Article

Factual Summary: Financial Institution issued LC No. 649 (LC 649) payable to Beneficiary to assure payment for purchase of hospital equipment. The LC stated that:

'[e]xcept as permitted hereunder, this Letter of Credit is not assignable or transferable.' ... In the following paragraph, the credit provides that

'[t]his Letter of Credit may be assigned or transferred only to MSF Holding Ltd.' upon the beneficiary's (1) execution of an 'Agreement Assigning Irrevocable Letter of Credit,' a sample of which is attached to the credit; and (2) the beneficiary's surrender to defendant of LOC 649 and a written request directing defendant to issue a replacement irrevocable letter of credit in favor of MSF Holding Ltd., reduced by the aggregate of all drawings previously made on LOC 649.

Beneficiary assigned to MSF-HSF (not MSF Holding) "its rights to a number of accounts receivable, which included the receivables owed under the [hospital equipment] Contract, as well as any additional sureties acquired by [Beneficiary/Seller] in association with those receivables."

The affiliate, MSF Holding, faxed a demand on the LC to Issuer which refused to honor. There followed various communications between representatives of Issuer and MSF Holding. During these communications, MSF Holding asserted that Issuer had repudiated its obligations under LC 649.

In any event, when Issuer refused to honor or replace LC 649, MSF Holding sued Issuer in Florida state courts from which the action was removed to federal courts in Florida and dismissed without prejudice. MSF Holding then filed this action in the federal court in New York and the parties filed cross motions for summary judgment. The trial court denied MSF Holdings' motions and granted summary judgment to Issuer.

The court noted that:

[T]he parties have muddled the issue of what interest in LOC 649 was conveyed, if at all, to MSF-HSF by failing to recognize and apply the letter-of-credit precepts of assignment and transfer, doctrines that are unique to letters of credit and wholly distinct from common-law contract principles.

Such confusion is not unusual with respect to matters related to the assignment of LCs. It was compounded in this case by two additional factors. In the first place as revealed in a prior motion related to discovery, abstracted at 2006 ANNUAL SURVEY 407, Issuer's records were lost due to the collapse of the World Trade Center and it had to rely on back-up files. In addition, the employee who handled this matter was deceased. The opinion assumes a bizarre dimension when the notice of refusal is read. In it, Issuer states that LC 649 was "cancelled upon our receipt of the original Letter of Credit from [Beneficiary/Seller] on May 15, 2001. At no [point] was this Letter of Credit assigned prior to such cancellation or was a replacement Letter of Credit issued on behalf of or [sic] MSF Holding Ltd. or any designee of [Beneficiary/Seller]." The court interprets this message to mean that a prior LC, No. 648, had been cancelled and replaced by No. 649. Apart from sorting out the confusion surrounding this communication, the opinion does not explore the implications of this message.

In the second place, New York's Prior UCC § 5- 116 was misaligned with letter of credit practice with respect to transfer and assignment. Its implications will be discussed in the Legal Analysis.

Legal Analysis:

1. Prior NY UCC §5-102(4); Choice of Law: The LC, issued prior to NY's adoption of Revised UCC Article 5, provided that it was subject to UCP500 and "'as to maters not governed by the UCP,' New York law should apply." The court observed that it was "required to apply New York law as it existed at the time the subject contract was made." The court stated that "[t]his principle is of particular importance to the interpretation of LOC 649" because Prior NY § 5-102(4) otherwise ousted Article 5 where it was subject to the UCP although "[i]n those instances where a letter of credit did not call for the application of New York state law, courts used the terms of Article 5 of the UCC to fill in the gaps left by the UCP."

2. Prior US UCC §1-105; Reasonable Relation; Choice of Law: Under Prior US UCC § 1-105, a choice of law such as the law of NY in LC 649 could only be given effect if there was a reasonable relation between the jurisdiction and the parties. The court observed that "New York maintains sufficient contacts to the transaction by reason of, inter alia, defendant's physical location in New York, and New York serving as the geographical locale from which LOC 649 was issued."

3. Transfer, Distinguished from Assignment; Assignment, Distinguished from Transfer: The court reviewed the meaning of transfer in letter of credit practice, noting the provisions of UCP500 Article 48 and distinguished transfer from an assignment of proceeds. It stated that:

Under the UCP, the beneficiary of a letter of credit may transfer the credit to another, in which case the transferee, in effect, steps into the shoes of the beneficiary, thereby replacing it and becoming the party entitled to draw proceeds under the credit. See [UCP500 Article 48.] A beneficiary alternatively may assign its right to the proceeds of the credit, in which case the only change effectuated is that the assignee becomes the only party entitled to the proceeds of the credit, while the original beneficiary maintains all other rights and obligations under the credit, including the duty to present the necessary documentation to the issuer so that payment may be issued to the assignee.

The court recognized that an LC transfer may only occur where the LC expressly so provides.

Regarding a transfer, the court stated that:

'The transferee is effectively substituted for the original beneficiary. After transfer, it is the transferee who must present the draft and documentation to cause payment.'). The requirement that the original beneficiary enter into an 'Agreement Assigning Irrevocable Letter of Credit' with the new beneficiary also evinces a transfer, notwithstanding its misleading title. Indeed, the 'assignment' agreement to be executed calls for the original beneficiary's transfer of 'all of its right, title and interest in and to' LOC 649, and the new beneficiary's acceptance of 'all rights and obligations thereunder.' ... An 'assignment' under the UCP is an assignment of the proceeds to a credit; it does not include the transfer or delegation of any duties.

