Article

Factual Summary: To provide payment for the construction of a luxury yacht, US Buyer obtained an LC from US bank (Issuer) in favor of Chinese bank (Beneficiary) which was to lend funds for construction to Chinese builder. As originally issued, the beneficiary was the builder, contrary to the contract, but the LC was amended to name the bank/ lender as the beneficiary.

The contract provided2:

8.2.1 Within ten (10) days following the date of execution of this Agreement, the Purchaser shall cause its bank, Bank of America, N.A. (the "Purchaser's Bank") to issue to the Builder an irrevocable standby letter of credit in the amount of Three Hundred Fifty Thousand U.S. Dollars (US$350,000) and in the form attached hereto as Schedule 6 ("the Purchaser's Letter of Credit"), and within ten (10) days following issuance of the Performance Bond, the Purchaser shall cause the Purchaser's Bank to amend and increase the Purchaser's Letter of Credit to the amount of the Basic Purchase Price. The Builder may draw upon the Purchaser's Letter of [Credit] under the conditions noted in Schedule 6. The Builder's receipt of payment pursuant to the letter of credit shall constitute receipt of payment by the Seller and credited against the Basic Purchase Price. The Purchaser remains liable to the Seller to the extent its bank wrongfully fails to effect payment under the Purchaser's Letter of Credit.

The Brief indicated that "[t]he stated purpose of the Performance Bond was to protect and secure the Jaffes from loss resulting from breach of the Sales Contract. (DE 1, Exh. A, Schedule 9). The Performance Bond annexed to the Sales Contract provides that:

THE CONDITION OF THIS OBLIGATION is such that if the Principal shall promptly and faithfully perform the [Sales] Contract then this obligation shall be null and void; otherwise it shall remain in full force and effect. PROVIDED HOWEVER, this Performance Bond is limited to the construction and delivery of the described vessel ...."

The credit required Beneficiary to make the following statement: "the amount of the draft drawn hereunder represents and covers unpaid balance of indebtedness including interest and bank charges, if any, due to the beneficiary by [Builder].; per yacht building contract no. s125-1." It also provided that a drawing could not occur until the month before the credit expired.

Regarding the LC, the contract also provided "once the Performance Bond was issued, "the Purchaser's Letter of Credit shall remain in full force and effect notwithstanding termination of this Agreement, and the beneficiary may draw on it in accordance with its terms."

The original amount of the LC was US$350,000 a contractual provision that required an increase in the LC amount on presentation of a performance bond by the builder. Allegedly the Builder presented a Performance Bond to Applicants indicating that it was issued by Allianz AG, at which point Applicants consented to the amendment increasing the amount of the LC to US$6,030,500. The performance bond apparently "turned out to be fraudulent."3

As a result, when Beneficiary drew on the LC, Applicants sought and obtained a temporary restraining order, claiming that "the contracted for boat was never built or delivered" and "the entire transaction was a fraudulent scam and the boat in question was never built." Applicants claimed that Beneficiary had committed intentional fraud in making the required certification, had engaged in a civil conspiracy or would be unjustly enriched, that Issuer had breached a fiduciary duty, and disputed any amount of indemnification to which Issuer was entitled.

At a hearing to determine whether to enter a preliminary injunction, the only testimony offered was by Applicant although the motion was opposed only by the Issuer. Builder subsequently sent a letter to the trial judge who struck it from the record in accordance with local rules. Beneficiary then obtained permission to intervene and filed motions to vacate, dismiss, and for summary judgment.

The trial court denied motions to vacate, dismiss, and for summary judgment, concluding that there were genuine issues of material fact with respect to the allegations made by Applicant. On appeal, the federal appellate court affirmed.

Legal Analysis:

1. Rev. UCC Section 5-109; Injunction

Based on "uncontradicted proof of [Applicant's] serious allegations of fraud", the trial court opinion recites its actions in issuing and continuing the preliminary injunction, but does not discuss the basis for its actions. The appellate opinion concluded that there was no abuse of discretion on the basis of a review of the briefs and the record. The appellate court noted that the Applicants "met the prerequisites for the issuance of an injunction: (1) a substantial likelihood the movant [Applicants] will prevail on the merits; (2) a substantial threat the movant will suffer irreparable injury if the injunction is not granted; (3) the threatened injury to the movant outweighs the threatened harm to the opposing party; and (4) granting the injunction is not adverse to the public interest."

Comments:

1. In reciting the "prerequisites for the issuance of an injunction", the appellate opinion fails to refer to Rev. UCC Section 5-109(b). The recital of these "prerequisites" is based on case law regarding injunctive relief. While these factors are important, they are not all of the prerequisites for award of an injunction, nor the most important ones.

As set forth in Revised UCC Section 5-109(b), a court may grant injunctive relief "only if the court finds" (1) there is no prohibition under the law applicable to accepted drafts or deferred payment undertakings; (2) there is adequate protection to parties who are adversely affected; (3) all of the conditions to the relief under local law have been met; and (4) the claim of material fraud or forgery is more likely to succeed and the person demanding honor is not a protected person.

The matters that the court recites fall within the third requirement, namely the requirements under the law applicable to injunctions. Since there were no accepted drafts or deferred payment undertakings involved, the first requirement is not relevant. As to the protection of the beneficiary under the third requirement, the trial judge had ordered that an injunction bond in the amount of US$150,000 be posted. It may be wondered whether a bond in that amount could protect the beneficiary and the issuer where the credit amount was US$6,030,500 but presumably the issuer was secured, the beneficiary could look to the issuer, and the only exposure was for legal fees and similar expenses.

The real problem is the failure of both the trial and appellate court to refer in any manner to the requirement that the claim of material fraud must be more likely than not to succeed. Assuming that the vessel had not been built, the issue appears to relate not to the vessel, but to the repayment of the loan. It is somewhat difficult to make this determination from the opinions without more explanation, but if the recital given above is the sole requirement for the LC, then the issue is whether the funds were advanced and whether they were repaid. If it could be proven that the bank knew in advance of the loan that the Builder intended to defraud the Applicant, one might conclude that the presentation "would facilitate a material fraud on the applicant by the beneficiary" as required by Revised UCC Section 5-109(a).

The failure of the courts to discuss this point leaves one wondering whether the attention of the court was on the yacht building contract rather than the loan. It is the latter that was secured by the LC.

2. The fraudulent character of the performance bond raises an interesting question since it was to provide protection for the buyer. However, it reinforces the separation of the LC obligation from the building contract. If buyer did not properly authenticate the performance bond, this failure should not be visited on the lender/beneficiary unless there is proof that it colluded with the builder and itself facilitated a fraud on the issuer or applicant.

3. A similar pattern involving the same Chinese shipyard emerged in 2002 Irrevocable Trust v. Huntington National Bank, No. 2:08-cv-556-FtM- 99DNF 2008 WL 5110778 (M.D. Fla. Dec. 1, 2008) [USA], abstracted in the 2009 volume.

[JEB/amb]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.

1. Because of the laconic statement of the facts of the case in the opinions, many of the facts stated in this Abstract are drawn from the briefs filed before the 11th Circuit.

2. Brief for Appellant Agricultural Bank of China, Jaffe v. Bank of America, N.A., No. 07-15170-EE (11th Cir. 2007).

3. Id.