Article

Factual Summary: Bank/Beneficiary, a wholly owned subsidiary of Applicant, received credit card and access check payments from Applicant's customers and then sold the receivables to various special purpose vehicles (SPVs) who, in turn, sold these receivables to several trusts owned by the Applicant's shareholders. The U.S. Office of the Comptroller of the Currency (OCC) began scrutinizing the financial health of Bank/Beneficiary. Subsequently, Applicant filed for bankruptcy. Applicant and Bank/Beneficiary negotiated a Consent Order with the OCC by which Applicant secured its continued performance through a US$ 78,000,000 standby LC issued in favor of Bank/Beneficiary.

The standby permitted a drawing if Bank/ Beneficiary had (a) to pay for receivables that the Applicant failed to purchase from the Beneficiary; (b) to pay for credit card charges that the Applicant failed to remit to the Beneficiary for reimbursement; or (c) if the Beneficiary intended to use the proceeds to fund bankcard receivables.

Applicant subsequently failed to purchase receivables from Bank/Beneficiary, and Bank/ Beneficiary drew $14,822,926 to pay for bankcard receivables, and access check receivables, including $2,420,334.24 as an anticipated amount to purchase future access check receivables. At that time, over $19,000,000 in access checks were outstanding and Bank/Beneficiary instructed the drawee bank to stop payment on these access checks so that they would not result in receivables being generated. Bank/ Beneficiary paid over $700,000 to the bank to process these stop payment orders.

Claiming rights to part of the proceeds of the LC, Applicant brought a claim against Bank/ Beneficiary and others for breach of warranty under the UCC, equitable subrogation, money had and received, and unjust enrichment. Applicant's claims against other defendants were dismissed, leaving Bank/Beneficiary as the sole defendant. The trial court held that Applicant's claim of breach of warranty was valid as related to one draw by Bank/Beneficiary which violated the agreement with Applicant, and that Applicant was entitled to an award in the amount of this draw alone. Applicant's three equitable claims were denied with one exception for damages related to declined credit for access checks which Bank/ Beneficiary conceded were unnecessarily drawn and should be refunded to Applicant. Bank/Beneficiary's equitable counterclaim for fees paid to stop payment on outstanding access checks was granted because failure to reimburse Bank/Beneficiary for these fees would lead to unjust enrichment of Applicant.

Legal Analysis:

1. Rev. UCC Section 5-110; Breach of Warranty: Although detailed in its statement of facts, this opinion is conclusionary in its application of Rev. UCC Section 5-110. The Applicant alleged that "three of the four amounts included in the draw against the Letter of Credit violate the UCC provision that a draw cannot violate any agreement between the applicant and the beneficiary" which is a paraphrase of the warranty provision of Section 5-110(a)(2). Accordingly, the court awarded Applicant $2,420,334.24. The amount allowed, however, was the amount conceded by Beneficiary to not have been applied pursuant to the terms of the LC. The court ruled that "this amount does violate the UCC warranty and should be returned to [Applicant]." It did not allow another amount claimed, considering the books, testimony, and the circumstances and concluding that the additional amounts claimed did not relate to the obligation to purchase receivables and "fall within the terms of the letter of credit and do not violate the UCC warranty provisions."

2. Equitable Subrogation: Applicant argued that "it acted as a guarantor of [Bank/Beneficiary] and that in good conscience, [Bank/Beneficiary] should not be allowed to keep the funds." Noting that the holding company controlled the three merchant companies, that its board agreed to apply for the LC, that Bank/Beneficiary was a wholly owned subsidiary of Applicant, and that it had "an interest in assuring the continuation of the credit card business," the court concluded that Applicant received a direct or indirect benefit from the issuance of the LC. It also concluded that there is no evidence that Bank/Beneficiary benefited from the receivables and that Applicant's equitable claim was not justified with the exception of approximately $500,000 as conceded by Bank/ Beneficiary. The court also concluded that Applicant benefited from the decision to stop payment on the access checks, and, accordingly, should be liable for the stop payment fees incurred by Bank/Beneficiary.

Comment: Since this decision is one of the first to apply Rev. Section 5-110 on warranty (a very controversial section), further explanation would have been welcome. It appears that the court did not consider itself limited to the documentary terms of the LC but that it took those terms into account in determining what was a violation of the agreement between the applicant and the beneficiary. If one is to create a new remedy in addition to that available for breach of contract, which might have been thought to be the appropriate remedy in such a situation, the independence principle has no relevance and the court should not only look at the underlying transaction and agreement but also the terms of the LC insofar as they relate to that agreement and manifest what was intended. In that sense, the court in this case behaved appropriately.

[JEB/dam]

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