Article

Factual Summary: To assure repayment of a loan, Bank (Issuer) issued a financial standby LC in favor of Beneficiary. To assure reimbursement, Issuer and Applicant entered into a Letter of Credit and Reimbursement Agreement (LRCA). It provided that surety "personally guaranteed [Applicant's] obligations . . . by entering into a separate guaranty agreement" with Issuer. Surety "undertook such guaranty 'as primary obligor and not merely as surety; and Issuer may enforce this Guaranty without any prior enforcement of the Guaranteed Obligations or any security therefor or other guaranty thereof'". The standby was also cash collaterized by US$30 million as memorialized in an amendment.

After Beneficiary drew on the standby and was paid, Issuer applied the cash collateral and sued Applicant and Surety jointly and severally for the balance of US$19,944,323.04 plus interest and attorney's fees. Issuer moved for summary judgment under the LRCA, guaranty and security agreement, claiming "once it paid monies to [Beneficiary,] it had the right to apply the cash collateral at hand and then seek the balance from [Applicant and Surety]". Applicant and Surety moved for a stay of this action in order to seek discovery and to resolve claims related to the underlying transaction pending in federal court. The trial court granted Issuer's motion for summary judgment against Applicant and Surety, and denied

Applicant and Surety's cross motions.

Legal Analysis:

1. Independence Principle: Applicant and Surety contended that the drawing on the standby was improper, that Issuer should not have honored it, and accordingly that there was no reimbursement obligation. Applicant and Surety argued that summary judgment was premature and "urge[d] the court to consider the [reimbursement agreement], guaranty and security agreement as part of a larger, vastly complex commercial transaction". Issuer argued that these matters were irrelevant since "the letter of credit is best conceptualized as an encapsulated and separate transaction, despite the presence of an underlying contract for services, goods, etc.". Issuer contended that "it was obligated to make the payment demanded [from Beneficiary] without having to evaluate the state of the underlying business transaction... once it determined [that] the sight draft was facially in order".

The Judge noted that "the fundamental principle governing letters of credit is the doctrine of independent contracts. . .this approach is consistent with the ICC's Uniform Customs and Practice for Documentary Credits (UCP), rules that banks apply to finance billions of dollars worth of world trade every year (http:// www.iccwbo.org/id93/index.html). [Surety and Applicant] expressly consented to the application of those rules in the [reimbursement agreement] and related letter of credit documents and cannot now be heard to complain that is not what was intended."

2. Independence Fraud Exception; Fraud and Abuse; Exception to Independence Principle; Good Faith; LC Fraud: Appellant and Surety argued that Beneficiary "did not act out in good faith and may have committed a fraud". The Judge ruled that while there were allegations of bad faith or fraud against Beneficiary, there were none against Issuer related to the LC and the only claims against it related to transactions that the Judge regarded as "independent contracts, separate and distinct" from the LC. The Judge rejected Applicant and Surety's arguments based on Beneficiary fraud because, "[w]hile allegations of fraud may represent a narrow exception to the doctrine of independent contracts, there are no fraud allegations by [Applicant and Surety] against [Issuer]."

3. Reimbursement Obligation; Underlying Transaction; Independence: Applicant and Surety argued that summary judgment was inappropriate because it was premature and that the reimbursement agreement and suretyship undertaking should be considered holistically in the context of the entire underlying transaction.

The Judge noted that "the issuer of the letter of credit is not required to resolve disputes or questions of fact concerning the underlying transaction" and that "the issuer must honor the demand for payment, regardless of whether there is a contract dispute".

Looking at the plain meaning of the undertakings of Applicant and Surety that requested Issuer to issue its LC subject to UCP500, the Judge concluded they were "unambiguous, independent contracts,... and there [was] no need to resort to parole evidence or extraneous document[s] to determine the parties' intent." Accordingly, the Judge concluded that Applicant and Surety were required to reimburse Issuer for having paid under its LC.

Comments:

1. While the Judge invokes the vocabulary of independence, the issue involves not the LC but the reimbursement obligation that is not "independent". What the Judge's ruling signifies is that other contractual obligations do not impact the reimbursement obligation and the reimbursement and suretyship agreements since the LC obligation, under which the issuer is liable, is independent and any LC right to reimbursement.

2. Perhaps the reimbursement undertaking is also a letter of credit. The agreement between Surety and Applicant contains the following terms: "[Surety] undertook such guaranty 'as primary obligor and not merely as surety; and Issuer may enforce this Guaranty without any prior enforcement of the Guaranteed Obligations or any security therefor or other guaranty thereof'". Such terms have been construed in other situations to signal an independent undertaking.

[JEB/sws]

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