Article

Factual Summary: Green Country Energy, a subsidiary of Cogentrix Energy entered into an agreement with National Energy Production Corp. (NEPCO), a subsidiary of Enron, whereby NEPCO agreed to build a power generation facility in Oklahoma. Green Country simultaneously entered into a separate equipment procurement contract with NEPCO Procurement, a division of Enron Equipment Procurement Co., whereby NEPCO was to provide Green Country with certain equipment for the facility. Both agreements required that NEPCO and NEPCO Procurement provide Green Country with letters of credit in order to provide security for the performance of their contractual obligations.

Pursuant to a master LC and reimbursement agreement between Enron and Bayerische Hypo- Und Vereinsbank (HVB), which was outstanding in excess of US$ 100,000,000 on other Cogentrix projects, Enron requested on behalf of NEPCO and NEPCO Procurement that HVB issue an irrevocable standby LC in favor of Green Country. HVB issued the LC in the amount of US$ 39,000,000 naming Green Country as Beneficiary and Enron, on behalf of NEPCO and NEPCO Procurement, as Applicant. It required presentation of a sight draft and a "draw certificate".

At the request of Applicant and Banca Nazionale Del Lavoro (BNL), HVB and BNL entered into a Participation Agreement by which BNL accepted 100% of the risk on the LC that HVB had issued. According to the Agreement, HVB retained the sole right to "administer" the LC. Therefore, when Beneficiary sought to draw on the LC, it would present documents to the Issuing Bank. Issuing Bank would honor or dishonor the LC, and notify BNL if a drawing had been made, at which time BNL was obligated to reimburse Issuing Bank for the drawing.

Enron filed for bankruptcy on 2 December 2001. The following day, Beneficiary presented documents to HVB in order to draw down the LC (Beneficiaries under separate LCs also made presentations the same day to HVB). HVB determined that the documents did not comply and dishonored the presentation on 3 December 2001.

On 4 December 2001, Beneficiary re-submitted the documents, and HVB, having determined that the documents complied with the terms of the LC, honored the presentation and paid Beneficiary. At approximately the same time, two other HVB Enron LCs were drawn on which were also honored. On 4 December 2001, HVB notified BNL that it had honored a drawing against the LC and requested reimbursement from BNL. After receiving no reply, HVB sent a second request for reimbursement on 5 December 2001. That day, BNL sent notification to Issuing Bank that it would not reimburse HVB for the drawing, because the documents submitted by Beneficiary did not comply with the terms of the LC, and HVB should not have allowed Beneficiary to draw. HVB then sued BNL for breach of the Participation Agreement, and, following discovery, moved for summary judgment, which was granted.

Legal Analysis:

1. Participation Agreement: Under the terms of the Participation Agreement, Issuing Bank had substantial discretion concerning the LC, provided that it exercised "the same care in the administration of the [Letter of Credit] as it would if it were the sole owner of it." The Participation also provided that Issuing Bank's actions taken in "good faith" would be binding on BNL and that Issuing Bank would be liable only for losses or damages caused by its "gross negligence or willful misconduct".

The court determined that, according to the affidavit of the Director of its LC Department, Issuing Bank had followed the same procedures concerning this LC as it would any LC under which Issuing Bank was obligated. Further, the court determined that all of Issuing Bank's actions were made in good faith. It noted that BNL had identified no material facts that would reasonably be expected to create a genuine issue of material fact sufficient to require a trial.

2. Participation Agreement: Cash Collateral from Applicant: BNL argued that Issuing Bank was required to demand cash collateral in the event of Applicant's default. BNL argued the following were possible instances of default: 1) Applicant's failure to abide by securities laws, 2) Applicant's failure to provide adequate financial statements, 3) Applicant's failure to reimburse Issuing Bank for the draw, and 4) Applicant's bankruptcy filing on 2 December 2001.

The court, however, noted that the Participation Agreement stated that Issuing Bank had no duty to inspect the property of Applicant, and therefore, had no obligation to discover the alleged securities violations and failure to provide adequate financial statements. Further, Applicant's failure to reimburse Issuing Bank occurred subsequent to the draw and could not be an instance of default. The court found that once Applicant filed for bankruptcy, Issuing Bank could not have obtained any collateral from Applicant, because the statutory automatic stay prevented Issuing Bank from making any such claim against Applicant.

