Documentary Credit World

Topics: Amendment; Breach of Warranty; Choice of Law; Drafting Error; Fraud; Standby LC; Rev. UCC Section 5-110; UCC Section 5-116(b); Unjust Enrichment

Note: To cover potential losses regarding its underlying purchase of oil lease assets located in Yukon₁, Canada, ELFO Energy (Buyer/Applicant) applied for and caused Credit Suisse AG (Issuer) to issue a CAD 4.38 million standby letter of credit in favor of Devon Energy Corp. (Beneficiary), an Oklahoma based company₂. Critically, Beneficiary had been named in error (by Buyer/Applicant). Devon Canada Corp. (Seller) was the correct party in interest under the sales agreement. Seller was the longtime managing operator under a Joint Operation Agreement (JOA) regarding the lease, carrying a 23% share. Buyer/Applicant purchased that working interest for CAD 270,000 in June 2012. The opinion also notes that both Buyer/Applicant and Pacific LNG Operations Ltd. (Second Applicant) were applicants under the standby; Second Applicant had provided collateral. The precise relationship between Seller and Beneficiary was undisclosed, and Seller unsuccessfully requested, on multiple occasions, that Buyer/Applicant have the standby amended to state the proper beneficiary. As a workaround, Seller and Beneficiary entered into a separate agreement were it necessary to demand payment before the beneficiary name was corrected₃. The standby, however, was extended several times.

Following an August 2015 inspection, a spill was allegedly discovered at the oil and gas facility. Third party Paramount Resources, Ltd. (Paramount) sent Seller a demand letter in April 2018 detailing expected costs to remedy the spill, millions of dollars already expended in remediation costs, and further detailed that Buyer/Applicant claimed it was insolvent and no longer the operator under the JOA₄. Seller in turn notified Buyer/Applicant of the demand letter and requested that Buyer/Applicant perform its obligations under the sales agreement by covering its share of the remediation costs.

Later, naming several companies including Buyer/Applicant and Seller, Paramount filed a statement of claim in the Supreme Court of Yukon essentially alleging breach of the JOA regarding payment of remediation costs. While litigation ensued, Seller continuously demanded that Buyer/ Applicant have the standby LC amended to both extend the expiration date as well as to reflect the correct beneficiary. Although an extension was forthcoming, Seller instructed Beneficiary to demand payment on the standby. The draw certificate stated that “the [SLOC] is properly payable pursuant to clause 2.2 of the Kotaneelee Closing Agreement dated June 29, 2012.” Issuer honored, and the opinion notes that Beneficiary transferred the funds to Seller.

Thereafter, Buyer/Applicant and Second Applicant sued Beneficiary; the amended complaint alleged (1) breach of warranty under Oklahoma UCC Rev. Article 5-110(a)(1); (2) unjust enrichment; and (3) fraud. Beneficiary moved for summary judgment. The motion was granted. The trial court found that the draw on the standby was not “wrongful” as the required notice provisions under the sales agreement had been satisfied. Even though Buyer/Applicant claimed the letter from Seller alleged potential and not actual incurred losses, the trial court disagreed, noting how broadly “losses” had been defined in the sales agreement. Buyer/Applicant appealed. The U.S. Court of Appeals for the Tenth Circuit, Matheson, Briscoe and Moritz, JJ., affirmed.

The standby was issued subject to ISP98 but otherwise stated no choice of law.

Applying Section 5-116(b) to determine what law applied to the 5-110(a)(1) claim, the appellate court ruled that Oklahoma law applied: “the liability of [Beneficiary] in connection with the breach of statutory warranty claim asserted by plaintiffs ‘is governed by the law of the jurisdiction in which [it] is located,’ i.e., Oklahoma.”₅ Oklahoma law would also govern the unjust enrichment and fraud claims.

Turning to whether the trial court misconstrued the sales agreement regarding indemnification, the appellate court quoted the agreement which provided that Buyer/Applicant would “be solely liable to and indemnify and defend [Seller] from and against all Losses which [Seller] may suffer, sustain, pay or incur as a result of any act, omission, matter or thing related to the Environmental Liabilities”. While Buyer/Applicant argued the trial court placed too much emphasis on the word may so as to allow for prospective losses, the appellate court disagreed. Instead, the trial court merely based its rationale on how broadly the underlying agreement defined “losses” and “Environmental Liabilities”, such that the terms captured losses stemming from the remediation costs. The agreement further made clear that Seller would bear no relevant liabilities “whatsoever”. After quoting and reviewing the contract’s text, the appellate court noted:

Together, the demand letter [from Paramount] and the statement of claim establish that the amount of the ‘Loss’ actually suffered by [Seller] as a result of the demands and claims asserted against it by Paramount was, at a minimum, approximately $4.71 million dollars, an amount that exceeded the value of the SLOC.

Turning to the breach of Section 5-110 warranty claim, the appellate court quoted both the UCC statute as well as its Official Comment 2. The critical defect with Buyer/Applicant’s 5-110 claim against Beneficiary was that Beneficiary was not party to the sales agreement between Buyer/ Applicant and Seller. Beneficiary had only been named in the standby LC due to an error by Buyer/ Applicant: “To be sure, [Buyer/Applicant] and [Seller] intended for the SLOC to augment the Sale Agreement and Closing Agreement, but [Beneficiary] was not a party to those agreements.”

On the unjust enrichment claim, Beneficiary had successfully obtained summary judgment at trial as it was undisputed that Beneficiary did not hold the standby proceeds; the funds had been promptly transferred to Seller post-honor. In affirming, the appellate court noted that Buyer/ Applicant cited no legal decision or principle which could support an unjust enrichment theory.

The fraud claim was based on a representation by Seller (allegedly acting as agent on behalf of Beneficiary regarding communications about the standby) to Buyer/Applicant that Beneficiary “would draw only if [Buyer/Applicant] did not timely renew and extend the [SLOC]”. Generally, Buyer/Applicant claimed to have been misled as to the true intentions regarding the standby. Beneficiary, however, argued that Buyer/Applicant was confused as Beneficiary had been acting as agent on behalf of Seller “in all matters relating to the Draw Request, not the other way around.” Thus, Beneficiary argued it could not be held liable for any allegedly fraudulent representation made by its principal, i.e. statements concerning refraining from demanding on the LC. Ultimately, the appellate court agreed with the decision of the trial court which ruled that Buyer/Applicant failed to produce any evidence of fraudulent conduct on the behalf of Beneficiary.

Comment: Most or all of this litigation could have been avoided by careful drafting of a multi- million dollar standby.

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