Factual Summary: Applicant borrowed funds from Beneficiary in order to build and maintain a mobile home community and secured the loan with a standby LC requiring presentation of a sight draft and the original standby. The underlying loan agreement provided for reductions of the standby corresponding to the increase of the value of the property used as collateral: "The Letter of Credit shall be reviewed by [Beneficiary] and appropriate reductions made every six (6) months after capital improvements are made to the property upon written notice of the amount of the reduction to [Applicant] and [Issuer], such written notice of reduction shall not be later than thirty (30) days after [Applicant's] request for the reduction".

Applicant and Beneficiary repeatedly amended the LC, although they did not follow the procedure set forth in the agreement. Both "[Issuer] and [Beneficiary] agree[d] that by January 18, 2010, the Letter of Credit had been reduced to $3,189,693.69." Beneficiary alleged that the amendments were only effected when Applicant sent a request for a reduction to Beneficiary, and, upon Beneficiary's consent, Issuer issued an amended LC. Issuer did not agree that this process was followed for each amendment.

A dispute arose when Issuer advanced $1,281,832.54 to Applicant for property improvements. No explanation is given of why Issuer was advancing funds to Applicant. Applicant sought a corresponding reduction to which Beneficiary refused to consent, noting that the Loan agreement provided for one reduction per six month period, and pointing out that one had already taken place in the past six months. Believing that Beneficiary had "implicitly consented" to the requested reduction based on "course of dealing", Issuer reduced the balance by the requested amount, leaving a total balance of $ 1,907,861.15. After Applicant defaulted, Beneficiary drew on the letter of credit claiming the full balance. Issuer only paid the reduced amount. Beneficiary then sued for the balance. Issuer counterclaimed for a declaratory judgment and attorney's fees, and filed a third party complaint. Both parties moved for judgment on the pleadings and the motions were denied.

Legal Analysis:

Independence; Amendment, Consent, Course of Dealing; US Rev. UCC §§ 5-103(d); US Rev UCC § 5-106(b); Reduction: When Beneficiary claimed that it had not consented to a reduction in the amount of the standby letter of credit request by Applicant, Issuer responded that it had followed the same procedure as it had for prior reductions. Beneficiary asserted that the terms of the underlying loan agreement only allowed for one reduction every six months. Although the Judge referred to the independence principle and US Rev. UCC§ 5-103(d) (Scope) codifying it, she stated that she was "unable to decide whether the independence principle applies when disputes exist regarding the validity of the outstanding balance of the Letter of Credit." In refusing to decide the case on a summary basis, the Judge noted that Issuer's claims of course of dealing, and the provisions of Official Comment 2 of US Rev. UCC § 5-106 (Issuance, Amendment, Cancellation, and Duration), suggest that consent to an amendment can be by implication from conduct of the parties.


1: Independence of Amendments: This decision is troubling in several respects. Most troubling is the Judge's conclusion that she was unable to decide whether or not the independence principle applied to a proposed amendment to reduce the amount of a standby letter of credit. If the independence principle and the notion of an irrevocable undertaking are to have any real significance, they must apply to the question of whether or not the amount outstanding can be reduced. Should automatic reduction be desired, the terms of the standby must so provide. Otherwise, there must be beneficiary consent to proposed amendment. As described in the Opinion, the standby did not provide that it was revocable nor did it provide for automatic reduction.

2. Other Errors: The Judge's mistake regarding the scope of the independence principle led to consideration of factors that should not have been considered in determining the terms and conditions of the standby letter of credit, namely the underlying agreement between the beneficiary and the applicant and their conduct. Absent Letter of Credit fraud (which was not alleged), the court cannot look beyond the face of the documents. The Judge's confusion stemmed from the issuer's claim that it had paid the outstanding amount and that the balance claimed by the beneficiary had been reduced.

3. Express Refusal: The Judge fails to explain how there can be an issue of whether there was implied consent when there was an express refusal of a proposed amendment by the beneficiary.

4. Implied Consent; Course of Performance/Dealing: Moreover, the facts that related to the reduction did not reveal express written consent by the beneficiary. Issuer argued that they did create an issue of fact regarding consent by implication as a result of a course of dealing (which probably should be treated as course of performance under Revised UCC § 1-303) or of conduct. Official Comment 2 to Revised UCC § 5-106 does recognize that the conduct of the beneficiary can indicate consent to an amendment. However, the Official Comment makes it apparent that the conduct must be the unambiguous demand or presentation of documents that would only relate to the credit as amended. In this case, the beneficiary's demand for the full amount that would have been due without the proposed amendment unambiguously indicates that it did not consent to the proposed amendment reducing the balance outstanding on the standby. That it had consented to prior amendment is irrelevant in two respects. First, consent to one amendment does not obligate the beneficiary to consent to a subsequent amendment. Second, the evidence of prior performance and consent would have only been relevant if the drawings by the beneficiary had evidenced unambiguous consent to the amendment or if there had been a pattern of behavior regarding more than one request for a reduction within a six month period. There is no indication of such prior consent mentioned in the Opinion.

5. The Transaction: The involvement of the issuer in funding the improvements to the applicant's property separately from the standby mechanism and the linkage between the reduction of the amount due on the standby and separate advances for improvements funded by the issuer adds further complexity. The issuer was aware that it had advanced the funds for improvements and that it was entitled to a corresponding reduction in the amount of the standby. Without more, the failure of the beneficiary to consent to an amendment under those circumstances would raise the specter of LC fraud or abuse. There is more in the case, however, namely the terms of the agreement between the applicant and beneficiary which refers to one amendment every six months. Where there has been such a reduction within that time frame, it is not LC fraud or abuse for the beneficiary to decline its consent to an amendment request.

6. Harm: While it may not do much harm to await a full development of the facts, the failure of the court to be clear about the legal principles involved is a serious matter that cannot be clarified by further factual determinations.



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.