Article

Factual Summary: To assure completion of Developers' (Applicants) projects, Bank (Issuer) issued a standby LC to County (Beneficiary) in December 1989. The LC provided for automatic six-month extension unless Issuer notified Beneficiary that it would not extend. Issuer never sent any such notice. Applicants did not complete the project by June 1991, the extended date for completion under the contract. In February 2008, Beneficiary demanded payment under the LC, and Issuer dishonored, claiming that payment was barred by the statute of limitations. In an action for wrongful dishonor, the court entered summary judgment in favor of Issuer.

Legal Analysis:

1. Contract. In classifying the obligation under the LC for purposes of determining the applicable statute of limitations, the Judge concluded that it was a contract. The Judge stated that "[a]lthough a letter of credit is an unusual type of contract, it is still a contract under Virginia law, and must be governed by contractual principles".

2. Limitation of Action. The Judge concluded that the applicable statute of limitations was five years and that Virginia law provided that "the running of the statute of limitations cannot be unreasonably delayed by a party who has the sole right to trigger when the statute of limitations will run". The Judge framed the issue as "whether it is reasonable for the [Beneficiary] to issue its demand seventeen years after the initial default by [Applicants]". The Judge applied case law to the effect that where there was no language in the contract "referring to the time when the demand is to be made, it is as if the words 'within a reasonable time' were found in it", citing Page v. Shenandoah Life Insurance Co., 185 Va. 919, 925, 40 S.E.2d 922, 925 (1947). Given this characterization, the Judge concluded that it was unreasonable for the County to wait seventeen years, "particularly considering that the statue of limitations for actions on written contracts in Virginia is five years". "To hold otherwise would give the County literally forever to file suit. Given the Virginia General Assembly's enactment of many statutes of limitations which bar untimely litigation, it is contrary to the policy of the Commonwealth to allow the County to file a lawsuit seventeen years after the obligation was created."

Comments:

1. This decision is terribly wrong. It confuses the rights under the underlying contract with obligations of the issuer on the LC. The undertaking of the issuer was that it would be obligated in sixmonth cycles until the Issuer notified the County that it would not renew. Not having done so, the credit was still in force and available for drawing.

2. The decision, if followed, would now require courts considering drawings on LCs to explore what time was reasonable in making a drawing if it is alleged to be "late". Such a result turns a simple LC obligation into a complex question of the motives and intentions of the parties with respect to the underlying transaction. The only arena for consideration should be why the parties require an LC with an automatic extension clause. The reason is that they do not want to have to worry about expiration unless it is triggered by a notice of non-extension. Many entities, including courts and their clerks who are beneficiaries of LCs, do not wish to have to monitor the expiration of LCs and want to be able to draw even if the drawing is long after the right to do so has arisen. The point of an automatic extension clause is to put the onus of monitoring the duration of the standby on the bank and not the beneficiary.

3. Nor would a judgment against the bank be unreasonable. The bank, having issued such a credit and not having given notice of non-extension, was obligated and presumably monitoring the assets and ability of the applicant to reimburse it as it was required to do under safety and soundness principles.

4. This LC was subject to Prior UCC Article 5, having been issued in 1989, which did not have its own internal statute of limitations as does Revised UCC Section 5-115(Statute of Limitations) or provisions regarding perpetual obligations as in Rev. UCC Section 5-106(Issuance, Amendment, Cancellation, and Duration). These provisions, however, are informative. The undertaking would not be regarded as without an expiry date or perpetual under Rev. Section 5-106(c) or (d) since it contains an automatic extension clause, as indicated in Official Comment 4 to that Section. Nor would it run afoul of the Rev. UCC Section 5-115(Statute of Limitations) since the cause of action would not have accrued since no demand was made. The same result should obtain under an LC under Prior UCC Article 5. The question is not the length of the Statute but its accrual.

[JEB/jdc]

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