Article

Factual Summary: To secure a loan for the construction of a luxury yacht, U.S. Buyer obtained a standby LC from U.S. Bank (Issuer) in favor of Chinese Bank/Beneficiary, to assure repayment of its loan of construction funds to Chinese Yacht Builder. Chinese Bank/Beneficiary had not done business with Yacht Builder, so its officer visited two facilities to determine whether it was capable of building yachts and found several in the process of being built. It relied on the standby, however, for its reimbursement. The terms of the LC "provided that [Issuer] would pay [Beneficiary/Chinese Bank] from the letter of credit upon the presentation of a certified statement of [Chinese Bank/Beneficiary]'s loan of funds to [Yacht Builder]". To protect themselves, Applicants/ Buyers demanded and received a standby LC (Yacht Builder's LC) in the amount of US$300,000 in their favor to be issued by the same Chinese bank, the Agricultural Bank of China, in the event that the yacht was not built. They also demanded and Yacht Builder tendered a performance bond which appeared to be from Allianz (Insurer) and guaranteed payment to Applicants in the event the yacht was not built. Buyers/Applicants later discovered that this performance bond was fraudulent.

Relying on the standby in its favor, Chinese Bank/ Beneficiary loaned funds to Yacht Builder. When it found that the yacht had not even been started, Buyer/ Applicants drew on the Yacht Builder's LC for its full amount of US$300,000. When it was informed by Yacht Builder that it had not commenced work on the yacht, Chinese Bank/Beneficiary honored the drawing on Yacht Builder's LC and demanded that Builder return the loan amount. Yacht Builder paid back a small part of the loan, but a significant amount remained outstanding.

After unsuccessfully demanding return of the standby and being informed that Issuer would honor a complying presentation, Applicant/Buyer sued Issuer in the United States to enjoin honor based on the fact that the yacht had not been built, alleging that Chinese Bank/Beneficiary and Yacht Builder had conspired together to defraud Buyers/Applicants. Issuer did not object, and the Judge granted an emergency injunction which, after a hearing, was continued as a preliminary injunction. After the injunction issued, Chinese Bank/Beneficiary made a facially conforming draw, which Issuer did not honor because of the injunction. Chinese Bank/Beneficiary subsequently intervened, and Issuer asserted a counterclaim against Applicants and third-party claims against Chinese Bank/Beneficiary and Yacht Builder, seeking declaratory judgment. Applicants amended their complaint, naming Issuer, Chinese Bank/Beneficiary, and Yacht Builder as defendants and seeking recovery against Issuer on theories of breach of fiduciary duty, negligent misrepresentation, equitable estoppel, and civil conspiracy with Chinese Bank/Beneficiary. Applicants sued Chinese Bank/ Beneficiary for civil conspiracy, unjust enrichment, and fraud. Applicants also sued Yacht Builder for fraud, but Yacht Builder was eventually dismissed as a defendant for failure to obtain service of process.

After a full trial, the trial judge ruled in favor of Issuer and Beneficiary and subsequently denied Applicants' Motion to stay dissolution of the injunction pending appeal. The Applicants appealed, and the appellate court affirmed.

Legal Analysis:

1. Fiduciary Duty. Applicants claimed that Issuer had breached its fiduciary duty to them in connection with the issuance of the LC by failing to correct the Applicants' mistaken impression that Chinese Bank/Beneficiary could not draw on the LC until the yacht was delivered. The appellate court affirmed the trial judge's ruling that Issuer did not owe a fiduciary duty to Applicants, ruling that their relationship was an arms-length, lender-borrower one despite the 25-year relationship that Applicants had had with the Issuer. The appellate court relied on case law, Issuer's former employee's testimony that Issuer would not undertake to protect Applicants' interests, the fact that Applicants were sophisticated business people, the fact that Applicants' lawyer reviewed the LC, and that Applicants required a performance bond to protect their interests to arrive at the conclusion that Issuer did not agree to assume a fiduciary duty on behalf of Applicants. Furthermore, the bank noted that "[Applicants'] claim for fiduciary breach failed because the information that [Issuer] allegedly neglected to disclose . . . was available to the [Applicants] and not peculiarly within the [Issuer]'s knowledge."

2. LC Fraud; Independence. Applicants claimed that the trial court erred in rejecting their fraud claim against Chinese Bank/Beneficiary. Relying on case law, the appellate court ruled that the independence principle insulated the LC from any dispute Applicants may have had concerning the underlying transaction.

Applicants claimed that the independence principal did not apply in this case for two reasons. First, they contended that the specific language of the standby LC ("per yacht building contract no. s125- 1") incorporated the underlying transaction into the terms of the LC. They argued that this meant that the Chinese Bank/Beneficiary had to fulfill its contract with Applicants in order to draw on the LC. The appellate court ruled that Applicants' argument failed as a matter of law and that UCP500 Article 3, which governed the LC, specifically provided that LCs, by their nature, are separate from the underlying transaction "even if any reference whatsoever to such contract(s) is included in the Credit."

Second, Applicants argued that the independence principle was inapplicable because "the letter of credit agreement itself was procured through fraud because [Chinese Bank/Beneficiary] never made a loan to the Yacht Builder. The appellate court ruled that the fraud exception to the independence rule "must be construed narrowly and must be based on legitimate and supported allegations." The court noted that Applicants failed to offer any evidence of misconduct and that witnesses actually testified that Chinese Bank/Beneficiary actually did make a loan to the Yacht Builder.

Comments:

Although Applicants argued that they were illserved by their bank, one wonders. They were amply protected by a standby covering the advance payment (on which they collected) and a bond. That the bond was forged was hardly the bank's responsibility. They failed to structure the transaction in a manner that provided for objective verification of the bond.

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