Article

Note: To procure government construction projects, ESA Environmental Specialists, Inc. (Contractor) obtained performance and payment bonds from Hanover Insurance Company (Surety). In order to acquire the bonds, Surety required Contractor to obtain a standby letter of credit for US$1,375,000 and execute a Letter of Credit Collateral Agreement in the form specified by Surety. To obtain the LC, SunTrust Bank (Issuer) required Contractor to post a certificate of deposit (CD) as collateral.

Contractor entered into a credit agreement with Prospect Capital (Creditor) that included two amendments. The first amendment advanced $625,000 to Contractor, and the second amendment advanced an additional $950,000. Contractor used the funds from Creditor to open the CD. Contractor later filed for bankruptcy and Surety drew on the LC for $1,375,000 and exercised its rights as a surety to complete the projects. Creditor acquired Contractor's assets in the bankruptcy proceedings. Contractor filed this adversary proceeding against Surety.

Surety moved for summary judgment. The United States Bankruptcy Court for the Western District of North Carolina, Hodges, J., granted the motion.

Contractor claimed: "[Surety] was an indirect beneficiary of the transfer of the [Creditor] Funds into the certificate of deposit and the transfer of the [Creditor] Funds was avoidable as a preferential transfer". The Judge found that the transfer was not avoidable. First, Surety did not receive a transfer of an interest in Contractor's property. "The Prospect Funds which were placed into the [Issuer] certificate of deposit were specifically provided by [Creditor] for [Contractor] to collateralize the Letter of Credit in order to obtain the New Bonds, as specifically stated by counsel for [Creditor] at the [first hearing] before this Court. There was no diminution to [Contractor]'s estate because the [Creditor] Funds came solely from a third party. The funds placed into the [Issuer] certificate of deposit were [Creditor]'s funds that were simply a pass-through in [Contractor]'s bank account. Even if the funds could have been characterized as [Contractor]'s, they were [Contractor]'s only for the specific purpose of putting them into the [Issuer] certificate of deposit." Second, Surety had a valid and complete new value defense. "The Letter of Credit was provided to [Surety] (and the Requirements satisfied) on ... the same date that [Surety] ... gave [Contractor] the New Bonds." Finally, the Judge found that "requiring [Surety] to return the funds drawn on the Letter of Credit (the vast majority of which would end up being returned to [Creditor]) would be a complete travesty in the circumstances as they played out. As a surety, [Surety] has been required to expend funds in connection with the effort to complete [Contractor]'s obligations for performance and payment on the bonded contracts and discharge of the bonded obligations secured by the Letter of Credit. This was the very purpose and risk which [Contractor] and [Creditor] knowingly took when they placed the [Creditor] Funds in the certificate of deposit to secure the Letter of Credit for [Surety]. It would be inequitable to require [Surety] to return the portion of the [Creditor] Funds used to cover the costs to complete the [Surety] bonded jobs and pay the associated obligations when [Surety] did the work, and paid the obligations, which jobs were supposed to have been completed first by [Contractor] and then by [Creditor's affiliate] when it assumed certain of the jobs."

[JEB/sws]

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