Article

Factual Summary: To sell state lottery tickets, Applicant had to obtain an Ohio Lottery Commission Dealer's Bond. Applicant applied to Bank for issuance of a US$20,000 standby LC in favor of Beneficiary, an insurance company, as security for the execution of a surety bond to the state of Ohio for Applicant.

The LC required presentation of a sight draft accompanied by a written certification that Beneficiary had executed or procured the execution of bonds or undertakings for Applicant, and that Beneficiary had incurred liability or, alternatively, provided that in Beneficiary's sole judgment, a claim could be made for loss, costs, or expenses (and that the money requested by the drafts is required to pay those losses, costs, or expenses).

The LC also provided that "it shall be automatically extended for additional periods of one year from the present or each future expiration date unless sixty (60) days prior to such date we shall notify you in writing . . . that [Issuer] elect[s] not to renew this Letter of Credit for such additional period." The LC provided that if Issuer failed to renew, Beneficiary

may draw on [Issuer] hereunder by . . . draft . . . at sight for the full amount of this Letter of Credit, accompanied by [Beneficiary's] written certification that [Beneficiary] ha[d] not been released from past and future liability and that the proceeds of [Beneficiary's] draft will be applied . . . to satisfy any unpaid premiums or fees or any loss, cost, claim or expense . . . as a result of having executed or having procured the execution of bond(s) or undertaking(s) . . .

The LC also included the following choice of rules and law clause:

Except as set forth below, this Letter of Credit shall be governed by the Uniform Customs and Practice for Documentary Credits (revision effective January 1, 1994) International Chamber of Commerce Publication No. 500, or any successor publication, and as in matters not covered therein, by the law of the State of South Dakota, including without limitation, the Uniform Commercial Code as in effect in such State.

Nearly three years later, Issuer notified Beneficiary that it would not renew the LC. Beneficiary then drew a sight draft for the full amount of the LC and issued the written certification called for by the credit to Issuer. On presentation, however, Issuer refused to honor.

Beneficiary sued Issuer for wrongful dishonor and moved for summary judgment. The trial court sustained Beneficiary's motion for summary judgment and entered judgment against Issuer for US$20,000, plus US$5,360 for attorney's fees, US$1868.49 for 11 months interest during litigation, and continuing interest of US$5.49 per day. Issuer appealed, claiming that the trial court committed reversible error in granting summary judgment and abused its discretion in granting attorney's fees. On appeal, the judgment of the trial court was affirmed.

Legal Analysis:

1. Letter of Credit (Defined); Contract: The appellate court stated that an LC "is a specialized commercial document arising from an agreement between a bank and its customer" and that LCs "are unique commercial instruments and are governed by their own unique rules."

2. Independence Principle; On its face; UCC 5-108(a): Issuer claimed that Beneficiary "has not incurred any liability in this case, nor has it shown that any claims have been made against it such that its bond to [Applicant] would be in jeopardy." It therefore argued that Beneficiary's certification, which in part certified "that it has not been released from past and future liability and that the proceeds of its draft will be applied by it to satisfy any loss, costs, claim or expense which has been incurred by it", was untrue and, as such, Beneficiary's drawing on the letter of credit should not be honored.

The appellate court, however, ruled that "reasonable minds could only conclude that [Beneficiary] made an appropriate draw on the letter of credit on . . . the 'notice of non-renewal' basis." The court quoted South Dakota's version of UCC 5- 108(a), which mandates "Except as otherwise provided in [UCC § 5-109], an issuer shall honor a presentation that, as determined by the standard practice referred to in subsection (e), appears on its face strictly to comply with the terms and conditions of the letter of credit." The court also quoted from Nassar v. Florida Fleet Sales, Inc., 79 F.Supp.2d 284, 291-292 (S.D.N.Y. 1999) (quoting Alaska Textile Co. v. Chase Manhattan Bank, N.A., 982 F.2d 813 at 815-16 (2d Cir. 1992)), which stated "the obligation of the issuing bank to [honor] a draft on a credit when it is accompanied by documents which appear on their face to be in accordance with the terms and conditions of the credit is independent of the performance of the underlying contract for which the credit was issued." [emphasis added by the instant court] The court concluded that the independence principle meant that summary judgment for the Beneficiary was properly granted, "despite [Issuer's] protestations that [Beneficiary's] certification was 'untrue'".

3. Attorney's Fees; UCC 5-111(e): Issuer argued that the trial court abused its discretion in awarding attorney's fees to Beneficiary on the grounds that Issuer did not act in bad faith, and that therefore an award of attorney's fees was unwarranted. Beneficiary countered by pointing to South Dakota's enactment of UCC 5-111(e), which the appellate court summarized as providing "that if an issuer of a letter of credit dishonors or repudiates its obligation to pay . . . then the beneficiary . . . must additionally be awarded, inter alia, interest owed from the date of dishonor and reasonable attorney fees." The court ruled that "the trial court did not abuse its discretion in awarding attorney fees to [Beneficiary]."

Comments by Lee H. DAVIS:

1. Drafting: The LC in the instant case had a clause stating that it was "governed by the Uniform Customs and Practice for Documentary Credits (revision effective January 1, 1994) International Chamber of Commerce Publication No. 500, or any successor publication". Did Beneficiary (or Issuer) really intend to be bound by rules that it had probably never seen and that are not finalized? In commercial LCs, because of their relatively short time frame, such clauses are usually only bad drafting. In a standby with an evergreen clause, on the other hand, such a provision is foolish. Especially in light of the ongoing revision of UCP500, but also generally, it is inadvisable to include "or any successor publication" in a choice of rules clause as you can never be certain as to what rules your undertaking is subject.

2. Untrue Statement: As the court recognized, Issuer's claim made no sense in light of the terms of the credit and the certification. Beneficiary did not claim that the funds were due but that they were still owed. Apart from this fundamental fact, there is no stop short of letter of credit fraud to excuse an issuer from honoring a complying presentation. Whatever "untruth" means, it is not enough unless it is the type of material fraud that constitutes letter of credit fraud.

3. Safe and Sound LC Practice: Once again, we have a bank issuer that apparently did not understand the scope of its obligation under a standby letter of credit containing an automatic extension clause. It goes without saying that a bank should have the operational expertise to understand its undertakings and that the failure to do so is unsafe and unsound.

4. Attorney's Fees: Unlike most of US commercial law, the US LC statute awards attorney's fees to the prevailing party under Revised UCC Section 5-111. It is encouraging to find courts taking this exceptional rule seriously and rebuffing claims that would insert a limiting requirement of bad faith or some similar higher hurdle. It is troubling, however, to find the appellate court affirming on the basis of a lack of abuse of discretion. The statutory term is "must" and not "may", curtailing the exercise of judicial discretion. The standard for review is whether the issuer wrongfully dishonored its LC obligation.

[JEB/lhd]

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