Article

Factual Summary: In order to avoid estate taxes that were estimated to be US$25 to 30 million for his 80 year old Mother, Son arranged with Lender to finance life insurance policies with US$22 million in benefits by lending funds to a family trust. To secure the loan of US$1,612,853, Son/Customer applied to Local Bank for a standby in favor of Lender. Lender, however, required a standby from a better capitalized bank and Local Bank requested a regional bank (Issuer) to issue the standby on behalf of Son.

The opinion indicates that several documents were executed in the process of applying for the standby. One document indicated that Local Bank appointed Issuer as its agent in issuing its standby for the account of Son/Customer designating Lender as Beneficiary. Another was an application completed by Local Bank entitled "[Standby] Application at the Request of Another Bank" and a "Letter of Credit Agreement" that provided that Local Bank and Son/ Customer were "jointly and severally liable" for reimbursement of Issuer. Subsequently, Local Bank pledged a certificate of deposit at Issuer in the amount of US$1,850,000 to secure all of its obligations to Issuer.

Issuer issued the standby in the amount of US$1,580,000. It contained an automatic extension provision and was drawable in the event of a default on the loan or receipt of a notice of non-extension.

When Lender/Beneficiary made a complying drawing on the standby, Issuer reimbursed itself by debiting the certificate of deposit and paid Lender/ Beneficiary US$1,580,000. At some point in this process, Local Bank was declared insolvent by the US government's bank regulator, the F.D.I.C. which was appointed Receiver for Local Bank. Receiver then demanded reimbursement from Son/Customer which failed to do so. As a result, Receiver sued Son for the principal, interest, attorneys' fees, and costs on a theory of reimbursement and unjust enrichment. The trial court awarded judgment to Receiver as a matter of law.

Legal Analysis:

1. Applicant: The Judge ruled that the role of both Local Bank and Son/Customer was that of applicant.

2. Rights of Receiver: The Judge noted that the basis for the Receiver's rights against Applicant flowed from its reimbursement of the Issuer, thereby satisfying Applicant's obligation to Issuer. The Judge stated that: "The Receiver's reimbursement obligation under the Letter of Credit Agreement was merely secondary, while [Applicant's] was primary." According to the Judge, this arrangement gave rise to liability under the doctrine of equitable indemnity.

3. Liability of Customer/Son to Receiver; Primary Liability: Noting that the Son/Customer and the Local Bank were jointly and severally liable, the Judge observed that Local Bank received "no benefit whatsoever" and that it had paid "more than its share" of the joint liability. The Judge concluded that: "Because the payment by [Issuer] on the Amended LOC was solely for [Son/Customer's] benefit and the Receiver/[Local Bank] received no benefit whatsoever, the Receiver's reimbursement obligation under the Letter of Credit Agreement was merely secondary, while [Son/Customer's] was primary."

4. Subrogation: Since the Receiver's liability was secondary, the Judge concluded that the Receiver was subrogated to the rights of the confirmer against Son/Customer based on the Letter of Credit Agreement. The Judge concluded that Beneficiary "would have had the right to recover the amount of the LOC from [Son/Customer] personally immediately" had Issuer wrongfully dishonored and if the family Trust refused to pay. The Judge concluded that being subrogated to Beneficiary's rights against Son/Applicant, the Receiver is subrogated to Beneficiary's rights against Son/ Applicant as surety for the family Trust.

The Judge stated that the issuer was subrogated to the rights of the beneficiary "to the same extent as if the issuer were a secondary obligor of the underlying obligation owed to the beneficiary." When Receiver reimbursed Issuer, the Judge decided that "the Receiver obtained the same subrogation rights."

The Judge stated that "the Letter of Credit Agreement contains no explicit provision requiring [Son/Customer] to reimburse [Local Bank] in case [Local Bank] is required to reimburse [Issuer] for payments made under the Amended LOC". He then attempted to explain the basis for the obligation to reimburse, namely the result of "applicable law" which was included in the letter of credit, namely: "[T]he California statutory rights of indemnity (Civil Code § 2847), contribution (Civil Code § 1432), subrogation (Civil Code §§ 2848 and 2849) and subrogation under the UCC (Commercial Code § 5117)". Breach of these provisions, according to the Judge, rendered Son/Applicant liable for the amount drawn, costs, and attorney's fees. In addition, the Judge noted that Son/ Applicant had been unjustly enriched, rendering him liable to the issuer for restitution.

In addition, the Judge concluded that Son/ Applicant was liable for attorney's fees based on the terms of the Letter of Credit Agreement (which apparently provided for attorney's fees) or as the prevailing party under California's Revised UCC Section 5-117(e) (Damages).

5. Suretyship: As an alternative basis for its decision, the Judge ruled that Son/Customer "is a surety of the [family] Trust's debt to [Lender/ Beneficiary] and that the Receiver is subrogated to [Lender/Beneficiary's] rights against [Son/ Customer]" making it liable for costs and expenses including attorney's fees. In this regard, he ruled that as a surety, Son/Customer "promised to answer for the debt, default or miscarriage of" the family Trust on whose behalf he was acting and which would benefit from the tax avoidance scheme.

Comments:

1. FDIC and Its Position re LCs. It is well known that it is not well known what position the FDIC takes regarding LCs. Here is a small insight. Where a bank exercises rights against an asset of an insolvent bank that it holds as security for an LC issued at the request of the insolvent bank, the FIDC will not contest the debit but pursue reimbursement in other directions. The case offers some insight into tactics for correspondent banks. The correspondent held a CD owned by the insolvent bank and debited it to reimburse itself.

2. The Agreement. It is a wonder that the Local Bank did not require its customer to enter into a reimbursement agreement, a simple step that would have solved many problems and much confusion.

3. The opinion with its multiple resorts to subrogation leaves the reader aghast and confused about what rights of whom to which one is being subrogated.

The confusion is intensified by the court's references to secondary and primary liability.

The matter is less complex than the opinion makes it appear. Although both co-applicant's are equally liable to the issuer (who is the creditor for purposes of suretyship law), one is a surety to the other. As between them, the Son ought to pay and the Local Bank ought not. As between themselves, the Son is the principal and the Local Bank is not.

As a result, under widely recognized principles of the law of suretyship, the surety has two rights, that of reimbursement and of subrogation to the rights of the creditor (issuer) against the applicants. Exercise of the right to reimbursement, absent a contract, would not include attorney's fees. Exercise of the right of subrogation to the rights of the LC issuer to reimbursement against a co-applicant would entitle the person exercising it to attorney's fees under Revised UCC Section 5-111(e).

Therefore, the Receiver acting on behalf of the Local Bank is seeking to recover as surety against its principal on the basis of subrogation to the rights of the creditor against the principal.

The only source of potential difficulty in this analysis is whether payment by the surety extinguishes the right of the creditor against the principal. The proper result is that it does not.

[JEB]

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