Mbia Ins. Corp. v. Royal Indem. Co.

Citation286 F.Supp.2d 347
Decision Date08 October 2003
Docket NumberNo. CIV.A.02-1294-JJF.,CIV.A.02-1294-JJF.
PartiesMBIA INSURANCE CORPORATION and Wells Fargo Bank Minnesota, N.A. as Trustee of SFC Grantor Trust, Series 2000-1, SFC Grantor Trust, Series 2000-2, SFC Grantor Trust, Series 2000-3, SFC Grantor Trust, Series 2000-4, SFC Grantor Trust, Series 2001-1, SFC Grantor Trust, Series 2001-2, SFC Grantor Trust, Series 2001-3, and SFC Grantor Trust Series 2001-I, Plaintiffs, v. ROYAL INDEMNITY COMPANY, Defendant.
CourtU.S. District Court — District of Delaware

David C. McBride, John W. Shaw, Christian Douglas Wright, Young Conaway Stargatt & Taylor, LLP, Wilmington, DE, Proskauer Rose LLP, New York, New York (Ronald S. Rauchberg and Steven E. Obus, of counsel), for Plaintiffs.

Lawrence C. Ashby, Philip Trainer, Jr., Tiffany L Geyer, Ashby & Geddes, Wilmington, DE, Sonnenschein Nath & Rosenthal, New York, New York (Michael H. Barr and Kenneth J. Pfaehler, of counsel) Alan S. Gilbert, Sonnenschein Nath & Rosenthal, Chicago, Illinois, for Defendant.

MEMORANDUM OPINION

FARNAN, District Judge.

Currently pending before the Court is a Motion for Partial Summary Judgment filed by the Plaintiffs, Wells Fargo Minnesota, N.A. ("Wells Fargo") and MBIA Insurance Corporation ("MBIA") (D.I.12). For the reasons discussed below, the motion will be granted.

I. Facts

This breach of contract case involves eight insurance policies issued by Defendant Royal Indemnity Company ("Royal") in connection with several thousand student loan transactions purchased by Student Finance Corporation ("SFC"). There is a great deal of background in this case, and therefore, I find it necessary to outline the background as it relates to the different parties and agreements in this case.

A. SFC and Its Business

SFC was incorporated by Andrew N. Yao in 1992. (D.I. 47, Ex. 1 at 16). In the beginning of its corporate existence, SFC limited its activities to traditional lending arrangements, where it purchased bundles of pre-arranged student loans at a discount with funds that it borrowed from commercial banks and private investors. Id. Later, SFC sought to engage in larger transactions through "securitized" arrangements, where it could raise financing through the sale of asset-backed securities in the private securities markets. Id. As a result, SFC and its Affiliates sought to sell bonds or trust certificates backed by the payment obligations arising from the bundles of student loans that it purchased or originated. Id. at 16-17.

SFC would obtain credit risk insurance covering the underlying obligations to make the trust certificates more attractive to investors by providing additional security for payment. Id. at 17. SFC completed its first securitized transaction in 1996 by selling asset-backed certificates through an entity called SFC Grantor Trust. Id. These certificates were backed by a pool of approximately 1,056 loans to truck driving students that SFC or its Affiliates had acquired or made and a credit risk insurance policy issued by AIU Insurance Company. Id. The insured under the policy was an entity called SFC Acceptance LLC and the beneficiary was Bankers Trust Company, who was the trustee for the benefit of the certificateholders. Id. Including this transaction, SFC or its Affiliates generated approximately 10,000 student loans from 1994 through 1998. Id. On average, these loans were for a term of 12.5 years, with relatively small principal amounts generally not exceeding a few thousand dollars, at an interest rate of 19-20%. Id.

B. The Transactions at Issue

In 1998, SFC sought to expand its securitization program by persuading additional insurance companies to issue credit risk insurance policies in support of SFC sponsored transactions. Id. In furtherance of this plan, SFC arranged eight securitized transactions, which are the subject of the instant litigation. (D.I. 13 at 5).

This breach of contract case involves eight Credit Risk Insurance Policies issued by Defendant Royal in connection with several thousand student loan transactions purchased by SFC. In eight separate transactions, those loans were pooled and all right, title, and interest in the loans were transferred to Trusts of which Plaintiff Wells Fargo is the trustee. The Trusts then issued trust certificates or floating-rate notes to investors, which entitled the investors to income streams from the underlying loans. The trustee, Wells Fargo, obtained eight Credit Risk Insurance Policies (the "Policies") securing the payment obligations on the underlying student loans. Specifically, the Policies insured the payment of principal and ninety days' interest in the event of defaults in the underlying student loans. Each of the Policies provides that a default occurs whenever a student loan is delinquent more than ninety days. (D.I. 13 at 6). As an additional layer of protection, MBIA issued to the Trusts separate financial guaranty insurance policies ("Guaranties") guaranteeing the Trusts' payment obligations on the Trust Certificates.

