Article

Type of Lawsuit: Applicant sued to enjoin Beneficiary from drawing on LC.

Parties:

Appellant/Applicant/Buyer/Debtor- Barbara H. Katz, Esq., Trustee for Commco Technology, LLC (Counsel: John B. Nolan of Day, Berry, & Howard, Hartford, CT)

Appellee/Beneficiary/Seller- Science Applications International Corporation (SAIC) (Counsel: James R. Fogarty of Fogarty, Cohen, Selby, & Nemiroff, Greenwich, CT)

Appellee/Issuer- U.S. Bank (Counsel: William Fish, Jr. of Tyler, Cooper & Alcorn, Hartford, CT)

Underlying Transaction: The purchase of computer software and hardware.

LC: Standby LC for US$7,120,000. Silent as to governing rules.

Decision: The U.S. Court of Appeals for the Second Circuit, Van Graafeiland, J., Parker, J., and Sotomayor, J., affirmed the judgment of the U.S. District Court for the District of Connecticut, Hall, J., affirming the judgment of the U.S. Bankruptcy Court for the District of Connecticut, Shiff, C.J., denying Appellant's request for injunction.

Rationale: Where parties to an LC agree that an existing LC remains viable as collateral under a subsequent payment contract, the LC is enforceable.

Prior History: Commco Technology, LLC v. Science Applications Int'l Corp. (In re: Commco Tech), 258 B.R. 63 (Bankr. D. Conn. 2001) abstracted at 2002 Annual Survey 223; Civ. No. 3:01-CV-343 (JCM) (D. Conn. 18 Dec. 2001) abstracted at 2002 Annual Survey 221.

Factual Summary (based in part on prior decisions): To assure payment for computer software and hardware, Applicant caused a standby LC to be issued in favor of Beneficiary. After a dispute between the two parties regarding the amount of payment due, they entered a Settlement Agreement to restructure the debt. The Agreement included a Promissory Note for a reduced balance to be paid by Applicant. Additionally, at the request of Applicant, Issuer extended the LC expiration date, because it had expired prior to conclusion of the Agreement.

Applicant subsequently filed Chapter 11 (reorganization) bankruptcy, and in Connecticut Bankruptcy Court sought injunctions prohibiting Beneficiary from drawing on the LC based on the theories of irreparable harm and likely success on the merits of a fraud claim against Beneficiary.

Applying Minnesota's Revised UCC section 5- 109 (the location of Issuer), the Bankruptcy Court noted that the success of Applicant's fraud claim would have depended on a showing that Beneficiary engaged in malicious fraud. Despite Applicant's arguments that any current draw would occur after the expiration of the LC, and therefore be fraudulent, the court stated that the LC was not expired (due to the extension of the expiration date) and that Beneficiary retained the right to draw.

The Bankruptcy Court denied injunctive relief and vacated a temporary restraining order against Beneficiary. Applicant appealed to the district court. Applicant filed an additional motion to stay the bankruptcy court's order pending appeal. The motion to stay was denied, and shortly thereafter, Beneficiary drew on the LC and was paid.

Although the question of enjoining the drawing was moot, Applicant did not return to the Bankruptcy Court for alternative relief, but, instead, pursued its appeal to the district court. Applicant sought an order requiring Beneficiary to return all funds from the LC to Issuer, and directing Issuer to restore the funds to Applicant that were debited to cover the LC draw. The district court affirmed the Bankruptcy Court's decision that Applicant was not entitled to injunctive relief because it was unlikely to succeed on the merits of a fraud claim. The district court did not address possibility of remittance of funds.

Applicant then filed this appeal, asking the court of appeals to "'vacate the District Court judgment and remand this matter to the District Court with instructions to remand the case to the Bankruptcy Court for the entry of an order directing [Beneficiary] to return all funds drawn from the [LC] to [Issuer], and directing [Issuer] to restore all funds withdrawn due to [Beneficiary's] draw on the [LC].'" On appeal, affirmed.

Legal Analysis:

1. Rev. UCC Section 5-109; Fraud: Applicant argued that Beneficiary's drawing was materially fraudulent and that the beneficiary should be required to return the proceeds it received after the interlocutory injunction was lifted. Noting that there were other outstanding issues, the appellate court focused on the issue of material fraud because it was determinative. Citing the same reasons as the district court, it concluded that the applicant failed to establish material fraud within the meaning of section 5-109.

2. Independence: Applicant argued that the underlying settlement agreement should not be read in light of the LC because of their independence from one another. The appellate court rejected this argument, determining that there was ambiguity in the underlying settlement agreement that permitted a resort to extrinsic evidence.

Comments:

1. Courts should feel free to look at extrinsic evidence, regardless of ambiguity, in the letter of credit or the underlying contract, in determining whether there was fraud within the meaning of section 5-109.

2. This is an unpublished decision.

[JEB/fkd]

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