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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
2008 LC CASE SUMMARIES 21 Misc. 3d 1123(A), 2008 WL 4745664 (N.Y. Sup. Ct. 2008) [USA]
Topics: Fraud; Breach of Contract; Revised UCC §5-109(b)(4); Fraud in the Transaction; No Colorable Basis; Revised UCC §5-109 Official Comment 1
Type of Lawsuit: Applicant sued Beneficiaries and Issuer to enjoin honor.
Parties:
Plaintiff/Applicant - Lenox Hill Hospital (Counsel: Timothy Butler, David J. McCarthy, and Mario D. Cometti of Butler, Fitzgerald, Fiveson & McCarthy, New York, NY.)
Defendant/Beneficiary - American International Group, Inc. (Counsel: Edward P. Krugman and David G. Januszewski of Cahill Gordon & Reindel, LLP, New York, NY.)
Defendant/Subsidiary/Beneficiary - Lexington Insurance Company, a subsidiary of American International Group, Inc. (Counsel: Edward P. Krugman and David G. Januszewski of Cahill Gordon & Reindel, LLP, New York, NY.)
Defendant/Issuer - Commerce Bank, N.A. (Counsel: Edward P. Krugman and David G. Januszewski of Cahill Gordon & Reindel, LLP, New York, NY.)
Underlying Transaction: Excess insurance contract for medical malpractice claims.
LC: Standby LC in the amount of US$2,000,000.
Decision: The Supreme Court, New York County of New York, Fried, J., applying New York law, denied Applicant's motion for a preliminary injunction to enjoin honor.
Rationale: Honor of an LC cannot be enjoined on the basis of fraud where there is no allegation of fraud other than allegations of "fabrication" of claims and the general statement that there is no basis for claims is insufficiently detailed, particularly when it is duplicative of contract claims.
Article
Factual Summary: For a US$4,000,000 premium, Applicant/Hospital contracted for excess insurance from Subsidiary to cover medical malpractice claims originating in 2004. In 2006, Subsidiary returned US$2,000,000 of the insurance policy premium to Applicant as excess on the condition that Applicant obtain a US$2,000,000 LC from Issuer in favor of Subsidiary to be drawn if Subsidiary received higher insurance claims and had to increase the premium. Applicant obtained the LC.
In the April 2008 loss statement, Beneficiaries reported over US$8,000,000 in claims related to prior policies, a "sharp increase" from the last report. Applicant subsequently "raised the possibility that it might have trouble coming up with the money." In September 2008, Applicant cancelled the insurance policy in writing and also sued, alleging breach of contract, breach of fiduciary duty, and seeking an injunction on drawing on the LC and a preliminary injunction and temporary restraining order with respect to claims on the 2004 policy. Applicant alleged that the April 2008 loss report numbers were "fabricated" and that Subsidiary was preparing to draw on the LC because its parent, AIG, was in "'dire financial straits.'" The parties agreed to maintain the status quo and not to draw on the LC, thus rendering the temporary restraining order moot. The Judge denied Applicant's motion for preliminary injunction.
Legal Analysis:
1. Fraud; Revised UCC §5-109(b)(4); Breach of Contract: Applicant claimed that Subsidiary was preparing to draw on the LC on the basis of fraudulent insurance loss statements due to the deteriorating finances of its parent, AIG. The Judge noted that under Revised UCC §5-109 the "threshold question is whether [Applicant] [sic] more likely than not to succeed in demonstrating fraud in the transaction or presentment of the letter of credit." The Judge found Applicant's fraud claim to be "duplicative" of its breach of contract claim and that such claims are usually dismissed "when the fraud cause of action adds no new allegation to a breach of contract claim, apart from the addition of the word 'fraud.'" Further, the Judge found that the record did not show sufficient evidence to support a finding of "active intentional fraud."
2. Fraud in the Transaction: In considering the likelihood of success of Applicant's fraud claim, the Judge noted that the complaint "does not allege fraud in the transaction or presentment of the letter of credit." The Judge reviewed case law under Prior NY UCC §5-114, stating "[c]ourts have 'uniformly' interpreted 'fraud in the transaction' sufficient to enjoin payment of a letter of credit to require a showing of 'active intentional fraud.'"
3. No Colorable Basis; Revised UCC §5- 109 Official Comment 1: Applicant argued that fraud under Revised UCC §5-109 differed from fraud in torts, suggesting that the standard was whether or not there was a "colorable" right to draw under the 2004 insurance policy. The Judge noted the use of the term in Official Comment 1 to the effect "'[m]aterial fraud by the beneficiary occurs only when the beneficiary has no colorable right to expect honor and where there is no basis in fact to support such a right to honor.' UCC §5-109 cmt. 1. The comments continue: 'The standard for injunctive relief is high, and the burden remains on the applicant to show, by evidence and not by mere allegation, that such relief is warranted.' UCC §5-109 cmt. 4."
Comments:
1. Breach of Contract Issue: The problem here is simply one of breach of contract and not letter of credit fraud. Accordingly, the court properly refused injunctive relief.
2. Fraud in the Transaction: While Revised UCC §5-109 omits the prior phrase "fraud in the transaction," it embraces the interpretation of this phrase that permitted courts to consider the underlying transaction and not just the documents in determining whether there was material fraud.
[JEB/plc]
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