Article

Factual Summary: In connection with a contract to build a cargo-handling facility at the Indira Gandhi International Airport in New Delhi, India, Applicant/Contractor was required to obtain a performance guarantee from local bank that ran in favor of the Airport Authority of India (AAI). As security for the performance guarantee, Applicant obtained a counter-standby LC in favor of Beneficiary. One of Applicant's sub-contractors helped Applicant obtain the LC by signing as surety for Applicant.

Subsequently, after a dispute between AAI and Applicant over Applicant's performance under the contract that was unrelated to Surety's performance on the underlying contract, AAI claimed on the performance guarantee. Beneficiary, in turn, drew on the standby LC, making a complying demand on the Issuer.

Without regard to a choice-of-law and forum selection clause in the underlying construction contract identifying India as the forum for any legal disputes, Surety sued Issuer in Alabama state court to enjoin it from honoring the LC.

The trial court granted Surety's request for an injunction. On appeal, reversed.

Legal Analysis:

1. Surety vs. Guarantor; Guarantor v. Surety: In a footnote, the court noted that the LC identified Surety as a "guarantor." According to the court, however, the entity is actually a "surety." "A surety is jointly and severally liable with the principal on the underlying obligation...When distinguishing between contracts of suretyship and guaranty, this Court looks to the substance of the obligation, not to the terms used by the parties." The court provided no additional analysis of this issue.

2. Independence; Fraud; UCC § 5-109(b): Claiming that AAI, the beneficiary of the local guarantee had fraudulently misrepresented its right to make a demand on the performance guarantee, Surety sued to enjoin honor. The trial court concluded that AAI's claim on the performance guarantee was, in fact, fraudulent because AAI's cost to remedy perceived deficiencies was only a small fraction of the amount of the performance guarantee, and AAI actually owed substantial sums to Applicant. The trial court also concluded Surety did not have any adequate remedy at law because the contract required Surety to pursue any claim against AAI in an Indian court, and AAI asserted that Indian law would not provide the surety a remedy.

Citing Alabama precedent, the appellate court initially noted the commercial import of maintaining a standby LC's independence from any underlying transaction. "[P]arties choose this security arrangement over another so that they may have the benefit of prompt payment before any litigation occurs. We recognize that, as a general rule, letters of credit cannot exist without independence from the underlying transaction. Thus, when courts begin 'delving into the underlying contract, they are impeding the swift completion of the credit transaction,'" Quoting Southern Energy Homes, Inc. v. AmSouth Bank of Alabama, 709 So. 2d 1180, 1185-86 (Ala. 1998). The court noted, that the "extensive use of the fraud exception" risked transforming the LC obligation into the equivalent of a surety contract, where the surety must first be sued in order for the aggrieved party to obtain payment. "Therefore, we resist the temptation that the fraud exception invites to 'transform the quick, efficient payment mechanism of the standby credit into the protracted surety contract inquiry.'"

3. Fraud; Revised UCC Section 5-109(b)(3): Applying Revised UCC Article 5-109(b)(3), the appellate court noted that "[b]efore enjoining payment, however, the court must find that 'all of the conditions to entitle a person to [injunctive] relief under the law of this state have been met.'"

4. Injunction; Fraud; Remedy at Law; Forum Selection: The appellate court concluded that Surety had an adequate remedy at law for any loss it incurred by way of reimbursing the Issuer because the surety had recourse against Applicant for reimbursement. "When a surety satisfies the principal's obligation, it is entitled to reimbursement or restitution from the principal. . . . Alabama law thus recognizes [the surety's] right to recover from [Applicant] to the extent that it must satisfy [Applicant's] obligation. . . . [This right] arises solely out of [Surety's] position as surety for [Applicant]... [and] is not subject to the choice-of-law and forum-selection clauses in the contract. [The surety] can sue [Applicant] in an American court to recover any money it must pay on [Applicant's] behalf." Accordingly, since Surety had an adequate remedy at law against Applicant, the court concluded an injunction was improper and reversed the trial court's order granting an injunction without even addressing the question of letter of credit fraud.

Comments by DCW:

1. This case properly illustrates the rigor with which courts should address applications for extraordinary relief.

2. One also wonders if the rule regarding sureties for an applicant is as absolute as this opinion indicates. For example, if the beneficiary was undoubtedly engaged in fraud, one wonders if the same result would obtain.

Comments by James G. BARNES*:

1. This opinion assumes that an applicant's surety has the standing of an applicant to enjoin honor of a fraudulent drawing and does not discuss the issue of standing or any facts relevant to standing such as whether the applicant named in the LC was named or otherwise bound as a party in the case. Revised UCC 5-109 provides for injunctive relief for an "applicant", but the definition of applicant is broad enough to include a co-applicant who would qualify as a surety under suretyship law. Moreover, some reimbursement agreements address this topic and provide, e.g., that only one of the obligees is entitled to notice, etc., from the issuer. Some even expressly limit the right to seek injunctive relief to one obligee, which may or may not be the person named in the LC as the "applicant".

2. The case holds that under the Alabama requirements for obtaining injunctive relief a plaintiff must show irreparable injury and that this plaintiff, as a surety, must address the effect on irreparable injury of its right of reimbursement against the principalapplicant as well as its right of post honor recovery against the overseas bank beneficiary and corporate counterparty. Denial of relief on this ground is simpler and for that reason preferable to denial for lack of standing.

[JEB/JB]

* Mr. Jon W. Burd is a Member of the Maryland Bar.

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