Article

Factual Summary: Indian Tribe planned to operate a commercial buffalo farm and to finance it by the sale of US$4,650,000 in corporate bonds. To do so, Indian Tribe formed Corporation and entered into a Trust Agreement with bondholders who appointed Trustee to act on their behalf. Pursuant to the agreement, Corporation granted Trustee a security interest in the buffalo herd, slaughter-house equipment, and land. In the event that the collateral was insufficient to cover any default, a standby letter of credit was required in favor of the Trustee.

At the request of a third party surety (Applicant), bank issued a standby for US$2,200,000 in favor of Trustee and Applicant signed the reimbursement agreement. "Pursuant to the reimbursement agreement, [Applicant] became party to...the application agreement" under which Applicant waived any "claim, defense, setoff, deduction" against Issuer unless Issuer acted with "willful misconduct or wanton disregard of [Applicant's] rights". In addition, Applicant agreed to reimburse Issuer for LC related attorney's fees and expenses "incurred by [Issuer]".

The standby required presentation of a draft accompanied by either:

A) STATEMENT FROM [Beneficiary/Trustee certifying that the Corporation is in default and that Beneficiary has foreclosed the security interest and mortgage and that the proceeds from such foreclosures were insufficient to cure the default]

OR;

B) [Issuer's] NON-RENEWAL NOTICE

The standby further stated:

IT IS A CONDITION OF THIS LETTER OF CREDIT THAT IT SHALL BE DEEMED AUTOMATICALLY EXTENDED, WITHOUT AMENDMENT, FOR AN ADDITIONAL ONE YEAR PERIOD FROM THE PRESENT OR ANY FUTURE EXPIRY DATE, UNLESS AT LEAST SIXTY (60) DAYS PRIOR TO THE THEN CURRENT EXPIRY DATE WE NOTIFY YOU IN WRITING, BY CERTIFIED MAIL OR COURIER, OF OUR INTENTION NOT TO EXTEND THIS LETTER OF CREDIT FOR ANY ADDITIONAL PERIOD. UPON RECEIPT BY YOU OF SUCH NOTICE OF NON-RENEWAL YOU MAY THEN DRAW HEREUNDER WITHIN THE THEN CURRENT EXPIRY DATE, AND UP TO THE THEN AVAILABLE AMOUNT BY PRESENTATION OF YOUR DRAFT DRAWN ON US AT SIGHT ACCOMPANIED BY A WRITTEN STATEMENT FROM THE TRUSTEE STATING THAT: "WE HEREBY CERTIFY THAT WE HAVE RECEIVED NOTICE FROM [U.S. Bank] THAT THEY DO NOT INTEND TO EXTEND THEIR LETTER OF CREDIT NO. S103966 BEYOND THE CURRENT EXPIRATION DATE." IN ANY EVENT THIS LETTER OF CREDIT SHALL NOT BE AUTOMATICALLY EXTENDED BEYOND MAY 15, 2003, THE FINAL EXPIRATION DATE.

Although Corporation defaulted, Trustee did not foreclose on any security interests. On the day prior to the final expiration date, Trustee/Beneficiary "submitted a sight draft for the full amount of the credit and certified that the Bank had declined to permit the credit to automatically renew." Claiming that it had not refused to renew the standby or sent a notice to that effect, Issuer refused payment.

Trustee/Beneficiary sued Issuer for wrongful dishonor, and Issuer brought a third party complaint against Applicant who counter-claimed against Issuer for willful misconduct and against Trustee/Beneficiary for breach of the trust agreement. On cross motions for summary judgment, the trial court granted summary judgment in favor of Issuer and against Beneficiary/Trustee, granted summary judgment in favor of Issuer against Applicant, and granted summary judgment in favor of Applicant against Beneficiary/Trustee.

Legal Analysis:

1. Interpretation: In interpreting the terms and conditions of the LC, the court applied "ordinary interpretive principles of law". It noted that "[a]lthough courts sometimes apply rules governing the construction of contracts to credits, such rules should be applied only when doing so would not undermine the unique purpose of credits.... As discussed, central to such purpose is the independence principle and the rule that the decision whether or not to pay a beneficiary be based solely on comparing the documents submitted to the terms of the credit. Thus, when a credit's terms are clear, a court should not construe them at all. A court should engage in interpretation only if a credit is ambiguous."

2. Evergreen, Ambiguity; Ambiguity; Notice of Non-Renewal: The court noted that one portion of the LC required presentation of a draft accompanied by a non-renewal notice while another portion required "PRESENTATION OF YOUR DRAFT DRAWN ON US AT SIGHT ACCOMPANIED BY A WRITTEN STATEMENT FROM THE TRUSTEE STATING THAT: WE HEREBY CERTIFY THAT WE HAVE RECEIVED NOTICE FROM [Issuer] THAT THEY DO NOT INTEND TO EXTEND THEIR LETTER OF CREDIT NO. S103966 BEYOND THE CURRENT EXPIRATION DATE." Although characterizing these provisions as ambiguous, the court noted that it need not address them because it concluded that Issuer had not sent a notice of non-renewal.

