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Note: When Samuel Buchbinder (Surety) and Rony Natanzon (Indemnitor), co-owners of various business interests dissolved their relationship, Surety transferred all interest to Indemnitor as reflected in a Memorandum of Understanding. Previously and in a separate transaction, Surety had agreed to reimburse UBS AG (Issuer) for any drawings on two US$500,000 LCs issued in favor of Bank Leumi (Beneficiary). Surety posted US$318,609 in cash and 85,000 shares of stock as collateral. In regard to the LCs, the Memorandum between Surety and Indemnitor provided that "[Indemnitor] guarantees personally that he will reimburse [Surety] without offset demand or counterclaim any draw on the [US]$1,000,000 letters of credit with all costs and attorneys fees of collection."

Although the LCs originally expired on 31 January 2002, an extension until 31 January 2003 was requested by Beneficiary and agreed to by Issuer. However, when Issuer amended the LCs to reflect the extension, it erroneously stated 31 December 2003 Beneficiary an extension of twelve months, Issuer effectively gave an extension of twenty-three months. On 29 January 2003, Beneficiary informed Issuer that it considered the LCs to be in effect until 31 December 2003. Issuer requested that Beneficiary agree to cancel the LCs as of 31 January 2003. Beneficiary refused, and on 3 February 2003 drew on the LCs for the full US$1,000,000. Issuer honored the LC then seized Surety's assets as collateral, applying it to the amounts paid.

Surety then asked Indemnitor for reimbursement which Indemnitor refused. Surety filed an action against Issuer for wrongfully debiting him, claiming that the LCs had expired at the time of payment. Surety also filed this action against Indemnitor, claiming reimbursement under the Memorandum. Surety's claim against the Issuer was settled and the US$318,609 in cash and 85,000 shares of stock was returned to Surety. As a result of this settlement, Surety reduced the claim against Indemnitor to US$114,450.07 for lost interest and litigation expenses for both actions. On cross motions for summary judgment, the U.S. District Court for the District of Maryland, Motz, J., granted Indemnitor's motion and denied Surety's motion.

The district court had ruled that because the letters specifically required Surety's written consent to modify the expiration date and such consent was not given to extend the letters past 31 January 2003, the LC ceased to exist after this date. Thus, Surety's claim based on non-existent LCs was moot.

On appeal, the United States Court of Appeals for the Fourth Circuit, Hamilton and Floyd, JJ., Niemeyer, J., dissenting, affirmed the ruling in favor of Indemnitor.

Surety argued that according the Independence Principle the LCs did not expire on 31 January 2006 and that the continued existence of the LCs and the agreement by the Indemnitor to reimburse Surety for "any draw on the [US]$1,000,000 letters of credit with all costs and attorneys fees of collection" required Indemnitor to repay the lost interest and attorney's fees.

The appellate court of appeals agreed with Surety's argument that the LCs did not end on the earlier 31 January 2006 date. The court further stated that the independence principle "provides for the independence of each distinct relationship pertaining to a particular letter of credit.... [which means that] the Letters of Credit had expired between [Issuer] and [Surety] as of January 31, 2003, but remained intact as between [Issuer] and [Beneficiary] until December 31, 2003." The court also noted that the Issuer had acknowledged the LCs as valid between itself and Beneficiary by honoring Beneficiary drawing on them.

However, because Surety's obligations towards Issuer ended on 31 January 2006, the taking of collateral on the part of Issuer was thus wrongful. Interpreting the Memorandum between Surety and Indemnitor, the court held that a reasonable person would not conclude that the promise by Indemnitor to repay costs associated with "any" draw on the LCs included lost interest and attorney's fees to reacquire "an amount equal to the amount of any assets wrongfully seized by a third-party in connection with draws on the Letters of Credit, made after [Surety]'s legally enforceable financial responsibility on those Letters of Credit had expired...."

[JEB/bain]

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