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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
2007 LC CASE SUMMARIES No. 04 Civ. 8177 (CM) (S.D.N.Y. September 22, 2007) [USA] Abstracted by Carter KLEIN*
Topic: Bankruptcy
Nature of Action: Adversary proceeding filed in the Enron bankruptcy case. Power Trader sued marketing exchange for return of LC proceeds and held in a segregated account.
Parties: Applicant/Plaintiff - Enron Power Marketing, Inc. Defendant/Beneficiary - California Power Exchange Corp. Co-defendants - Pacific Gas & Electric Co., and Southern California Edison Co.
Underlying Transaction: Wholesale electricity markets.
LC: Seven irrevocable standby LCs totaling US$136,000,000. Silent as to governing rules.
Decision: U.S. District Court for the Southern District of New York, McMahon, J., granted Defendants' motion to dismiss.
Rationale: The court held that under LC law, neither the LCs nor their proceeds are property of the estate of the bankrupt applicant, but rather property of the issuing banks [to the extent that they do not belong to the beneficiary]. Since Enron Power Marketing, Inc. (Enron) had no specific property interest in the funds in the segregated account, its adversary proceeding had to be dismissed. Even if Enron were to have some sort of cognizable property interest in the letter of credit proceeds, the proceeds were held for obligations governed by Federal Energy Regulatory Commission (FERC) rules and therefore could not be disbursed without FERC's approval.
Article
Factual Summary: Enron arranged for several banks to post LCs required by FERC tariff regulations so Enron could participate in the power markets with California Power Exchange Corp. (CalPX). The LCs were posted to cover liabilities while accounts were settled and cleared. After both CalPX's and Enron's respective bankruptcy filings, CalPX drew down $136,000,000 on the Enron LCs and deposited the proceeds in a segregated account with Bank of New York.
CalPX obtained an order from FERC asserting FERC's jurisdiction over the proceeds with a requirement that the proceeds could not be disbursed without FERC's approval. Shortly thereafter, Enron filed a proof of claim in CalPX's bankruptcy proceeding asserting a secured claim and seeking return of the LC proceeds as its collateral. CalPX's plan of reorganization included provisions which required FERC's approval for the LC proceeds to be released.
CalPX also asserted a claim in Enron's bankruptcy that the LC proceeds secured claims owed to CalPX. Enron resisted on the grounds that CalPX had no valid security interest in the funds and that they belonged to Enron.
Tariff proceedings against Enron had previously found that Enron committed market manipulation which damaged CalPX and its customers and that the proceeds of the LCs could be used to satisfy those claims. The court further found that under wellestablished caselaw, LC proceeds were not property of the applicant but property of the issuing bank.
Enron countered that the proceeds became cash collateral after drawn and therefore were property of the Enron estate. The court thought this argument unpersuasive because, in the court's mind, Enron did not post its own cash, had no reversionary interest in the proceeds and at most had a claim against CalPX, citing Papio Keno Club, Inc. v. City of Papillon (In re Papio Keno Club), 262 F.3d 725 (8th Cir. 2001); Demcyk v. Mutual Life Ins. (In re Graham Sqwuare, Inc.), 126 F.3d 823 (6th Cir. 1997).
Legal Analysis:
The court's analysis of FERC jurisdiction and whether CalPX held the proceeds as security, does not implicate LC law. The holding of the case that LC proceeds do not belong to the applicant because they came from the issuing bank, while desirable for making standby LCs more attractive as payment assurances, has implications that the court never thought through.
The court's holding that Enron had no reversionary interest in the proceeds is based on the maxim that when a beneficiary draws on an LC, it obtains proceeds of the issuing bank. That rule may be true if the proceeds drawn are promptly applied to an outstanding obligation owed to a beneficiary which the LC was posted to secure. It is less true when the proceeds drawn are not applied promptly to an outstanding obligation, but instead are held for some period of time as cash collateral. At some point after the draw, there is a transmutation of the LC proceeds into cash collateral in which the applicant can claim an interest and LC law no longer applies.
The issuing banks did not participate in these proceedings to reclaim the proceeds of their LCs. It may be that they were fully secured and reimbursed. If so, the court ignored the fact that Enron procured the LCs for its own account presumably with its own credit, and after the LCs had been drawn down and the issuing banks reimbursed, the issuing banks no longer had an interest in the proceeds. If they had no interest, Enron certainly could claim a right to receive surplus LC proceeds held as cash to the extent that CalPX either was oversecured or did not have a perfected security interest in that cash. Whether that claim or interest in the proceeds constituted a property interest or just an unsecured claim against CalPX as the court held, is an issue that deserved more analysis than the court gave it. Under well-recognized bankruptcy principles, a bankrupt's "property" of the estate is broadly defined and interpreted to cover all kinds of interests.
*Carter KLEIN is a partner at Jenner & Block LLP
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