An MBIA subsidiary and LaCrosse Financial Products  have filed a lawsuit against two Merrill Lynch entities for misrepresentation and breach of contract in connection with credit default swaps tied to subprime residential mortgages.

A spokesman for Merrill, which is now owned by Bank of America, declined to comment on the lawsuit which was filed in New York State Supreme Court. The plaintiffs are seeking rescission and damages.

MBIA alleges in the suit that Merrill's "effort to market the CDS contracts to MBIA was part of a deliberate strategy to offload billions of dollars in deteriorating U.S. subprime residential mortgages that Merrill held on its books by packaging them into collateralized debt obligations or hedging their exposure through swaps guaranteed by insurers."

The plaintiffs charge that "as a direct result of Merrill Lynch's misrepresentations" and breaches of contract, MBIA now faces expected losses of almost $700 million on four CDOs.

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