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Note: In connection with a contract to purchase electricity from Electric Reliability Council of Texas (Seller/Beneficiary), Texas Commercial Energy (Buyer/Applicant) posted standby letters of credit to assure its purchase of a minimum amount of electricity.

When Buyer/Applicant filed for bankruptcy, a court order was issued preventing Seller/Beneficiary from drawing on the standbys securing prior invoices. Buyer/Applicant continued to operate during the bankruptcy. As part of the bankruptcy process, the pre-bankruptcy debt was replaced by reorganization plan debt. In order to continue purchasing electricity from Seller/Beneficiary, Buyer/Applicant entered into a new contract that required an additional LC be posted. To satisfy the requirement, a shareholder of Buyer/Applicant obtained the second standby for US$900,000.

When Buyer/Applicant defaulted on the bankruptcy plan debt, Seller/Beneficiary drew on the second standby although the Buyer/Applicant had not defaulted on current purchases.

Claiming that Seller/Beneficiary had drawn the standby in violation of a bankruptcy court order, Buyer/Applicant sued Seller/Beneficiary. The United States District Court for the Southern District of Texas, Janis Graham Jack, J., entered judgment in favor of Buyer/Applicant and awarded damages. On appeal, the United States Court of Appeals, Fifth Circuit, Edith H. Jones, J., reversed.

The District Court ruling was based on Buyer/ Applicant's argument that since the bankruptcy plan debt was an "obligation represented by those [prebankruptcy] invoices", Seller/Beneficiary drew on the standby in violation of the court order and should be required to repay the money.

However, the intermediate appellate court concluded that the pre-bankruptcy debt was assumed when the reorganization plan was signed. Therefore, drawing on the second standby to satisfy the bankruptcy plan debt did not "represent" any of the pre-bankruptcy debt.

[JEB/kmw]

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