Article

Bankruptcy

Note:The U.S. Court of Appeals for the Fifth Circuit reversed a decision of the U.S. District Court for the Western District of Texas which affirmed the Bankruptcy Court for the Western District of Texas, and ruled that an applicant/debtor is not permitted to reclaim payments as preferential from one of its creditors who is also the beneficiary of an LC secured by collateral of the insolvent applicant.

Bank issued an LC to secure repayment of any advances by beneficiary for continued shipments of crude oil. Applicant gave issuer a priming lien, which by agreement was given priority over preexisting debts. Shortly thereafter, beneficiary notified applicant of its default, stopped supply of crude oil, and applicant filed for bankruptcy protection. Applicant filed a suit to avoid as preferential and recover payments made to beneficiary during the 90 days preceding the bankruptcy filing as preferential. Apparently, no drawing was made on the LC.

The appellate court concluded that there was no preference where the LC beneficiary was secured by collateral granted by the applicant. The payments by the applicant to the beneficiary during the preference period were made with proceeds of that collateral. The direct payments by the applicant did not have the effect of releasing the issuing bank's collateral because the appellate court found that the bank retained all of its collateral during the preference period (apparently the full amount of the LC at all times supported an outstanding debt of the applicant to the seller/beneficiary).

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