Note: As portion of a security deposit for a commercial lease, PhotoPoint Corp. (Applicant), arranged for LC payable to 250 LLC (Landlord/Beneficiary) in the amount of US$890,175, a sum equal to 18 months' rent which was subsequently reduced to US$712,140. When Applicant failed to pay rent for four consecutive months, Beneficiary drew down corresponding amounts on the LC. Following this action, Beneficiary drew down the remaining US$563,777.49 and served Applicant with a "Notice of Belief of Abandonment" and a "Notice to Quit" containing an election to forfeit the lease.

Beneficiary filed an unlawful detainer action. Applicant's assignee, Sherwood Inc., sued seeking return of the security deposit including LC funds. Beneficiary then amended the complaint, seeking damages for breach of the lease.

The Superior Court of City and County of San Francisco, Meeks, J., entered a net judgment of US$944,567 in favor of Beneficiary, representing US$1,557,898.78 in damages less the security deposit and a US$100 California state statutory penalty for improperly applying a security deposit to future rent damages. The Court of Appeals, Kay, J., reversed.

The appellate court stated that the amount of the security deposit wrongly retained could not be offset against future rent damages because that would enable Beneficiary to profit from its statutory violation.

Beneficiary also claimed that the portion of the security deposit represented by the LC was not a "payment or deposit of money" within the meaning of the state statute regarding what is considered substantially equivalent to money, and that so treating it would violate the independence principle. The appellate court did not rule on whether an LC was a "payment or deposit of money" but stated that because Beneficiary had drawn the entire amount of the LC before the security deposit was due to be returned, it was "money" at that point. The court cited In re Graham Square, Inc., 126 F. 3d 823 (6th Cir.1997) abstracted at 1998 Annual Survey 430, as support, stating, "It is one thing to attempt to prevent the distribution of the proceeds of a letter of credit, an attempt the doctrine of independence is designed to prevent; but it is quite another to bring an action on the underlying contract that created the letter of credit."

Since this case did not concern a right to draw on the LC, the appellate court concluded that the independence principle was inapplicable, and it was irrelevant that the security deposit originated as an LC.



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.