Article

Factual Summary: To assure payment of rent, Tenant/Applicant obtained a standby LC for US$594,340.30 in favor of Landlord/Beneficiary. After several drawings were made on the LC, it was subjected to a preliminary injunction restraining Tenant/Applicant from removing any funds from any account maintained with Issuer in an action arising from Tenant/Applicant's involvement in a fraudulent scheme in which it received proceeds of certain refinanced mortgage loans without paying off the original loans.

When Landlord/Beneficiary drew US$126, 964.72 on the LC, Issuer moved for a declaration that the preliminary injunction did not prohibit it from honoring Landlord/Beneficiary's standby. The Judge denied the motion.

Legal Analysis:

1. UCC § 4-303 - Restraining Notice: The Judge noted that under UCC ' 4-303, a restraining notice served after a bank has accepted a draft drawn on a letter of credit is ineffective. However, the Judge concluded that service of preliminary injunction on Issuer suspended Issuer's obligations to pay or accept drafts pursuant to the standby. The motion for preliminary injunction was brought on by an order to show cause dated December 9, 2009. Thus, the restraining order was served before the date Issuer accepted and paid Landlord/Beneficiary's first sight draft on December 29, 2009.

2. Nature of Standby LCs: Citing Nissho Iwai v. Korea First Bank, 752 N.Y.S.2d 259 (2002), the Judge explained that unlike a commercial letter of credit, a standby letter of credit "is used secondarily after the beneficiary fails to obtain payment from the applicant" and is "payable only upon proof of applicant's nonperformance or default." The Judge noted that "the instrument was a standby letter of credit which was to be used by [Landlord/ Beneficiary] only after it failed to obtain payment from [Tenant/Applicant]." While the Judge did not elaborate on this point, further, he appeared to imply that because Landlord/Beneficiary did not seek payment from Tenant/Applicant prior to drawing on the standby, Issuer's acceptance of drafts on a standby letter of credit would not have been legitimate. Such an acceptance would thus not have rendered the preliminary injunction ineffective as against the standby under UCC § 4-303, even if Issuer accepted the drafts before the date of service of preliminary injunction.

Comment:

1. The Judge has seriously confused LCs & UCC Article 5 with Commercial Paper & UCC Article 3. Revised UCC § 5-116(d) (Choice of Law and Forum) provides that in the event of conflict between UCC Article 5 and 3, UCC Article 5 controls.

2. But there is no conflict. Issuer's obligation on the LC is independent from its right to reimbursement from Applicant whether or not, it can change Applicants' account, Issuer is obligated on the LC unless LC fraud is proven by beneficiary.

3. The supposed difference to which the court refers between standbys and commercial LCs under the rubric of "primary" or "secondary" is out of touch with the doctrinal reality. All LCs are primary obligations of their issuer to beneficiary.

4. Moreover, the standby did not undertake to accept a draft in any event.

[JEB/avk]

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