Note: Lancaster, Ohio (City) and Island Capital Property Owner/Applicant) entered into a tax increment financing agreement (Agreement). The court explained the nature of a tax increment financing agreement as follows:

"A city will [sell] bonds for public improvements, with the intent to recoup the money from increases in the value of property positively impacted by those public improvements. The property owners make service payments to a fund in lieu of property taxes, and the city pays the bond obligations with the money from this fund, rather than the public city's general revenue fund."

To provide security for the debt service payments relating to Agreement, Property Owner/Applicant was required to provide a standby letter of credit "issued by an institution having unsecured, uninsured and unguaranteed long-term debt rating 'A2' or higher by Moody's Investors Service or 'A' or higher by Standard & Poor's Rating Service." Agreement also provided that Property Owner/Applicant was required to replace the standby "at least 15 days prior to the expiration of the then existing [standby]" or City could draw on the standby in the full amount and use the proceeds "to pay Debt Service and for no other purpose." Property Owner/Applicant obtained a standby letter of credit for US$1,084,320 issued by Flagstar Bank (Issuer).

Subsequently, City and Applicant agreed to reduce the required standby amount by 50%, but Applicant did not replace the standby with a new standby reflecting the reduced amount. The standby was scheduled to expire on 3 October, 2009 and Applicant had not replaced it by 1 October, 2009, when City learned that Issuer's credit rating had been downgraded to below the required minimum. Consequently, City demanded payment. Issuer wired the full amount of Standby to City and City returned $542,160 to Issuer, retaining the remaining $542,160 in "an escrow account for application pursuant to the terms and conditions of [Agreement]." On 2 November, 2010, Issuer presented a replacement standby to City and requested the return of the $542,160 that City was holding in escrow, but City refused to return the proceeds.

City sued Issuer and Applicant seeking a declaration that City had acted within its rights in drawing on the full amount of the standby and retaining the proceeds. Issuer and Applicant removed the case to the U.S. District Court for the Southern District of Ohio, and Issuer filed a counterclaim against City for breach of contract and sought a declaration that City was obligated to accept the replacement standby. On City's motion to dismiss Issuer's counterclaims and motion for judgment on the pleadings, the court, Marbley, J., granted the motion to dismiss and declared that City had acted within its rights when it drew on Standby, was not obligated by terms of the agreement to accept the replacement standby offered by Issuer, and had the right to retain the proceeds, but declined to make a summary ruling on the issue of whether City could only apply proceeds to debt service payments proportional to Applicant's liability.



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.