Article

Factual Summary:

To pay for three separate orders of oriental rugs, the applicant had three separate letters of credit issued. The first two letters of credit expired on 30 April 1996 and the third on 30 May 1996. All three letters of credit were negotiable, required presentation within 15 days of shipment, and were payable 30 days after presentation and acceptance of drafts drawn under them.

On 8, 17, and 20 May, the negotiating bank paid the seller under each of the letters of credit and forwarded the drafts to the issuer. On 10 June, the issuer notified the negotiating bank of its acceptance of the drafts.

On 6, 10, and 25 June, the applicant received the three shipments and found the goods to be soiled and worth less than 5.2% of the value of the ordered goods. Consequently, on 12 June, the applicant filed in the Illinois state courts for a temporary restraining order against honor based on UCC - 5- 114(b) which was granted. On 20 June, the court replaced the temporary order with a preliminary injunction in a proceeding which did not include the negotiating bank.

On 17 September, the negotiating bank intervened in the lawsuit and had it removed to a federal district court where the negotiating bank moved to have the injunction dissolved, for summary judgment and to require that a bond be posted. The motion was granted in part and denied in part.


Legal Analysis:

1. Honor: Consequence of Acceptance of Drafts: Where the LC had expired, the negotiating bank argued that under UCC - 4-303, legal actions such as injunctions came too late to prevent payment if the item had already been accepted, as had the drafts in this case. Because - 4-303 specifically superseded other laws, the negotiating bank argued that it took precedence over - 5114(b). The court noted the decisions in All Service Exportacao, Importacao Comercio, S.A. v. Banco Bamerindus Do Brazil, S.A., 921 F.2d 32 (2d Cir. 1990) and First Commercial Bank v. Gotham Originals, Inc., 64 N.Y.2d 287, 475 N.E.2d 1255, 486 N.Y.S.2d 715 (1985). It distinguished these cases on the ground that two of the drafts were drawn after expiration of the LC. The court indicated that the presentation should have been dishonored as to these two presentations because the late dates constituted material discrepancies.

2. Negotiating Bank Not Holder in Due Course of Drafts: The negotiating bank argued that it was a holder in due course under UCC - 3-302 regardless of expiration of two LCs. The court rejected this argument because the bank had negotiated after the expiration date, thereby being placed on notice of a defect.

3. Negotiating Bank Indispensable Party: The negotiating bank argued that under the Federal Rules of Civil Procedure the court was required to dissolve the injunction because the negotiating bank was an indispensable party to the action and had not been involved in the injunction proceedings. Additionally, the issuer had stated to the negotiating bank that it would not involve itself in the lawsuit, and, therefor, the negotiating bank's interests would not be adequately represented.

The court agreed but ruled that it would be inequitable completely to dissolve the injunction with respect to the credits that were negotiated after expiry. After referring to Comment 2 to - 5-106 which illustrates the situation where an issuer is bound to the beneficiary but may not be able to recover from the applicant after undertaking to honor beyond expiry in anticipation of applicant waiver, the court modified the injunction to prevent the issuer from reimbursing itself from the applicant's accounts but allowing the issuer to honor and pay the negotiating bank if it chose to do so.

4. Honor: Consequences of Acceptance of Drafts: With respect to the third credit which had been timely negotiated, the applicant presented an affidavit of one of the issuer's employees stating that the original presentation from the negotiating bank was not in compliance with the requirements of the credit. Neither the applicant nor the employee, however, pointed to any specific discrepancy. The applicant requested additional discovery time to interview employees of the negotiating bank and acquire files relating to the drawings, presumably so that it could provide the court with this information. The court denied this request however, noting that the applicant had made no efforts to uncover this information during the allotted time and, therefore, did not deserve extra time. As the applicant had not pointed to a specific discrepancy or issue of fact regarding the third letter of credit, the court determined that summary judgment in favor of the negotiating bank was appropriate. Accordingly, the court also dissolved the injunction against payment on the third letter of credit.

5. Injunction Bond: In response to the negotiating bank's request that applicant post a bond, the court ruled that the remaining two letters of credit would serve as adequate security against any damages that may be caused by the injunction. Accordingly the applicant did not have to post any additional security.

Comment:

1. "Odd reasoning; proper result" best describes this opinion. While giving lip service to the cases which suggest that a bankers' acceptance arising under a letter of credit must be treated as falling exclusively under the law relating to acceptances and not letters of credit, the court decides the case based on LC law.

2. The two cases, Banco Bamerindus and Gotham Originals, both stand for the proposition that an acceptance is governed by UCC Article 3 and 4 and that an injunction is too late to prevent payment after acceptance. There are two problems with this analysis. In the first place, an acceptance does not extinguish rights under the LC. The LC obligation is to accept and pay not merely to accept. Secondly, it is not correct that an acceptance is immune to injunction for fraud under negotiable instrument law. The issue comes down to who it is that is seeking payment and whether it is necessary for them to prove that they are holders in due course of the acceptance.

3. The court takes the interesting approach that the injunction should not be lifted as to LCs which had expired before the drafts were drawn. It is elementary (and fundamental) that the presence of discrepant documents or even an expired credit does not justify the award of injunctive relief. Here, though, there is fraud in the transaction. The only question, then, is whether the presence of a third party should alter the award of injunctive relief. As to the draft which was timely negotiated, the court' s conclusion is that it does change things and that the negotiating bank is entitled to have the injunction lifted. As to the other two LCs, however, the discrepancy provides the court with a basis to continue the injunction in place even though the negotiating bank was an indispensable party. The reason given, while not entirely satisfying in the abstract, is surely correct, namely that there is a question as to the good faith and lack of notice of the negotiating bank where the expiration was apparent when it took up the draft. One would think that these facts would change if the problem were any other discrepancy but expiration. The issuer is obligated to examine and give notice as to such discrepancies and is precluded from asserting any as to which it does not give notice. This rule does not apply to expiration. One wonders, though, if the same result would not obtain if the negotiating bank had notified the issuer of the expiration in its cover letter and if the issuer had accepted the documents nevertheless. In such a case, it may well be that the issuer has waived the expiration and, as a result, no injunction would be appropriate against an innocent third party.

4. Left in obscurity is the question as to what constitutes an innocent purchaser. While the UCC Article 3 terminology of "holder in due course" is commonly used, the concept is flawed when it comes to LCs. With respect to LCs, the notice requirements are certainly different because the beneficiary itself can have notice of disputes regarding the underlying transaction much less third parties. Notice and good faith (narrowly construed) tend to come together when it comes to LCs.

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