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Note: To provide security in addition to a security deposit to cover agreed share of the cost of tenant improvements in connection with a commercial lease, Bitmath, Inc. (Tenant) agreed to provide a letter of credit in favor of Eli Reinhard (Landlord). The terms provided, "[i]f Tenant is in default, Landlord can use the Letter of Credit or any portion of it to cure the default or to compensate Landlord for any reasonable damages sustained by Landlord resulting from Tenant's default."

Accordingly, Tenant obtained a standby letter of credit for US$159,168. The LC stated that it would "be automatically extended for an additional period of one year, without amendment, from the present or each future expiration date, unless, at least sixty (60) days prior to the then current expiration date we notify you... that this letter of credit will not be extended beyond the then current expiration date, but in any event not beyond May 15, 2003, which shall be the final expiration date of this letter of credit."

Oz Optics Limited (Principal) subsequently purchased Tenant and "executed a 'Guaranty of Lease' in which it guaranteed [Tenant]'s performance of its obligations under the contract with [Landlord]."

Tenant's use of the premises had declined noticeably but it continued to pay rent in a timely fashion. However, on 26 February, LC Issuer notified Landlord of the non-renewal of the credit which it stated would "terminate" on 15 May. Subsequently, Landlord's representative sent a letter to Tenant regarding the non-renewal and requesting that it be renewed within 30 days to avoid default on the lease.

On 8 April, Landlord made a demand on the LC for its full amount asserting, pursuant to the required terms, that "an event of default (as defined in the lease) has occurred ...". On 30 April, Issuer sent a notice of refusal because the required certification had not been made by the proper official of Landlord. On 1 May, documents were re-presented and Issuer paid.

During this period there were various communications between representatives of Landlord and Tenant. Notably, after the first drawing and before the re-presentation, there were discussions between Tenant's attorney and Landlord's representative. The attorney indicated that efforts were being made to create a new banking relationship but the attorney declined to provide any specifics and, particularly, did not give representative assurances that the LC would be renewed or a new LC would be forthcoming. The evidence indicated that attorney "did not say 'one way or another.'"

Landlord sued Tenant for damages due to its anticipatory breach of the Lease and Tenant crossclaimed for wrongful drawing on the letter of credit. The Santa Clara County Superior Court entered judgment for Landlord on a jury verdict. On appeal, the Court, in an opinion by Mihara, J., reversed with Elia, J., concurring and Rushing, P.J., dissenting.

The jury deliberated on the reasonableness of the drawing of the letter of credit and in a special verdict found unanimously that Landlord "had not committed an act of conversion and generally found in favor of [Landlord] on the cross-complaint." The appellate court noted that the lease did not address the question of renewal of the letter of credit. It also examined the events in the lease which would constitute a default. It concluded that Landlord's claim of abandonment was not supported by evidence and that there was no evidence that any damages were suffered by it in view of the fact that all payments were current.

As to the allegation of anticipatory repudiation by failure to provide a letter of credit or to renew or replace it in a reasonably timely fashion, the appellate court noted that the credit was not due to expire until 15 May. It further observed that Tenant "had not failed to perform [its] contract obligation to provide a letter of credit since the letter of credit had been provided and had not expired."

The appellate court noted that breach by anticipatory repudiation can only occur when there is an express or implied repudiation. It noted that this must be evidenced by the "clearest terms". The appellate court noted that there was no claim by Landlord of an express refusal to renew or replace the credit. The claim, it noted, was that Tenant had "stonewalled" and "provided 'no indication' that they would renew or replace the LC." The appellate court suggested that Landlord's claim was that the implied repudiation occurred by Tenant "doing nothing". The appellate court noted that for this claim to succeed, it would be necessary for Landlord to prove that Tenant had made it impossible for it to obtain a letter of credit or to make substantial performance in obtaining the renewal or replacement of the letter of credit. The appellate court observed that there was no evidence to show this. Its conclusion was that "in the absence of such evidence, no rational fact finder could have concluded that [Tenant] repudiated the contract when [Landlord] drew on the letter of credit."

In dissent, Rushing, P.J., found two problems with the majority opinion. Firstly, the lease was effectively abandoned because a real estate agent hired by Tenant to find a subtenant testified that there was often, "nobody there, ... during business hours." Such an abandonment was seen as constituting damages in the way of natural and direct future losses of rent income to Landlord. Secondly, the dDssent believed that Tenant's failure to secure an LC constituted repudiation because the letter of credit was the "only one reliable assurance it could give." Dissent concluded that there was a reasonable inference that Tenant's conduct evinced an intention of not paying further rent were the letter of credit to expire and therefore would have affirmed the jury's findings.

Comments: Hindsight suggests that this landlord ought to revisit his lease terms re LCs. A mechanism permitting a drawing on an LC that has not been renewed or replaced by a certain date prior to expiring regardless of default (or as a species of default) would have avoided the problem here- although a question arises as to how to apply or handle the proceeds.

[JEB/tjb]

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