The Value of Uncertainty

Details

Author(s):
  • Cathy Hwang
  • Benjamin P. Edwards
Publish Date:
January 25, 2016
Publication Title:
Northwestern University Law Review
Format:
Journal Article
Citation(s):
  • Cathy Hwang & Benjamin P. Edwards, The Value of Uncertainty, 110 Northwestern University Law Review 283 (2016); 110 Northwestern University Law Review Online 19 (2015).
Related Organization(s):

Abstract

In the aftermath of the financial crisis, the federal courts have heard arguments in contract disputes involving billions of dollars worth of securitized financial products—yet it is not clear that the federal courts have subject matter jurisdiction over these cases.

In these “default disputes,” sophisticated financial parties owning securities in different tranches of the same securitized financial instrument (SFI) litigate over whether an event of default has occurred and whether the alleged event requires liquidation of the SFI. Events of default and liquidations give some security holders better outcomes than others: a holder in the highest priority tranche may secure the accelerated return of its principal; lower priority tranche holders may collect nothing. Absent an event of default, lower priority tranches may continue to collect high interest payments from the SFI (and, ideally, later recover their principal investment).

Many of these default disputes squeak into federal court under the federal interpleader statute. Often, cases involve parties domiciled in New York or Delaware, so complete diversity rarely exists. The federal interpleader statute expands federal diversity jurisdiction to require only minimal diversity so long as certain special requirements are met. One such requirement is that the interpleader plaintiff deposits the amount in dispute with the court. But in large default disputes, the amount typically has not been deposited with the court, so it seems unclear whether federal courts have jurisdiction. Yet, despite the fact that some security holders may benefit from raising this jurisdictional issue and possibly having the case dismissed, courts and parties have generally not raised it.

This silence is puzzling. In this Essay, we advance possible explanations for why parties to default disputes do not raise these jurisdictional defects. While others have discussed the value of uncertainty to parties in contracting, this Essay analyzes the value of uncertainty to parties in litigation. We argue that, even though unaddressed jurisdictional defects inject significant uncertainty into the litigation, parties may actually welcome and value this uncertainty as a litigation strategy: continued uncertainty could keep parties in a preferred forum, drive parties to settle, or permit parties to collect insurance payouts. Sometimes parties may prefer that particular issues remain unresolved. SFI default disputes serve as one example that may lead to fruitful avenues for future study.