MBIA Ins. Corp. v. Patriarch Partners VIII, LLC

• Decision Date: 06 February 2012
• Docket Number: 09 Civ. 3255
• Parties: MBIA INSURANCE CORPORATION, Plaintiff, v. PATRIARCH PARTNERS VIII, LLC, a Delaware limited liability company, and LD INVESTMENTS, LLC, a Delaware limited liability company, Defendants.
• Court: U.S. District Court — Southern District of New York

MBIA INSURANCE CORPORATION, Plaintiff,

v. PATRIARCH PARTNERS VIII, LLC, a Delaware limited liability company,and LD INVESTMENTS, LLC,a Delaware limited liability company, Defendants.

09 Civ. 3255

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

Date: February 6, 2012

OPINION

APPEARANCES:

Attorneys for Plaintiff

BINGHAM MCCUTCHEN LLP

By: Jeffrey Q. Smith, Esq.

Susan P. DiCicco, Esq.

Kevin J. Biron, Esq.

Attorneys for Defendants

BRUNE & RICHARD LLP

By: Charles A. Michael, Esq.

David Elbaum, Esq.

Hillary Richard, Esq.

Sweet, D.J.

The defendants Patriarch Partners VIII, LLC ("Patriarch") and LD Investments, LLC ("LDI") (collectively, the "Defendants") have moved pursuant to Fed. R. Civ. P. 56 for summary judgment dismissing the complaint of MBIA Insurance Corporation ("MBIA" or the "Plaintiff"). MBIA has also moved pursuant Fed. R. Civ. P. 56 for partial summary judgment dismissing the Defendants' affirmative defenses of unclean hands and equitable estoppel. In addition, both parties have moved in limine to exclude certain testimony and exhibits submitted by the opposing party.

Upon the facts and conclusions set forth below, the Defendants' motion for summary judgment dismissing the complaint is granted in part and denied in part, and Plaintiff's motion for partial summary judgment to dismiss the Defendants' affirmative defenses of unclean hands and equitable estoppel is granted. The parties' motions to exclude evidence are denied.

These parties are sophisticated, well-advised entities engaged in complicated financial transactions. MBIA had issued financial guaranty insurance on collateralized debt obligations("CDOs") and had turned to Patriarch and its Chief Executive Officer Lynn Tilton ("Tilton") for assistance in remediating seven CDOs where losses estimated to be between $91 and $287 million were anticipated. The parties' dispute turns on the interpretation of the complicated agreements reached between them.

Prior Proceedings

MBIA filed its complaint on April 3, 2009 alleging breach of contract, anticipatory repudiation, breach of the implied duty of good faith and promissory estoppel, along with a request for the Court to issue a declaratory judgment concerning both the enforceability of an agreement between the two parties and the scope of Patriarch's obligations under that agreement.

Discovery proceeded and the instant summary judgment motions were marked fully submitted on July 6, 2011. The parties' motions in limine were marked fully submitted on July 21, 2011.

The Facts

The facts, as set forth in the Defendants' 56.1 Statement, the Plaintiffs' Local Rule 56.1 Response, the Plaintiff's Local Rule 56.1 Response,¹ and supporting affidavits and exhibits, are undisputed except as noted below.

MBIA is a corporation headquartered in Armonk, New York that is in the business of providing financial guaranty-insurance on debt obligations. At all relevant times, MBIA provided, among other things, financial guaranty insurance to structured finance transactions, such as collateralized debt obligation transactions or "CDOs."

Patriarch is a limited liability company organized under the laws of the State of Delaware. Tilton founded Patriarch and still leads the company today, and the firm has developed an expertise in investing in distressed assets. According to its website, Patriarch concentrates on direct investments in distressed businesses, managing funds with over$7 billion of equity and secured loan assets. Patriarch's sole member is Zohar Holdings LLC, whose sole members are Tilton and a trust for Tilton's daughter for which Tilton is the sole trustee. Patriarch is an affiliate of Patriarch Partners, LLC, a global investment firm formed and managed by Tilton. Patriarch Partners manages funds that make direct investments in distressed businesses. Patriarch and its affiliates specialize in the management of distressed assets and, among other things, Patriarch is engaged in the business of managing CDO transactions. As a collateral manager, Patriarch selects a portfolio of underlying assets for a CDO and manages those assets over the life of the CDO.

LDI is a limited liability company organized under the laws of the State of Delaware, with its principal place of business in Charlotte, North Carolina. Tilton, a Florida resident, is the sole member of LDI. LDI is a holding company for certain Patriarch Partners affiliates and their subsidiaries.

