Article

Factual Summary: In connection with the purchase of assets that included two leases of which Seller was the tenant and that imposed obligations on it, Buyer agreed to indemnify Lessee against a range of events and to obtain an LC "from a bank reasonably satisfactory to [Lessee/Beneficiary]". The underlying agreement provided "the Letter of Credit shall remain in effect until [Buyer] either: (a) obtains a novation of all applicable leases, franchise agreements, rights of way, easements, and licenses releasing [Beneficiary or its affiliates], as appropriate, from all liability; or (b) provides and maintains financial assurance satisfactory to [Beneficiary] in the form of at least $ 10 million of net worth . . . ."

Buyer then caused its parent, of which it was a wholly owned subsidiary, to apply for the LC in favor of Lessee/Beneficiary which was issued on 21 May 1998 with an expiry date of 21 May 1999. The LC provided that it:

SHALL EXPIRE ONE YEAR FROM THE DATE HEREOF PROVIDED HOWEVER, THAT IT SHALL BE DEEMED AUTOMATICALLY RENEWED WITHOUT AMENDMENT FOR ADDITIONAL ONE YEAR PERIODS FROM THE PRESENT OR ANY FUTURE EXPIRATION DATE HEREOF, UNLESS AT LEAST 30 DAYS PRIOR TO ANY SUCH DATE(S), [BENEFICIARY] SHALL HAVE SENT [ISSUER] NOTICE BY CERTIFIED MAIL, RETURN RECEIPT REQUESTED, OR OVERNIGHT COURIER SERVICE, THAT [BENEFICIARY] ELECTS NOT TO REQUIRE THIS LETTER OF CREDIT RENEWED FOR ANY SUCH ADDITIONAL PERIOD.

At the time of issuance, Applicant provided Issuer a negative pledge to keep certain assets unencumbered.

In 2001, Buyer/Applicant filed a complaint against Beneficiary/Seller claiming that Beneficiary/Seller had failed properly to terminate the LC. The Buyer/ Applicant obtained a default judgment ordering that the LC be cancelled although it had been notified by Beneficiary's attorney of improper service of process. Specifically, the order stated that Beneficiary "is deemed to have consented to the termination of the Letter of Credit...". Issuer, as successor in interest to Issuing Bank, was not a party to this action or subject to the court's jurisdiction. After the order was delivered by Applicant/Buyer, Issuer cancelled the LC. Shortly thereafter, the court vacated the judgment and ordered that the LC be reinstated. Issuer did not reinstate the LC. The court stated "[t]he Letter of Credit does not provide [Issuer] with a right to elect that the letter of credit not be automatically renewed."

Starting in 2004, the Lessor required proof of insurance and a surety bond under their lease agreement. Pursuant to the agreement, Seller/ Beneficiary expected Buyer/Applicant to provide insurance coverage and the surety bond. Buyer/ Applicant, however, refused. In 2005, Beneficiary drew on the LC and presenting documents that complied on their face with the terms and conditions of the LC and Issuer sent notice of dishonor, stating "LC cancelled" due to court order and, alternatively, that the LC was terminated on 21 May 2003 five years after the LC was issued.

Beneficiary then brought this action against Issuer for wrongful dishonor, specific performance, breach of contract, breach of statutory duty, and declaratory relief and both parties moved for summary judgment which was granted to Beneficiary in part and denied in part.

Legal Analysis:

1. Perpetual LC; Expiration; Revised UCC § 5-106(d); Notice of Nonrenewal: Beneficiary argued that the LC "nowhere states that it is perpetual" and pointed out that it "contains a specific expiration date and by its express terms automatically renews at one year intervals for additional terms of one year." Issuer contended the LC as issued was perpetual and pursuant to Revised UCC Section 5- 106(d) expired five years after it was issued. Revised UCC Section 5-106(d) provides "[a] letter of credit that states that it is perpetual expires five years after its stated date of issuance, or if none is stated, after the date on which it is issued." Issuer further argued that the LC "by implication, states that it is perpetual, 'since it ha[s] no fixed expiration date or duration, and [i]s automatically renewing, at the sole discretion of the beneficiary.'" It contended that express use of the word "perpetual" is not necessary "because, as a policy matter, letters of credit with no fixed duration are considered unsafe or unsound."

The court observed that an LC would be perpetual under Revised UCC § 5-106(d)1 if it explicitly stated "it is to remain in effect in perpetuity". It also stated that "[e]ven in the absence of such explicit language, if a letter of credit is silent as to an expiry date, in light of the policy against open-ended letters of credit, Section 5-106(d) would apply." The court ruled, however, where there was an expiration date, "albeit one that renews automatically and terminates only upon notice by the beneficiary, the Letter of Credit cannot be said to be perpetual." The court concluded that "[Issuer] has failed to allege facts sufficient to warrant a look beyond the stated terms of the Letter of Credit. The Letter of Credit, by its terms, could only be terminated by [Beneficiary]. Accordingly, unless terminated in some other manner, the Letter of Credit was still in effect on February 2, 2005 and [Beneficiary] was within its rights as beneficiary to present its sight draft."

