Article

Factual Summary: To support a combined insurance program created by Applicant for roofers encompassing general liability, worker's compensation and automobile liability coverage, Underwriter obtained reinsurance from Reinsurer. The obligation was set forth in various documents including a "shareholder agreement" that required Owners to indemnify the Reinsurer. To cover their personal obligation to Reinsurer, the Owners of the insurance agency applied to Bank which issued a standby LC payable to Reinsurer. The shareholder agreement contained a forum-selection clause stating that "this Agreement ... shall be exclusively governed by and construed in accordance with the laws of Bermuda and any dispute concerning the Agreement shall be resolved exclusively by the courts of Bermuda."

Underwriter's agent under reserved the claims. When Underwriter realized that it was responsible for the losses, it "instructed [the officers of Underwriter] to tell [Applicants] that they were personally liable for those losses ... [and] that in exchange for payment, [Underwriter] or[Beneficiary] could obtain additional reinsurance to cap [Applicants'] potential liability. Thus ...[Underwriter] and [Beneficiary] were asking [Applicants] to pay for additional insurance to cover losses that were not the responsibility of [Applicants], but rather were the responsibility of [Underwriter]."[Hendricks v. Comerica Bank, abstracted at 2006 Annual Survey 347] To avoid any potential personal liability, Applicants agreed to pay Beneficiary US$1,000,000 for additional reinsurance based on what they were told by Underwriter.

When Applicants discovered the deception, they sued Beneficiary for fraud in the Northern District of Illinois, and subsequently sued to enjoin Issuers and Beneficiary from honoring any draws on the standby in this appeal from the action in the Central District of California, where one issuer was located, and another in the Eastern District of Michigan, where another issuing bank was located.

The U.S. District Court for the Northern District of Illinois, Castillo, J., dismissed the lawsuit because the forum selection clause in the shareholder agreement required Applicants to pursue their claims against Beneficiary in the courts of Bermuda. However, the U.S. District Court for the Central District of California, King, J., and the Eastern District of Michigan, O'Meara, J., issued temporary restraining orders. The injunction ordered by the District Court for the Eastern District of Michigan was conditioned on Applicants prosecuting their Seventh Circuit appeal diligently, or, if their appeal failed, commencing an action in Bermuda on the same claims.

Subsequently, in the appeal of the action before the Northern District of Illinois, the Seventh Circuit Court of Appeals affirmed the decision of Castillo, J., dismissing the claim because of the forum selection clause. Applicants then instituted an action against Beneficiary in Bermuda.

Beneficiary then commenced the instant appeal from the injunction granted by King, J., in the Central District of California. The U.S. Court of Appeals for the 9th Circuit affirmed the trial courts issuance of the injunction.

Legal Analysis:

1. Venue; Collateral Estoppel; Issue Preclusion: Beneficiary argued that the forum selection clause in the shareholder agreement required dismissal of the action in California since this venue was improper. Beneficiary contended that the trial court was, in effect, bound by the decision of the Ninth Circuit Court of Appeals in the related American Patriot case brought in Illinois under the doctrine of collateral estoppel or issue preclusion under which a court is bound where the identical issue has been previously decided as between the same parties. The Seventh Circuit Court of Appeals had ruled that "the shareholder agreement's forum selection clause bars courts outside Bermuda from adjudicating [Applicants'] substantive claims for fraud, breach of contract, and other claims." Beneficiary claimed that the California trial court was, therefore, collaterally estopped or precluded from considering this issue. The appellate court disagreed, noting that independent consideration of the venue question would only be prevented if "'the issue at stake' in the instant litigation is 'identical to' an issue' alleged' and 'actually litigated in the prior litigation.'" The appellate court distinguished the venue issue in this case from that decided in the American Patriot Insurance Agency, Inc. v. Mutual Risk Management, Ltd. (supra.) case cited by Applicants because, in American Patriot, the Applicants "sought a final judgment on the merits of their dispute[,]"whereas in this case the question was "whether the shareholder agreement's forum selection clause prevents courts outside Bermuda from issuing temporary injunctions to secure assets pending a final judgment on the merits in Bermuda."

With respect to the forum selection provision, the appellate court noted a presumption of validity and enforceability unless the party challenging it is able to establish that it is unreasonable. The appellate court noted, however, that the issue in this case is "significantly different" in that Applicants were contending that "the clause's scope does not extend to actions designed to preserve assets pending a judgment on the merits in the contractually selected forum."

The appellate court, drawing on a prior decision involving a charter party in which the court concluded that a forum selection clause in the charter party did evidence intent to prevent a party from obtaining prejudgment security in another forum by means of attachment, applied this rationale to injunctions under revised UCC Section 5-109.

The appellate court concluded that "the forum selection clause manifests the parties' consensus to litigate the merits of 'any dispute concerning [the Shareholder] Agreement' in Bermuda." It then reasoned that Beneficiary "has not shown from the language of the shareholders agreement or presented any evidence that the parties intended to limit actions outside Bermuda for prejudgment injunctive relief[.]"Accordingly, it ruled that there was no abuse of discretion in the conclusion of the trial court that California was an appropriate venue for an injunction.

