Article

Factual Summary: To assure performance of two separate construction projects on the part of Contractors (who were apparently controlled by Surety), Surety requested LCs from Issuer in favor of Beneficiaries. Beneficiaries were corporate entities owned by a third corporation, which in turn was owned by Third Party Owners. Surety also undertook to reimburse Issuer pursuant to a Master LC Reimbursement Agreement. The LC provided that it was subject to UCP500. The parties also recognized that it was subject to New York law. First Beneficiary's LC named Surety as "applicant" while Second Beneficiary's LCs "are not clear concerning the identity of the applicant, as [they] list [Contractors] as applicant[s] in one part but list ... [Surety] in another." When the LCs were drawn down, Issuer paid.

Unable to obtain reimbursement because Surety was insolvent, Issuer filed an adversarial proceeding against Beneficiaries for wrongfully drawing on the LCs and breach of their LC warranties in Surety's bankruptcy proceeding, claiming to be subrogated to the rights of Contractors against Beneficiaries and claiming unjust enrichment. Issuer also sued Third Party Owners, alleging that they had induced breach of contract and warranty by Beneficiaries. Beneficiaries and Third Party Owners moved to dismiss the action. The bankruptcy court granted all the claims as to unjust enrichment, dismissed the actions against Third Party Owners, dismissed the action against First Beneficiary for subrogation but denied the motion as to subrogation to Surety's rights against Second Beneficiary.

Issuer specifically alleged that Beneficiaries had paid funds to Contractors for payments to vendors and sub-contractors on the projects, but that Surety had "swept" up the cash and did not use it for the purpose for which it was paid. Issuer alleged that, as a result, the projects were disrupted, leading to Beneficiaries drawing on the LCs. Issuer alleged, however, that the two projects were in fact completed "substantially on time," or, as to Second Beneficiary, "deliberately delayed to cause the LC drawing." Issuer further alleged that Third Party Owners had induced these actions.

Legal Analysis:

1. Applicant; UCP500 Article 2; Revised UCC §5-102(a)(2): Issuer argued that Contractors were applicants to the LCs to whose rights on the underlying contract against Beneficiaries it was subrogated. In what the court described as an attempt to avoid the absence of privity between it and Contractors, Issuer contended that

[T]he revision of Article 5 replaced the term customer with that of applicant[,] which was intended to broaden the definition to comprehensively cover a party that requests the [LC] and, therefore, is in privity with the issuer, as well as a party not in privity with the issue but for whose account the [LC] is issued at another party's request.

First Beneficiary argued that, because the UCC definition of "applicant" conflicted with that of UCP500, the UCP500 definition should control. It further contended that "an applicant is a party that requests an LC and takes on the reimbursement obligation (which in this case was Surety) or the party for whose account the LC is obtained." [Emphasis added]. First Beneficiary argued that "because the term 'or' is used in the statute, only one of the parties can be the applicant." The court pointed out that Surety requested issuance of the LC and assumed the reimbursement obligation, making Surety "the one permissible applicant."

The court noted that the opinion in Kools v. Citibank, 872 F.Supp. 67 (S.D.N.Y. 1996), abstracted at 1996 ANNUAL SURVEY 443, addressed the question of who was an applicant, having concluded that "you cannot sue a party if you do not have a direct relationship with it ... ." The court stated that:

"[T]he Kools court rendered its decision interpreting the UCP prior to the revision of Article 5, and asserted that even the then prevailing UCC definition of customer was broader than the definition under the UCP. The Kools court further stated that '[the UCC's] definition unlike the UCP's suggests that the customer can be someone other than the person who actually enters into the agreement with the bank. The UCP is therefore more restrictive in determining who may be considered a party to a letter-of-credit transaction.' Kools, 872 F. Supp. at 71. While this suggests that under other circumstances, one of the [Contractors] could have been considered an applicant even in the absence of privity, under the circumstances present here, this Court finds, at least with respect to the Letter of Credit related to the Green Country construction project, that the [Contractors] are not 'applicants' ..."

