Article

Factual Summary: In order to appeal a judgment, Judgment Debtor applied to bank which issued an LC as a supersedeas bond in favor of Judgment Creditor. The LC was subject to UCP500 and, as the court explained it, provided that "The draft[demand for payment] must also be accompanied by the original of this Letter of Credit for our endorsement on this Letter of Credit of our payment of such draft." [Emphasis in opinion] Following resolution of the underlying appeal, Beneficiaries drew on the LC in the amount of US$152,122.77, the amount of the judgment and attorney's fees.

Issuer refused to honor, notifying Beneficiaries of discrepancies, namely that the original LC did not accompany Beneficiaries' demand. Beneficiaries then made a re-presentation, adding a written statement that "The original Letter of Credit was never produced by [Applicant] or its lawyer. We have searched diligently to find the same, but cannot."

Issuer again refused to honor, citing the failure to present the original LC. The LC expired shortly afterwards.

Beneficiaries sued Issuer for wrongful dishonor, negligence, and unjust enrichment in Iowa District Court for Scott County. Both parties filed cross motions for summary judgment. Issuer's motion was accompanied by a sworn statement from one of its employees. Beneficiaries' motion was also accompanied by a sworn statement, given by a local banker. He stated "I believe it to be the standard of practice of financial institutions who regularly issue letters of credit in this geographic area that it would be expected that said institutions would honor the presentment of an unaltered photocopy of a letter of credit if accompanied by an affidavit from the beneficiary that the original document was lost, stolen, or destroyed."

The trial court granted summary judgment in favor of Beneficiaries. The Appellate Court On appeal, reversed and remanded the case for entry of summary judgment in favor of Issuer.

Legal Analysis:

1. Letter of Credit Defined; Definition of LC: The appellate court recited the definition from Iowa's version of Revised UCC Section 5-102(a)(10), "a definite undertaking... by an issuer to a beneficiary at the request or for the account of an applicant or, in the case of a financial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item."

2. Letter of Credit, basis. The appellate court stated that "a properly established letter of credit' constitutes an enforceable obligation created by statute in the nature of a contract by the issuer...in favor of the beneficiary'[,]" citing with approval from Comdata Network, Inc. v. First Interstate Bank of Fort Dodge, 497 N.W.2d 807, 809 (Iowa 1993)(quoting Newvector Commc'ns, Inc. v. Union Bank, 663 F. Supp. 252, 254-55 (D. Utah 1987)).

3. Independence: The appellate court cited the Comdata decision, above, for the proposition that the LC is "wholly independent" of the underlying contract. It summarized case law with the proposition that "The duty created in the letter of credit is wholly independent of the underlying contract between the issuer's customer . . . and the beneficiary." The appellate court also stated "Central to the unique purpose of letters of credit is the "independence principle," which requires the issuer to pay a beneficiary on proper demand regardless of a breachor default on the underlying contract."

4. Strict Compliance; Compliance; Revised UCC Section 5-108(a) and (e): The appellate court noted that Revised US UCC Section 5-108 (a) and(e) adopt the standard of strict compliance, a standard that had been applied in Iowa cases. Section 5-108(a)provides "[a]n issuer shall honor a presentation that, as determined by the standard practice referred to in subsection 5, appears on its face strictly to comply with the terms and conditions of the letter of credit. .. ." Revised Section 5-108(e) provides "An issuer shall observe the standard practice of financial institutions that regularly issue letters of credit. Determination of the issuer's observance of the standard of practice is a matter of interpretation for the court. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice."

5. Standard Practice; Revised UCC Section 5-108(e); Strict Compliance: Beneficiaries argued that Revised Section 5-108(a) and (e) "requires the district court to determine the standard of practice for honoring letters of credit prior to a determination of strict compliance." The trial court had concluded that:

" It is the standard practice of financial institutions that regularly issue letters of credit in this geographic area to give such documents the same force and effect as the original document. Hence, [Beneficiaries] have complied precisely with the terms and conditions of the letter of credit.[Issuer] has failed to observe the applicable standard practice by dishonoring [Beneficiaries']presentation for payment, and has not established that payment under these circumstances would generally undermine the usefulness and attractiveness of letters of credit."

Beneficiaries argued that the trial court properly considered the sworn statement of the local banker. Issuer argued that this statutory section "does not permit consideration of extrinsic evidence of standard practice in this case, where the unambiguous language in the letter of credit required presentment of the original letter of credit. It contends the drafters of the Uniform Commercial Code, by referring to 'standard practice,' intended to codify cases that required strict compliance with express conditions of a letter of credit but recognized that mere immaterial discrepancies, such as typographical errors, could not form the basis of dishonor. "

The appellate court agreed with Issuer. Looking to the independence principle, the court indicated that a court should only engage in interpretation of the terms of a credit where they are ambiguous, noting decisional law to the effect that it would be ambiguous when it could plausibly be read more than one way."[B]y adopting standard practice as a way of measuring strict compliance, the drafters indorsed only those cases in which minor typographical errors were overlooked by the court in applying the strict compliance rule."

The appellate court also cited case law illustrating that the "strict compliance rule did not warrant the dishonor of drafts where deviations-change of "L" in "Letter" to "l," use of "No." instead of "Number," and addition of words "Clarksville, Tennessee"-were 'insubstantial' and there was no possibility that the bank could have reasonably been misled to its detriment. "

The appellate court distinguished decisions that found a presentation to be non-complying where an original was required by the LC but was not presented. It stated that the courts in these cases:

" did not look beyond the express terms of the letter of credit at issue in each case. We find nothing in the revised UCC or its comments that requires us to do any differently in the case before us, where the letter of credit's terms were clear and unambiguous. The letter of credit required presentment of the original letter of credit to obtain payment. [Beneficiaries] failed to present the original letter of credit, thereby failing to comply with the explicit provisions of the letter of credit. Therefore, [Issuer] properly denied payment."

Comments by James E. BYRNE:

1. The appellate court properly concluded that the issuer could require presentation of the original.

2. Interestingly, neither Issuer nor the court referred to ISP98 Rule 3.12 (Original Standby Lost, Stolen, Mutilated, or Destroyed) which would have shed light on the meaning of standard practice in this area.

3. The issuer could have avoided this litigation had the standby been issued under the ISP, which was designed to provide for this situation.

4. The court's treatment of strict compliance is notable. Instead of assuming literal replication, it recognized that trivial differences do not render a presentation non compliant.

5. As to standard practice, the appellate court was only partially correct. Had it been the uniform practice that an affidavit would suffice if, for example, accompanied by an acceptable indemnity, that practice would have been relevant. As to the local banker's statement, he could have meant that all local banks would have followed this practice or that they thought that they had discretion (which is what ISP98 says). At most, this statement would have given rise to an issue of fact that required further consideration and oral testimony with the opportunity for cross examination.

6. This case should also serve as a reminder to beneficiaries of the danger of the requirement that the original LC be presented without providing for an alternative. In particular, this case signals the danger of acting without having the original text in hand. Here, it appears that Applicant failed to provide it to Beneficiary.

[JEB/ees]

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.