(Reuters) - New York's top state court on Thursday revived a bond insurer's $120 million lawsuit claiming Goldman Sachs Group Inc (GS.N) lied about a pool of securities backed by subprime mortgages during the period leading up the financial crisis.

The New York Court of Appeals in a 5-2 decision said the suit by ACA Financial Guaranty Corp ACAFG.UL should move forward because the insurer had raised issues about the role of billionaire John Paulson's hedge fund in a collateralized debt obligation called Abacus.

ACA Financial said Goldman had deceived it into believing hedge fund Paulson & Co was a long investor in Abacus when it knew Paulson was betting the underlying mortgages would fail.

ACA says it lost approximately $900 million on the deal when the subprime mortgage market collapsed.

Under state law, a fraud case may only proceed if the plaintiff can show it "justifiably relied" on representations made by the defendant.

A mid-level appeals court in 2013 said ACA Financial was a sophisticated company that could have done its own research, including asking Paulson directly about its role in Abacus.

The Court of Appeals disagreed, saying ACA Financial specifically asked Goldman about Paulson's participation in the transaction and received assurances it was a long investor.

The court sent the case back to a lower appeals court to consider other issues before the suit proceeds in a state trial court in Manhattan.

Goldman spokesman Michael DuVally said the firm was disappointed with the decision, but "confident that ... these contrived claims will fail”.

ACA Financial CEO Steven Berkowitz said in a statement that the company was pleased with the decision.

In dissent, Court of Appeals Judges Susan Read and Sheila Abdus-Salaam said ACA Financial could have asked more questions and requested a written assurance from Goldman.

"Instead ... ACA merely relied on what it says Goldman told it without actually checking the source," Read wrote.

In 2010 Goldman agreed to pay $550 million to settle claims by the U.S. Securities and Exchange Commission that it misled investors in Abacus, though it did not admit wrongdoing.

ACA Financial in 2013 amended its suit to add Paulson & Co as a defendant. The hedge fund moved in state court in Manhattan to dismiss the claims, and the case was stayed, pending the appeal decided Thursday.

The case is ACA Financial Guaranty Corp v. Goldman Sachs & Co, New York State Court of Appeals No. 49.