, the existence of a fact which tends todiminish, or the non-existence of a fact which tends toincrease, the risk of the occurrence of any loss, damage,or injury within the coverage of the contract. . . .

(b) A breach of warranty shall not avoid an insurancecontract or defeat recovery thereunder unless such breachmaterially increases the risk of loss, damage or injurywithin the coverage of the contract. . . .

N.Y. Ins. Law 3106 (McKinney 2011).

On their face, neither section has anything to do with rescissory damages

or any damages at all; their plain words demonstrate (as the legislative history

discussed below confirms) that the sections were designed to protect insureds by

limitingan insurers right to avoid (i.e., rescind) an insurance policy by requiring

that any claimed misrepresentation or breach of warranty be material. Thus,

Section 3105(b)(1) states: No misrepresentation shall avoid any contract of

insurance or defeat recovery thereunder unless such misrepresentation was

material. (emphasis added). And Section 3106(b) provides: A breach of

warrantyshall not avoidan insurance contract or defeat recovery thereunderunless


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such breach materially increases the risk of loss, damage or injury within the

coverage of the contract. (emphasis added).

Neither Section 3105 nor Section 3106 contains anything approaching a

statement of legislative intent to abrogate the common law requirement that an

insurer, or any plaintiff, prove causation in order to obtain damages for fraud or

breach of contract. [I]t is a general rule of statutory construction that a clear and

specific legislative intent is required to override the common law.Hechter v. N.Y.

Life Ins. Co., 46 N.Y.2d 34, 39 (1978);see alsoN.Y. Stat. Law 301 (McKinney

2012) (The common law is never abrogated by implication, but on the contrary it

must be held no further changed than the clear import of the language used in a

statute absolutely requires.).14

The legislative history of Sections 3105 and 3106 confirms what the

statutes plain language makes clear: they were not intended to expand insurers

rights or to make it easier for insurers to prove damages claims, but rather to

protect insuredsby limiting insurers ability to avoid policies on the basis of

immaterial misrepresentations or breaches of warranty. Specifically, Sections

14

It is indisputable that loss causation was an established element of the common law causes ofaction for fraud and breach of contract at the time Sections 3105 and 3106 were enacted.See, e.g.,Majestic Export Co., Inc.v.Katz & Greenfield, Inc., 248 A.D. 205, 206 (1st Dept1936) (in a cause of action for fraud, the true measure of damage is indemnity for the actualpecuniary loss sustained as the direct result of the wrong) (emphasis added); Rives v. Am.Ry. Express Co., 227 A.D. 375, 376 (1st Dept 1929) (noting that [i]t is well settled thatdamages for breach of contract are only those which are incidental to, and directly caused by,the breach) (quotation marks omitted; emphasis added).


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3105 and 3106 were intended to clarif[y] the meaning of materiality of a

misrepresentation for the benefit of insureds, so as to abolish[] the implication

of [the predecessor statute] that a fraudulent immaterialmisrepresentation avoids

the contract. Report of the Joint Legislative Committee on Revision of Insurance

Laws, 1938 N.Y. Legis. Doc. No. 77 at 14; Ins. Dept ofN.Y., Insurance Law

Revision of the State of New York (Tentative Draft) 63 cmt., at 143-44 (1937)

(emphasis added); see also N.Y. Ins. Law 150, Ins. Dept Revision Note

(McKinney 1949) (predecessor to Section 3106 was enacted to abolish the

technical rule that an immaterial breach of warranty avoids an insurance

contract.).15

This pro-insured purpose was consistent with the predecessor statute

to Sections 3105 and 3106, former Section 58, which was likewise directed

toward the protection of the insured. Gozanv.Mutual Life Ins. Co. of N.Y., 40

N.Y.2d 707, 711 (1976).16 Thus, there is no basis for the IAS Courts reliance on

15 See also, e.g., Proceedings of Joint Legislative Comm. for Recodification of Insurance Law,at 400 (Nov. 16, 1938) (statement of Hon. Edwin W. Patterson, Chairman, Comm. onInsurance Law Revision) ([W]e think that it is high time to put an end to that old contractdoctrine that an immaterial breach of warranty would void a contract.); Gluck v. Exec. RiskIndem., Inc., 680 F. Supp. 2d 406, 418 (E.D.N.Y. 2010) (legislative history demonstratespurpose of stop[ping] an insurer from ex post disclaiming an insurance contract, which

proved to be a bad deal only in hindsight, by nitpicking the insurance application for minormisrepresentations).