Interpreting the terms of the Revised UCC definition of "applicant" in Revised UCC Section 5- 102(a)(2), the court stated:

"As the term 'or' is used, it implies that, absent a contrary agreement by the parties, the default provision would provide for only one applicant. Otherwise, an issuer may find itself subject to direction from two separate entities which could result in conflicting instructions on what documents were acceptable to permit draws on a letter of credit. While the parties might have the option of contracting for multiple applicants, any such agreement would of necessity have to set forth the respective parties' rights if their directives were ultimately to conflict. However, absent an agreement delineating the parties' respective rights and powers, from a business perspective, it makes sense that there would only be one entity in control."

In response to Issuers argument that the clause in the definition, "or for whose account" would be rendered superfluous by the interpretation that the party who requests the LC is the applicant, the court states "it is not superfluous if one accepts that there can only be one applicant and the party 'for whose account a letter of credit is issued' is only considered the applicant if the requester does not take on an obligation to reimburse the issuer and is a party other than the party for whose account it is issued."

The court concluded that "absent a contrary agreement by the parties, section 5-102(a)(2) only provides for one applicant at a time". It, therefore, ruled that since Surety requested the Green County LC and undertook to reimburse Issuer for it, that Contractors were not "applicants". Because Quachita had not moved to dismiss, the court indicated that as to these LCs, evidence of the parties' intent was necessary to determine whether Surety or Contractors were applicant or "whether the parties have 'otherwise' contracted to have two applicants".

2. Conflicts; UCP; Revised UCC §5-103(c): The court also concluded that "non-conflicting sections of the UCC apply even where the Letter of Credit incorporates the terms of the UCP." Noting that UCP500 did not address subrogation but that Revised UCC Section 5-117 does, it stated "an issuer, who otherwise has rights of subrogation, may subrogate to the rights of a beneficiary or of an applicant notwithstanding the independent nature of a letter of credit." The court recognized that the section did not confer a right of subrogation but merely permitted any right that already existed to be asserted, concluding "if [Issuer] has any right of subrogation, UCC section 5-117 removes any impediment to its asserting any such direct right to subrogate to the rights of the beneficiary, Green Country or the applicant, [Surety]."

3. Subrogation; Revised UCC §5-117: Issuer, as subrogee to Surety's rights under the Green County LCs, the court noted that Revised UCC Section 5- 110(a) created a statutory warranty to the applicant. It agreed with Professor James J. White Rights of Subrogation in Letters of Credit Transaction, 41 St. Louis U.L.J. 47, 61-74 (1996) "that warranty rights should be treated as the underlying obligation owed to the applicant to which the issuer is the secondary obligor. Moreover, the Court agrees that multi-level subrogation may be a possibility."

4. Unjust Enrichment: As to the claim for unjust enrichment, the court noted that the existence of a contract precludes recovery under that theory. It ruled that the LCs and reimbursement agreements are supplemented by a statutory framework which "fills any gaps". In response to Issuer's argument that an LC is not a contract, the court recognized that "most regard letters of credit as 'unique commercial instruments.'", it concluded that "it is a relationship that, like a contract, has well defined rights and obligations", citing John F. Dolan, The Law of Letters of Credit, section 2.02 at 2-5 (2nd ed. 1990).

Comments:

1. It is strange that the court would construe the term "or" in Revised UCC Section 5-102(1)(2)'s definition of "applicant" to impose a normal requirement that there be only one applicant. In fact, there are often multiple applicants. Unstated was the impact of what is stated in the terms of the LC. The court did not discuss whether a term in the LC that states that party X is the applicant is definitive or not. The question and the analysis here becomes far more pressing than may be apparent because of the resort by UCP600 to formal definitions and the unsatisfactory definition of "applicant" that has been used.

2. As to a conflict between definitions in the UCP and UCC, one wonders how they can be in conflict unless they are taken to apply to terms in the credit or other undertakings. Absent such provisions, they simply define the terms in the respective texts. Even if they are different, they can hardly be in conflict although the different meanings in the two texts may result in a conflict.

[JEB/dgd]

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