Finally, BNL argued that because Issuing Bank had demanded collateral under other LCs involving Applicant, which had also been drawn on by the individual beneficiaries at approximately the same time, it had breached its duty of care by not demanding it for this LC. The court determined, though, that cash collateral was demanded from Applicant concerning those LCs because it was Issuing Bank's policy to demand cash collateral when extending the expiration date of an LC. Because that was not the situation in the case of this LC, Issuing Bank had followed its ordinary standard of care concerning this LC.

3. Participation Agreement: Honoring Documents: BNL argued that Issuing Bank knew or should have known that the Applicant's subsidiaries were not in default under the agreements, and Issuing Bank therefore should not have honored the draw. BNL first pointed the court to a memo released by the project finance syndicate to Issuing Bank stating that the plant was 98% finished. The memo was dated November 2001 but was not circulated until February 2002. Thus the court determined that the memo, as well as four other documents that allegedly showed Issuing Bank had knowledge that the Applicant's subsidiaries were not in default, was brought to the attention of Issuing Bank subsequent to the drawing and did not create an issue of material fact.

Further, BNL argued that Issuing should have consulted with it before honoring the drawing. BNL had independently made a determination that the Applicant's subsidiaries were nearing completion of the project. It therefore opposed a 100% drawing of the LC, when it believed the project was near completion. Suspecting that the Beneficiary was drawing on the LC because of Applicant's bankruptcy filing, it offered to issue a replacement LC, which would satisfy Beneficiary and allow time for an investigation. BNL had contacted Issuing Bank's counsel to discuss the alleged fraudulent overdraw and BNL's proposed replacement LC. However, counsel for Issuing Bank did not inform the LC Department of any of those discussions.

The court determined that Issuing Bank had not breached its duty of care by: 1) not informing Beneficiary of the proposed replacement LC, or 2) not making the LC Department aware of the alleged fraudulent overdraw. Regarding the proposed replacement LC, the court determined that Issuing Bank had no responsibility to BNL under the Participation Agreement or their relationship to inform Beneficiary of BNL's proposal, and it did not breach the Participation Agreement. Regarding the alleged fraudulent overdraw, because it was not Issuing Bank's policy that the LC Department consult Issuing Bank's counsel on every LC drawing, it did not breach the duty of care by not doing so here.

BNL further argued that the construction contract mentioned in the draw certificate presented to Issuing Bank did not exist in the form cited. Essentially, BNL argued that the contract was not accurately named in the draw certificate, and therefore, Issuing Bank should be charged with knowledge that the draw certificate was fraudulent.

The court determined, however, that the terms of the LC only required the relevant sections of the contract be inserted into the draw certificate. Because that was done here, and because the Participation Agreement did not require Issuing Bank to investigate facially conforming documents, Issuing Bank did not breach its duty of care.

Finally, the court determined that because the Participation Agreement specifically excluded Issuing Bank from liability regarding any document that appeared on its face to be genuine, Issuing Bank is relieved from any liability for honoring an allegedly fraudulent draw certificate.

4. Participation Agreement, Non-Conforming Documents: BNL argued that the documents presented to Issuing Bank to draw on the LC did not conform to UCP500 or New York's Commercial Code. Specifically, BNL offered the testimony of the head of BNL's LC Department, who testified that the sight draft presented by Beneficiary was not negotiable because it was not addressed to a named drawee and because it included payment instructions. The court determined, however, that the sight draft was subject to the stipulated conditions of the LC, which the witness had not read.

Further, the court found that to the extent that the testimony was offered to show industry practice, the testimony was not relevant. Issuing Bank's actions, according to the Participation Agreement, were to be measured against its own duty of care, not the standard duty of care of the industry.

5. Material Fraud: BNL argued that by the afternoon prior to payment of the LC, "regardless of whether there was strict compliance with the draw documents, there was substantial evidence that honoring the presentation would facilitate a material fraud by Green Country on HVB and/or on Enron and NEPCO."

