Article

Factual Summary: Buyer of a business caused bank to issue a standby letter of credit for US$331,000 payable to Seller to assure payment of the outstanding balance and repayment of a line of credit on which Seller was guarantor. The sales agreement required that the line of credit be paid off or that Seller be released from its guarantee by a date certain. Four days prior to that deadline, Buyer/Applicant obtained an additional line of credit with the bank that had opened the line of credit and paid it off. However, the bank's accounting system did not reflect the payment on or before the deadline.

Beneficiary and his attorney made a number of inquiries of the bank, and were informed that the computer did not reflect a payment although Applicant assured Beneficiary and continued to insist that the line of credit had been paid. The Seller and his attorney were concerned that inquiries to Buyer's attorney were met with responses that were deemed to be equivocal.

The day after the deadline, Seller's attorney delivered a notice of default. That evening, Buyer's attorney delivered a letter detailing the sequence of events and attaching a letter from the lending officer that had handled the payoff. At sometime during that day, Seller's attorney instructed a lawyer in North Carolina to present documents at the main office of Issuer which took place at approximately 10:00 AM that day.

When Beneficiary and his attorney learned the next day of the letter from Applicant's counsel, they inquired of the bank officer with whom they had been dealing who contacted the officer who had paid off the loan. Because the loan was reflected in the lender's computer system, they were informed that Beneficiary remained as guarantor on the loan until the payment was posted, although payment was confirmed. Beneficiary continued to insist that the terms of the agreement had been breached since it was not released on the required date and refused to withdraw the demand for payment.

Applicant then obtained a temporary restraining order on an ex parte application. After a hearing, a temporary restraining order was entered by the trial court. On appeal, affirmed.

Legal Analysis:

1. Injunction, Standard of Review: Beneficiary argued that the trial court's judgment should be reviewed de novo since the trial court had made a mistaken legal conclusion that fraud was not necessary in order to grant injunctive relief. The appellate court rejected this argument, noting that there was evidence that the order cited California's version of Revised UCC Section 5-109(b) which was deemed to be "sufficient to show that he was well aware of the legal requirement of fraud." The appellate court then proceeded to review the appeal on the abuse of discretion standard of review.

2. Injunction, Fraud; Material Fraud; Likelihood of Success on the Merits: Beneficiary argued that the trial court erred in concluded that Applicant was likely to succeed on the merits in proving that Beneficiary committed material fraud. The appellate court stated that:

"This case demonstrates that the term 'fraud' in section 5109 is ambiguous. It can be argued that the term incorporates the elements of the common law tort of 'fraud,' one of which requires the maker of a false statement to possess an active intent to deceive. On the other hand, it can also be argued that any time an issuer releases funds under a letter of credit in reliance on false statements, there has been a 'material fraud ... on the issuer' because the funds were released under false pretenses. The latter is true regardless of whether the maker of the statements knew they were false and intended to deceive."

Beneficiary argued that the concept of fraud should include the common law element of "subjective intent". The appellate court disagreed, stating that "fraud be determined by an objective examination of the circumstances, rather than by reference to the subjective beliefs of the beneficiary." It cited Intraworld Industries, Inc. v. Girard Trust Bank, 461 Pa. 343, 336 A.2d 316 (1975), noting that this decision was recognized in the Official Comment to Rev. Section 5-109 for the proposition that "an injunction would not issue to prevent a draw on a letter of credit unless the beneficiary's presentation 'had absolutely no basis in fact' or there was 'no bona fide claim to payment under the [underlying contract].'"

The appellate court stated: "This standard requires the court to make an evaluation of the beneficiary's entitlement to payment under the letter of credit, rather than to inquire into the beneficiary's state of mind. No injunction will issue if the circumstances demonstrate that the beneficiary has a 'colorable' (or stronger) claim of entitlement to draw."

The appellate court then framed the issue on appeal as "whether there is substantial evidence in the record to support the conclusion that [Applicant] is likely to demonstrate that [Beneficiary] has no colorable claim of default under the promissory note."

Applying this standard, it concluded that since Beneficiary had "closed" the line of credit in the sense that it could no longer be drawn on at the time of the sale, "[Applicant] could satisfy this obligation merely by paying off the line of credit by April 21, regardless of whether [Beneficiary] remained a guarantor. The evidence that [Applicant] did so is undisputed. Accordingly, [Applicant] was never in default under the promissory note."

The appellate court regarded the statements of the bank officer with whom Beneficiary was in contact as "simply irrelevant" and "mistaken". The appellate court stated "since [Applicant's] obligation was stated in the alternative: either to pay off the line or secure a release of liability. When [Applicant's] paid off the note, he satisfied his contractual obligation, regardless of whether [Beneficiary] continued as a guarantor."

3. Injunction, Balance of Harm: The appellate court noted that the traditional standards of injunctive relief required that factors be balanced including the relative harm to the parties of granting or not granting injunctive relief, irreparable injury, the necessity to preserve the status quo, and the effect on third parties. Beneficiary argued that there was an insufficient showing of irreparable injury. The appellate court noted that this factor was only one of several whose importance decreased with the increased likelihood of success on the merits and when the injunction preserves the status quo. The court recognized that while some of the harm was compensable in damages, other harm such as the potential loss of gains due to liquidation of securities and the harm to the business reputation of the Applicant in the event of a drawing were not. The court also noted that the harm to Beneficiary was relatively little. Accordingly, it concluded that the trial court had not abused its discretion in granted the injunction.

4. Injunction, Overbroad: Beneficiary contended that the preliminary injunction was overbroad in that it required it to obtain judicial approval before making another drawing on the basis of future defaults. The appellate court noted that "The trial court frankly stated its concern that [Beneficiary], having once attempted to draw on the letter of credit without substantial grounds, could not be trusted to exercise proper restraint in the future."

Reflecting on the trial court's actions, the appellate court noted that there were "two particularly troubling aspect of [Beneficiary's] conduct", namely that he had acted "precipitously" in declaring a default especially since the LC was not about to expire and that there was persistence in the draw even through it became clear that the loan had been paid off. The appellate court concluded that under these circumstances the trial court did not abuse its discretion in requiring approval before making a future drawing.

Following the filing of the appeal, Beneficiary had filed a motion with the trial court claiming a different breach of the underlying contract and seeking to draw on the LC, a motion that was granted. Pending the appeal, the appellate court stayed the order and in its opinion vacated it since the trial court lacked of jurisdiction due to the appeal. The decision noted that the stay was lifted and that Beneficiary was free to again seek leave of court.

[JEB/ss]

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