Highland CDO Opportunity Master Fund, L.P. v. Citibank, N.A.

• Decision Date: 21 March 2013
• Docket Number: 12 Civ. 2827 (NRB)
• Parties: HIGHLAND CDO OPPORTUNITY MASTER FUND, L.P., Plaintiff, v. CITIBANK, N.A., CITIGROUP GLOBAL MARKETS INC., CITIGROUP GLOBAL MARKETS LIMITED, and CITIGROUP FINANCIAL PRODUCTS INC., Defendants.
• Court: U.S. District Court — Southern District of New York

HIGHLAND CDO OPPORTUNITY MASTER FUND, L.P., Plaintiff,

v.CITIBANK, N.A., CITIGROUP GLOBAL MARKETS INC.,CITIGROUP GLOBAL MARKETS LIMITED, and CITIGROUP FINANCIAL PRODUCTS INC., Defendants.

12 Civ. 2827 (NRB)

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

Dated: March 21, 2013

MEMORANDUM AND ORDER

NAOMI REICE BUCHWALD

UNITED STATES DISTRICT JUDGE

Plaintiff Highland CDO Opportunity Master Fund, L.P. ("CDO Fund") brings this action asserting claims for breach of contract; breach of the implied covenant of good faith and fair dealing; violation of Article 9 of the New York Uniform Commercial Code (the "U.C.C."); and unjust enrichment, with an accompanying request for imposition of a constructive trust. In the motion before the Court, defendants Citibank, N.A. ("CBNA"), Citigroup Global Markets Inc. ("CGMI"), Citigroup Global Markets Limited ("CGML"), and Citigroup Financial Products Inc. ("CFPI") (together, the "Citi Parties") seek dismissal of CDO Fund's complaint pursuant to Rule 12(b)(6) of the Federal Rules ofCivil Procedure.¹ For the reasons set forth below, the Citi Parties' motion is granted in part and denied in part.

BACKGROUND²

I. Introduction

This action arises from a series of complex financing transactions that met their early demise in the credit crisis. In 2007 and 2008, CDO Fund and one or more of the Citi Parties (collectively, the "Parties") executed a number of lending and financing agreements. Compl. ¶ 1. Under one set of contracts, CDO Fund sold credit protection to CBNA as part of a secured credit default swap transaction (the "CDS Transaction").³ Id. ¶ 20. Under a second set of contracts, CBNA and CFPI provided a secured financing (or lending) facility to CDO Fund (the "Facility"). Id. ¶ 21. In connection with these transactions, CDO Fund pledged collateral comprised primarily of interests in collateralized loan obligations ("CLOs"), collateralized debt obligations ("CDOs"), and other such investments. Id. ¶¶ 1, 20-21. In addition, CDO Fund agreed to post additional collateral(or "margin") if the value of the existing collateral decreased relative to the Citi Parties' exposure. Id. ¶¶ 20-21.

The CDS Transaction and the Facility were unrelated at their inception. However, the Parties later linked these transactions through the Restated Credit Support Administrative Agreement (the "CSAA"), dated October 10, 2008. Id. ¶ 22. The CSAA served as a "master netting product" that governed the administration of credit support under the transactions and cross-collateralized their underlying contracts. Id. As relevant here, the CSAA authorized the Citi Parties to value the collateral underlying the transactions and to issue margin calls to the extent there were shortfalls. Id. ¶ 23.

The crux of CDO Fund's complaint is that the Citi Parties abused this authority to generate "quick cash" at CDO Fund's expense. Id. ¶ 5. According to the complaint, the Citi Parties "inexplicably and unreasonably" marked down the value of the collateral and employed "coercion and economic duress" to force CDO Fund to satisfy inflated margin calls. Id. ¶¶ 24, 27. After CDO Fund defaulted on the margin calls, the Citi Parties allegedly seized the collateral at "rock bottom prices" and engaged in "disingenuous efforts" to sell it. Id. ¶¶ 5-6. CDO Fund maintains that the Citi Parties intended to, and did, keep most of the collateral they seized. Id. ¶ 7. As the collateral steadily regained its value, the Citi Parties allegedly reapedan "undeserved windfall" of approximately $200 million -- all at CDO Fund's expense. Id.

II. The Transactions and Their Underlying Contracts

A. The CDS Transaction

CDO Fund and CBNA entered into the CDS Transaction in 2007. Haynes Decl. Ex. A. The terms of the transaction were set forth in the following contracts (collectively, the "CDS Contracts"):

• the ISDA Master Agreement (together with the Schedule, the "CBNA ISDA"), dated January 12, 2007, between CBNA and CDO Fund;

• the ISDA Credit Support Annex (the "Credit Support Annex"), dated January 12, 2007, between CBNA and CDO Fund; and

• the Amended Confirmation, dated September 18, 2008, between CBNA and CDO Fund.

Id. ¶ 19(a); Haynes Decl. Exs. A, B, C.⁴

Under the CDS Contracts, CDO Fund sold credit protection to CBNA in relation to certain "Reference Obligation[s]" consisting of complex securities.⁵ Haynes Decl. Ex. C § 1. As the credit protection seller, CDO Fund was required to make floating-ratepayments to CBNA whenever necessary to compensate for a decrease in the market value of any Reference Obligation. Id. § 3. In exchange, CDO Fund received periodic fixed-rate payments from CBNA during the life of the contract. Id. § 2.