16 FormerSection 58 had provided in relevant part that [e]very policy of insurance issued ordelivered within the state . . . by any life insurance corporation doing business within thestate shall contain the entire contract between the parties and nothing shall be incorporatedtherein by reference . . . and all statements purporting to be made by the insured shall in theabsence of fraud be deemed representations and not warranties. N.Y. Ins. Law 58(McKinney 1926). The purpose of this provision, requiring the whole insurance contract to


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Sections 3105 and 3106 to inform[]MBIAs entitlement to an expandednever-

before-contemplated form of damages. [R82, Ord. 13.] The IAS Court erred by

transforming Sections 3105 and 3106 into a pro-insurance company excuse to

avoid any payments whatsoever by inequitably shifting all of its responsibilities,

even as to fully compliant, non-breaching loans, onto Countrywide.

New York case law applying Sections 3105 and 3106 has, consistent with

the statutes text and history, arisen solely in situations in which an insurer has

sought either to avoid a policy pursuant to these statutes17

or to invoke them as an

affirmative defense or counterclaim to an action by an insured seeking payment of

a claim.18

Tellingly, the case law is devoid of instances in which Section 3105 or

3106 have been used to create orinform[] distinct causes of action unsupported

be stated in the policy, was for the protection of those insured and of the beneficiariesclaiming thereunder, andnot the relief of the insurer. Abbott v. Prudential Ins. Co. ofAm., 281 N.Y. 375, 383-84 (1939). The comments to former Section 58, however, hadprovided that [u]nder this section a statement in an application for life insurance,constituting or having the effect of a warranty, whereof a breach would necessarily and ipsofacto avoid the policy must be characterized by and include the element of fraud. N.Y. Ins.Law 58 cmt. (McKinney 1926). As noted above, the potential implication of thislanguage, which current Sections 3105 and 3106 were intended to eliminate, was that afraudulent immaterial misrepresentation avoids the contract. Ins. Dept ofN.Y., InsuranceLaw Revision of the State of New York (Tentative Draft) 63 cmt., at 143-44 (1937).

17 See, e.g., Sun Ins. Co. of N.Y. v. Hercules Sec. Unlimited, 195 A.D.2d 24, 27 (2d Dept 1993)(seeking declaratory judgment that the policies are void from the inception of coverage);Christiania Gen. Ins. Corp. v. Great Am. Ins. Co., 979 F.2d 268, 273 (2d Cir. 1992)(declaratory judgment action seeking to rescind the agreements).

18 See, e.g., Glickman v. N.Y. Life Ins. Co., 291 N.Y. 45, 49 (1943) (invoking insurersdefense that although a policy was issued, no insurance thereunder ever took effect);Ginsburg v. Pac. Mut. Life Ins. Co. of Cal., 89 F.2d 158, 158 (2d Cir. 1937) (insurancecompany sought rescission in counterclaim).


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by those provisions plain terms. Cf. GuideOne Specialty Mut. Ins. Co. v.

Congregation Adas Yereim, 593 F. Supp. 2d 471, 486 (E.D.N.Y. 2009) (In point

of fact, 3105(b) lacks any language creating causes of action relating to

misrepresentations by an insured or defining any defense to such an action. This

silence does not impede rescission rights, of course, for an insurers right to seek to

void an insurance contract ab initio derives from the common law.).

Although MBIA purported to seek rescission of the Insurance Policies in its

initial complaint, it dropped that request in its Amended Complaint. [Compare

R256, Compl. 110 (MBIA is further entitled to rescission of the Insurance

Agreements because of Countrywides fraudulent inducement.), with R354, Am.

