The United States District Court for the Southern District of New York recently issued a summary judgment decision that supports the enforceability of credit default swap obligations (“CDSs” or “swaps”) to pay principal and interest on defaulted collateralized debt obligations (“CDOs”) in the matter of Merrill Lynch International v. XL Capital Assurance Inc., et al,

Case #: 1:08-cv-2893-JSR. The ruling is significant because of the substantial losses incurred by investors and financial institutions that were caused by CDO defaults, the use of CDSs to hedge or protect against such losses, and the anticipated growth of litigation with respect to both.

An inability to enforce swaps would sharply deepen the CDO-based financial crisis for investors and financial institutions, which hedged their CDO positions with swaps. The ruling stands for the proposition that unproven, speculative allegations of a breach of CDO control provisions, specifically, voting rights, will not survive summary judgment or relieve the issuers of credit protection of payment obligations on insured CDO default, absent proof of actual breach.

See Advisory for more information.