Factual Summary: As security for its obligations under an ISDA Master Agreement related to derivatives trading, Derivative Trader posted a standby LC issued by Bank (Issuer) in favor of Derivatives Broker/Beneficiary. The Master Agreement was subject to English law.

Broker/Beneficiary and Issuer were also parties to a prior ISDA Master Agreement that was governed by New York law. The obligations of Broker were guaranteed to Issuer by Guarantor. Section 6(f) of the Master Agreement provided that "with respect to a party ("X"), the other party ("Y") will have the right without prior notice to X or any other person to set-off or apply any obligation of X owed to Y against any obligation of Y owed to X." [¶ 4]

When Guarantor filed for bankruptcy, Issuer notified Broker/Beneficiary that US$ 15,030,239 was owed under the prior ISDA Agreement. As a result, when Broker/Beneficiary drew on the standby, Issuer set-off the amount owed on the earlier Master Agreement (converted to EUREUR 11,622,809.31). Consequently, Issuer paid Beneficiary EUREUR 38,377,190.69 instead of EUR 50,000,000. Broker/Beneficiary then sued Issuer for wrongful set-off and recovery of full LC proceeds. Broker/Beneficiary then sued Issuer for the full LC proceeds. The court ruled in favor of Issuer.

Legal Analysis:

1. Set-off

Beneficiary argued that Issuer's set-off under the LC resulted in an absurd or unreasonable result because it created "a windfall of EUR 11,622,809.31 for [Beneficiary] with [Applicant] being liable for that amount twice over."[¶ 28] Since the proceeds of the LC paid to Beneficiary were reduced from EUR 50,000,000 to EUR 38,377,190.69 by Issuer's set-off, the Applicant's debt to Beneficiary was only reduced by EUR 38,377,190.69 rather than EUR 50,000,000 leaving Applicant's remaining debt to Beneficiary at EUREUR 87,161,270.40 rather than EUREUR 75,538,461.

The Judge rejected Beneficiary's argument and ruled that the sum owed by Applicant to Beneficiary was to be reduced by the total value received by Beneficiary under the LC, which included both the proceeds of the LC and the value received by way of set-off of the amount Beneficiary owed Issuer. "Where an obligee is owed money by A and can look to B in respect of the same debt, a set-off by B reduces pro tanto the debt owed by A." [¶ 29] The Judge further ruled that had Beneficiary been paid the full value of the LC by Issuer, that Applicant would be obliged to "reimburse or indemnify [Issuer] in respect of that full value." [¶ 30]

Beneficiary argued that its instruction to Issuer in a letter "to transfer the amount of EUR 50,000,000 without deduction" prohibited Issuer from making the set-off because the LC specifically stated that "[Issuer] hereby irrevocably undertake[s] to cover [Beneficiary] as per [Beneficiary's] instructions." The Judge rejected Beneficiary's argument, ruling that such language merely "covers situations where drawings are multiple or partial or where particular bank accounts are identified to which payment is to be made" and is not a relinquishment by Issuer of a pre-existing right of set-off per Beneficiary's subsequent instructions. [¶ 40]

Beneficiary further argued that since the EDF/ ISDA Master Agreement maintained the LC arrangement between Beneficiary/Applicant as a form of Eligible Credit Support not at risk of the exercise of set-off by EDF, then it would be inconsistent to subject the LC to set-off by Issuer. The Judge also rejected this argument. Since Issuer was not a party to the EDF/ISDA Master Agreement and "was unaware of the [EDF/ISDA Master Agreement] when it entered into the Master Agreement and when it issued the Letter of Credit" [¶ 42], the Judge concluded that the "...Master Agreement cannot itself affect Issuer's pre-existing rights of set-off and nor can the [EDF/ISDA Master Agreement] be part of the factual matrix against which the Letter of Credit stands to be construed." [¶42]



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.