Article

Factual Summary: Underwriter underwrote the full amount of a combined insurance policy for roofing contractors that was created by Insurance Agency. The policy encompassed general liability, worker's compensation and automobile liability coverage. Underwriter set the premiums and withheld10%, which it used to pay claims and expenses. For amounts in excess, Underwriter obtained reinsurance from Reinsurer to which it forwarded 90% of the premiums. Underwriter, however, undertook to indemnify Reinsurer for losses exceeding the premiums.

The first year claims were under-reserved by Underwriter's agent who was handling them. When Underwriter realized that it was responsible for the losses, it "instructed its [Officers] to tell [Owners]that they actually were personally liable for those losses ... [and] that in exchange for payment,[Underwriter] or [Reinsurer] could obtain additional reinsurance to cap [Owners'] potential liability. Thus... [Underwriter] and [Reinsurer] were asking[Owners] to pay for additional insurance to cover losses that were not the responsibility of [Owners],but rather were the responsibility of [Underwriter]."To avoid personal liability, Owners agreed to pay Reinsurer US$1,000,000 for additional reinsurance based on what they were told by Underwriter.

The obligations were contained chiefly in a "shareholder agreement". The shareholder agreement contained a forum-selection clause stating that "this Agreement has been made and executed in Bermuda and 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." The shareholder agreement also required the Owners of the Agency to indemnify the Reinsurer. To cover their personal obligation to Reinsurer, Owners applied to two banks which each issued a standby LC payable to Reinsurer.

When Owners discovered the deception, they immediately sued Reinsurer and related entities for fraud and injunctions in the US federal courts in Northern District of Illinois, and simultaneously sued in the US federal courts to enjoin the two Issuers and Reinsurer from honoring any draws on the standby where each Issuer was located. The bank in this case was located in the Eastern District of Michigan and the other bank in the Central District of California.

Temporary restraining orders were quickly issued against honor and negotiations ensued. After they broke down, Reinsurer sued Owners in Bermuda to enforce the shareholder agreement and moved to dismiss in each of the American lawsuits on jurisdictional grounds and on the propriety of the venue.

In the Illinois action, the trial court dismissed the lawsuit because the forum selection clause in the shareholder agreement required Owners to pursue their claims against Reinsurer in the courts of Bermuda. The court noted that Owners had not argued that they were fraudulently induced into agreeing to the forum selection clause, but merely that Bermuda was inhospitable because its bankruptcy laws favored Reinsurer. However, the Central District of California granted a preliminary injunction. In this case, the US District Court for the Eastern District of Michigan also issued an injunction, but conditioned it on Owners prosecuting their Illinois appeal diligently, or, if their appeal failed, commencing an action in Bermuda on the same claims.

Subsequently, in the Illinois decision, the Seventh Circuit affirmed, dismissing the claim because of the forum selection clause. Owners then instituted an action against Reinsurer in Bermuda.

Reinsurer appealed the Michigan court injunction in this case, and the Sixth Circuit vacated the preliminary injunction.

Legal Analysis:

1. Standing: Owners argued that Reinsurer lacked standing to appeal the injunction because "it was not itself enjoined." The appellate court noted that Reinsurer had been named as a party and was affected since an injunction against Issuer deprived it of funds. It ruled that standing may not be denied to a named party even if it contests jurisdiction.

2. Standard of Injunction; Injunction, Standard of; Preliminary Injunction: The appellate court stated the four traditional factors to be considered when issuing a preliminary injunction:(1) whether the person seeking relief has shown a strong likelihood of success on the merits; (2)whether the person seeking relief will suffer irreparable harm if the injunction is not issued;(3) whether the issuance of the injunction would cause substantial harm to others; and (4) whether the public interest would be served by issuing the injunction. It also noted that "a preliminary injunction is an extraordinary remedy."

3. Injunction; Irreparable Harm: The appellate court called attention to the conclusion of the trial judge that "there is also certainly a possibility of irreparable injury inasmuch as once released, the money is likely as alleged to be dissipated in light of the questionable financial circumstances of [Reinsurer]." The appellate court ruled that issuance of the preliminary injunction was error because as a matter of law Owners had failed to demonstrate irreparable harm. The court noted that injunctions are extraordinary, stating that "[i]n the context of an international letter of credit, there are particular concerns that make the issuance of a preliminary injunction even more extraordinary and which accordingly require a clearer demonstration of exceptional circumstances." Citing Enterprise Int'l,Inc. v. Corporaction Estatal Petrolera Ecuatoriana, 762 F.2d 464 (5th Cir. 1985), the court noted with approval the proposition that an injury cannot be "irreparable" if it can be "undone" by a monetary remedy and that courts generally do not enjoin honor of LCs if the only harm is monetary, the exceptions being when it is clear there is no legal remedy whatsoever. It also noted that the speculative nature of potential relief in a foreign court does not constitute irreparable harm.

