Merrill vs. XLCA

In an important case for the structured finance market, Merrill has won a court ruling in its favour in a case against XL. Reuters reports:

Security Capital Assurance had said it severed seven credit guarantee contracts with a Merrill unit because the investment bank had given key rights promised to SCA under the contracts to at least one other party.

SCA said its XL Capital Assurance unit was promised control rights on the $3.1 billion of portfolios it had guaranteed for Merrill Lynch International, but Merrill Lynch had given those same rights to one or more third parties.

By terminating the contract, SCA was hoping to get out from under an obligation that could cost it hundreds of millions of dollars.

Basically the case was about who in the tranche structure controls voting rights on the underlying collateral: it appears that SCA was insuring a mezz tranche while MBIA was above it. SCA seems to have argued that the MBIA contract had voting rights that belonged to them. According to Bloomberg:

Merrill argued that, even though Armonk, New York-based MBIA was covering CDO tiers more senior to those insured by XLCA, the bank could still vote the shares according to XLCA's directions.

The case is important because if the assignment of voting rights is unclear, or subject to later litigation despite the provisions of the documentation, any writer of protection on a tranche potentially has wiggle room to avoid payment. I just hope for the sake of the broader structured finance market that the docs here hold up to further legal scrutiny.