3. Evergreen Clause; Nature of Non-Renewal; Renewal; Non-Renewal: Trustee/Beneficiary stated that "in any event, this letter of credit shall not be automatically extended beyond May 15, 2003, the final expiration date." The court rejected this argument. The court concluded that the notice triggering the drawing must express Issuer's intent not to extend the credit. It ruled that the statement in the LC that read "in any event, this letter of credit shall not be automatically extended beyond May 15, 2003, the final expiration date", reserved Issuer an option to extend the LC and therefore failed as a notice of non-renewal. The court also stated that "treating the letter as a non-renewal notice would produce absurd results. Because the letter authorizes [Beneficiary/Trustee] to draw on it 'upon receipt' of the non-renewal notice, if the letter were a nonrenewal notice, [Beneficiary/Trustee] could have drawn the full amount of the credit as early as the day the credit was created provided that the Bank mailed the letter to [Beneficiary/Trustee] by certified mail on that day. This result would beabsurd [sic] because a letter of credit is designed to provide for payment upon the happening of certain events subsequent to its issuance."

4. Fraud; Prior UCC Section 5-114; Letter of Credit Fraud: The court stated that the "evidence establishes that [Beneficiary/Trustee] falsely certified that it had received a non-renewal notice. Putting aside the letter, it is undisputed that the Bank never sent [Beneficiary/Trustee] a non-renewal notice, and as previously explained, under the UCC an issuer need not honor a request for payment when it knows that the documents submitted in support of the request are fraudulent." The court cited Wisconsin's version of Prior UCC Section 5-114.

5. Willful Misconduct; Reimbursement: Applicant argued that it was excused from indemnifying Issuer for attorney's fees under the Reimbursement Agreement because of Issuer's willful misconduct. The court rejected the argument, noting that the argeement does not excuse Applicant from an obligation to indemnify for attorney's fees for willful misconduct: "Thus, even if the Bank committed willful misconduct or acted in wanton disregard of [Applicant's] rights, [Applicant] would still be liable for the Bank's expenses and attorneys' fees. Second, [Applicant] fails to explain how the Bank's erroneous interpretation of the letter constituted either willful misconduct or a wanton disregard of her rights. Willful misconduct is 'misconduct committed voluntarily and intentionally,' and 'misconduct' is '[a] dereliction of duty; unlawful or improper behavior.'" The court also noted that there was no proof of conduct by Issuer that rose to the level of willful misconduct and ordered Applicant to fully reimburse Issuer for legal costs.

6. Prior UCC Section 5-111; Breach of Warranty; Indemnity; Standing; Interested Party; Trust Agreement: Applicant argued that Trustee/Beneficiary breached the trust agreement by submitting documents without first foreclosing on the security interests or receiving Issuer's notice of nonrenewal. Trustee argued that Applicant lacked standing under the trust agreement, which stated only bond-holders are third-party beneficiaries. Although the court agreed that Applicant was not a third-party beneficiary to the trust agreement, it concluded Trustee in breach of a warranty under Wisconsin's version of Prior UCC Section 5-111 which states "beneficiary by...presenting a documentary draft or demand for payment warrants to all interested parties that the necessary conditions of the credit have been complied with." The court concluded that Applicant was an "interested party" thus enabling Applicant "in a standby letter of credit case to proceed against a beneficiary who falsely certifies that the conditions of the credit have been satisfied. As discussed, in the present case [Beneficiary] falsely certified that the [Issuer] had provided it with a non-renewal notice. By doing so, [Beneficiary] breached its warranty to [Applicant] and is liable to [Applicant] for the damages she incurred because of the breach." The court, therefore, granted Applicant's motion for summary judgment and ordered Trustee to pay Applicant's attorney fees and costs to include those arising out of Issuer's indemnity action against Applicant.

7. Choice of Law, Revised UCC Article 5: The court applied the law of Wisconsin to the LC and the reimbursement agreement, noting that there was no argument that there was a conflict of law. Noting that the LC Application is subject to the law of Minnesota, the court nonetheless applied Wisconsin law because their breach of warranty provisions are "not materially different." The court did note that Minnesota, which had enacted Revised UCC Article 5 in July 2001, provided for attorney's fees. Since Wisconsin had not yet enacted Revised UCC Article 5, there was no provision for attorney's fees. The court requested further briefing on this issue.

Comments

1. Final Expiration Date. The court's reasoning about the absurdity of the argument that the LC could be drawn on at the time it was issued is misplaced. While some LCs cannot properly be drawn on as soon as they are issued, most LCs are available for drawing when they are issued. That fact does not make them a money order as the court suggests. A money order is payable at sight. A LC is payable against required documents. Simply because the LC is available at the time of issuance does not mean that the documents can properly be produced and presented at once. Whether they can or not, however, has nothing to do with when the LC is available. The court misses the more important reason supporting its decision, namely the basis of the final expiration date in a LC. For safety and soundness reasons, such clauses when present in credits should be given effect. Such a clause brings to an end the cycle of renewal regardless of notices. To imply that a notice is required where not expressly mandated by the LC would undermine this device. In its more subtle form, the beneficiary's argument that the pending expiration entitled it to draw is not supported by the terms of the credit. In retrospect, beneficiaries that face such a final expiration provision may want to consider requiring that there be a term in the LC also permitting a drawing in such an event. In its absence, however, a drawing such as that made here is improper.

2. The court suggested that the beneficiary's action in certifying the LC constituted material fraud. Without regard to the beneficiary's intent (which is not relevant for LC purposes), a statement that there had been a notice of non-renewal when none had been given does constituted letter of credit fraud.

3. The inconsistent drawing requirements in the LC reveal a certain carelessness in drafting the LC. Had the issue arisen, the beneficiary should have been allowed to make a presentation in compliance with either version.

[JEB/ejh]

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