(Corrects to fix company name in headline to SCA, not SAC)
LOS ANGELES, June 10 (Reuters) - A U.S. District Court judge ruled on Tuesday that Security Capital Assurance Ltd’s (SCA.N) XL Capital Assurance Inc unit will have to stand by $3.1 billion of guarantees on collateralized debt obligations, in dispute with Merrill Lynch & Co Inc MER.N.
Judge Jed Rakoff in a summary judgment ruled that Merrill Lynch International had not repudiated its obligations under seven credit default swaps it entered with XCLA, and that XLCA’s attempt to terminate those swaps was invalid.
“MLI’s motion is granted in all respects,” Rakoff, of the Southern District of New York, wrote in a one-page ruling late on Tuesday, referring to Merrill Lynch International.
The judge, who said he would give reasons later, also dismissed three XLCA counterclaims as asked by Merrill.
Merrill spokesman Mark Herr said the firm is “pleased by the decision.” A Security Capital Assurance spokeswoman had no immediate comment.
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.
Ending the contract would have forced Merrill to write down billions of dollars of exposure, which is why the investment bank is suing XL Capital Assurance to get the insurer to make good on the agreement.
Control rights allow the seller of credit default protection to liquidate the portfolio if asset performance weakens. Those rights are crucial for minimizing losses on credit default swaps that require payouts.
The issue of bond insurers terminating contracts is thorny for the $45 trillion credit derivatives market, where investors, banks, and others transfer credit risk.
Most parties post collateral for their credit derivatives trades, but bond insurers do not, and if the insurers do not make good on their obligations, banks that traded with them could lose billions of dollars.
SCA took $632.3 million of charges in 2007 relating to the seven contracts, of which more than $427.4 million represented reserves for actual expected losses. (Reporting by Peter Henderson and Duncan Martell; editing by Carol Bishopric)