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Insurer Gets Early Win on Buy-Back Causation

Philip R. Stein

Proof of Causation Not Required for Insurer to Trigger Repurchase Demands

On June 19, 2012, Judge Paul Crotty of the Southern District of New York provided a boon to monoline insurance provider Syncora Guarantee Inc. in its protracted litigation with JPMorgan Chase & Co. unit EMC Mortgage Corp. The focus of the litigation is a defunct mortgage loan securitization sponsored by EMC that allegedly cost Syncora more than $168 million in insurance claims.

Judge Crotty held that Syncora need only demonstrate that it was deceived about the risk profile of the underlying loan pool to sustain its claims against EMC, rather than demonstrate both the existence of the deception and its causal link to Syncora’s damages.

Syncora and EMC at Odds

Syncora and EMC have been at odds since 2009, when Syncora sued EMC for, among other things, breach of contract for failure to repurchase allegedly bad mortgages. The genesis of the litigation is a 2007 transaction in which EMC pooled nearly 10,000 HELOCs with an aggregate principal balance of more than $666 million into mortgage-backed securities that were later sold to investors through a trust. Syncora insured the investors’ returns with respect to certain classes of the securities.

Contractual Representations

Syncora’s decision to insure the securities was based on EMC’s contractual representations and warranties regarding the quality of the HELOC loans, as well as EMC’s contractual promise to repurchase those loans that did not live up to the proffered representations and warranties. Syncora alleges that as a result of EMC’s false representations and warranties, Syncora ended up paying more than $168 million in insurance claims.

In its motion for partial summary judgment, Syncora argued that EMC was obligated to repurchase any bad loans at the time its representations and warranties were breached regardless of whether the breach actually caused the loans to be in default. Conversely, EMC argued that the alleged breaches could not, standing alone, support Syncora’s repurchase demands, because Syncora first had to show that the alleged breaches actually caused the defaults that resulted in the insurer’s multi-million dollar pay-out to investors.

Alleged Misrepresentations

Judge Crotty sided with Syncora, finding that the existence of EMC’s alleged misrepresentations was enough to trigger the repurchase provisions and that it was not necessary for Syncora to prove that the alleged misrepresentations actually caused Syncora’s damages. Judge Crotty stated that “Syncora relied on EMC’s material misrepresentations and warranties in deciding whether to insure the transaction and how to price that risk.”

“Indeed, the truthfulness of these representations and warranties as of the closing date was a condition precedent to Syncora’s obligation to issue the policy. A breach of these warranties, if proven, would have adversely affected Syncora’s interests as an insurer.”

Moreover, the repurchase agreement between Syncora and EMC did not explicitly state that Syncora could only be remedied if it demonstrated EMC’s false representations and warranties actually caused Syncora’s losses. As Judge Crotty said, “[h]ad the parties intended this requirement, they could have included such language. They did not.”

Judge Crotty’s decision might seem like a good omen for EMC noteholders and other MBS investors, but the judge went out of his way to distinguish Syncora, an insurer, from the typical investor or other party claiming to have relied upon particular representations and warranties.

Repurchase Obligations

“Here, the language of the parties’ repurchase provisions reflects this distinction; EMC’s repurchase obligation is triggered when a breach of a representation or warranty ‘adversely affects the interests of the note insurer,’” he wrote, italicizing “note insurer,” and thus distinguishing it from noteholders. He also observed that a breach of underlying representations and warranties “would have adversely affected Syncora’s interests as an insurer,” something that is specifically prohibited under New York insurance law.

So while Judge Crotty clearly intended his ruling to apply to monoline insurers, it is not clear that the ruling applies to MBS investors, or to banks that acquired mortgage loans from correspondents or other parties.

Judge Crotty’s opinion did not involve the merits of Syncora’s claims.

The trial, which is scheduled for August 2013, will examine whether Syncora’s losses can properly be attributed to EMC’s alleged breaches.

The case is Syncora Guarantee Inc. v. EMC Mortgage Corp., Case Number 1:09-cv-03106, United States District Court, Southern District of New York.

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