Compl. 152 (MBIA is further entitled to rescissory damages . . . .)]. In its

motion for partial summary judgment, MBIA explicitly disavowed rescission,

stating that MBIA is seeking damages, rather than to void the policies. [See

R452, MBIA Mem. at 14.]19

Yet the IAS Court concluded that Sections 3105 and

3106 still applied, notwithstanding that MBIA is not seeking rescission. The IAS

Court reasoned that Countrywide has made no showing that MBIA may only use

Sections 3105 and 3106 in a request for declaratory judgment or as an affirmative

19 That MBIA is not seeking rescission is also clear from its decision to sue onlyCountrywideit has not joined the Trusts, the actual insured under the policies, and theparties that have received all of MBIAs claims payments under the Insurance Policies. Cf.Tudor v. Riposanu, 93 A.D.2d 718, 718 (1st Dept 1983) (under New York law, in an actionfor rescission, all parties to the agreement must be joined as necessary parties).


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defense and New York insurance statutes make no such statement. [R81, Ord.

12.] Placing this burden on Countrywide was error: under the settled principles of

statutory interpretation discussed above, the absence of an express statement in the

statutes limiting their application should not be read as license to use them

affirmatively to inform[]really, createnew damages causes of action that

abrogate established common law requirements. See, e.g., N.Y. Stat. Law

301(b).

Indeed, all of the cases the IAS Court relied upon in concluding that MBIA

need not demonstrate loss causation to prove its damages claims arise in the

context of an insurance company seeking either (1) to avoid a policy affirmatively

or (2) to interpose a defense to a claim for payment.20

And that is the limited

domain of Sections 3105 and 3106dealing with rescission in a manner that is

entirely consistent with the common law.

20 [R83-84, Ord. 14-15(citingBW Sportswear, Inc. v.Those Certain Underwriters at Lloyds ofLondon, 32 Misc. 3d 1245(A) (Table; text at 2011 WL 4357674, at *2 (Sup. Ct. N.Y. Cnty.2011)) (insurer sought to rescind a policy ab initio on basis of material misrepresentationsin application);Kiss Constr. NY, Inc.v.Rutgers Cas. Ins. Co., 61 A.D.3d 412, 413 (1st Dept2009) (addressing insurers entitlement to a declaration that the policy was void ab initiobased on the material misrepresentations in the insurance application); Geer v.Union Mut.Life Ins. Co., 273 N.Y. 261, 273 (1937) (Finch, J., dissenting) (insurer asserted material

misrepresentation as defense to action by beneficiary of life insurance policy to recover onthe policy); Interested Underwriters at Lloydsv.H.D.I. III Assocs., 213 A.D.2d 246, 247(1st Dept 1995) (action by insurer to avoid insurance contract based on materialmisrepresentation in application); Greenev.United Mut. Life Ins. Co., 38 Misc. 2d 728, 728(Sup. Ct. Bronx Cnty. 1963) (insurer sought to avoid policy as defense to action for recoverythereunder); Star City Sportswear, Inc.v.Yasuda Fire & Marine Ins. Co. of Am., 1 A.D.3d58, 60-62 (1st Dept 2003) (affirming grant of summary judgment to insurer, based onmaterial breach of warranty, as to plaintiffs claim to recover on insurance policy)).]


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When, as here, the insurer is seeking not to rescind the policy but to obtain

damages, the case law makes clear that the relevant causation standard remains

whether the defendants conduct proximately caused those damages. See, e.g.,

Dress Shirt Sales, Inc. v. Hotel Martinique Assocs., 12 N.Y.2d 339, 343 (1963)

(In contrast to an action for rescission, in an action for damages for fraud actual

pecuniary loss must be shown.). Insurance companies do not, and ought not,

enjoy some special status that excuses them from the fundamental requirement of

proving causation linking the defendants action and the insurance companys

alleged damages.

For example, in Stein v. Security Mutual Insurance Co., an insurance

company sought to rescind an insurance policy under Section 3105 while also

pursuing negligence and breach of contract claims against the insurance broker

who submitted the inaccurate insurance application. 38 A.D.3d 977, 978-79

(3d Dept 2007). The Third Department held that the insurance company could

prevail on its common law claims against the brokeronly if the brokers conduct

was the proximate cause of [the insurance companys] damage. Id. at 979.

Indeed, in Stein, the court granted summary judgment dismissing the claims

against the broker, concluding that intervening events occurring afterissuance of

the policy were the true proximate cause of the insurance companys losses. See

id. (holding that the insurance companys decision to cancel the policy as of a later


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date, rather than seek to rescind it ab initio, proximately caused the damages

alleged).

