A New York judge rejected Morgan Stanley's bid to throw out a lawsuit accusing the bank of fraudulently inducing bond insurer MBIA Inc to insure $223.2 million of risky mortgage debt.

MBIA filed the lawsuit in December accusing Morgan Stanley and its Saxon Mortgage Services Inc unit of making false representations about the quality of the underwriting on a pool of 4,979 second-lien residential mortgages.

MBIA said it found breaches in 97 percent of the loan files it examined, and expected to be responsible for much more than the $71 million of claims for which it had already paid out.

In a ruling Thursday, New York State Supreme Court Justice Gerald Loehr threw out MBIA's unjust-enrichment claim against Saxon but refused to dismiss claims alleging fraudulent inducement, breach of contract and punitive damages.

He said it was premature to accept Morgan Stanley's argument that MBIA's losses were a result of the nation's housing slump, which caused higher loan delinquencies.

Morgan Stanley had unique and special knowledge regarding the mortgage loans, particularly the quality of the underwriting, Loehr wrote. It cannot be said that MBIA's reliance on the defendant's representations was unreasonable.

Mary Claire Delaney, a Morgan Stanley spokeswoman, declined to comment. MBIA is based in Armonk, located in New York's Westchester County, where Justice Loehr sits.

MBIA, once the largest municipal bond insurer, piled up big losses by insuring mortgages and other debt that proved toxic. It and other investors have sued a large number of banks to recover losses on billions of dollars of toxic loans.

Morgan Stanley is among roughly a dozen banks challenging the 2009 restructuring of MBIA that was overseen by New York's insurance superintendent. The banks say the restructuring left MBIA's insurance unit undercapitalized and unable to pay out on their claims.

New York's highest court, the Court of Appeals, is scheduled to consider the banks' arguments on May 31.

In morning trading, Morgan Stanley shares were up 25 cents at $23.80, and MBIA shares were down 14 cents at $9.06.

The case is MBIA Insurance Corp. v. Morgan Stanley et al, New York State Supreme Court, Westchester County, No. 29951/2010.

(Reporting by Jonathan Stempel; editing by John Wallace)

Morgan Stanley Lawsuit