4. Terms of the LC: Seeking to construe the terms of the LC, the court noted that:

These two conditions evince what appears to be confusion about the differences between a transfer and assignment under the UCP. While the credit states that performance of the two conditions is to precede either an assignment or transfer, they solely concern the beneficiary's right to transfer the credit because they call for a new beneficiary to replace the original beneficiary and accede to all of its rights and obligations under the credit.

5. Transfer of Drawing Rights: The court ruled that there was no transfer of drawing rights since the LC only permitted such a transfer to MSF Holding on certain conditions which were, admittedly, not met. It stated:

The terms of LOC 649, then, limit its transfer to one party-MSF Holding Ltd.-if the two enumerated conditions are met. The question whether [Beneficiary/Seller] actually transferred LOC 649 to MSF-HSF under the Assignment Agreement, despite its misleading title, is easily answered in the negative. LOC 649, by its own terms, limits its transfer solely to MSF Holding Ltd. and no other party. Any attempted transfer to MSF-HSF, an entity distinct from plaintiff, fails, and the Court need not address whether the credit's two subsequent conditions on transfer were met.

6. Assignment of Proceeds: The court noted that: "While a credit's restriction on transfer is strictly construed to preclude transfer to any party other than the named transferee, the UCP and New York state law does not so strictly construe restrictions on the assignment of a credit's proceeds."

It observed that:

While the UCP is clear on the differentiation between a transfer and assignment of a credit, it is less than lucid on the mechanics of an assignment, and, indeed, is silent on the issue pertinent to the resolution of this motion, that is, whether the Assignment Agreement effectuated the assignment of LOC 649's proceeds to MSFHSF.

The court concluded and Issuer conceded that Beneficiary had assigned the proceeds of LC 649 to MSF-HSF. Reading the plain terms of UCP500 Article 49, the court concluded that: "On the other hand, the UCP follows common-law principles in that credits are freely assignable 'in accordance with the provisions of the applicable law.'"

7. Prior UCC §5-116; Assignment of Proceeds: The court stated that "Courts faced with the application of the UCP and New York law have consistently held that, because the UCP is silent on when and how an assignment of proceeds is made, the more detailed terms of New York's UCC shall apply." It then sought to navigate the provisions of Prior UCC Section 5-116. It ruled that the provision of the credit seeking to restrict its assignment was "void, provided an assignment is made and the credit is delivered to the assignee. However, the statute does not define when or how such an assignment of proceeds is made. The parties both imprecisely 'concede' that the Assignment Agreement effectuated an 'assignment' of LOC 649, rather than an assignment of its proceeds. Regardless, the Court finds that because the question of whether a contract effectuates an assignment-either the assignment of a contract or the assignment of proceeds under a letter of credit-involves the construction of the contract, that question is one purely of law for the court to decide."

Concluding that an assignment had been effected, the court ruled that:

The effect of [Seller's] effective assignment of LOC 649's proceeds to MSF-HSF is, therefore, clear: MSF-HSF retained, as of the date of the assignment, a right-in the form of a security interest-to the proceeds of LOC 649, while [Seller] remained obligated to draw the proceeds from defendant in MSF-HSF's favor.

8. Assignment, Proper Party: Affiliate of Assignee argued that its entitlement was identical to that of the assignee, its affiliate. The court noted that "[g]enerally speaking, a parent corporation and its subsidiary are regarded as legally distinct entities and a contract under the corporate name of one is not treated as that of both", quoting from Carte Blanche (Singapore) Pte., Ltd. v. Diners Club Int'l, Inc., 2 F.3d 24, 26 (2d Cir. 1993). Accordingly, the court ruled that "[c]onsequently, plaintiff is not the real or proper party in interest to seek payment under the credit."

9. Assignment, UCP500 Article 49; UCP500 Article 49: The court noted that, unlike questions related to transfer, UCP500 Article 49 deferred to local law with respect to questions of the assignment of proceeds.

Comments:

1. Revisiting Prior UCC §5-116 regarding transfer and assignment resembles recalling a nightmare. Happily, under Revised UCC §5-112 (Transfer of Letter of Credit) and 5-114 (Assignment of Proceeds), the US LC community has awakened.

2. The court does a reasonable task of sorting out the prior statute. It should have ignored it as have bankers for decades. Under Prior NY nonconforming §5-102(4) which displaces the statute where it is subject to the UCP. Unfortunately, the court actually read UCP500 Article 49 (Assignment of Proceeds) and took it literally, that is to say, to read that one must defer to local law. Hence, Prior UCC §5-116. No banker really believes that it must check local personal property records or filings before making payment on an LC and few think that they are obligated to pay any attention to an assignment that they have not acknowledged. These principles now are captured in US law but nowhere else. Therefore, it falls to the UCP to correct any misimpression as has ISP98 Rule 6.06 - 6.10. Sadly, UCP600 has failed to do so.

[JEB/dgd]

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