Article

Factual Summary: To pay a broker for the delivery of Chinese steel to the US, Buyer caused an LC to be issued in its favor for US$3,583,356.84. To assure reimbursement of the Issuer, several parties undertook surety obligations.

After Beneficiary presented documents to Issuer and before payment, disputes arose over the quality and place of delivery of the steel. When Beneficiary insisted on payment, Applicant and Sureties sued Issuer and Beneficiary to enjoin payment and for breach of contract in the state courts of the US state of North Dakota. The state court granted a temporary restraining order against payment. Beneficiary then sought to remove the case from the state courts to US federal courts under special removal statutes and moved to dismiss. Applicant and Issuer opposed removal and filed motions to remand to the state courts. Applicant also moved to amend its Complaint. The federal trial court granted Applicant and Issuer's motions to remand the case, denied Applicant's motion to amend the Complaint, and denied Beneficiary's motion to dismiss.

Legal Analysis:

1. Jurisdiction, Diversity; Jurisdiction, Independence; Revised UCC Section 5-109; Letter of Credit Fraud; Fraud, Exception: Under US statutes regarding removal, each party must have total diversity in that each must be from a different federal state or other jurisdiction and that none of the defendants can be citizens of the state in which the action is brought. Since Issuer was a North Dakota bank, it did not appear that there was complete diversity. Beneficiary argued, however, that Issuer was only a nominal party to the suit, and should not be counted for a diversity jurisdiction determination. The Beneficiary argued that the independence principle required such a result since the issuer of a LC is generally not subject to the claims and defenses of the applicant with respect to that transaction.

The court noted that "When fraud is claimed, most jurisdictions recognize the right of an applicant to seek injunctive relief against the issuing bank prohibiting payment on the letter of credit. Also, fraud is one of the few grounds upon which an issuing bank can refuse to make payment." It cited Revised UCC Section 5-109, noting that "this is a real and present claim against a statutorily-authorized defendant, which, based on the law previously cited, makes[Issuer] more than a formal or nominal party." The court also noted that although the Issuer was probably secondary to the dispute between Buyer and Seller, the Buyer retained its right to seek injunctive relief against Issuer and does not make Issuer a nominal party to the suit. The court also noted that the funds at issue under the LC were those of Issuer. It stated that "the fact that [Issuer's] own funds are [at] risk means it has a substantial interest in the outcome, making it a real party in interest and not a nominal or formal party."

The court stated: "In fact, the risks and interests of [Issuer] are several. First, there is the risk that, if it honors the letter of credit and makes payment to[Beneficiary], it may not recover back all of what it paid out because the [Applicant and Sureties] are not good for it. In fact, while not dispositive, [Issuer] claims in this case that it will suffer a financial loss if it is required to make payment. Second, if payment is made, there are the costs and delays that may be attendant to any collection effort against the[Applicant and Sureties]. Third, given [Applicant and Sureties'] claims of fraud and the fact it has been put on notice of these claims, [Issuer] potentially could face a defense of lack of good faith in any collection action against the [Applicant and Sureties]should it honor the letter of credit and it is ultimately determined that [Beneficiary] was not entitled to payment as a result of the claimed fraud. [North Dakota version of Revised UCC Section 5-109(1)(b)]...protect[s] an issuer with respect to payment in such a situation only when the payment is made in good faith... & [North Dakota version of Revised UCC Section 5-111(2)] ...subject[s] an issuer to claims of damages incurred by the applicant in the event of a breach by the issuer of its obligations including incidental damages and attorney fees.... Fourth, when fraud is present, [Issuer] has the right in certain instances to refuse payment."

The court distinguished two cases cited by Beneficiary that were removed to federal courts notwithstanding the presence of an issuing bank that would have prevented complete diversity on the basis that there was no viable claim of letter of credit fraud. Essentially, the actions were for breach of the underlying contract between buyer and seller.

[JEB/az]

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