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Fine Print Bites Deutsche Bank in CDS Suit

Indeed, that's exactly the problem that occurred in the dispute between Deutsche Bank and Ambac.

In the deal, Deutsche Bank was required to make a series of fixed-rate payments to Ambac for providing insurance against the default on a series of bonds issued by Solutia, a chemical company. In return, Ambac agreed to pay Deutsche Bank $8.77 million in the event of a default by Solutia, as long the German bank could deliver those bonds within a month of after making a demand for the payment.

Solutia filed for bankruptcy in December 2003. A few weeks, later Deutsche Bank notified Ambac it intended to collect on the $8.77 million and would soon deliver the underlying bonds as required. But Deutsche Bank had difficulty obtaining those bonds from two other big banks, J.P. Morgan Chase (JPM) and Credit Suisse (CSR). It missed the deadline for the delivering the bonds by several months.

Deutsche Bank entered into the swap agreement with Ambac without having actual custody of the Solutia bonds. But it had separate deals with JPMorgan and Credit Suisse to get those bonds in the event of a default.

In fact, the deal with JPMorgan also was arranged as a credit default swap. In that deal, JPMorgan was buying insurance from Deutsche Bank and promising to deliver the bonds to the German bank in the event of a default.

But this round-robin method of locating the Solutia bonds didn't go as smoothly as planned. When Deutsche Bank finally was able to make delivery, Ambac refused to pay, ultimately sparking the dispute that led to the litigation.

Such disputes rarely come to the public's attention because they often either arbitrated or resolved through private negotiation. But credit derivative experts say such disputes could become more common once the economy softens and more companies begin filing for bankruptcy.

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