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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
2006 LC CASE SUMMARIES 2006 WL 721764 (N.D. Ohio, Mar. 20, 2006) [USA]
Topics: Guaranty; Breach of Contract; Set Off; LC Proceeds; Statute of Limitations; Default
Type of Lawsuit: City filed a third-party claim against Bank for wrongful exercise of set-off on proceeds of LC.
Parties: Defendant/Beneficiary/City- The City of Youngstown, Ohio (USA) (Counsel: Joseph M. Houser and Thomas J. Lipka of Manchester, Bennett, Powers & Ullman, Youngstown, OH)
Issuing Bank/Lender- J.P. Morgan Chase & Co., known as Bank One when it was Issuing Bank (Counsel: Seamus J. McMahon and William H. Falin of Moscarino & Treu, Cleveland, OH)
Plaintiff/Assignee- MTGLQ Investors, L.P. (Counsel: Philip R. Bautista, Robert J. Valerian, and Stuart L. Larsen of Kahn Kleinman, Cleveland, OH)
Borrower/Developer- Big G
Underlying Transaction: Two dependent accessory/suretyship guarantees for urban development loans.
LC: Standby LC. Silent as to amount. Silent as to governing rules.
Decision: The United States District Court, N.D. Ohio, Eastern Division, Boyko, J., on cross motions for summary judgment, granted summary judgment for Bank and against City on City's claims for breach of contract and indemnification.
Rationale: When money is owed by Beneficiary to the Issuer on an obligation different from that of the LC, which is not in breach of its contractual obligations, the Issuer can set off the payment of proceeds from the LC against that debt.
Article
Factual Summary: In connection with an urban redevelopment project, Developer borrowed funds from Bank. Repayment of the loan was guaranteed by City, which was required to establish special fund with designated revenues. City was also the beneficiary of a standby LC issued by Bank in connection with the project.
When Developer defaulted, Bank made demand on City, which, having failed to establish the fund, failed to make payment. When City subsequently drew on the standby, Bank set off the proceeds against City's unpaid guarantee obligations. Bank assigned the balance of its claims to Assignee which sued Developer and City, among others. City filed a third-party complaint against Bank, alleging wrongful dishonor, breach of contract and conversion. Bank filed a motion for summary judgment, which was granted.
Legal Analysis:
1. Breach of Contract; Guaranty; Set Off; LC Proceeds; Default: The court noted it was undisputed that City had failed to establish the required fund and that at least one of the guarantees did not limit payment to the fund. Since City had failed to fulfill its contractual obligations to reserve funds, the court ruled that City was estopped to deny its breach of its contractual obligation.
The court also noted that the guarantee contained broadly drafted terms regarding enforcement of the guarantees. The court ruled that Ohio common law permits set off where money is owed and the entity exercising the set off is not in breach of its contractual obligations. It stated two prerequisites to the exercise of set off, namely: 1) mutuality of obligation; and 2) the funds are not held in a special purpose account. The court concluded that both of these requirements were met.
2. Statute of Limitations: Under Ohio law at the time the LCs were issued, the statute of limitations was six years. More than six years had passed at the time the action was filed. However, contract and guarantee actions were subject to a 15-year limitations period which had not passed. The court ruled that the claims regarding the breach of contract and guarantee were subject to the longer statute.
Comments:
1. Set off: Set off is not addressed in Revised UCC Article 5 but it is widely recognized that the rule of finality of LC payments is not affected when a bank sets off against a payment of LC proceeds a debt unrelated to the LC award to it by the beneficiary, provided that such a set off is permitted under other applicable local law and procedure. This principle is expressly recognized in Article 18 (Set-off) of the UN LC Convention which provides "Unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, the guarantor/issuer may discharge the payment obligation under the undertaking by availing itself of a right of set-off, except with any claim assigned to it by the principal/applicant or the instructing party."
[JEB/hah]
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