Here, MBIAs entire theory of rescissory damages is an effort to pretend

that the economic crisis and recession never happened. By adopting this theory,

the IAS Court allowed MBIA to recover a greater measure of damagesall of the

claims it has had to or will have to pay under the policieswith a lesserstandard

of proof. This was error: MBIA should not be allowed to avoid the established

causation standard for its common law damages claims.

B. There Is No Basis For The IAS Courts Recognition Of ThePossibility OfRescissory Damages In Favor Of An

Insurance Company That Has Made The Voluntary Choice

Not To Seek To Rescind An Insurance Contract.

Despite the clear irrelevance ofSections 3105 and 3106 to MBIAs damages

claims, the IAS Court imported the lessened causation standard forrescission of an

insurance policy into this common law damages action by holding that MBIA

which does not seek rescission or avoidance of its policiescould recover as

rescissory damages every penny of insurance coverage it has paid or will pay

without ever proving that such damages were caused by Countrywides conduct.

[R86-87, Ord. 17-18.] This holding was based on an unwarranted extension of

cases from the Delaware Court of Chancery and other jurisdictions, arising in very

different and unique contexts. [R86, Ord. 17.] These cases do not support the IAS

Courts holding in favor of MBIA.


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The rescissory damages remedy discussed in the cases on which the IAS

Court relied was developed and applied in the corporate-law context, in very

specific circumstances in which, by virtue of a freeze-out merger or similar

transaction, a minority shareholder has been divested of his or her shares at an

unfair price due to a breach of fiduciary duty by the defendant (typically, a

controlling shareholder who has abused its control power).21 In such

circumstances, the unfair transaction has already occurred and cannot as a practical

matter be unwound, rendering actual rescission impossible or impracticable. Faced

with the fact that rescission is called for by the defendants conduct but is no

longer possible, the Delaware courts have permitted rescissory damagesthat is,

allowing the injured minority shareholders to recover in money damages not just

the fair price of their shares on the date of the wrongful transaction, but also any

accretion in their value from the date of the transaction through the time of

21 Of the cases cited by the IAS Court to support MBIAs purported entitlement to rescissorydamages, [R85-86, Ord. 16-17], all but one involve Delaware law and allegations of breachof fiduciary duty in the context of a sale of stock or other equity interest in a merger, tenderoffer, or similar transaction. The sole remaining case does not support MBIAs position.That case, Outdoor Life Network, LLC v.EMTA Corp., applying Arizona law, addressedrescission of a contract to disseminate advertising. No. 2:06-cv-00463 JWS, 2006 WL

3834287, at *1 (D. Ariz. Dec. 29, 2006). The court noted in passing that, since theadvertising that had already been disseminated pursuant to the contract could not be returnedand the status quo ante could not be recreated, some measure of rescissory damages couldbe appropriate. Id. at *5. But the court did not address the availability of those damages inthe posture of the case, and explicitly stated that it expresse[d] no opinion as to the measureof those damages or the manner in which they are to be e stablished. Id. at *5 n.48. And itcertainly did not hold that any such rescissory damages, if available at all, could beestablished without any showing of causation.


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judgment. That measure of damages allows the injured minority stockholders to be

put in as close a position as possible to that which they would have occupied had

the wrongful transaction not occurred (hence, the rescissory nature of the

damages), while preventing the wrongdoer from being unjustly enriched by

keeping the benefit of the appreciation in the stock it purchased. See, e.g.,

Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1144-47 (Del. Ch. 1994)

[cited at R86, Ord. 17.]22

The Delaware Chancery Court has explained the purpose of rescissory

damages in that unique corporate-law context as follows:

At the most general level, this remedy is premised uponthe idea that (1) the transaction whereby the party gaveup an asset was wrongful in some way and (2) the natureof the wrong perpetrated is such that plaintiff is entitledto more than his out-of-pocket harm, as measured by

the market value of the asset at or around the time of the

wrong.

