BAC Bank of America Corporation

By Serena Ng and Christina Rexrode 

A pair of New York hedge funds won a legal dispute that clears the way for them to collect a potential windfall on investments in a batch of crisis-era mortgage securities.

A decision by a New York judge could also enable other investors to collect payouts on defaulted mortgage bonds that were issued before the 2007 housing downturn.

The hedge funds, Prosiris Capital Management L.P. and Tilden Park Capital Management L.P., had placed a wager that some beaten-down mortgage bonds with unusual wording in their contracts were in line to receive millions of dollars from a 2011 Bank of America Corp. mortgage settlement.

Both hedge funds are run by former Goldman Sachs Group Inc. mortgage debt traders who in recent years had scooped up junior slices of over two dozen mortgage securities. Last year, their lawyers asked a judge to rule on whether they were entitled to a portion of the bank settlement. The size of the hedge funds' wager isn't known, but they stood to earn double-digit returns on the bonds if the court ruled in their favor.

Investors including BlackRock Inc. and insurers American International Group Inc. and Aegon NV, which owned more-senior slices of the same mortgage securities, had challenged the hedge funds. They argued that the hedge funds' interpretation was unfair and contrary to the settlement's original intent to pay the more-senior bondholders first. They had also argued that the contracts governing the bonds bought by the hedge funds were ambiguous.

The money at the center of the dispute is left over from an $8.5 billion settlement that Bank of America agreed to pay. The money was to go to investors who bought shoddy mortgage securities from Countrywide Financial Corp., which Bank of America now owns.

The agreement covered 530 mortgage-backed securities trusts, some with varying fine print in their contracts. Most of the settlement money was distributed last year.

In a ruling dated March 31 and released Tuesday, Justice Saliann Scarpulla of New York State Supreme Court agreed with AIG and the other large institutional investors that some features of the bonds' contracts "are designed to protect senior investors and ensure that they are paid their principal first."

"However," she added, "the parties plainly understood" when they negotiated the $8.5 billion settlement "that there could be instances" where that principle didn't apply.

"We are delighted that the court applied the strict terms of the contracts to determine the distribution," said Steve Molo, a lawyer representing the hedge funds. "My clients' close reading and savvy analysis of the complex financial instruments prevailed."

An AIG spokesman said: "We respectfully disagree with the decision and are considering an appeal."

Write to Serena Ng at serena.ng@wsj.com and Christina Rexrode at christina.rexrode@wsj.com

(END) Dow Jones Newswires

April 04, 2017 18:53 ET (22:53 GMT)

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