Article

Factual Summary: To assure payment of three orders for glycine, Buyer obtained a commercial standby in the amount of US$600,000.00 in favor of Seller. It required "presentation of the original Letter of Credit and any subsequent amendments and [Seller's] statement on its letterhead, completed, dated and signed by an authorized individual, stating that [Buyer] has failed to pay invoices within the agreed payment terms .... ." Buyer subsequently requested Seller to cancel three purchase orders. In accordance with past practices and chemical industry custom, Seller paid for one order that had already been shipped. Seller's representative informed Buyer that the other two orders would be cancelled. Subsequently, Seller indicated that it was being pressured by its supplier to take the orders, which were not regarded as cancelled.

Concerned that a drawing would be made on the standby in connection with the two cancelled orders, Buyer sought injunctive relief in the Missouri state courts against Seller, and obtained a temporary restraining order. Seller removed the action from the state court to the federal court. On Buyer's motion, the federal trial court entered a preliminary injunction against drawing on the commercial standby.

Legal Analysis:

1) Probability of success. The Judge found that Seller's employee "sent an email to [Beneficiary] indicating that the two purchase orders were cancelled." He also found a course of dealing related to past transactions in which Seller had cancelled orders without penalty. The Judge stated that "the notion that orders could be cancelled prior to shipment leaving the supplier is demonstrated by [Buyer's] attempt to cancel an order, but later having to accept and pay for the order since it had hit the water." With respect to the two orders that had not been shipped, the Judge stated that Buyer "is entitled to rely on the industry practice that no payment would be required." The Judge also noted testimony that "this cancellation policy of the parties was consistent with the standard of businesses in the chemical supply and sales industry."

2) Irreparable Harm. The Judge stated that the focus of the requirement of irreparable harm was "on the harm or potential harm to the plaintiff of defendants' conduct or threatened conduct." Observing that Buyer's President testified that if [Seller/Beneficiary] "presents the letter of credit for payment of the goods which have not been shipped, and therefore he has not received, [it] would have a devastating effect on [Buyer's] business such that the [Buyer] may not survive." and "that the business would be unable to secure sufficient lines of credit to continue as a going concern, leaving it out of business prior to any trial on the merits of this case." The Judge noted that "while the Court is mindful that a mere loss of monetary income is insufficient to justify a finding of irreparable harm, complete devastation of an ongoing concern is indeed irreparable. Once a great concern is no longer, monetary damages are an inadequate remedy."

3) Balance of interests. The Judge weighed the relative harm of granting or not granting an injunction and concluded that the harm to Buyer resulting in the failure of its business outweighed solely monetary loss to Seller/Beneficiary. He also noted that "the potential of any monetary loss is somewhat lessened by the US$10,000.00 bond posted by [Buyer]."

4) Public Interest. The Judge concluded that there was a significant public interest in granting the relief:

As previously noted, the practice of cancelling orders in the chemical sales industry is consistent with allowing cancellation prior to shipment. Purchasers and suppliers should be entitled to rely on established practices. Allowing [Seller] to 'change the game rules' in the middle hinders the flow of commerce and manipulates the industry custom such that it benefits only [Seller]. Specifically, parties would be hesitant to issue letters of credit for fear that those letters of credit will be presented for payment for goods not received, or suffer exorbitant 'cancellation penalties' for cancelling an order, when previously orders could be cancelled without penalties if the shipment had not yet 'hit the water.' The public interest is best served by maintaining the established system of the timing of cancellation. Indeed, this is exemplified by [Buyer's] recognition of this established system by accepting the fact that it must pay for one order since it had been shipped.

Comment:

1. Whatever the merits of the result of this opinion, it is not satisfactory as an exercise of letter of credit jurisprudence. It simply ignores the statutory mandate of Revised UCC Section 5-109(b) that an injunction would lie only if its requirements were met. Instead, the court applied traditional equitable tests that were designed to determine whether to use an injunction to preserve the status quo. These requirements are, indeed, part of the test under Section 5-109(b)(3). However, since an injunction of payment under a letter of credit disrupts the status quo and the commercial arrangement set in place by the parties which allocated the risk of payment pending litigation to the applicant, a more rigorous standard is justified and statutorily mandated.

2. What the court overlooked was the requirement of Revised UCC Section 5-109(b)(4) that the applicant is more likely to succeed in its claim of material fraud. To be sure, the opinion did consider the probability of success as a factor but its focus was with respect to whether the Buyer could cancel its invoice and not whether or not there was material fraud. As noted in Official Comment 1 to Section 5- 109, the test is whether or not there is a colorable basis for the drawing and not whether or not there is a finding of the existence of contractual rights. If there is a legitimate dispute between the parties, the beneficiary is entitled to have and hold the proceeds of the LC unless the drawing would facilitate a material fraud by the beneficiary.

While the actions of the beneficiary might indeed amount to material fraud, there is not a word about it in the opinion. Instead, the court engages in contract analysis and concludes that there is a likelihood that the buyer will succeed on its contract claim. The real question, however, is whether the beneficiary's claim is without a credible argument or colorable basis such that the drawing would facilitate a material fraud by it. It is on that question that the trial court must make findings. While such conclusions might be implied from the trial court's findings, they do not necessarily follow from it. The question would be whether the seller has a colorable right to ship and draw accordingly or whether doing so would constitute material fraud because it has no arguable contractual claim that it can perform under the contract.

3. Revised UCC Section 5-109(b)(2) also requires adequate protection of the beneficiary against loss in the event of an injunction. The comment of the court that a US$10,000 bond somewhat lessens the potential of monetary loss to the beneficiary, however, does not satisfy that requirement. Left unanswered is the question of whether or not the commercial standby remains in place and whether the issuer is protected if it is to be extended beyond its expiration date. Even if the LC remains in place, the question remains as to whether the amount of the bond will cover the attorney's fees and costs of litigation to which the issuer should be entitled regardless of the outcome and to which the beneficiary will be entitled in the event that the seller does not prevail under Revised UCC Section 5-111(e) (Remedies).

[JEB/krp]

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.