Specifically, BNL argued that its counsel put the Issuing Bank on notice that a 100% drawing was potentially wrongful since the Issuer's counsel did not act to prevent the drawing even though it could have done so under Revised UCC Section 5- 109(a)(2). The court concluded that, having decided not to follow BNL's advice, Issuer's counsel had no obligation to inform its LC department about the concerns. In addition, the court noted that there was no offer on the part of BNL to indemnify the Issuer should it refuse payment and become liable for wrongful dishonor. Rejecting BNL's argument that the Participation Agreement would have provided for indemnification, the court indicated that "indemnification in the event of wrongful dishonor is arguably outside the scope of the Participation Agreement."

As to whether the Issuer should have taken into account the allegations that the 100% drawing was fraudulent, that court stated:

"BNL interpreted these facts to mean that NEPCO had not defaulted and that HVB should dishonor the draw despite time constraints HVB faced for honoring the Letter of Credit draw. There is no indication that BNL could have concluded that the 98% completion figure bore any meaningful economic correlation to 10% of the project cost for the Jenks Plant (covered by the LC). Moreover, the website indicated that the Jenks Plant was "under construction." This statement does not signify that the Jenks Plant was complete. Further, there is proof that BNL understood that the Jenks Plant was not complete. In an e-mail from counsel for BNL to counsel for Green Country, BNL explains that "BNL confirms that it will reissue the [Letter of Credit] in its own name for a maturity which will allow the project to be completed." ... There is nothing in the record that would establish a direct relationship between the percentage of completion and the percentage of cost that may relate to completing the Jenks Plant."

The court also noted that, although LC law "is not the applicable standard under the Participation Agreement" except with respect to what constitutes HVB's usual practices, "from a practical standpoint HVB's usual procedures would have to be substantially consistent with letter of credit law. Central to letter of credit law is the principle that an issuing bank does not have a duty to look behind draw documents when the draw documents comply on their face to the requisites of the letter of credit. ... When HVB honored the Letter of Credit, it had no legal duty to inquire beyond the draw documents. HVB's obligations under letter of credit law permitted it to honor the request for disbursement of funds. The principle of independent contracts is an essential aspect of letter of credit transactions."

6. The Participation Agreement Did Not Include Implied Terms: BNL also argued that the court should read into the Participation Agreement the implied terms of good faith and fair dealing, reasonableness, a duty to investigate, and fiduciary duty. Regarding the duties of good faith and fair dealing, the court found that because the parties had agreed to a deferential standard towards Issuing Bank's normal duty of care, it would not read into the contract the covenant of good faith and fair dealing. Further, because the parties had specifically agreed to limitations on Issuing Bank's duties, it would be inappropriate to subject it to a covenant of good faith and fair dealing. Even if such a covenant were implied in this Agreement, though, the court determined that BNL had failed to show any material fact that would suggest Issuing Bank did not act in good faith or with the requisite care.

With respect to the duty of reasonableness and the duty to investigate, the court found that the Participation Agreement is an unambiguous contract and Issuing Bank's standard of care is only that stated in the contract. Further, the court held that any breach of a duty of reasonableness would, at most, result in a finding of ordinary negligence for which Issuing Bank would not be liable under the Participation Agreement.

With regard to the fiduciary duty, BNL argued that because Issuing Bank administered the LC while BNL assumed the risk, an agency relationship was established between the two. However, the Participation Agreement expressly disclaimed any obligation not set forth in the Agreement. Further, BNL had not established any material facts which would suggest a fiduciary duty. The court further stated that when parties deal at arm's length without more, there is no implied fiduciary duty.

7. Conflict of Interest: BNL argued that it was excused from its reimbursement obligations because the Issuer had a conflict of interest in that it "was motivated to pay the Letter of Credit in violation of letter of credit law in order to insure the continued profitability of its other loan arrangements with Green Country/Cogentrix." The court concluded that BNL had failed to demonstrate that any alleged conflict constituted a breach of the Participation Agreement, caused the Issuer to breach it, or to fail to mitigate damages.

[JEB/jam]

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