Article

Factual Summary: When Samuel Buchbinder (Surety) and Rony Natanzon (Indemnitor), co-owners of various business interests dissolved their relationship, Surety transferred all interest to Indemnitor as reflected in a Memorandum of Understanding. During their relationship, Surety had agreed to reimburse UBS AG (Issuer) for any drawings on two US$500,000 LCs it had issued in favor of Bank Leumi (Beneficiary). In addition, Surety had posted US$318,608 in cash and 85,000 shares of stock as collateral. The Memorandum provided that "[Indemnitor] guarantees personally that he will reimburse [Surety] without offset demand or counterclaim any draw on the US$1,000,000 letters of credit with all costs and attorneys fees of collection."

Although the LCs expired on 31 January, an extension until 31 January of the following year was requested by Beneficiary and agreed to by Issuer. The opinion states that by their terms, "the written consent of both [Surety] and [Issuer] was required to modify the expiration date" of the LCs. When the Issuer amended the LCs to reflect the extension, it erroneously typed 31 December of the following year instead of 31 January. On 29 January, Beneficiary informed Issuer that it considered the LCs to be in effect until 31 December. When Issuer discovered and informed Beneficiary of the error, Beneficiary refused to agree to their cancellation.

In February, demands for the full amount were made on both LCs and honored. When Issuer then seized the collateral, applying it to the amounts paid, Surety requested that Indemnitor reimburse him. On his refusal to do so, Surety filed an action against Issuer for wrongfully debiting him, claiming that the LCs had expired at the time of payment. The litigation was settled and funds and stock returned.

In the meantime, Surety filed this action against Indemnitor, claiming reimbursement under the Memorandum. After the settlement, he reduced the claim to lost interest, attorney's fees, and costs in both litigations based on the Memorandum. On cross motions for summary judgment, the U.S. District Court for the District of Maryland, Motz, J., granted Indemnitor's motion and denied Surety's motion.

Indemnitor claimed that the payment by Issuer to Beneficiary "was not a draw on the letters of credit under the [Memorandum], which only contemplated timely and proper draws." Noting that Maryland law required determination of "what a reasonable person in the position of the parties would have thought the language of the agreement to mean", the judge stated that "[i]f that had been the meaning of the words, in the [Memorandum Indemnitor] would have been assuming an obligation of infinite duration, unlimited by the express written terms of the letters of credit. Reasonable business people do not assume - or expect others to assume - such obligations."

The judge also rejected any claims by Surety that the LCs had not expired, noting that such a position was inconsistent with the position taken in the other litigation against the Issuer and that the LCs had expired. "The letters of credit did expire January 31,2003. The letters specifically required [Surety's] written consent to modify the expiration date, and such consent was not given to extend the letters past January 31, 2003. [Issuer's] typographical error did not (and could not) breathe life into the letters of credit after their expiration date, because UBS never had the power to act unilaterally to extend the letters."

Comments by James E. BYRNE:

1. The interpretation of the terms of an indemnity can be difficult. Here, the court concluded that an improper drawing of an LC was not the type of drawing that was contemplated. The suggested reason, however, that the obligation would then be of unlimited duration, is not entirely convincing. Under the facts, the exposure was limited to the claimed expiration date, 31 December, and not an unlimited time.

2. One wonders if the same rationale would apply to a non-conforming drawing, excusing the co owner where the drawing was not proper. Or would the propriety of the drawing turn on whether the Issuer was entitled to reimbursement?

3. One also wonders at the requirement of a written consent by Surety. Such a term in a UCP500 LC is strange. Unless the written consent is required to be presented by the LCV, it cannot affect the Beneficiary's right against the Issuer. The consent of an Applicant or Guarantor is separate from the obligation of the Issuer, even if mentioned in the LC. Otherwise, it would be disregarded as nondocumentary under UCP500 Article 13(a) or Revised UCC Section 5-108(g).

4. Even if the validity of Beneficiary's claim against the issuer under the LC is not arguable, the ability of the issuer to claim reimbursement against the surety is arguable. The consent to the extension was only to the earlier date and not to the later date. Although the opinion does not address the issue, the question arises as to whether or not the surety had a defense against the issuer. While this question may be impacted by the Memorandum of Understanding, the issuer's mistake arguably exposed the surety to additional risk that would have discharged him under traditional suretyship law. Since the amount seized was returned, it if fair to assume that the risk of its mistake had to be borne by the issuer.

5. Coupled with the seizure of assets and necessary litigation to recover them, one wonders if a reasonable person would have assumed that the term "drawing" in the indemnity would be construed by a reasonable person so narrowly to mean only a drawing that ultimately entitled the issuer to reimbursement. Here, there was a drawing. The LCs did not legally cease to exist. As issued, they were valid until the stated expiration date unless Beneficiary was charged with notice of the mistake. The problem here is not the validity of the LCs, but whether Surety is discharged by Issuer's mistake.

6. Although not an issue in this case, one wonders at the effect of a mistake on the beneficiary's entitlement under the LC. While the beneficiary should ordinarily be immune to issuer mistakes in issuance, a mistake in extending the LC date may be a different matter if the beneficiary had reason to know of the mistake, as is suggested by the notification sent by Beneficiary on 29 January, two days before the expiration date it had requested, that "it considered the letters of credit as valid and in force until December 31". One also wonders whether the beneficiary can properly retain the funds under Revised UCC Section 5-110(b).

[JEB/cbw]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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.