2. Default judgment; Unilateral withdrawal; Issuer withdrawal: Issuer argued that it was justified in canceling the LC pursuant to the state court order and that the court lacked jurisdiction over it to compel it to reinstate the credit. Both Issuer and Beneficiary agreed that the state trial court "did not have jurisdiction to direct, instruct, command, or otherwise order [Issuer] to terminate the Letter of Credit." Beneficiary's position was that Beneficiary never consented to the LC being cancelled and that its consent could not be inferred from the trial court's initial order.

The court characterized Issuer's argument as "untenable". It noted that the credit was irrevocable and cited Revised UCC Section 5-106(b) for the proposition that "once an irrevocable letter of credit is issued, it cannot be cancelled without the consent of the beneficiary." It also noted that the LC itself indicated that it could only be cancelled by receipt of Beneficiary's signed statement. The court, noting that Issuer was on notice that Beneficiary was not present in court when the default judgment was entered, therefore concluded that "[i]t was unreasonable...for [Issuer] to believe [Beneficiary] consented to or could be deemed to have consented to the default judgment."

3. Preclusion; Revised UCC Section 5- 108(c): Beneficiary argued that Issuer was precluded from asserting that Beneficiary waived its right to assert non-compliance with the state court order to reinstate the LC by not raising this point in its notice of refusal. The court rejected this argument as "mistaken". It noted that the discrepancy to which the Revised UCC Section 5-108(c) preclusion rule "relates to the presentation of documents for a draw on the letter of credit" and that it "applies only if the issuing bank asserts as a basis for dishonor a discrepancy in the presentation of which it did not give timely notice."

4. Waiver; Revised UCC §5-108(c): Issuer argued that Beneficiary had waived the right to reinstate the LC by waiting too long to enforce a court order requiring Applicant and Issuer to reinstate the LC. UCC § 5-108(c) Issuer itself waived. The court stated "[Issuer's] assertion of waiver must fail" because a legal right must first exist before it can be waived. In this case, it stated that the "right to reinstate" the LC never existed because the credit did not empower Issuer to terminate the LC, so that Beneficiary could not "waive" the right.

5. Revised UCC §5-108(e); Standard Practice: Beneficiary argued that Issuer had breached its statutory duty to observe standard LC practice, namely that its counsel provided confidential information in the state court action. Issuer, however, responded that the person to whom the information was provided as Applicants' counsel which was the bank's client. Noting that such a belief would not constitute a breach of the duty of privacy, the court ruled that there were outstanding issues of material fact that could not be resolved summarily.

Comments:

1. Perpetual LC: The court misunderstood and misapplied Revised UCC § 5-106. While recognizing the policy against perpetual undertakings, the court failed to give effect to this policy in its interpretation of the LC. It confused the absence of an expiration date with perpetuity. Revised UCC § 5-106(c) provides "[i]f there is no stated expiration date or other provision that determines its duration, a letter of credit expires one year after its stated date of issuance or, if none is stated, after the date on which it is issued." This provision addresses situations where an LC is issued without an expiration date. Revised UCC § 5-106 (d), however, addresses a situation where the LC is perpetual. It provides "[a] letter of credit that states that it is perpetual expires five years after its stated date of issuance, or if none is stated, after the date on which it is issued." The court implied, the word "perpetual" need not be used in stating the LC "nowhere states that it is perpetual." However, what the trial court failed to understand was that a credit can be open-ended even though it has an expiry date as did the one in this case. The Subsection says nothing about an expiration date. LCs can provide for their extension with or without an expiration date. Where there is no "final" expiration date, such a provision does not violate the policy against perpetual LCs if it can be paid or terminated by the issuer. However, the LC in this case allocated that role to the beneficiary and not to the issuer. Therefore, the LC was perpetually renewable unless the beneficiary elected to stop the renewals. Such LCs violate the policy intended to be given effect by Revised UCC § 5-106 (d) against undertaking without duration. In failing to so interpret and apply the statute, the court was wrong.

2. Contract Terms Re LC; "Bank Reasonably Satisfactory": It is interesting to note the contract terms describing the LC issuer, namely that it be a bank "reasonably satisfactory" to Beneficiary. While there are no standard provisions regarding contract terms related to LCs, there are general principles. This formula entitles beneficiary to insist on a bank that is satisfactory to it provided that it acts in good-faith.

3. Choice of Law; Revised UCC Article 5 Version; Revised UCC §5-116: Noting that although the LC was issued in Virginia and implying that its law should be applicable, the court applied California's version of the UCC since the California version "has been adapted in identical form in Virginia."

[JEB/EJH]

1 California has adopted the UCC language and commentary as its own at California Commercial Code, § 5101 et seq. Although the Application under which the Letter of Credit was issued is, in part, governed by Virginia law, Article 5 of the UCC has been adopted in identical form in Virginia. See VA Commercial Code § 8.5A-101 et seq. Accordingly, there is no dispute that Article 5 of the UCC governs the instant dispute.

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