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New York Appellate Court Upholds Noteholder's Right to Declare a Default Based Upon Fall in Ratings of Financial Guaranty Insurance Policy


In a recent decision the Appellate Division, First Department upheld the right of a noteholder to declare a default under the applicable loan documents when the Moody's and S&P ratings of the issuers of certain financial guaranty insurance policies on underlying bonds representing security for the loan fell below the levels set forth in the loan documents. In Stonebridge Capital, LLC v. Nomura International PLC1, the court affirmed the lower court's decision dismissing the plaintiff's complaint for reformation and a declaratory judgment finding that the plaintiff's claims of scrivener's error and mutual mistake were unavailing since plaintiff failed to meet the heavy presumption that an executed document manifests the true intention of the parties.


In September 2007, the parties entered into a transaction whereby certain collateralized loans were securitized. Certain small to mid-sized business owners ("Investors") sold their business to employees through Employee Stock Ownership Plans ("ESOPS"). Pursuant to government created incentive to encourage ESOPs, investors are able to invest the proceeds of these sales into U.S. corporate bonds to defer capital gains from the sale. These bonds are insured against default by certain financial guaranty insurers. Here, the Investors purchased certain corporate bonds and used them as collateral for loans they obtained from Stonebridge Capital, LLC ("Stonebridge"). Stonebridge, in turn, obtained the funds it lent to the Investors by securitizing the loans and issuing notes to Nomura International PLC ("Nomura"). The transaction documents executed by Nomura and Stonebridge entitled Nomura to collect an increased rate of interest on the notes if the Moody's and S&P credit ratings of the financial guaranty insurance policy related to the underlying bonds fell below a certain level and to declare a default if the ratings fell even further. After the rating of one of the issuers of a financial guaranty insurance policy on the bonds fell below the trigger level, Nomura claimed a higher rate of interest and declared Stonebridge in default.

Stonebridge commenced an action against Nomura in the New York County Supreme Court seeking an order reforming the clauses that made the default triggers dependent on ratings of the "financial guaranty insurance policy related to the underlying bond" rather than the "underlying bond" and granting it a declaratory judgment that Stonebridge was not in default of those clauses. According to Stonebridge, the parties had negotiated and agreed to a clause that would make the default trigger dependent upon the ratings of the financial guaranty insurance policies rather than the ratings of the underlying bond. Stonebridge argued that its own attorney had committed a scrivener's error resulting in a document that did not reflect the agreement of the parties. Nomura counterclaimed for a declaratory judgment that an event of default had been triggered pursuant to the loan documents and made a motion for an order dismissing the complaint filed by Stonebridge and for a declaration that Nomura had the right to declare a default under the loan documents. The Supreme Court, New York County granted Nomura's motion in its entirety.

The Appellate Division Decision

The Appellate Division affirmed in its entirety the lower court's order dismissing Stonebridge's complaint and declaring that Nomura had a right to declare a default. The Appellate Division found that the lower court had properly disregarded Stonebridge's claim that a scrivener's error and mutual mistake resulted in a revised default trigger as opposed to the one agreed to by counsel. Specifically, the court held that Stonebridge failed to meet the "heavy presumption that a deliberately prepared and executed written instrument manifest[s] the true intention of the parties"2 and that since the parties did not agree among themselves with respect to the disputed language reformation was not appropriate. Likewise, the Court found that Stonebridge failed to overcome the strong presumption against mutual mistake claims since it failed to allege that the parties had reached an agreement not reflected in the transaction documents and failed to state "exactly" what such agreement was. Finally, the court found that the lower court properly ruled on Stonebridge's declaratory judgment claim as a matter of law since the declaration sought by Stonebridge would render several sections of the documents meaningless and would deprive Nomura any possibility of ever declaring a default.

The court's decision in Stonebridge is a strong reminder that a party's failure to closely read a document before executing it can have dire consequences. Once a document is finally prepared and fully executed, there is an extremely high burden that must be met before a court will relieve a party from the full import of that document by means of reformation based upon either scrivener's error or mutual mistake.

1 ---N.Y.S.2d.---, 2009 WL 4797448 (Dec. 15, 2009 1st Dep't), 2009 N.Y. Slip Op. 09302

2 Id. at *1 (internal citations omitted)

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