Article

Note: To satisfy obligations under a Security Agreement related to deductible workmen's compensation nsurance policies, Insured/Applicant (HMKR, Inc.) obtained three standby letters of credit totaling US$491,000 in favor of Insurer/Beneficiary, Fireman's Fund Insurance Company. The Security Agreement stated that Applicant retained an unsecured contractual right to unused proceeds against the Beneficiary.

When Applicant filed a petition for voluntary relief under Chapter 11 of the US Bankruptcy Code, Beneficiary drew on the LCs and was paid. Subsequently, the Bankruptcy Court approved the sale of substantially all of Applicant's assets to Purchasers, A&M, Inc. (now known as Homemaker Industries). The sale was pursuant to an Asset Purchase Agreement which gave Purchaser certain rights and excluded certain others including "all rights in and to [Applicant's] directors and officers liability insurance and any other insurance policies and rights." Also excluded were "any and all debts, liabilities and obligations of [Applicant's] incurred or accrued with respect to any period, or circumstances, or state of facts or occurrences, on or prior to the Closing Date, relating to ... workmen's compensation."

After resolving all workmen's compensation claims against it, Beneficiary deposited US$ 400,245 of excess proceeds into an interest-bearing escrow account to await the Bankruptcy Court's decision as to who was entitled to them.

Purchaser's claim to the excess proceeds was contested by the unsecured creditors who brought an action for declaratory judgment. The Bankruptcy Court for the Southern District of New York, Drain, J., granted creditors summary judgment and the 296 Purchaser appealed. The US District Court for the Southern District of New York, Cote, J., affirmed.

The appellate court concluded that all the contractual provisions relating to the insurance and proceeds were integrated and that all extrinsic evidence was excluded. It enforced the provisions which it described as unambiguous that allocated the proceeds of the insurance letters of credit to the debtor and not to the Purchaser.

In particular, the appellate court rejected Purchaser's argument that "the Proceeds are no different than any other advance payments or security deposits made by" Debtor. Accordingly, it claimed that they were covered by another provision of the purchase agreement.

The appellate court noted that "this argument ignores the established law that letters of credit are 'unique commercial instruments' governed by distinct legal principles", quoting Mutual Export Corp. v. Westpac Banking Corp., 983 F.2d 420, 423 (2d Cir. 1993). It stated that Purchaser "has provided no basis for the interpretation of the purchase agreement as referring to the unique commercial instrument of a letter of credit." The appellate court also rejected an argument premised on general principles of commercial law that requires that any surplus be accounted for. The appellate court noted that "[t]raditional contract rules, however, apply to letters of credit 'only to the extent that contract principles do not interfere with the unique nature of credits'" citing Mutual Export, 983 F.2d at 423. The appellate court stated that "the application of the general commercial principle suggested by purchase conflicts with this express condition and therefore interferes with the unique nature of letters of credit. [Applicant's] only right to the Excess Proceeds is the unsecured contractual right arising under [Applicant's] integrated insurance policy agreement with Beneficiary, which was excluded from the agreement."

Comment: While it is comforting to find such recognition of the unique and independent nature of a letter of credit decision in a bankruptcy case, one wonders if this discussion was relevant or useful. The credit had been honored. What was at issue were the proceeds. There was nothing especially unique about the excess proceeds that required special treatment because they were the proceeds of a letter of credit. Surely if the agreement had provided that the LC proceeds went to the Purchaser, the court would have enforced this provision. The reason that it did not had nothing to do with the nature of the LC but with the terms of the agreements.

[JEB/tas]

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