Article

Factual Summary: To secure a loan for a $53 million purchase of real property, Applicant/Borrower obtained a $10 million standby LC in favor of Lender/ Beneficiary. When Lender/Beneficiary failed to fund the loan as agreed, Applicant/Borrower obtained a bridge loan from Second Lender. The Lender/ Beneficiary "assigned the letter of credit - which by its terms was transferable - to [Second Lender], which was made beneficiary in place of [Lender/ Beneficiary]."

Second Lender used the standby LC as collateral in a separate loan transaction with Third Party. The Applicant/Borrower claims that this done without its consent, but Lenders pointed to a letter of acknowledgment signed by Applicant's agent consenting to the use of the LC to "collateralize an obligation of [Second Lender] to the lenders ... to facilitate the transaction for which ... the [LC] was [originally] issued."

When Second Lender failed to fund the bridge loan, Applicant/Borrower sent a notice of default to Second Lender, demanding cancellation and return of the standby. Concerned that a default on Second Lender's separate loan would result in a drawing on the standby, Applicant/Borrower sued to enjoin drawing and moved for a preliminary injunction that the trial court granted.

Legal Analysis

1. Preliminary Injunction. The Judge stated that in order to obtain a preliminary injunction under New York law there must be "(1) a likelihood of ultimate success on the merits; (2) irreparable injury absent the granting of injunctive relief, and (3) a balance of the equities in [Applicant's] favor." Quoting applicable case law, the Judge also noted that the remedy of injunction should only be "sparingly" available and when there is no factual dispute.

2. Injunction, Likelihood of Success on the Merits. Lenders argued that a letter of credit is completely independent of a contract between applicants and beneficiaries except in cases where "fraud in the transaction or presentment of the letter" can be demonstrated. The Judge noted that the "failure to fund the loan was a breach of the contract as to the letter of credit that was issued," revealing a likelihood of success in seeking the injunction.

3. Irreparable Injury. Lenders argued that there was no irreparable injury since money damages would suffice. The Judge rejected this argument, noting that a drawing would severely impact Applicant/ Borrower's credit, impairing its ability to complete the project, particularly in light of the illiquid situation of the Lenders.

4. Injunction, Balance of Equities. Lenders argued that the rights of Third Party to the funds under its underlying contract outweighed the rights of Applicant/Borrower. The Judge rejected this argument, noting that both Lenders breached their contracts to fund the loans, and that Applicant/ Borrower satisfied its obligations and was neither a party to the loan agreement between Second Lender and Third Party, nor did it consent to the agreement. The Judge also pointed out the existence of other collateral that was available to Third Party.

5. Summary Judgment. Lenders argued that summary judgment cannot be granted to Applicant/ Borrower when its managing member signed a letter of acknowledgement in which Lenders and Applicant/ Borrower consented to the use of the LC as collateral in Second Lender's transaction with Third Party. The Judge rejected Applicant/Borrower's objection that Third Party could only use the LC if Applicant/ Borrower went into default, because such a provision was not explicitly stated in the letter of acknowledgment. Accordingly, the Judge denied Applicant/Borrower summary judgment.

Comment:

a. LC Fraud or Abuse. The court mentioned neither U.S. Rev. UCC Article 5-109 (fraud and forgery), nor anything about material fraud in its ruling. While the failure to fund the loan may have constituted material fraud, the answer is not so apparent as to not require express consideration.

b. Transfer or Assignment. Although the opinion says "assigned," it appears to have been transferred. Only if it was transferred could the Second Lender have drawn on it.

c. LC Fraud or Abuse; Transfer. If the facts involve a transfer rather than an assignment, the focus of the inquiry shifts. A transferee beneficiary is independent of any LC fraud or abuse by the transferor beneficiary and only the conduct of the transferee beneficiary matters. In this respect, the failure of the transferee beneficiary to fund the loan that is the underlying reason for the transfer of the standby is material.

[JEB/eml]

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