Article

Note: To assure payment of a lease of realty, Tenant, ITXS, Inc., pledged collateral to a bank in exchange for the issuance of an LC in favor of Landlord, F & S Hayward, LLC. Subsequently, Tenant filed for protection under Chapter 11 (reorganization) of US Bankruptcy law. Landlord evicted Tenant and drew US$62,360 on the LC for unspecified reasons.

Tenant filed an adversary complaint against Landlord seeking to avoid and recover the draw on the LC as preferential, for breach of the lease agreement, and for wrongful eviction. On Landlord's motion for partial summary judgment with respect to the preference claim, the U.S. Bankruptcy Court for the Western District of Pennsylvania, McCullough, J., granted judgment for Landlord, ruling that the drawing on the LC was not an avoidable preference.

Tenant claimed that the drawing constituted an avoidable transfer under 11 U.S.C. § 547 (b) "of an interest of the debtor in the property." The court ruled that although the drawing on the LC occurred within the 90-day preference period, "a preference can only arise if what has been transferred is the debtor's property, ... '[a] letter of credit and the proceeds derived therefrom [(i.e., a draw on such letter of credit)] are not property of a debtor's estate for purposes of [Bankruptcy law],'" quoting In re Metro Communications, Inc., 115 B.R. 849, 854 (Bankr.W.D.Pa. 1990) because payment to the beneficiary is from the issuer's funds.

Tenant argued that it had an interest in the LC proceeds, relying on cases in which the LC is treated as equivalent to a security deposit. Distinguishing these cases, the court pointed out that they only equated the LC with a security deposit to determine whether an LC draw "must, like a security deposit, be subtracted from the ... cap on lease termination damages. ... [They] neither hold nor imply that a debtor has a property interest in letter of credit proceeds." The court ruled that even if there was an interest in the security deposit, that interest does not create an interest in the LC proceeds.

Tenant also argued that the draw on the LC was an avoidable preference because it was an indirect transfer of property of the bankruptcy estate given in exchange for the LC due to Tenant's pledge of collateral to the issuing bank. Tenant relied on one sentence from Metro Communications, 115 B.R. at 854, "[i]f Debtor granted a valid security interest in its property to [Issuer] in exchange for the issuance [by Issuer] of the letters of credit, then payment thereon could be an indirect transfer and a preference to [the letter of credit beneficiary]." The court stated that "an indirect transfer as just described ... is preferential only if such security interest is granted within the 90-day preference period. See Metro Communications, 115 B.R. at 857." Characterizing this sentence as "perplexing", the court recognized that it "could, when viewed in isolation from the remainder of the Metro Communications decision, admittedly provide fuel for the Debtor's position ... ." The court noted, however, that when viewed in context, the sentence referred to the security interest granted to the issuer and not the LC proceeds. The court concluded that since the pledge of collateral was not within the 90-day preference period, the draw by Landlord on the LC was not an avoidable preference.

[JEB/lhd]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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.