In this case, Leonard Blavatnik, a Russian billionaire, made an agreement with JP Morgan. He allowed JP Morgan to invest $1 Billion of his fortune. Because Blavatnik prefers lower-risk investments, the parties agreed that JP Morgan would not invest more than 20% in mortgage securities. In early 2006, the parties formalized the agreement.
JP Morgan Invested a Great Deal into Subprime Mortgage-Based Securities
Perhaps unsurprising for the time, JP Morgan invested a great deal of Blavatnik’s fortune directly into subprime mortgage-based securities. When the 2008 crisis collapsed the subprime securities market, JP Morgan invested over 60% of Blavatnik’s portfolio in that class of securities. In the ensuing turmoil, Blavatnik lost millions of dollars. Upon learning how JP Morgan invested his fortune, he filed suit against JP Morgan for breach of contract and negligence; JP Morgan invested very heavily in such high-risk securities.
In the end, a New York court ruled that JP Morgan had breached the contract. The bank placed too large a proportion of Blavatnik’s money into high-risk subprime mortgages. The bank claimed that the subprime home loans were in fact “asset-backed securities” rather than mortgages according to banking standards. Therefore, the investments were not mortgages by the terms of the contract. The court rejected this argument; home equity loans backed these securities, so they were effectively mortgages. The bank had breached the contract as a result.
The court, however, then found that the bank’s conduct, though showing an “error in judgment”, was not so severe as to violate their duty to Blavatnik. Therefore JP Morgan was not negligent in the investment of Blavatnik’s money. It rejected the negligence charge.
There are two interesting takeaways from this case. First, it appears that, even in situations where the layperson would find the conduct of the bank to be highly negligent, a court may be reluctant to substitute its judgment for those of professional bankers.
Second, it appears that at least some courts do not allow industry standards to determine the course of litigation. JP Morgan had insisted that Subprime Mortgage-Backed securities were not mortgages and that no bank considered them to be. Instead of accepting that explanation at face value, the court instead dug deeper. Ultimately the court came to the conclusion that semantics aside, home equity loans that back a security is a mortgage after all.