Bermuda-based bond insurer Security Capital Assurance Ltd.'s share price plunged 27 percent yesterday after it lost a legal battle with Merrill Lynch.

The court ruling means that SCA will have to stand by some $3.1 billion of guarantees on disputed derivatives trades.

The dispute centred on SCA's XL Capital Assurance (XLCA) unit's efforts to terminate seven credit default swaps it had entered with the New York-based Merrill.

US District Court Judge Jed Rakoff ruled in Merrill's favour on all claims against XLCA and dismissed counter-claims by the SCA unit.

Bermuda-based commercial insurer XL Capital Ltd. owns 46-percent of SCA. But it is not a party to the court case.

In a statement issued after the Manhattan court made its one-page summary ruling late on Tuesday, XL stressed it had no reinsurance exposure to the swaps involved in the Merrill case.

"XLCA is not a subsidiary of XL Capital Ltd.," the XL statement said. "The swaps at issue in the lawsuit were entered into by XLCA after SCA's IPO (initial public offering). XL Insurance (Bermuda) Ltd's reinsurance guarantee to a subsidiary of SCA applies only to pre-IPO exposures."

XL Capital's share price yesterday fell 7.4 percent to $30.62.

Merrill had alleged that the SCA unit had tried to walk away from its guarantees on collateralised debt obligations (CDOs), or pools of bonds.

XLCA had issued notices purporting to terminate the credit-default swaps ¿ which are a form of insurance against credit default ¿ "without any basis and under a pretext based entirely on rank speculation", Merrill argued.

Last year, Merrill had entered into a a series of agreements with XLCA to insure $3.1 billion of CDOs. SCA tried to terminate the contracts, claiming that Merrill had violated the terms by giving control rights to one or more third parties.

Control rights allow the seller of credit default protection ¿ in this case the SCA unit ¿ to liquidate the portfolio if asset performance weakens. Those rights are crucial for minimising losses on credit default swaps that require payouts.

Merrill sued in March this year to force XLCA to honour the agreement.

XLCA, in a countersuit, alleged that Merrill, which has written down the values of its CDO holdings by billions of dollars, had entered into the insurance deal just to report a lower CDO exposure.

"Merrill Lynch undertook a rushed campaign to find parties willing to hedge or provide protection on its remaining CDO positions," the suit claimed. Merrill denied the allegations.

SCA shares fell 14 cents (27 percent) to $0.38 yesterday.