Article

Factual Summary: To assure payment of a lease for two telephone systems, Applicant caused an "evergreen" letter of credit to be issued in favor of Beneficiary. The LC provided that it would be renewed automatically unless notice of nonrenewal was given. The LC permitted Beneficiary to draw on the LC in the "Event of Default," which included the failure to maintain the LC.

After Applicant filed for protection under the US Bankruptcy Code Chapter 11 (Reorganization), Issuer notified Beneficiary of non-renewal of the LC. Applicant arranged to sell the telephone system lease along with other assets to Lease Purchaser, and the sale was approved by the bankruptcy court. On the same day, Beneficiary drew on the LC in the amount of US$194,237, the remaining balance on the lease for the telephone systems. Two days later, the approved sale closed, and on that day, Issuer honored Beneficiary's draw on the LC, satisfying Applicant's obligations under the lease. At no time prior to its draw on the LC had Beneficiary sent Applicant a notice of default. Issuer was subsequently granted permission by the bankruptcy court to obtain reimbursement from Applicant pursuant to the LC application.

Applicant then sued Lease Purchaser in the bankruptcy court for subrogation of the amount paid Leasor through the LC and for unjust enrichment because Lease Purchaser had contracted to assume payment of the lease. Applicant argued that because Beneficiary had been paid the full lease amount via the LC, Applicant, not Lease Purchaser, had made the lease payment. Applicant also sued Beneficiary for violation of the automatic bankruptcy stay, breach of contract and wrongful draw on the LC. The bankruptcy court ruled in favor of Applicant against both Lease Purchaser and Beneficiary. On appeal, affirmed as to the judgment against the Lease Purchaser and reversed as to the judgment against the Beneficiary.

Legal Analysis:

1. Unjust Enrichment: Applicant asserted that Lease Purchaser was unjustly enriched by Beneficiary's draw on the LC to the detriment of Applicant after the transfer of the lease from Applicant to Lease Purchaser. The appellate court rejected this contention, stating that "[u]njust enrichment, as an equitable remedy, comes into play only when the rights of the parties are not governed by a valid contract." Because Applicant did not contest that its relationship with Lease Purchaser was controlled by the purchase agreement, it ruled that the unjust enrichment rationale was inapt.

2. Subrogation: Lease Purchaser contended that the bankruptcy court's only basis for judgment against it was a theory of unjust enrichment, because the bankruptcy court allegedly rejected Lease Purchaser's obligation under the theory of subrogation. The appellate court noted that the bankruptcy court initially granted summary judgment to Applicant on the basis of its subrogation claim without an assessment of damages because the bankruptcy court reached liability on the basis of unjust enrichment. The appellate court therefore reviewed the case under a subrogation theory, finding Lease Purchaser liable on that ground.

Applicant asserted that there was an agreement that since Lease Purchaser "would receive the telephone equipment in return for assuming the lease obligations [,] [Lease Purchaser] received the benefit of the equipment, but escaped its obligations under the lease because [Beneficiary's] draw on the letter of credit fully paid off the lease." In addressing the transfer of liability for the lease, the court stated that "it is debatable whether [Applicant] was primarily liable on [the date of sale approval], [Applicant] clearly was not liable on [the date of sale closing]. Also clear is that [Lease Purchaser] received the consideration-in the form of the telephone lease equipment-for the payment." The appellate court concluded that Applicant was no longer primarily liable for the debt, therefore it was entitled to recover from Lease Purchaser under a theory of subrogation.

3. Bankruptcy, Property: Applicant asserted that Beneficiary's drawing on the LC after Applicant's declaration of bankruptcy violated the automatic stay that "prohibits creditors from taking action to obtain 'property of the estate.'" While recognizing that "it is well established that letters of credit are not property of a debtor's estate", Applicant attempted to distinguish this case by asserting that Beneficiary was in violation of the automatic stay because it obtained a "surplus" amount from the LC, thereby encroaching on Applicant's estate. The appellate court rejected that contention, stating that Applicant "might have a contract claim regarding the letter of credit proceeds, but the law is settled that letters of credit are not property of the debtor's estate." The appellate court therefore affirmed the bankruptcy court's determination that there was no violation of the automatic stay.

4. Breach of Contract: The bankruptcy court determined that Issuer's notice of non-renewal of the LC was not a default under the lease, and, consequently because there was no notice of the drawing, found Beneficiary to be in breach of the lease agreement by drawing on the LC. The appellate court reversed stating that: 256 [t]he plain language of the [LC] Addendum permits a draw on the [LC] upon an Event of Default. Notice of non-renewal, also according to the plain language of the agreement, constitutes an Event of Default ... . Nothing in the [LC] requires notice and an opportunity to cure. The [LC] Addendum provides, "Upon the occurrence of an 'Event of Default', Lessor [Beneficiary] may draw all amounts available under the [LC] but in no event more than an amount equal to the Lessor's Loss."

In addressing the lack of opportunity to cure, the appellate court noted that "although the lease agreement does discuss both notice and an opportunity to cure, those provisions apply only to certain types of default, and do not apply to the failure to maintain an evergreen [LC]."

The appellate court concluded that "[a]lthough [Applicant] could have negotiated the [LC], Lease, and [LC] Addendum differently, it did not do so ... . It is not the Court's task to rewrite the contract in terms more favorable to the debtor. Thus, if [Applicant] defaulted, [Beneficiary] was entitled to draw on the [LC] without providing notice or an opportunity to cure. [Beneficiary's] draw was proper because the uncontested facts set out at trial established that [Applicant] defaulted. The appellate court remanded the issue to the bankruptcy court for the appropriate amount of "Lessor's Loss" and stated that if the bankruptcy court determines that Beneficiary's draw exceeded the amount it was entitled to, "the bankruptcy court will then have to determine whether, in light of the assignment to [Lease Purchaser], [Applicant] can pursue a claim for breach of contract."

[JEB/fkd]

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