2. Injunction; Revised UCC 5-109: Beneficiary argued that a preliminary injunction in this action was inappropriate because "final resolution of the underlying fraud claim would not occur" in the California court. Looking to California law, the appellate court noted that:

California law expressly allows "a court of competent jurisdiction [to] temporarily ... enjoin"a bank from honoring a letter of credit "or grant similar relief" if the plaintiff claims that honor would "facilitate a material fraud" by the beneficiary on the plaintiff and certain requirements are satisfied. Cal. Com. Code §5109(b) [California's version of Revised UCC Article 5 Section 5-109]. The statute contains no requirement that final resolution of the merits must occur in the same court that grants the "temporar[y]" or "similar" relief.

The appellate court, therefore, ruled that the trial court had the authority to enter a preliminary injunction, noting that there was no difference between "temporary" and "preliminary" relief.

3. Standing: The appellate court noted that Issuer chose not to appear since the preliminary injunction. It asked whether Beneficiary had standing to appeal the order against Issuer. The appellate court ruled that Beneficiary had standing to appeal even though the enjoined party did not appeal. The appellate court cited Goldie's Bookstore, Inc. v. Superior Court, 739 F.2d 466 n. 2 (9th Cir. 2001) for the proposition that, in order to have standing, the beneficiary must have been a named party at the time of judgment and must also demonstrate that it "[was] aggrieved by the decision being appealed." The beneficiary in this case satisfied both requirements. Moreover, the court was unmoved by the argument that Beneficiary's continued objection to personal jurisdiction affected its standing, finding that, if such a position waived appellate standing, "we would essentially immunize district courts' personal jurisdiction determinations from appellate scrutiny."

4. Injunction; Jurisdiction: As a threshold matter, the court addressed whether it could review Beneficiary's procedural challenges to venue and personal jurisdiction as pendent to the court's preliminary injunction determination. The court assessed whether these issues were "inextricably intertwined' with or "necessary to ensure meaningful review of" the order issued below. The court found that the issues were necessary to ensure meaningful review (and thus it did not have to reach the question of whether they were also 'inextricably intertwined').It based its decision on the grounds that:

[Beneficiary's] procedural defenses bear on the district court's power to issue the injunction, because the court would lack authority to grant relief if (1) Mutual was a necessary and indispensable party and immune from personal jurisdiction in this forum, or (2) venue was improper because the forum selection clause precluded preliminary injunctive relief outside Bermuda.

5. Personal Jurisdiction; Injunction, Necessary Parties: Beneficiary argued that the trial court should have dismissed the action for injunctive relief since it was not subject to the power of the trial court. The appellate court noted that dismissal would not be appropriate if Beneficiary was neither a necessary nor an indispensable party to the injunction action. In considering the effect of the action of the trial court, the appellate court concluded that it "delivered complete relief to [Applicants] without [Beneficiary's]direct participation in the suit by enjoining the Bank from honoring a draw on the LOC pending the outcome of litigation between the [Applicant] and[Beneficiary] in another forum." It noted that Beneficiary remained able to protect its interests in the LC and was not threatened with inconsistent obligations "because the district court merely preserved an asset while the parties awaited final judgment on the merits in another forum".

6. Irreparable Harm: The appellate court noted that the text of Revised UCC Section 5-109 does not expressly include a requirement of irreparable harm although some courts have also applied that test. It avoided answering that question since it determined that irreparable harm had been shown. The appellate court found persuasive Applicants' argument that the risk of irreparable harm was "virtually self evident". Noting that evidence before the trial court justified the conclusion that Beneficiary "remained in a precarious financial position", the appellate court concluded that the trial court had not abused its discretion in granting injunctive relief and that Beneficiary was in serious financial straits "and would likely dissipate the LOC funds before the [Applicants] could obtain a judgment on the merits". Relying on the Sixth Circuit Court of Appeals reversal of the action brought in Michigan in a related case,[Hendricks v Comerica Bank, supra.] that ruled that as a matter of law Applicants had failed to prove irreparable harm since insolvency alone is insufficient and noting that Beneficiary had not made that argument but had argued that there was no evidence that Beneficiary was or was about to be insolvent and that it could not pay a judgment, the appellate court ruled that Beneficiary was foreclosed from raising this argument on appeal. It also noted that Beneficiary had not raised the question of whether the Sixth Circuit Court decision was binding in this case on the grounds of collateral estoppel or the like.

7. Material Fraud; Letter of Credit Fraud; Revised UCC Section 5-109; Injunction; Injunction, Likelihood of Success on the Merits: The appellate court noted that injunctive relief was appropriate "only if the record shows that allowing[Beneficiary] to draw down on the LOC 'more likely than not' would facilitate a material fraud by[Beneficiary]." The district court granted the injunction because there was a "sufficient showing of likelihood of success on the merits of [their] claim of material fraud" and that there was certainly a possibility of irreparable injury. The court inquired as to whether "the record shows that allowing Mutual to draw down on the LOC 'more likely than not' would facilitate a material fraud." The court was satisfied with the district court's finding because the Hendricks had established a prima facie case of fraud, which Beneficiary "did not challenge."