22 By way of example, consider a situation in which a controlling shareholder caused minorityshareholders to sell their stock at an unfair price of $1 per share. At the time of thetransaction, $2 would have been a fair price, but by the time of the courts judgment, thevalue of the stock had risen to $3. If rescission were practicable, the wronged minorityshareholders would be returned stock with a value of $3 per share; awarding damages of only$2 minus $1 would give the benefit of the subsequent appreciation in the stock price to thewrongdoer controlling shareholder, which now owns stock worth $3, rather than to the

minority shareholders who were injured by the controlling shareholders breach of fiduciaryduty. Thus, in these circumstances, rescissory damages of $3 minus $1 might be awarded.See generallyReis v.Hazelett Strip-Casting Corp., 28 A.3d 442, 468 (Del. Ch. 2011)([R]escissory damages are not calculated as of the merger date . . . but rather generallyreflect the value of the wrongfully taken property at the time of judgment . . . or the highestintervening value between the time of the wrong and the time of judgment); Glick v.Campagna, 613 F.2d 31, 37 (3d Cir. 1979) (rescissory damages place the plaintiff in thesame financial position he would have been [in] were it possible to return the stock).


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Id. at 1144 (emphasis added);see also, e.g., Mecca v.Gibraltar Corp. of Am., 746

F. Supp. 338, 348 (S.D.N.Y. 1990) (in securities law, [u]nder a rescissory

measure of damages, the plaintiff is entitled to a return of the consideration paid,

reduced by the amount realized when he sold the security and by any income

received on the security (quoting Randall v.Loftsgaarden, 478 U.S. 647, 656

(1986)). In this respect, such damages are restitutionary, based on an idea of

precluding unjust enrichment. Cinerama, 663 A.2d at 1144. They have been

described as an exceptional remedy, In re Transkaryotic Therapies, Inc., 954

A.2d 346, 362 n.55 (Del. Ch. 2008), appropriate in circumstances in which an

out-of-pocket or merger appraisal remedy may be inadequate to compensate a

shareholder for losses suffered as a result of an unfair transaction, Weinbergerv.

UOP, Inc., 457 A.2d 701, 714 (Del. 1983). By contrast, the Delaware courts

continue to adhere to the normal common law doctrine that where a plaintiffs

claims are based in contract, an award of rescissory damages is not an

appropriate remedy. Telstra Corp. v. Dynegy, Inc., No. Civ. A 19369,2003 WL

1016984, at *1 (Del. Ch. March 4, 2003).23

23 This limited remedy appears to have had its genesis in the law of trusts, Donald J. Wolfe,Jr. & Michael A. Pittenger, Corporate & Commercial Practice in the Delaware Court ofChancery 12.04, under which, where a trustee has sold property that he was directed toretain the courts may measure his liability by the amount of subsequent appreciation in thevalue of the property, George Gleason Bogert et al., The Law of Trusts and Trustees 862.Its origin underscores the inapplicability of that remedy here.


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Whether New York joins Delaware in recognizing rescissory damages even

in this specific corporate-transaction fiduciary-breach context is questionable. See

Grace v. Rosenstock, 228 F.3d 40, 50 (2d Cir. 2000) (finding no authority under

New York law, in context of freeze-out merger, for an action for rescissory

damages encompassing post-merger surges in value). But in any event, there is

no support in New York law for rescissory damages of the sort the IAS Court

permitted here. Rather, apart from the Delaware corporate-law cases shown to be

inapplicable above, the IAS Court cites a single 1937 Court of Appeals case for the

proposition that [d]amages may be recovered as incident to an action in equity for

rescission. [R87, Ord. 18 (citing Equitable Life Assurance Socy of U.S. v.

Kushman, 276 N.Y. 178, 184 (1937).]

ButEquitable Life does not support the availability of rescissory damages in

this context. To the contrary, Equitable Life addressed only whether an insurer

could maintain an action in equity to have a policya life insurance policy with a

disability componentdeclared null, void and of no effect as a result of

misrepresentations by the insured, while also seeking a monetary judgment for

amounts previously paid to the insured under the disability component of the

policy. 276 N.Y. at 181. The Court of Appeals concluded that the insurer did not

have an adequate remedy at law, since the beneficiary under the life insurance

component of the policy would not be a proper party to such a suit, and thus the


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insurer could maintai