C. The Relevant Provisions and Parties of the Credit Risk Insurance Policies

As noted previously, Royal as the insurer issued eight Credit Risk Insurance Policies in connection with several thousand student loan transactions purchased by SFC, which list SFC Acceptance VI, LLC as the insured and Plaintiff, Wells Fargo as Beneficiary. (D.I.17, Ex. 5). Plaintiff MBIA contends that it is a third party beneficiary of the Policies, because in each transaction, the Royal Policy was transferred to the Trust as part of the Trust Estate "for the benefit of the Certificate holders and MBIA." (D.I. 18, Ex. 9 at § 2). Also, MBIA points out that each of the Policies specifically names MBIA, and provides that the Policy shall not be waived or modified unless consented to in writing by MBIA. (D.I. 17, Ex. 5 at § X; Exs. 6, 7 at § VIII).1

The relevant provisions of the first six Policies contain identical language. Specifically, the provision outlining Royal's obligation to pay claims under each of the first six Policies states:

STUDENT LOANS

The insurer's obligation to pay any claim made under this Policy is absolute, unconditional and irrevocable and shall not in any way be affected, mitigated or eliminated by (y) a breach of any representation or warranty made by the insured, the Servicer, Student Finance Corporation or the Beneficiary, or (z) the failure of the Insured or Student Finance Corporation to comply with the Underwriting Policies.

D.I. 17, Ex. 5, at § IV.F.4. The same six Royal Policies also include a waiver of defense clause in Article XII, which provides in pertinent part:

Notwithstanding any other provision of this policy to the contrary, the right of the beneficiary to receive payment for loss under this policy after payment of the initial premium by the insured shall be absolute, irrevocable and unconditional, and no failure on the part of the insured, the servicer or the beneficiary to observe or perform any covenant or condition contained in this policy ... shall entitle the insurer to any right of set-off, counterclaim or defense against the beneficiary or any other parties or otherwise relieve the insurer of any liability to make any such payment for loss to the beneficiary under this policy, subject only to the limit of liability.

D.I. 17, Ex. 5 at § XII.

The above quoted language contained in §§ IV.F.4. and XII of the first six Policies does not mirror the language contained in the last two Policies. Rather, § XI of the last two Policies sets forth the right of the beneficiary to receive payment for losses under those particular Policies. Section XI of the last two Policies states in pertinent part:

Notwithstanding any other provision of this policy to the contrary, the right of the beneficiary to receive payment for losses under this policy shall be absolute, continuing, irrevocable and unconditional irrespective of (a) any fraud with respect to the student loans, (b) the genuineness, validity or enforceability of any insurance agreement, pooling agreement or student loan or the breach of any such contract or any covenant or representation or warranty made therein, or (c) any other rights or defenses that may be available to the insurer to avoid payment of its obligation under this policy(all of which rights and defenses are hereby expressly waived by the insurer) ....

Exs. 7, 8 at § XI.

D. The Collapse of SFC

On March 20, 2002, SFC, which is now party to an involuntary bankruptcy proceeding in the United States Bankruptcy Court for the District of Delaware, disclosed that a significant number of the student loans it pooled and sold were in default.

On March 22, 2002, Royal received a telephone call from Mr. Yao, SFC's president and CEO, indicating that SFC had been making, but would no longer be able to make, the "forbearance" payments on the student loans. (D.I. 46 at 10). Mr. Yao explained that these payments were payments made on the loans by SFC, rather than the students as Royal had originally understood. Id. Subsequently, Royal, Wells Fargo and MBIA began to conduct an investigation into SFC's activities. Id.

Royal's investigation revealed that SFC had made forbearance payments to allegedly conceal student defaults of two million in 1999, $9.5 million in 2000, and $33 million in 2001. Id. Royal's investigation also revealed that the forbearance payments appear to have been funded with cash generated by originating larger amounts of new loans. Id. Further, Royal contends that its investigation revealed that removing the effects of the forbearance payments demonstrates that before Royal's insurance commitments, SFC's loan portfolios across all programs were experiencing default rates of 25.9% in January 1999, 26.5% in December 1999, and 55.2% in June 2001. Id. at 11.

Royal also contends that it learned that there was a failure to implement SFC's underwriting criteria and acquired evidence of fraud by the truck driving schools. Id. Specifically, Royal contends...

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