Fri Sep 25, 2009 10:35pm EDT

NEW YORK, Sept 25 (Reuters) – Citigroup Inc (C.N) sued Morgan Stanley (MS.N) on Friday for breach of contract, saying the Wall Street firm owed it $245.4 million for protection it bought on a loan.

Citibank bought a credit default swap (CDS) from Morgan Stanley & Co International in 2006 on a $366 million revolving credit facility it provided to an issuer of collateralized debt obligations (CDO), according to the complaint filed in U.S. District Court in Manhattan.

The swap obliged Morgan Stanley to pay Citibank the money as a result of a payment default on the credit facility to the CDO, known as Capmark VI, it said in the complaint.

Liquidating the CDO collateral did not cover the entire amount, and Citibank said it exercised its right under the CDS to have Morgan Stanley make up for the shortfall, but it refused, according to the complaint.

Citibank paid Morgan Stanley about $750,000 for the CDS, according to the complaint.

Morgan Stanley could not immediately be reached for comment.

The case is Citibank NA vs Morgan Sanley & Co Internation al PLC, U.S. District Court, Southern District of New York, No. 09-8197 (Reporting by Paritosh Bansal; Editing by Nick Macfie)