District Court Enforces Credit Default Swap

On June 10, 2008, US District Judge Jed S. Rakoff of the US District Court for the Southern District of New York issued a notable ruling enforcing a credit default swap ("CDS") that Merrill Lynch & Co. ("Merrill Lynch") had purchased to hedge certain of its collateralized-debt obligations ("CDOs"). The ruling is significant for financial institutions relying on CDSs, which often are used for hedging or risk management purposes but have evolved within recent years to become investments by themselves.

In a one-page order, Judge Rakoff granted Merrill Lynch summary judgment against bond insurer XL Capital Assurance Inc. ("XLCA") and ruled that XLCA must honor its more than $3 billion CDS obligation, holding that "XLCA's purported terminations of those credit default swaps are without effect." XLCA had attempted to terminate the CDSs on the grounds that Merrill Lynch had breached certain provisions