In Bayerische Landesbank, New York Branch and Bayerische Landesbank, plaintiffs-appellants v. Aladdin Capital Management LLC, defendant-appellee,1 the US Court of Appeals for the Second Circuit considered whether the manager of a synthetic collateralized debt obligation transaction (CDO) owed any direct obligations or duties under the related portfolio management agreement (PMA) to the plaintiffs, as investors in the CDO. The defendant was the manager under the PMA.

The plaintiffs alleged that Aladdin’s gross mismanagement of the investment portfolio caused plaintiffs to lose their entire investment in the CDO. They sued Aladdin for breach of contract and in tort for gross negligence in managing the investment portfolio. The plaintiffs were not parties to the PMA naming Aladdin as the portfolio manager and defining its duties, but contended that they were intended third-party beneficiaries, or, alternatively, that Aladdin breached a duty in tort by managing the portfolio in a reckless and grossly negligent fashion. The PMA was governed by New York law. 

On a motion to dismiss, the district court ruled that no obligations or duties existed. In a de novo review, the court of appeals found that Section 29 of the PMA, which purported to limit beneficiaries and third-party rights under the PMA, was ambiguous and that, from the facts (assumed, since it was a motion to dismiss by the defendant, in a light most favorable to the plaintiffs), it was apparent that the PMA, when properly construed, was intended to benefit the investors in the CDO directly and to create obligations running from Aladdin to the investors. The court further held that the plaintiffs plausibly alleged that the relationship between Aladdin and the plaintiffs was sufficiently close to create a duty in tort for Aladdin to manage the investment on behalf of the plaintiffs and that the plaintiffs had plausibly alleged facts that supported its breach of contract claim and claim in tort. The court remanded the case to the district court for further proceedings consistent with the court of appeals decision.

Section 29 of the PMA provided, in relevant part, that “[t]his Agreement is made solely for the benefit of the Issuers and the Portfolio Manager, their successors and assigns, and no other person shall have any right, benefit or interest under or because of this Agreement, except as otherwise specifically provided herein.” (emphasis added.) The court of appeals discussed at some length whether the phrase “except as otherwise specifically provided herein” referred solely to Section 29 or to the PMA as a whole. The court stressed that the word “herein” in the phrase “except as otherwise specifically provided herein” was not defined and concluded that Section 29, on its face, did not unambiguously exclude any intent to benefit the CDO Noteholders, including the plaintiffs. The court further noted that the clause comes at the end of a sentence that states “no other person shall have any right … under … this Agreement, except as otherwise specifically provided herein.” (emphasis added). 

Absent specific limitations or other language definitively precluding any intent to confer benefits on a third party, the court determined that it must weigh other provisions of the PMA as well as extrinsic factors outside the PMA, including certain extraneous marketing materials and representations that the defendant had provided to the plaintiffs (including certain representations made in-person), in order to determine whether it could be read that rights were intended to be conferred on third parties. In light of certain provisions of the PMA reflecting an intention to benefit the CDO Noteholders (including the right of the CDO Noteholders to remove the defendant as manager under the PMA for cause), certain provisions discussing the scope of liability to CDO Noteholders and certain other extrinsic factors, the court of appeals determined that there was sufficient evidence of a direct obligation and duty to the plaintiffs to reverse the district court’s original decision.

The decision in this case reinforces the value of properly drafted provisions to negate third-party beneficiaries and indirect contract or tort liability of advisers to investors in a securitization.

1 Bayerische Landesbank v. Aladdin Capital Management LLC, 11-4306-cv, NYLJ 1202566433217, at *1 (2d Cir., Decided August 6, 2012).