Comments by James E. BYRNE:

1. Irreparable Harm: The court is ambivalent about the degree to which irreparable harm is a factor. In effect, it bases its irreparable harm finding on the fact that the beneficiary did not question the relevancy of solvency to an irreparable harm finding but merely challenged whether there was an actual showing of insolvency. This approach may not be consistent with the general rule that recovery of a money judgment provides adequate relief and that it is irrelevant whether the judgment can be collected. With respect to LC fraud, however, the cases have been less rigorous in their approach to irreparable harm and what constitutes it, perhaps for the reason that an additional factor is present, namely the necessary presence of letter of credit fraud. In addition, the award of an injunction, while interrupting the agreed payment and distorting the status quo, does not ultimately prevent payment provided that the beneficiary is assured through an extension of the LC or a similar device. Consequently, where the court is persuaded that there is a likelihood that LC fraud will be proven, issues that are of concern regarding irreparable harm in a typical injunction action may be of less concern where there is letter of credit fraud.

2. Standing: The decision stands for the proposition that a court can enter an injunction against an issuer without the participation of the beneficiary. This conclusion is reached using the terminology of the Federal Rules and the various jurisdictional statutes, but it is one that comports with LC law and the expectations of the community. The key question is jurisdiction over the bank. If there is a confirmer, the beneficiary will be able to draw on it in its own locale. If not, it took that risk.

3. Forum Selection Clause: In its discussion of the forum selection clause, the appellate court recognized that the letter of credit undertaking was different in some fashion from the shareholder's agreement that gave rise to it, drawing on decisional law that considered the impact of a forum selection clause in a charter party agreement on the ability of one of the parties to the agreement to obtain prejudgment attachment of the assets of the charterer. The difference goes far beyond that seemingly recognized by the appellate court. Not only are we dealing with a different promise in this case, namely the letter of credit as opposed to the shareholder agreement, but one made by a different party, the issuer, rather than the parties to the shareholder agreement. Moreover, this promise is not just any promise but one that more than two centuries of law and practice have invested with the concept of abstraction or independence from the underlying transaction. One would have thought that this concept of independence would be at the forefront of the court's analysis. Perhaps in a perverse manner, the independence of the LC undertaking applies when it comes to any action on the LC including the applicable forum in which an exception to that independence can be determined. In particular, the issuer should been titled to application of the law of the place of issuance in a court that is selected in the LC or where there is jurisdiction over it and not bound by a clause n an underlying agreement.

Comments by Professor Claire R. KELLY:

1. The appellate court correctly considers whether the record will support the finding that permitting the beneficiary to draw on the LC would facilitate a fraud as part of "whether the movant has shown a strong likelihood of success on the merits." In doing so it basically relies upon the fact that the Applicant's prima facie went unchallenged by the Beneficiary. The court does not seem troubled by the fact that its inquiry into whether or not there was fraud would somehow involve assessing "a dispute concerning the shareholder agreement" which would be governed by the venue selection clause.

2. As discussed below, the court rejects the notion that the venue selection clause reaches an action to preserve assets (indicating that the parties could have written the clause in a way that would reach this type of action had they wanted to do so) even though the standard for an injunction includes an analysis of the likelihood of success on the merits.

3. Although the court notes that the Applicants bear the burden of showing that trial in the contractual forum would be unreasonable, the court shifts the inquiry from reasonableness to one that inquires into the scope of the clause. The court addresses as a question of first impression whether a venue selection clause relating to the underlying dispute controls an action to preserve assets. In doing so the court seems to place the burden on the proponent of the broader view of the clause to show that the asset preservation is covered by the clause when it indicates that there was "no indication . . . that [the parties] intended to limit proceedings to obtain prejudgment security to that forum. If the parties so intended they could have easily worded [the forum selection clause] to so provide[,]" quoting Polar Shipping Ltd. V. Oriental Shipping Corp., 680 F.2d 627, 632 (9th Cir. 1982).

Comment by James G. BARNES:

1. Although most of the decision addresses fine points of practice and procedure, including a holding that the Beneficiary is not a necessary party to the Applicant's action against the Issuer for injunctive relief, the Ninth Circuit panel upheld a fraud injunction where the Applicant made a prima facie showing of material fraud and asserted irreparable harm due to the likelihood of Beneficiary insolvency before the Applicant's fraud action against the Beneficiary would be resolved. The narrow ground on which the court based its conclusion was that the beneficiary did not argue that its solvency is irrelevant on the issue of irreparable harm, but only had argued that the Applicant failed to demonstrate that Beneficiary could not satisfy a judgment[,] and [had] failed to introduce any evidence to demonstrate that the Beneficiary was or was about to become insolvent. In my opinion, the appellate court walked a fine line to protect the applicant which had made a strong showing of fraud.

[JEB/lhd]

* Claire R. KELLY has been an Assistant Professor at Brooklyn Law School since 2003. She serves as an Associate Director for thestudy of International Business Law and is the faculty advisor for the Brooklyn Journal of International Law. Professor Kelly receivedher J.D. from Brooklyn Law School.

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