Although the features of CDOs vary, in simplest terms, a CDO is a transaction in which a special purpose vehicle (generally referred to as the "issuer") (i) issues notes and/orequity securities to investors and (ii) uses the proceeds of the issuance to acquire a portfolio of assets. During the life of the transaction, returns on the issuer's asset portfolio are periodically distributed to satisfy the issuer's payment obligations, including those on the issuer's notes or equity securities.

MBIA provides insurance to CDO issuers for the benefit of the noteholders. In exchange for premiums, MBIA agrees to pay interest or principal on the outside investors' notes in the event the CDO's cash flows are insufficient.

MBIA was motivated to pursue a relationship with Patriarch because it recognized that it faced a large exposure on insurance policies covering seven troubled CDOs. By early 2003, it appeared likely that the asset portfolios of these seven troubled CDOs would generate insufficient funds to satisfy the payment obligations on the MBIA-insured notes, which would eventually result in MBIA being required to make payments under the applicable insurance policies. In an effort to avoid that result, MBIA began discussing with Patriarch a plan to remediate the troubled CDO transactions. The seven CDOs ultimately involved in the remediation transaction between Patriarch andMBIA were: (i) Z-1; (ii) Captiva; (iii) Ceres; (iv) Aeries; (v) Amara-1; (vi) Amara-2; and (vii) Oasis (collectively, the "Identified CDOs"). According to Mark Zucker ("Zucker"), global head of structured finance at MBIA, these CDOs were the "seven ugly step sisters" in MBIA's insured portfolio. MBIA disputes that all seven of the Identified CDOs were troubled. Both MBIA and Patriarch projected no losses on Aeries and Oasis, and MBIA projected losses on Amara-1, Amara-2 and Ceres to be zero under certain scenarios. Over time, five of the Identified CDOs were able to pay off the MBIA-insured notes in full without any insurance payment by MBIA.

As of April 14, 2003, MBIA estimated its total losses on the Identified CDOs to be between $91 and $198 million, while Patriarch estimated the losses at $287 million. MBIA had established loss reserves of $11 million. MBIA's projected range of loss estimates was based on a variety of assumptions. MBIA maintains that at all relevant times, MBIA expected to remediate any potential losses on the Identified CDOs and had taken this remediation into account when establishing its loss reserves.

According to Patriarch, MBIA was aware that the losses could greatly exceed reserves and that reserve levels were insufficient to cover the potential magnitude of the loss. MBIA disputes this contention and states that losses ultimately incurred could be greater or lesser than loss reserves and denies that loss reserves established in prior periods were insufficient.

MBIA and Patriarch worked together to develop solutions that could help remediate the Identified CDOs without requiring MBIA to increase its loss reserves. MBIA maintains that it sought solutions to avoid losses in the transactions that would require it to pay claims on its insurance policies and that specific loss reserves on a transaction are separate from MBIA's general unallocated loss reserves. According to MBIA, any increase in a specific case loss reserve is accompanied by a corresponding decrease in MBIA's unallocated loss reserves.

The discussions over many months led to a series of agreements dated November 13, 2003. According to the Defendants, the first line of defense to MBIA's reserve problem was for MBIA to designate Patriarch as the new collateralmanager for the Identified CDOs in exchange for fees. Patriarch offered strategies for turning around the CDOs in an effort to reduce their losses. According to MBIA, the designation of Patriarch as the new collateral manager for the seven CDOs occurred pursuant to several distinct agreements, none of which were dated November 13, 2003. The Plaintiff acknowledges that MBIA and Patriarch discussed appointing affiliates of Patriarch as the new collateral managers of the Identified CDOs.

Patriarch also created a new CDO, called Zohar CDO 2003-1, Limited, or "Zohar I." According to the Defendants, a second, more speculative, line of defense to MBIA's reserve problem involved junior notes issued by Zohar I termed the Class B Notes. Patriarch states that it agreed to contribute a portion of the Class B Notes to the Identified CDOs to the extent it would, in Patriarch's sole judgment, substantially reduce or eliminate the potential losses. MBIA disputes the Defendants' characterization of their obligation to contribute the Class B Notes as a secondary form of remediation. According to MBIA, the Class B Notes were to be the primary form of remediation for the Identified CDOs because, once in the asset portfolio of an Identified CDO, the payment on or sale proceeds from the Class B Notes would be used to make payments on theMBIA-insured notes or reimburse MBIA for payments made under the relevant insurance policies.

Like most CDOs, Zohar I is governed by an indenture (the "Indenture"). The parties to the Indenture are (i) Zohar CDO 2003-1, Limited, (ii) Zohar CDO 2003-1, Corp., (iii) Zohar CDO 2003-1, LLC, (iv) MBIA, (v) Natixis (f/k/a CDC Financial Products, Inc.), and (vi) U.S. Bank National Association. An investment bank, now called Natixis, was retained to assist in structuring and arranging the Zohar I transaction. Zohar I issued three classes of securities at a ...