Article

Factual Summary: In connection with the purchase of assets that included two leases of real estate of which Seller was the tenant and that imposed obligations on Seller/Tenant, Buyer agreed in a Letter Agreement to indemnify Seller/Tenant against a range of future events and to obtain an LC "from a bank reasonably satisfactory to [Lessee/Beneficiary]." The underlying agreement provided that "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 . . . ." The appellate opinion stated that "[t]he Letter Agreement required [Beneficiary] to terminate the letter of credit upon satisfaction of the conditions relating to the leases," although it is not clear whether it was interpreting this provision or whether there was an affirmative requirement in the Agreement.

Buyer then caused its parent, of which it was a wholly owned subsidiary, to apply for a 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.

The credit also contained an express provision regarding its termination:

The amount of this letter of credit shall be reduced or terminated on receipt by [Issuer] of a notarized written agreement signed by a vice president of [Beneficiary] and a vice president of [Applicant] authorizing such reduction or termination.

At the time of issuance, Buyer/Applicant provided Issuer a negative pledge to keep certain assets unencumbered but provided no other collateral. The appellate opinion stated that Issuer "believed, based on representations by Pat Robertson, that the letter of credit would only be outstanding for ninety days."

In 2001, Buyer/Applicant sued Beneficiary/Seller in California state court, claiming that Beneficiary/ Seller had failed to properly terminate the LC. When Seller/Beneficiary failed to file a responsive pleading in a timely manner, 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 to it by Applicant/Buyer, Issuer cancelled the LC. Shortly thereafter, the state court vacated the judgment and ordered that the LC be reinstated, requiring both Applicant and Beneficiary to "take all actions . . . appropriate to effectuate" the LC; however, Issuer did not reinstate the LC.

Starting in 2004, the Lessor of the property required proof of insurance and a surety bond under the Lease. Pursuant to the Lease, Seller/Beneficiary expected Buyer/Applicant to provide the mandated insurance coverage and the surety bond. Buyer/ Applicant, however, refused. In 2005, Beneficiary drew on the LC, presenting documents that complied on their face with the terms and conditions of the LC. In response, Issuer sent a 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 pursuant to Revised UCC Section 5-106(d).

Beneficiary then brought this action 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 and denied to Issuer. On appeal, affirmed.

Legal Analysis:

1. Revised UCC Section 5-106(c), (d); Perpetual LCs; Automatic Renewal; Expiration

Issuer argued that the LC was "perpetual" and, accordingly, expired five years after its issuance under Revised UCC Section 5-106(d) and before the drawing by Beneficiary. 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." As explained by the appellate opinion, the trial court concluded that "the letter of credit was not perpetual because so long as a letter of credit 'articulates 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.'" Agreeing, the appellate opinion stated that "the plain language of UCC § 5-106(d) requires that a letter of credit state that it is perpetual to qualify as a perpetual letter of credit."

The appellate opinion subjected the text of Revised UCC Section 5-106(c) and (d) to intimate text analysis and critical interpretation, drawing on the Official Comments and the canons of statutory construction. The appellate opinion also drew on a series of its prior decisions about the interpretation of statutes that are "unambiguous" and where the "statutory scheme" is "coherent and consistent" and whose text is "clear," has a "usual and plain meaning." Eschewing the "legislative history", it stated that a court should confine itself in such situations to the "plain meaning" of terms as a guide to legislative intent. Accordingly, the appellate opinion resorted to a collegiate dictionary in order to determine the meaning of the term "perpetual" in the context of a statute about letters of credit. Its conclusion: "a letter of credit is only perpetual if it expresses in words that it is perpetual."

As to whether the "exact word 'perpetual'" must appear, the appellate opinion noted that Beneficiary had conceded that "[t]his . . . means that a letter of credit can be perpetual without using the exact word 'perpetual' . . . ." The opinion reasoned that it can be perpetual by "instead using synonyms that clearly declare that the letter of credit will remain outstanding in perpetuity, but it is essential that the words of the letter of credit definitively provide it will continue in perpetuity."