In connection with the CDS Contracts, CDO Fund pledged collateral amounting to $59 million in aggregate notional value. Compl. ¶ 20; see also Haynes Decl. Ex. B ¶ 2 (each Party providing "a first priority continuing security interest in, lien on and right of Set-off against all Posted Collateral"). Furthermore, CDO Fund agreed to post margin if the value of the existing collateral, as calculated by CBNA, decreased relative to CBNA's exposure. Haynes Decl. Ex. B ¶ 3. Pursuant to this arrangement, CBNA regularly calculated an "excess/deficit amount" for the CDS Transaction using "the market value of the collateral offset by agreed-upon margins, asset marks, and posted cash." Compl. ¶ 20; see also Haynes Decl. Ex. B ¶¶ 3-4. Under the terms of the CDS Contracts, CBNA undertook to perform these calculations "in good faith and in a commercially reasonable manner." Haynes Decl. Ex. B ¶ 11(d). To the extent that CDO Fund disagreed with the Citi Parties' calculations, the Credit Support Annex provided for dispute resolution. See id. Ex. B ¶ 5.

B. The Facility

Independently of the CDS Transaction, CBNA and CFPI agreed to provide a financing facility (i.e., the Facility) to CDO Fund. Compl. ¶ 21. The Facility was governed by the following contracts (together with their amendments, the "Facility Contracts," and, together with the CDS Contracts and the ISDA Master Agreement, dated January 12, 2007, between CGML and CDO Fund, the "Underlying Contracts"):

• the Third Amended and Restated Facility Letter, dated August 27, 2007, between CBNA and CFPI, on the one hand, and CDO Fund, on the other;

• the Third Amended and Restated Master Financing Agreement, dated August 27, 2007, between CBNA and CDO Fund;

• the Second Amended and Restated Master Financing Agreement, dated August 27, 2007, between CFPI and CDO Fund; and

• the Master Repurchase Agreement, dated July 24, 2007, between CGMI and CDO Fund.

Id. ¶ 19(c)-(f); Haynes Decl. Exs. D, E, F, G, H, I, J.⁶

Under the Facility Contracts, CBNA and CFPI permitted CDO Fund to draw cash loans up to a predetermined maximum amount. Compl. ¶ 21. In exchange, CDO Fund agreed to make monthly interest payments on outstanding loans and to repay theprincipal in full on the scheduled maturity date. Haynes Decl. Ex. D ¶ 5; Ex. F ¶ 3.6; Ex. H ¶ 3.6.

CDO Fund pledged certain assets, notionally valued at $213 million, as collateral against the Facility. Compl. ¶ 21. As with the CDS Transaction, CDO Fund undertook to post margin when the value of existing collateral, as calculated by CBNA and CFPI, fell below specified levels in relation to outstanding loans. Haynes Decl. Ex. F ¶ 3.5; Ex. H ¶ 3.5. Therefore, CBNA and CFPI regularly calculated an "excess/deficit amount" using "the market value of the pledged collateral offset by an agreed-upon 50% haircut and loan and cash amounts." Compl. ¶ 21. Once again, CBNA and CFPI undertook to perform these calculations in "good faith." Haynes Decl. Ex. F, at 5; Ex. H, at 5.

C. The CSAA

Due to the complexity of the CDS Transaction and the Facility, the Parties executed a master agreement (i.e., the CSAA) that unified the administration of credit support with respect to the Underlying Contracts. Id. ¶ 22; Haynes Decl. Ex. K. The CSAA designated one or more of the Citi Parties as "Credit Support Administrator,"⁷ see Haynes Decl. Ex. K, at 4 (defining "Credit Support Administrator"), to perform margincalculations under each Underlying Contract, Compl. ¶ 23; see also Haynes Decl. Ex. K § 2(a) (requiring the Credit Support Administrator to "determine the Exposure Mark-to-Market Amount and the Independent Amount, if any, for each Underlying Contract"). The CSAA required the Credit Support Administrator to perform margin calculations in accordance with the relevant provisions, if any, of each Underlying Contract. Compl. ¶ 23; see also Haynes Decl. Ex. K, at 4-5 (defining "Exposure Mark-to-Market Amount"). Where no such provisions existed, the CSAA authorized the Credit Support Administrator to exercise discretion in determining the appropriate margin. Id.

To reduce the number of margin transfers required under the Underlying Contracts, the CSAA permitted the Credit Support Administrator to net any margin calls arising on the same date. Compl. ¶ 23; see also Haynes Decl. Ex. K § 2(g) ("In the event that on any one day, [CDO Fund] and any Citigroup Entity would otherwise be required pursuant to one or more Contracts to Transfer Credit Support or payments to or among one another in the same currency or in the same type of non-cash asset, the Credit Support Administrator may, at its option, calculate the netting of any or all such Transfers so that fewer Transfers need be made."). If CDO Fund became "generally unable to pay its debts when due," the Citi Parties were entitled to declare a "Close-out Event," which permitted the Citi Parties to terminatethe CSAA and/or any of the Underlying Contracts and net the termination amounts. See Haynes Decl. Ex. K §§ 1, 6(a), 6(b).

III. The Allegations Underlying the Instant Dispute

As alleged in the complaint, "[d]uring the credit crisis of 2008, there was substantial panic by investors in assets of the type that comprised the collateral" securing the CDS Transaction and the Facility. Compl. ¶ 2. Between September 30, 2008 and October...