On April 2, 2013, the New York Supreme Court, Appellate Division, First Department issued its decision in MBIA Insurance Corp. v. Countrywide Home Loans et al., No. 602825/2008. The decision is significant for insurers, especially financial guaranty insurers, for two reasons. First, it confirms the long-standing insurance-law causation rule in New York, as codified in NY Insurance Law Sections 3105 and 3106. Under the statutory causation rule, a claim for fraudulent inducement of a policy or breaches of warranty in a policy permits an insurer to recover payments made on claims made under the policy, without resort to rescission, by showing that it would not have issued the policy absent the misrepresentations, or that the misrepresentations materially increased the insurer’s risk of loss. It is not necessary under this rule for the insurer further to show a direct causal link between the misrepresentations and the claims payments. Second, the First Department held, consistent with recent federal court decisions to the same effect, that an insurer need not show that breaches of representation and warranty caused a loan to default in order to obtain contractual repurchase of that loan.
MBIA brought suit in 2008, alleging that Countrywide fraudulently induced MBIA to insure residential mortgage-backed securitizations and that Countrywide breached certain representations and warranties in the transaction documents. On January 3, 2012, the NY Supreme Court (Bransten, J.) granted MBIA’s motion for partial summary judgment that it need not establish a causal connection between Countrywide’s alleged misrepresentations and MBIA’s claims payments under the policies issued to Countrywide.
The NY Supreme Court concluded that NY Insurance Law Sections 3105-3106, which enable insurers to avoid insurance contracts obtained on the basis of material misrepresentations and to defeat recovery under such contracts, informed MBIA’s fraud and breach of contract claims. More specifically, the court concluded that if MBIA could establish that Countrywide’s misrepresentations led MBIA to issue policies it otherwise would not have issued or that these misrepresentations materially increased its risk of loss under the policies, MBIA could succeed on both sets of claims. The NY Supreme Court rejected Countrywide’s contention that MBIA was required to prove that its claims payments were directly and proximately caused by Countrywide’s alleged misrepresentations to the exclusion of the so-called “mortgage meltdown.”
On appeal, the First Department affirmed these holdings. Because Sections 3105-3106 mention both “avoid[ing]” an insurance policy and “defeating recovery thereunder,” the First Department concluded that there was no basis to conclude that the statute could not facilitate the recovery of payments made pursuant to an insurance policy procured through misrepresentations, without resort to rescission. Although this decision involved residential mortgage-backed securities, it may have broader application to other contractual frameworks where an insurer issues a policy. Indeed, as the First Department noted, a New York court is “not required to ignore the insurer/insured nature of the relationship between the parties to the contract in favor of an across the board application of common law.”
The rationale for the insurance law causation rule is clear. As the Court of Appeals has repeatedly held, a fundamental principle of insurance law is that an insurer has the right to select the risks it insures. Moreover, if an insurer had to prove loss causation to obtain relief from policies it was induced to issue by fraud or breach of warranty, the law would incent insurance applicants to misrepresent facts relevant to the insured risk.
Similarly, the First Department agreed with MBIA that, based on the contractual language as confirmed by the insurance-law causation rule, MBIA need not show that loans that breached representations and warranties actually defaulted in order to obtain contractual repurchase of such loans. The First Department held that all MBIA must show is that the breaches materially and adversely affected its interests. This decision will also have broad application to all insurers asserting repurchase claims based on contractual provisions similar to the MBIA policies at issue.