Article

Factual Summary: To secure a related company's obligations as tenant, the applicant provided a standby in favor of the lessor/beneficiary as a condition of a lease. The applicant pledged guaranteed investment certificates to the bank as security. The terms of the letter of credit specifically incorporated terms from the lease, which provided that if the obligation to the beneficiary were less than amount drawn on the LC, the beneficiary would repay the difference to the issuer. After the leased premises were sold to the transferee beneficiary, a default occurred and it drew down the LC.

Meanwhile, the related company for which the applicant supplied the LC had gone into bankruptcy. The related company being unable to reimburse the issuer, the issuer realized on the applicant's security. The applicant then informed the beneficiary that it was entitled to recover any portion of proceeds not required to fulfill the related company's obligation under the lease. The beneficiary refused, and this suit followed. The trial court awarded judgment to the applicant.

Legal Analysis:

1. Standing: The beneficiary argued that the applicant did not have standing to bring the action since there was no legal relationship between them. The court rejected this argument, noting that the funds to secure the LC had come from the applicant, and the LC, by incorporation of the terms of the lease, specifically provided "that the landlord will repay 'to the party providing the letter of credit'" the difference between the amount drawn and the amount owed.

The beneficiary further urged that applicant did not have standing, 'even in the realm of unjust enrichment, because [the applicant] has no legal relationship with [the beneficiary]". The court also disapproved of this contention.

The court stated that it is 'plain that [the applicant's] right to standing does not depend on a contractual relationship between [the applicant] and [the beneficiary]. Rather, the court's focus is upon the retention of money 'against the fundamental principles of justice or equity and good conscience'".

2. Independence: The beneficiary argued that the applicant's action would undermine the independence of the standby. The court noted that:

Letters of credit are a specialized form of commercial credit, designed by their very nature to be free and clear of the equities between the parties to the underlying transaction which they are issued to secure. They constitute an independent contract between the issuer (usually a bank, as in this case) and the beneficiary (one of the parties to the underlying transaction - a landlord, in this case). This principle of "autonomy" goes to the root of the practice surrounding their issuance. The only admitted exception to the principle is fraud. ....

It is clear... that a letter of credit is an autonomous instrument. The utility of letters of credit do not usually depend upon the underlying transaction. However ... in this case the letter of credit incorporated by reference paragraph 3A of the lease ... . which, in turn defines an event of default under the lease as including "an act of bankruptcy." Upon such default, [the beneficiary] could, and did, draw down on the letter of credit. However, [the beneficiary] is by the terms of paragraph 3A obliged to account to [the applicant] for the difference between the proceeds of the letter of credit and the obligations of [the related company].

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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.