Merrill Lynch & Co. sued XL Capital Assurance Inc. to force the bond insurer to honor $3.1 billion of guarantees on collateralized debt obligations as the securities firm attempts to avoid more writedowns of mortgage-backed debt.

“We filed suit to make clear that XL Capital Assurance Inc. is required to meet its contractual obligations,” a spokesman for New York-based Merrill, Mark Herr, said in an e-mailed statement yesterday.

CDOs, which repackage mortgage bonds and other assets into new securities, were the biggest source of the more than $195 billion of mortgage-related writedowns and losses reported by the world’s largest banks and securities firms since the beginning of last year. Merrill’s $24.5 billion top the list. Losses may rise if default protection bought from companies such as XL, a unit of Security Capital Assurance Ltd., fails to pay off.

Merrill, the third-largest American securities firm, fell $5.18, or 11%, to $41.45 in New York Stock Exchange trading yesterday, its biggest one-day percentage drop since September 2001. SCA rose 7 cents to 79 cents in over-the-counter trading.

Other bond insurers including MBIA Inc. and Ambac Financial Group Inc. may also seek to cancel $100 billion of contracts on CDOs tied to subprime mortgages that they wrote if they’re unable to shore up capital through other means, according to the president of Chicago-based Tavakoli Structured Finance, Janet Tavakoli.

“Apparently in light of the current dramatic downturn and deterioration in the credit markets, defendants are having ‘sellers’ remorse,” Merrill said in the complaint filed yesterday in Manhattan federal court.

Hamilton, Bermuda-based SCA, stripped of its AAA bond insurer ratings this year by the three major ratings companies, said last week it was seeking to void the contracts, responsible for $427.4 million of the new reserves for losses set aside last quarter. SCA declined to name the counterparty, which the chief executive officer, Paul Giordano, said on a March 14 conference call failed to meet requirements “in a fundamental way.”

“We believe that the terminations are appropriate and effective and we expect to defend against any challenge by Merrill,” a spokesman for SCA, Michael Gormley, said in a telephone interview yesterday.

The debt that Merrill bought protection on from XL last year includes classes of: West Trade Funding II Ltd., Silver Marlin CDO I Ltd., and Jupiter High-Grade CDO VI Ltd. The credit-default swaps offer payments if the securities aren’t repaid as expected, in return for regular insurance-like premiums.

Merrill’s complaint said that XL this year sought to cancel the contracts by arguing that Merrill isn’t ready to exercise the “voting rights” as the holder of the insured CDOs classes in ways that reflect XL’s written instructions, as agreed upon by Merrill in the contracts.

The complaint says that XL based the assertion on public information from Standard & Poor’s that says Armonk, N.Y.-based competitor MBIA has written protection on classes of the CDOs senior to what XL is providing protection on and is the “sole controlling party” for the CDOs.

Merrill responded that it hasn’t entered into contracts with another party on the CDOs that would preclude it from acting in the way specified in XL’s contracts, according to the complaint.

A spokesman for MBIA, Jim McCarthy, declined to comment about the complaint. Vandana Sharma, a spokeswoman for New York-based Ambac, didn’t immediately return a call for comment.