The opinion of the court was delivered by: VICTOR Marrero, United States District Judge
Plaintiff Stanford Square, LLC ("Stanford") invoked the Court's
diversity jurisdiction pursuant to 28 U.S.C. § 1332 to assert breach
of contract claims against defendant Nomura Asset Capital Corporation
(now known and appearing before the Court as Capital Company of America)
("Capital"). Capital filed a counter claim seeking to recover Hedge
Losses" that it contends are due under the Contract. On cross motions for
summary judgment, the Court found that Stanford was entitled to a return
of a refundable deposit reduced by Capital's costs, expenses and Hedge
Losses. But, if Hedge Losses, costs and fees exceed the refundable
deposit, then Capital is due the difference. The Court also determined
that the question of what Hedge Losses Capital incurred presented a
genuine issue of material fact.*fn1
The Court conducted a bench trial to determine what quantum of damages
is due which party, and now sets forth its findings of fact and
conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil
Procedure. For the reasons set forth below, the Court finds Capital
entitled to a payment from Stanford in an amount of $1,658,075.40,
representing Capitals Hedge Losses and other allowable costs reduced by
Stanford's refundable deposit.
1. While the Court has reviewed and considered all of the live testimony
and designated trial exhibits offered in connection with the trial of
this matter, the Court addresses only those items of evidence relevant to
its legal conclusions.
2. The parties agree that the facts in the Decision are undisputed and
are not issues for trial.
3. According to the agreement between Stanford and Capital, dated
September 27, 1997 (the "Agreement"), the parties agreed that:
In the event that the Rate Lock Period has expired and
[Capital] has not yet funded the Loan, [Capital] shall
have the right at any time to close out the Hedge
Position . . . [Capital's] only obligation to [Stanford]
shall be to return the refundable portion of the Early
Rate Lock Deposit after setting off (A) losses incurred
in the Hedge Position, if any, and (B) fees and expenses
(including attorneys' fees) incurred by [Capital] in
connection with the proposed Loan. [If Capital's hedge
losses, costs and fees] exceed the combined Early Rate
Lock Deposit and the Commitment Fee (after deduction of
the non-refundable portion), [Stanford] shall pay
[Capital] the difference within two business days
following termination of the Rate Lock Period.
The Agreement did not define how to calculate "losses incurred in the
Hedge Position" or "Hedge Losses".
4. On September 29, 1997, Stanford exercised an interest rate lock for
the proposed loan by, inter alia, paying Capital a refundable deposit of
$257,750 (the "Refund Amount").
5. The Agreement provided that the interest rate lock would be calculated
at the time of the "rate lock" by adding an "interest rate spread" of 165
basis points to the yield on a ten-year U.S. Treasury Note with a 6.625%
coupon rate maturing on May 15, 2007 (the "Benchmark Security").
6. In connection with providing the fixed interest rate to Stanford,
Capital entered into a hedging transaction that theoretically would
protect against the financial risk that interest rates would change
adversely prior to the closing on the underlying loan. To hedge an asset
against the risk of change in a market condition, a lender or investor
will enter a financial transaction that it believes will have an
approximately equal and inverse financial reaction to market changes as
they occur. In the event market conditions change, the position taken in
one transaction that decreases in value should be balanced by another
that increases and offsets any loss. By this strategy, the hedging party
protects itself against a particular change in the market that would
reduce the value of an asset.
7. The industry practice is to hedge on a portfolio-wide basis. In this
approach, an initial transaction is taken to hedge an individual asset
when it is added to the asset portfolio. Immediately thereafter the
initial transaction becomes an indistinguishable part of the hedge
portfolio's overall position, losing any specific association with the
individual asset. As a result, there is no separate accounting for any
individual hedge position.
8. Indeed, Capital hedged the loans and commitments that it made on a
portfolio-wide basis. That is, Capital placed the individual mortgages and
loans into a larger mortgage portfolio (the "Mortgage Portfolio")
consisting of many other loans, and maintained a separate hedge portfolio
(the "Hedge Portfolio"). The Hedge Portfolio was to have an equal but
inverse financial impact as the Mortgage Portfolio. Stanford does not
take issue with Capital's portfolio-wide hedging practice.
9. To fully hedge its Mortgage Portfolio against changes in the treasury
interest rate, Capital usually took short positions in U.S. Treasury
Notes. To take a short position means that Capital would borrow and sell
a U.S. Treasury Note. Later, to close out the short position, Capital
have to purchase the shorted U.S. Treasury and return it to the
10. In order to determine what transactions would be necessary to hedge
the new risk associated with the Agreement and its rate lock, Capital
calculated the financial effect that a change in the interest rate would
have on its Mortgage Portfolio including that new asset. Capital
expressed the financial effect as the dollar loss in the value of the
Mortgage Portfolio that would result from an increase in market interest
rates of one basis point. The Court refers to the portion of the Mortgage
Portfolio attributable to the Agreement as "the Stanford Commitment".
11. In order to hedge the Stanford Commitment on September 29, 1997,
Capital short-sold two sets of U.S. Treasury Notes, one with a maturity
date of August 2002 and a face value of $10,000,00, and another with a
maturity date of August 2007 and face value of $7,000,000.
12. Capital recorded these sales in its handwritten trading log and
13. Months later, on July 29, 1998, Stanford and Capital entered into a
revised commitment extension and modification letter (the "Revised
Agreement"). The Revised Agreement defined Hedge Loss to be "all actual
losses incurred by [Capital] in connection with the Hedge Position taken
by [Capital] in order to provide the Locked interest Rate to [Stanford]."
(Pl.'s Ex. 12.).
14. For the period after the Revised Agreement went into effect with its
definition of Hedge Losses, Capital maintained the same portfolio-wide
hedging and record keeping practices it had followed from the inception
of the Stanford's rate lock on September 29, 1997.
15. For reasons discussed in the Decision, the Stanford Commitment was
16. On October 16, 1998, Capital informed Stanford that the Revised
Agreement was terminated and that the relevant hedge position had been
broken. The Court refers to the period of time during from September 29,
1997 to October 16, 1998 as the "Rate Lock Period."
17. Capital broke its hedge position that day by buying U.S. Treasury
Notes maturing in May 2008 in the face amount of $18,000,000. The yield
on the Benchmark Security on the day the hedge position was broken was
4.48 percent, which is lower than the 6.17 percent interest rate that the
security held on the date of the interest rate lock. The decrease in the
interest rate on the benchmark security shows that Capital incurred