Applying these principles, the appellate court determined that the only injury shown by Owners was monetary. The court asked whether there were exceptional circumstances that would outweigh the policy against the award of injunctive relief. It noted that Owners had argued that Reinsurer/Beneficiary and related entities were insolvent, supporting their contentions by introduction of evidence of rehabilitation proceedings for a related entity. The court also stated that "[w]ithout more, this does not constitute extraordinary circumstances. Indeed, other courts have denied injunctions in cases in which it was unlikely that any foreign court could hear the underlying claim, a much more dire situation.... Here, the chance that [Reinsurer] is or will become bankrupt and will not be able to satisfy a judgment obtained against it presents less threat of irreparable harm than the chance that there will not even be a proceeding available in which to obtain judgment."

The appellate court also noted that Owners had not argued that "they can never achieve a remedy in Bermuda courts. Because the [Owners] have not demonstrated that their potential monetary injury constitutes an exceptional circumstance, they are not entitled to an injunction".

4. Independence Principle: Owners argued that an injunction was appropriate because Reinsurer had not demonstrated the validity of its claims to the LC proceeds. The appellate court dismissed this argument, stating "[t]his argument ignores the very nature of a letter of credit - it guarantees payment apart from the merits of the underlying disputes.... The [Owners]are free to litigate the merits of their fraud claim in Bermuda, but those merits are not relevant to the question before this court."

Comments by James E. Byrne:

1. Standing: Interestingly, in ruling that the beneficiary has standing, the appellate court overlooked the provision of Revised UCC Section 5-109(b)(2) that referred to the right of the beneficiary to adequate protection.

2. The court states the general proposition that injury is not irreparable with respect to an international letter of credit when there is insolvency without more. Indeed, it notes that the unlikelihood of relief in a foreign court itself may not be a basis for injunctive relief. It is fair to note that the jurisprudence has not produced a coherent standard when it comes to the question of irreparable harm and monetary damages and the cases are difficult if not impossible to reconcile. The statute offers no guidance on this question, other than its failure to list the traditional requirements for injunctive relief. While there is not a clear answer, the degree of the letter of credit fraud is a factor that should be considered in addition to the other factors. What is wanted is a balance of these various factors without any one being decisive.

Comments by Professor Claire R. KELLY*:

1. Irreparable Harm: The court correctly upholds the principle that injury is not irreparable when it can be undone by monetary damages. The speculative claim that a party may become insolvent should not be enough to satisfy the prong of irreparable harm. By referring to the Iranian cases the court correctly leaves open the possibility that that the possibility of damages may nevertheless be illusory where in fact it is clear that the moving party would have "no legal remedies at all."

2. Independence Principle: The court is correct with respect to its analysis and statement concerning the independence principle. However, as discussed below it would seem that some inquiry as to the fraud itself would be part of the preliminary injunction standard as it relates to "whether the movant has shown a strong likelihood of success on the merits."

3. Fraud, the Preliminary Injunction and Likelihood of Success on the merits: One slightly troubling bit of dicta comes at the very end of the opinion where the court correctly rejects the Applicants' arguments that Beneficiary has not demonstrated the validity of its claims to the funds. The court is correct that right to payment is generally irrelevant to the injunction inquiry because of the independence principle and Beneficiary should not have to demonstrate that it is entitled to funds in order to be able to draw on a LC or to avoid the injunction. Nevertheless the court thereafter states that the Applicants are "free to litigate their fraud claim in Bermuda, but those merits are not relevant to the question before the court." One prong of injunctive inquiry however inquires as to whether there is a likelihood of success on the merits, more specifically whether it will likely be shown that honoring the LC will facilitate a fraud. Thus to the extent that the fraud claim is related to fraud in the 5-109 sense it would not seem to always be irrelevant to a court's inquiry on a preliminary injunction motion. Of course, the court may not have needed to get that far since the failure to show irreparable harm in this case could be enough to defeat the motion for an injunction. Moreover, the notion that the court would be required to make some inquiry into actual fraud might suggest that the dispute was actually more appropriately heard in Bermuda pursuant to the venue clause. This last point however may be countered by the fact the Bank was not a party to the shareholder agreement in which the venue selection clause or as the Ninth Circuit found in the related case that the scope of the clause simply did not reach an action to preserve assets. However, the court did not address either of these arguments.

[JEB/jjdd]

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

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