Article

Note: In connection with the preconstruction purchase of beach front condominiums, Janice Pigott and other purchasers (Applicants) provided standbys in favor of Sanibel Development, LLC. (Developer) in the amount of 20% of the purchase price as security for completion of the purchase. Applicants sued to rescind their purchase agreements, alleging violation of the US Interstate Land Full Sales Disclosure Act, 15 U.S.C. §§1701 et seq. (1996), as a result of Developer's failure to provide property reports as required by the statute and for fraudulent failure to make the statutorily required disclosure that the properties had been "flipped" in that they were sold and then resold to increase the price.

On cross motions for partial summary judgment, the United States District Court, Southern District of Alabama, William H. Steele, J., granted summary judgment in favor of Applicants, ordering rescission of the purchase agreements. The order also provided that on entry of final judgment, Developer or its escrow agent were to "release" all LCs being held. The Judge denied summary judgment on the statutory fraud claims, ordering that they proceed to trial.

Noting that the federal statute was remedial in character, the Judge rejected the Developer's claim that it was exempt from the scope of the statute under a technicality, interpreting it "flexibly" to achieve its purpose.

Although there was no discussion by the Judge of the order to release the LCs, the statute provided that a purchaser that properly exercised its revocation rights "shall be entitled to all money paid by him or her under such contract or agreement". [US] 15 U.S.C. §1703(e).

Comment:

1. The starting place for an analysis of this case must be the application of Rev. UCC §5-109, a point ignored by this judge. The statutory remedy, rescission and return of "all money paid", is insufficiently specific to override Rev. UCC §5-109's requirement that there be a finding of forgery or material fraud to interrupt a LC obligation. For any so-called "illegality" or similar statutory override of Rev. UCC Article 5, it is necessary that it be apparent that the statute intended to interfere with the LC drawing and honor. Consequently, an injunction against honor or drawing would be improper absent a determinant that lacked a colorable basis under Rev. UCC §5-109.

It is less clear what would be the impact of an order limited to prohibiting a drawing by the beneficiary. While an injunction against honor is within the scope of Rev. UCC §5-109, an order requiring that the beneficiary post cash collateral or release the LC may be outside its scope. It may also be appropriate to require that the applicant post collateral, as apparently occurred in this case.

In addition, there are creditors' rights issues hiding here. It is possible that the cash collateral is held in such a way that the applicant's interest, contractual or statutory, is not better than the interests of other creditors. Perhaps the fraud exception is the proper dividing line for granting an injunction that keeps the LC proceeds away from the beneficiary's other creditors. Perhaps the beneficiary's trustee in bankruptcy is not subject to the fraud defense in the event it decides to draw under what could be demandonly or clean LCs. (Suppose the beneficiary's bankruptcy court decides that providers of cash collateral and LCs should be treated the same and that that requires draws converting the LCs into cash collateral subject to the return claims of the applicants as well as claims of other creditors.)

It should be noted that US UCC Article 9 (Security Interests in Personal Property) treats a debtor's LC rights differently from various forms of cash held by or for the debtor.) Fear of a weak beneficiary's creditors drives a lot of the push to stop LC draw/honor. Under Rev UCC §5-109, the apparent inability of the beneficiary to repay LC proceeds goes to irreparable injury and is not itself enough to stop a drawing that is questionable but not fraudulent. That said, financial desperation drives a lot of draws that lack colorable commercial right and is an factor when considering the good faith intent of the beneficiary when a draw is challenged as fraudulent under Rev. UCC §5-109.

2. The decision of the Alabama Supreme Court in Holiday Isle, LLC v. Adkins, No. 1070202, 2008 WL 2153366 (Ala. May 23, 2008) [USA], should be consulted. It concludes that an injunction is not available under the Alabama Uniform Condominium Act regarding a letter of credit used as escrow. The Pigott decision, on the other hand, is predicated on a federal statute.

[JEB/mcb]

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