Feb. 24 (Bloomberg) -- UBS AG, Switzerland’s biggest bank, sued Highland Capital Management LP in New York, claiming losses of at least $745 million in a failed collateralized debt obligation transaction.

Highland Capital, the investment firm founded by James Dondero and Mark Okada, failed to fulfill terms of the deal reached in April 2007, UBS said in a breach-of-contract lawsuit filed today in state court in Manhattan. UBS Securities LLC, a UBS unit, agreed to arrange the transaction and serve as placement agent, according to the complaint.

After the original transaction expired in early 2008, the parties restructured the agreement in March 2008, UBS said. UBS and Dallas-based Highland Capital agreed that the fund and a special holding company would bear 100 percent of the risk of losses, according to the lawsuit.

“UBS has suffered losses of no less than $745 million as a result of the depreciation in value of the warehoused collateral obligations and credit default swap obligations that it assumed in connection with the failed CDO transaction,” Zurich-based UBS said in the complaint.

Because of declining market values for the portfolios and collateral in September and October 2008, UBS said it required Highland to produce additional collateral. Highland offered “certain securities” that UBS rejected, according to the complaint.

Greg Markel, a lawyer for UBS who filed the suit, couldn’t immediately be reached for comment. Highland’s Dondero didn’t return a voice-mail message left at his office seeking comment.

CDOs are securities backed by corporate loans, mortgages, auto loans, credit cards and other assets that are sliced into layers carrying different risks.

The case is UBS Securities LLC v. Highland Capital Management LP, 650097/2009, New York State Supreme Court (Manhattan).

To contact the reporter on this story: Patricia Hurtado in New York State Supreme Court in Manhattan at pathurtado@bloomberg.net.

Last Updated: February 24, 2009 19:21 EST