Article

Note: Tenants, Wall Street Strategies, Inc. and Wall Street Strategies, Corp., agreed with Landlord, Praedium II Broadstone, LLC, to lease Manhattan office space. Tenants obtained a US$270,592 Citibank letter of credit in favor of Landlord as a security deposit for unpaid rent or other damage.

When Tenants defaulted on the lease, Landlord/ Beneficiary drew on the letter of credit the amount of US$270,000. Over the next several months, Tenants paid Landlord the arrears owed under the lease. Landlord, however, retained the letter of credit proceeds against further default.

Subsequently, Tenants filed for protection under Chapter 11 (reorganization) of the US Bankruptcy Code and moved to reject the lease and enter into a license agreement with Landlord to remain in the leased premises. The Bankruptcy Court for the Southern District of New York, Drain, J., granted Tenants' motion and allowed Landlord to set off US$91,417 for unpaid rent, ruling that the balance of the Letter of Credit proceeds must be returned to Tenants. On appeal, the US District Court for the Southern District of New York, Pauley, J., affirmed.

In affirming the ruling of the Bankruptcy Court, the appellate court noted that:

"[Landlord] relies on the general principle that neither a letter of credit, nor its proceeds, are property of a debtor's Chapter 11 estate. ... The general rule on which [Landlord] relies does not apply to the use of letter of credit proceeds after draw down, because 'when the proceeds are in the beneficiary's hands the underlying agreement controls, unless otherwise unequivocally directed.' ... Because [Landlord] drew down the full amount of the Security Deposit in August 2001, it is the underlying agreement between the parties that controls. ... To that end, the Bankruptcy Court properly referred to the Lease, since that was the operative agreement between the parties when [Tenants] entered Chapter 11."

The appellate court noted that as Tenants complied with the terms and conditions of the lease the security deposit must be returned, and Landlord failed to assert any other claims against Tenants. The appellate court also denied Landlord's appeal of the bankruptcy court's denial of leave to amend its proof of claim, stating that the bankruptcy court had sufficient reason to deny the claim and did not abuse its discretion.

[JEB/lhd]

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