Fixing on the "plain meaning" of the statutory term "states" (in the phrase "states that it is perpetual"), the appellate court concluded that the LC was not perpetual. The appellate opinion noted that LC "'states' to the contrary 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 ... unless ... [Beneficiary] ... elects not to require this letter of credit renewed.' Thus, the letter of credit recites that it will expire, that it will not continue perpetually, either when [Beneficiary] elects not to renew or when [Issuer] receives a written agreement by both [Beneficiary] and [Applicant] authorizing the termination."

Acknowledging that "the matter is not entirely free from doubt because of the automatic renewal provision," the appellate court concluded "that under the plain language of § 5-106(d), the letter of credit is not perpetual."

In rationalizing its decision, the appellate opinion warned that adopting the "nonliteral" interpretation urged by Issuer "would introduce grave uncertainties into the use of letters of credit and impair their utility for domestic or foreign commerce."

Issuer argued that the interpretation adopted conflicted with the intention of the drafters of Revised UCC Article 5 and offended "the primary purpose of letter of credit law-namely, to limit letters of credit of unlimited duration." As described by the appellate opinion, Issuer urged the court "to adopt a functional and broad definition of 'states that it is perpetual.'"

The appellate court declined to do so, concluding that such an interpretation would render Revised UCC Section 5-106(c) "superfluous, in contravention of the rules of statutory interpretation." The appellate opinion stated that this subsection would result in a one year limitation period "if there is either no stated expiration date or no other provision that determines its duration." It reasoned that "[t]his subsection thereby contemplates two methods to avoid expiration of a letter of credit one year after issuance: the letter of credit could (1) 'state' an expiration date; or (2) include another provision that determines its duration . . . the default provision if a letter of credit has no termination date or other measure of its duration . . . ." Given this interpretation, "subsection (d) is the default provision if a letter of credit states that it is perpetual." The appellate opinion concluded that the interpretation urged by Issuer, "the second method to avoid expiration of a letter of credit one year after its issuance-namely, including in the letter of credit a provision that determines its duration-would be superfluous."

The appellate opinion also rejected Issuer's argument based on Official Comment 4 to Revised UCC Section 5-106 to the effect that a credit that can be revoked or terminate "at the discretion of the issuer by notice to the beneficiary is not 'perpetual.'" The appellate opinion declined Issuer's invitation to adopt a negative inference from this Comment, namely "that letters of credit that provide for revocation or termination only at the discretion of the beneficiary are perpetual" [emphasis in original]. The appellate court stated that the absence of a reference to a clause controlled by the beneficiary "does not make such letters of credit perpetual." The appellate opinion stated that "[w]e will not speculate what the drafters intended by electing not to comment on a particular type of letter of credit."

2. Preclusion; Revised UCC Section 5-108(b), (c) & (d); Waiver as a Discrepancy

Beneficiary argued that Issuer waived its right to assert that the Beneficiary had waived its right to enforce the LC because the defense was not raised in the notice of refusal. Relying on Revised UCC Section 5-108(d) (Issuer's Rights and Obligations) which notes that the preclusion rule is not applicable to expiration, fraud, or forgery, Beneficiary argued that all other defenses to wrongful honor, including waiver, had to be raised in the notice of refusal. The trial court concluded that Issuer had not waived its right to raise the defense of waiver and the appellate court agreed.

The appellate court noted that the phrase "any discrepancy" in the Revised UCC preclusion rule is "not clear." As a result, the appellate court considered the meaning of the phrase in light of "the entirety" of the section in which it appeared. Looking to Revised UCC Section 5-108(b), it noted the reference to giving "notice to the presenter of discrepancies in the presentation." It concluded that "the only discrepancies an issuer is required to state in the notice of dishonor are 'discrepancies in the presentation' . . . ." Based on this interpretation, the appellate court reasoned that the meaning of the exceptions to the preclusion rule noted in Revised UCC Section 5- 108(d) was explained. "Fraud, forgery and expiration are all discrepancies in the presentation-they are challenges to the actual presentation-whereas the waiver claim here is an equitable challenge, separate from the presentation submitted by the beneficiary, regarding the right of the beneficiary to attempt a draw on the letter of credit after three years of inaction following the [California] Superior Court's order reinstating the letter of credit." The appellate court also noted the use of the term "discrepancy" in connection with "tardy presentation" in Official Comment 3 to Revised UCC Section 5-108.

