Article

Note: To assure its completion of a shopping mall construction project including roads, bridges, and other infrastructure for Kohl's Indiana, L.P. (Retailer), Dennis Owens (Contractor) was required to provide four performance standby LCs in amounts ranging from US$47,284.65 to US$230,245.31 in favor of the Evansville-Vanderburgh Area Plan Commission (Commission/Beneficiary), the governmental agency overseeing the development. At Contractor/ Applicant's request, Fifth Third Bank (Issuer) issued the LCs. Their text follows this Note.

When problems occurred in the development, Retailer sued Contractor/Applicant seeking in excess of US$3 million in damages. As part of that litigation, Retailer sought an order requiring the Commission/ Beneficiary to draw on the LCs and to order the Commission/Beneficiary to assign the LC proceeds to Retailer. Issuer was permitted to intervene and on motions for summary judgment, the Vanderbough Circuit Court, Heldt, J., granted summary judgment in favor of Retailer. On appeal, reversed and remanded by the Court of Appeals of Indiana, Barnes, Kirsch (concurring), and Najam, JJ., in an opinion by Najam, J.

In reaching its decision, the trial court ruled that the undertaking of Issuer was not an LC but a dependent performance bond. In reaching this conclusion, the trial court relied on Official Comment 6 to Revised UCC Section 5-102 which distinguishes between a documentary undertaking that may contain a non-documentary condition and one that turns on the presentation of documents exclusively.

Issuer objected to this characterization in its appeal, noting that the undertakings were labeled "letters of credit" and required presentation of documents. Retailer argued that Commission/ Beneficiary was required to provide a signed statement that Contractor had failed to meet approval requirements. Examining the text of the LCs, the intermediate appellate court concluded that the undertakings were LCs as a matter of law. It noted that the determination of whether payment was due was to be made by Beneficiary not the Issuer.

In reaching this conclusion, the intermediate appellate opinion recognized a tendency to draw on other legal relationships to compare the LC. It noted that the emphasis of the LC was in order to protect "[t]he unique and rigid nature of letters of credit is what makes them the invaluable tools that they are in facilitating business transactions".

The appellate court also considered whether the trial court erred in its conclusion that Retailer was a "third party beneficiary" of the LC and entitled to proceeds. Quoting extensively from Arbest Construction Co. v. First National Bank & Co. of Oklahoma City, 777 F.2d 581 (10th Cir. 1985), a case decided under Prior UCC Article 5 that ruled that a third party beneficiary could not enforce an LC against an issuer, Issuer argued that Revised UCC Article 5 does not provide for third party beneficiaries.

Referring to the independence principle codified in Revised UCC Section 5-103(d), the appellate court concluded that "the issuer of a letter of credit has no duty to a third party not named as a beneficiary or properly designated as an assignee". It stated that Issuer "is obligated to pay under the terms of the letters of credit only if and when the Commission should present the letters and deliver the necessary documentation. [Retailer] does not have any rights derived from the letters of credit".

Comments:

1. Non-Documentary Conditions and Their Effect. There are two phases to the analysis of an undertaking that is arguably an LC where it contains non- documentary conditions. The first is the question of whether it is indeed an LC . The problem is particularly acute with respect to undertakings that support transactions other than for the sale of goods. They can be structured as either dependent or independent. A court that is faced with such an undertaking must determine whether the nondocumentary condition is accidental or essential. If the latter, it is not an LC-type undertaking. If the former, the non-documentary condition is to be disregarded.

The trial court in this case misunderstood the nature of a non-documentary condition in determining the character of the undertaking. While the LC required a determination to be made about whether the applicant had performed, that determination was to be made by the beneficiary and recited in a document required to be presented. Such a requirement is not non-documentary.

2. To Whom Does the Issuer's Obligation Run? The appellate court properly rejected the notion that there was a third party beneficiary to the LC entitled to draw under it. The only situations where a stranger may draw under an LC is where a transferable LC has been duly transferred or where there is a drawing by a transferee by operation of law. No one else is a beneficiary of an LC other than the named beneficiary.

The LCs read as follows, varying only by the amount:

ISSUING BANK:
FIFTH THIRD BANK, (SOUTHERN INDIANA)
BENEFICIARY: EVANSVILLE-VANDERBURGH AREA PLAN
COMMISSION ROOM 312 CIVIC CENTER COMPLEX
EVANSVILLE, IN 47708
APPLICANT:
DENNIS OWENS
1101 NORTH 4th AVENUE
EVANSVILLE, IN 47710

* * *

RE: CARPENT[I]ER CREEK PAVILION

WE HEREBY OPEN OUR IRREVOCABLE LETTER OF CREDIT IN YOUR FAVOR FOR THE ACCOUNT OF DENNIS OWENS FOR AN AMOUNT NOT TO EXCEED . . . ($ 47,284.65) AVAILABLE BY YOUR ONE OR MORE CLEAN DRAFTS DRAWN AT SIGHT ON US. DRAFTS MUST BE MARKED "DRAWN UNDER FIFTH THIRD BANK, (SOUTHERN INDIANA) LETTER OF CREDIT NO. CIS403248, DATED JANUARY 26, 2005,["] AND ACCOMPANIED BY A SIGNED STATEMENT OF THE [COMMISSION] THAT DENNIS OWENS HAS FAILED TO MEET STATUTORY AND ORDINANCE REQUIREMENTS AND/OR THE STIPULATIONS OF PRIMARY APPROVAL WITH REGARD TO BASIC IMPROVEMENTS.
THE AGGREGATE AMOUNT OF $ 47,284.65 MAY BE PERIODICALLY REDUCED UPON OUR RECEIPT OF A SIGNED STATEMENT FROM THE [COMMISSION] CERTIFYING THAT "WORK ON ONE OR MORE OF THE PUBLIC SUBDIVISION IMPROVEMENTS HAS BEEN ACCEPTED [*4] AND/OR APPROVED BY THE DEPARTMENT HAVING THE AUTHORITY TO ACCEPT AND/OR APPROVE THE IMPROVEMENT(S), AND THAT DUE TO SUCH ACTION, THIS IRREVOCABLE LETTER OF CREDIT MAY BE REDUCED BY (AMOUNT TO BE SPECIFIED) BASED ON THE FUNDS SPECIFIED IN THE COST ESTIMATES FOR CARPENT[I]ER CREEK PAVILION.["]
THIS ORIGINAL LETTER OF CREDIT MUST BE PRESENTED AT TIME OF DRAW. WE HEREBY AGREE WITH YOU THAT ALL DRAFTS DRAWN IN COMPLIANCE WITH THE TERMS AND CONDITIONS OF THIS IRREVOCABLE LETTER OF CREDIT WILL BE DULY HONORED ON PRESENTATION AND DELIVERY OF THE DOCUMENTS SPECIFIED ABOVE TO FIFTH THIRD BANK . . . ON OR BEFORE JANUARY 26, 2006.
THE LIABILITY AND OBLIGATIONS OF FIFTH THIRD BANK FOR THIS LETTER OF CREDIT SHALL BE GOVERNED BY THE LAWS OF THE STATE OF INDIANA. IN THE EVENT OF ANY DISPUTE OR CONTROVERSY ARISING OUT OF THE LETTER OF CREDIT, WE AGREE THE FORUM FOR ANY CAUSE OF ACTION FILED BY ANY PARTY SHALL BE VANDERBURGH COUNTY. [JEB/jdc]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.