Article

Note: Claiming that the Waddell Group (Buyer/ Applicant) had defaulted on its contract to purchase a number of condominium units in its Dauphin Island, Alabama project, Holiday Isle, LLC (Developer/ Beneficiary) drew on LCs issued by RBC Bank (USA) (Issuer) to cover 20% of the purchase price. Buyer/Applicant sought but failed to obtain an injunction against the drawing. These funds were deposited into an account at Issuer.

Buyer/Applicant lodged arbitration proceedings against Developer/Beneficiary which resulted in a ruling that Buyer/Applicant was "'due to...have all monies paid to [Developer/Beneficiary], either by earnest money deposit or proceeds from a letter of credit, together with interest accrued thereon, returned to them'" since the units were not completed as required. The award was reduced to a judgment whereupon Issuer filed an action in interpleader for a determination as to the rights to the LC proceeds in Developer/Beneficiary's account.

Buyer/Applicant counterclaimed against Issuer and others, namely alleging that:

"[Issuer's] conduct damaged [Buyer/Applicant] because they have had to pay principal and interest on the loans the issuing banks forced on them when the letters of credit were called. They also note that [Developer/Beneficiary] has indicated there may be insufficient funds remaining in the Account (after its $ 1 millionplus in withdrawals) to reimburse all prospective purchasers. [Buyer/Applicant] have also allegedly incurred litigation expenses and experienced emotional distress. They seek relief including return of all misappropriated deposit funds (including payment from outside the Account if its contents are insufficient), and interest and costs associated with the call of the letters of credit and resulting force-placed loans, plus attorney's fees, emotional distress damages, and punitive damages."

The ten counts included:

"(1) violations of the Alabama Uniform Condominium Act ("AUCA"); (2) conspiracy to violate the AUCA; (3) conversion; (4) wrongful call of the letters of credit; (5) unjust enrichment; (6) breach of fiduciary duty; (7) fraudulent suppression; (8) money had and received; (9) intentional interference with contractual and business relations; and (10) injurious falsehood."

The counterclaim alleged that Issuer was complicit in a plan proposing that Developer/ Beneficiary obtain temporary certification of occupancy, enabling it to draw on the LCs, even though the common areas, and thus the building, were incomplete. The complaint further asserted that Issuer failed to disclose information about Developer/ Beneficiary's solvency in the injunction hearing and subsequent arbitration. It also alleged that Issuer claimed security interests in the account through subsidiaries and permitted various payments depleting the account. In response to Issuer's motion to dismiss the counterclaim, the United States District Court for the Southern District of Alabama, Southern Division, Steele, J., granted the motion as to counts 3, 4, 5, 6, and 10, but denied it as to the balance.

Issuer argued that the counterclaims were impermissibly broader than the claim, alleging that the relief sought was return of the funds. The court, however, noted that Buyer/Applicant sought other relief as well, including the LC proceeds and interest on the account, principal and interest on the loan to fund the LCs, attorney's fees, damages for emotional distress, and punitive damages. The court noted that Buyer/Applicant's claim

"is not based on the premise that [Issuer] should have paid the funds in the Account to them in preference to [Seller/Beneficiary] and the other claimants. Rather, the counterclaim is based on the theory that [Issuer] should have taken and avoided certain action long before the funds even existed, should not have taken possession of the funds to begin with, and should not have allowed the funds to be dissipated. A thief who stole from a divorcing couple would not gain immunity simply by interpleading a portion of the stolen property, and neither can [Issuer] by interpleading the remaining funds in the Account preclude [Buyer/ Applicant] from suing for [Issuer's] wrongful conduct in and before acquiring those funds and in allowing a portion of the funds to be withdrawn by [Seller/Beneficiary]. Issuer cites no law even remotely to the contrary."

Issuer argued that those claims of Buyer/ Applicant that were adversely decided against them in the arbitration proceedings were barred from being raised against it by the doctrine of res judicata, a legal rule of finality. The court, however, noted that Buyer/ Applicant's claim differed, namely that it

"indicates that [Issuer], inter alia, actively engineered the allegedly wrongful calling of the letters of credit, breached its own duty to correct [Seller/Beneficiary's] misrepresentations concerning the need for an escrow account, manipulated its interest in the funds to [its subsidy] so as to advance its own interests at the other claimants' expense, and participated in [Seller/Beneficiary's] withdrawal of over $1 million from the Account, which is now unavailable to the [Buyer/Applicant]."

Issuer argued against count 6 by asserting that it did not become an escrow agent and thus was not subject to a fiduciary duty, because the contracts did not suggest such responsibility and because Issuer did not "'consciously assume'" such responsibility. The court ruled, however, that Issuer failed to address Buyer/Applicant's argument that Issuer in fact became an escrow and thereby assumed a fiduciary duty when it took control of the LCs with knowledge that the purchase agreements required the LCs to be held in escrow. In response, Issuer argued that there is no duty under the applicable consumer protection laws to place LCs that have been called or their proceeds in escrow. The court rejected this argument pointing to the statute's text, which states, "If the proceeds of the letters of credit are disbursed and the purchasers' default cannot later be established, the purchasers' remedy is an action at law against the beneficiary of the letters of credit or perhaps against the depository party for want of due care in honoring the demand for payment..." The court ruled that this statement supports the assertion that both LCs and their deposits are subject to an escrow requirement.

Issuer also argued that the claim that it fraudulently suppressed information should be dismissed since it had no duty to disclose its security interest in the LCs. The court noted, however, that the claims were broader, namely

"that the [Buyer/Applicant's] letters of credit were never placed in escrow; that [Issuer] maintained plenary control over them, including the unilateral right to force their call; that [Issuer] considered the letters of credit its collateral; that [Issuer] seized as its own the disputed proceeds; and that [Issuer] allowed the developers to spend those proceeds on construction costs and other operating expenses."

[JEB/anf]

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