3. Waiver of Beneficiary's Right to Claim Under the LC; Expiration

Issuer argued that by failing for three years to seek to have the credit reinstated after the state court order following its order of cancellation, the Beneficiary had waived "its right to enforce the letter of credit." Issuer argued that Beneficiary knew that the state court had no jurisdiction over Issuer to order reinstatement of the LC unless it took some action which it failed to do.

Noting that waiver was the intentional relinquishment of a right, the appellate court observed that the trial court had concluded that the supposed right that was waived, namely the right to reinstate the LC, "never in fact existed." Issuer argued that, although the state court had no jurisdiction over it, it had notice of the order cancelling the LC. The appellate court rejected this argument, noting that the state court litigation could not have given Issuer any basis for cancellation of the LC without the Beneficiary's consent. The appellate court also noted that the credit itself contained the mechanism for termination.

4. Remedies; Specific Performance; Revised UCC Section 5-111

The appellate court observed that its ruling made it unnecessary to consider Beneficiary's claims for specific performance since the relief sought under them was "entirely duplicative of [the remedies] awarded under the wrongful dishonor claim." The appellate court stated, "[w]hether breach of contract and specific performance theories can support relief beyond that flowing from UCC Section 5-111 in the case of a wrongfully dishonored letter of credit can be considered in a case where it makes a difference."

Comments:

1. Principles of Interpretation of Revised UCC Article 5 and LC Statutes in General. In interpreting Revised UCC Section 5-106(d), the appellate court resorts to the dictionary and "plain meaning" to interpret a highly technical provision of letter of credit law. Whenever a court has resort to such tools in this field, it signals that the court is clueless and is a warning that the result will be untoward. Particularly inapt is the notion of the "plain meaning" of the terms (in this case the word "states"). How could one understand the "plain meaning" of the term "states" outside of the context of the sentence in which it appeared and the significance that was attributed to it? When all the drafters thought and intended that the "plain meaning" would have covered agreements that were effectively perpetual as was this one, it is difficult to understand how a college dictionary could produce a better or more appropriate result. On a practical level, one would have thought that a "perpetual" LC under standard LC practice is a LC that continues in effect without containing provisions for it to cease to be available for drawing by its own terms or notice by the issuer.

2. The Role of Policy in LC Statutory Analysis. The court chose to give little weight to the policy concerns behind the statutory provision. Yet these policies, particularly those against perpetual undertakings, should have been foremost in the interpretation of the text. In passing, it should be noted that the notion of legislative intent is a fiction with respect to the UCC and Revised UCC Article 5. It is the action and intent of the Drafting Group that matters in determining the text of the statute unless the legislature has adopted a non conforming amendment.

3. The Policy Underlying Revised UCC Section 5-106(c) & (d). The policy underlying Revised UCC Section 5-106(c) & (d) is one that strongly opposes perpetual undertakings. What is a perpetual undertaking? One that permits LCs to extend indefinitely outside the control of the issuer. Where the LC could continue indefinitely unless the issuer acted to terminate it, the LC does not violate that policy because the issuer could stop the cycle. But where that power is solely in the hands of the beneficiary, the proposition changes. It is, in effect, perpetual. Whether it "states" that it is perpetual is beside the point. It is perpetual. That the beneficiary could act to terminate it adds little to any LC. Any LC can effectively be terminated if the beneficiary surrenders it. Where the beneficiary surrenders the LC and requests termination, it is terminated.

4. The Decision is Harmful. The appellate opinion misunderstood the policy implications of its decision. This decision places in the hands of powerful beneficiaries a tool by which they can require banks to issue perpetual undertakings that lack the protections of Revised UCC Section 5-106(c) or (d). Such undertakings violate the spirit if not the letter of the safety and soundness provisions of 12 CFR Section 7.1016 which abandoned the requirement that US banks not issue LCs unless they contained expiry dates partially on the basis of reliance on the Revised Article 5 statutory period.

7. How to Fix This Mess. Action by the OCC is necessary as is an Official Comment disapproving of the decision by the Permanent Editorial Board.

[JEB/rc/mdg]

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