Article

Factual Summary: As a condition to further financing for a construction loan, Developer was required to provide an additional US$1 million in the form of an LC in favor of Beneficiary/Lender. In order to obtain the LC, Developer agreed with Applicant/Surety that Applicant/Surety would procure the LC. The letter of credit required presentation of a draft and of the following signed and dated statement:

The undersigned, an authorized officer of [Lender,] hereby certifies, under penalty of perjury, that all funds have been advanced (less any interest reserve) to [Developer] under or in connection with that certain construction loan promissory note (the "Note") dated as of June 27, 2003 in the aggregate amount of $4,500,000 established by [Lender] in favor of [Developer], an "Event of Default" (as defined in the Note) has not occurred, no event exists that may, with the passage of time, constitute an "Event of Default", [Developer] is currently not in default, [Lender] has notified [Surety] of the intended drawing under the [Issuer] Letter of Credit No. NZS488105, [Lender] will disburse the proceeds of this Letter of Credit to [Developer] solely for the development and construction of the Project and such funds shall not be used by [Lender] for any other purpose, including, without limitation, retiring any portion of the Note, and [Lender] is now drawing the sum of {insert amount}.

Before the letter of credit was issued, Applicant/ Surety proposed a side letter of agreement that stated that a drawing would not occur in the event of default and that the LC would only be utilized after the proceeds of the loan were disbursed. Beneficiary's response did not include these provisions, and the existence of a binding contract was an outstanding issue of fact.

Over the course of the year, Beneficiary/Lender provided an additional US$1,000,000 in loans, and drew the full US$1,000,000 on the LC although aware that Developer had increased the scope of the project, adding another US$1,000,000 in construction costs, thereby creating concerns about Developer's ability to repay the loans. Additionally, Developer had not paid its real estate taxes for the first half of the year. Beneficiary did not inform Applicant/Surety of its concerns about the project.

At the end of the year, Beneficiary declared Developer to be in default on its loan, and Developer defaulted on its letter of credit agreement with Applicant/Surety. Beneficiary's position as the first mortgagee rendered it likely that no funds would be available under Applicant/Surety's mortgage to Applicant/Surety. Applicant/Surety then sued Beneficiary for breach of contract, tort, and equitable claims. The trial court granted summary judgment for Beneficiary/Lender which was reversed and remanded by the Court of Appeals. The Supreme Court of Washington reversed the decision of the Court of Appeals and reinstated summary judgment in favor of the Beneficiary/Lender.

Legal analysis:

1. One-Year Statute of Limitations under UCC Article 5:

The Supreme Court of Washington stated that whether the claim was subject to the limitation period under US Rev. UCC Section 5-115 depended on whether Applicant/Surety's claim was based on an underlying contract between Applicant/ Surety and Beneficiary/Lender. If so, the UCC Article 5 warranty merely supplemented Applicant/Surety's claim and the Rev. UCC Article 5 statute of limitations would not apply. If not, the Rev. UCC Article 5 warranty would displace Applicant/Surety's claim and the Rev. UCC Article 5 Statute of Limitations applies. The Supreme Court concluded that since the underlying contract was between Beneficiary/Lender and The Fourth Party/Developer, rather than between Applicant/Surety and Beneficiary/Lender, Applicant/ Surety had no basis outside of the UCC article 5 for his breach of contract claim. Accordingly, the oneyear limitations period of UCC should apply. The Supreme Court refused to recognize the written communications between Applicant/Surety and Beneficiary/Lender as the underlying contract in that the language did not indicate an offer, acceptance, or any new consideration.

Comments by Jacob Manning of Dinsmore & Shohl:

That the Washington Supreme Court should focus on whether the Applicant/Surety and Beneficiary/ Lender had separately formed a contract is, of course, required by US Rev. UCC Section 5-110(2). The Section 5-110(2) warranty is beneficiary's warranty to the applicant that the drawing "does not violate any agreement between the applicant and beneficiary or any other agreement intended by them to be augmented by the letter of credit." Thus, when a court is asked to determine whether a claim is a warranty claim (to which the one-year statute of limitations applies) or a common law claim (to which another statute would apply), it must determine whether there are any agreements between applicant and beneficiary or that the parties intended to be augmented by the letter of credit. The Washington Supreme Court, therefore, correctly decided that it must first resolve whether there was an agreement before it could decide the nature of the claim.

That decision was not inevitable, however. As was discussed in more detail in J. Manning, [The Statute of Limitations Under Article 5 of the UCC], 42 UCC L. J. 95 (2009), reprinted in this volume, the intermediate appellate court in the same case stated that the issue whether the Applicant/Surety and Beneficiary/Lender had formed a separate agreement had not been placed before it. The intermediate court then proceeded to analyze the claim, assuming that the Applicant/Surety had alleged sufficient facts to support its claim that there was such an agreement and it was breached. Without analyzing the alleged agreement, though, it was not possible to conduct the analysis that Section 5-110 requires and as a result, the intermediate appellate court came to a conclusion opposite of that reached by the Supreme Court.

[JEB/ny]

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