Article

Factual Summary: In connection with the sale of portable road construction equipment for more than US$ 2.1 million to Buyer, a French corporation, Seller, a Tennessee corporation, agreed to provide a performance bond of 10% of the value of the equipment. The sales contract was subject to the law of France and provided for mediation in Paris, and jurisdiction of the appropriate court in Paris if it failed.

Accordingly, Seller obtained a performance standby issued by Finance Company, a non-bank issuer, for US$220,000 in favor of Buyer. Among other required documents was a statement by Beneficiary that "the asphalt plant it had purchased from [Applicant] pursuant to their contract ... 'does not meet the specifications' set out in the contract, and specifying an amount 'due and owing.'" The standby provided that presentation was to be made to a bank in North Carolina.

After the equipment was delivered to Beneficiary in France, numerous problems were encountered, including customs clearance, a lack of steering axles, warning decals, a missing mud flap, electrical circuit problems, and reflectors and lights that did not comply with European standards. Because of these problems, Beneficiary notified Applicant in writing of its intent to draw on the LC for the full amount.

Asserting that it had "'substantially and satisfactorily performed its obligations under the Agreement and any claim by [Beneficiary] on the [Standby LC] would be entirely unwarranted and injurious to [Applicant],'" Applicant filed an action against Buyer, Issuer, and the North Carolina bank for a TRO and preliminary injunction enjoining drawing and payment on the LC. The court denied Applicant's motion for a TRO and preliminary injunction.

Legal Analysis:

1. Temporary Restraining Order; Fraud; Injunction: The court weighed the requested relief in light of the traditional equitable tests for injunctive relief, irreparable harm, success on the merits, balance of harms, and the public interest. Applicant contended that it would suffer irreparable harm because a drawing "will require a very expensive and difficult lawsuit to retrieve the money because its adversary is in France." The court rejected this claim, noting that "entered into this agreement with full knowledge that its buyer was located in another country and it expressly agreed to mediate and litigate any disputes abroad." The court also indicated that the LC figure of 10% of the contract price was "not an extraordinary amount in this context." The court also rejected the claim that a drawing would result in loss of goodwill. It noted that a successful defense would preserve Applicant's reputation and that any damage could be addressed by a monetary award.

The court also observed that an injunction would harm Beneficiary's exercise of a "contractual right and a part of the agreement for which it bargained and paid value. To prevent this company from exercising its contractual rights could very likely cause it harm."

As to the ability of Applicant to succeed on its claims that any drawing would be "unwarranted, or even fraudulent", the court looked to the purpose of the LC. While noting that there was some evidence to suggest that the LC was "to insure the shipping and start up provisions" of the contract, the court noted that the "Agreement itself and [Applicant's] application for the Letter of Credit indicate that the Letter was a 'performance bond.'" The court found sufficient evidence to conclude that the standby was intended as a performance bond to suggest that it was doubtful whether Applicant would succeed on this claim. It also noted that the LC amount was roughly 10% of the contract price, and that one documentary requirement of the LC was a statement that the "'asphalt plant ... does not meet specifications,' not that the shipment failed or that the startup services were not provided."

Applicant argued that the public interest would not be served by allowing Beneficiary "to harass and threaten it" into providing services not contracted for and would be a "potential windfall". The court rejected this argument, stating that the Standby LC was "part of the agreed-upon exchange between these two parties. [Applicant] had to know when it entered this agreement that [Beneficiary] could draw down the funds on the mere presentation of the documents to Wachovia. There is no public interest in protecting [Applicant] from a risk it knowingly and intelligently took."

Comments:

1. The court suggests that the threatened drawing "may well be imminent" because of the threat in writing. One wonders if that standard suffices.

2. The major difficulty with this case, however, is the failure of the court to consider whether or not there was letter of credit fraud under Revised UCC 252 Section 5-109 to which the LC was subject and which the court fails to mention. The principal question, therefore, should have been not whether the drawing was "unwarranted", but whether there was material fraud. Based on the court's analysis, it is likely that it would conclude that a threat to draw down the entire amount of the LC over a contract dispute was not material fraud. While the court reaches the same practical result, it would have been more comforting for it to have done so by the most direct route.

[JEB/fkd]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.