Article

Note: When Charles Smith (Applicant) approached First Metro Bank (Lender) of Alabama requesting a USD 1.5 million loan for Tennessee Materials Corp. (Borrower), Lender agreed on the condition that it be secured by a standby letter of credit from Central Bank (Issuer). Subsequently, Chris Jerrolds, Issuer's President and Chief Executive Officer (Issuer's President), disbursed the loan for a six-month term, with the possibility of renewal.

Issuer's President informed Lender that it would issue two standbys, one to cover a bridge loan of USD 100,000 for operating expenses and the second subsequently until a USD 1.5 million loan was closed. Subsequently in January 2009, Issuer delivered a USD 100,000 standby to Lender/Beneficiary and approximately two weeks later issued a USD 1.5 million standby whereupon Lender/Beneficiary made and disbursed the loan for a six-month term, with the possibility of renewal.

When Borrower requested that the loan be increased to USD 2.2 million, Issuer delivered a standby in that amount. Because this standby contained a mistake, a replacement standby was issued and the loan was increased and extended. Regular renewals of the standby and loans occurred until July 2011. At that time, Lender/Beneficiary commented to Issuer that "it was exercising its right to draw on the letter of credit that [Issuer] had issued to secure the loan." Issuer's President then communicated with Lender/Beneficiary stating that government funding was imminent and that the loan should be renewed. One letter stated that the Issuer "would 'honor its letter of credit issued on behalf of [Borrower] even if [Borrower] files bankruptcy. You will not have to wait through the normal legal process and we will honor it as agreed.'" When Borrower made a USD 200,000 payment and Issuer reissued the standby LC "for the full amount of the renewed loan", Lender renewed the loan. Subsequent renewals occurred through February 2012 although no government funding was received.

At this time, Lender/Beneficiary received the following standby:

"We have as of February 17, 2012 issued this Irrevocable Letter of Credit in your favor available by your drafts drawn on [Issuer], 485 Wayne Road (P.O. Box 1207), Savannah, Tennessee 38372 at sight, for any sum not exceeding the total of $1,783,660.44 for the account of [Borrower]. The drafts must be accompanied by your signed statement certifying copies of unpaid statement of account detailing balance due and statement of [Borrower] that the charges are due and unpaid from February 17, 2012.

This letter of credit expires on August 17, 2012, but will automatically extend without amendment for six months from the expiration date, or any future expiration date unless ten (10) days prior to such expiration date we notify you by registered mail that this letter of credit will not be renewed. Upon receipt by you of such notice you may draw on us hereunder by means of your draft at sight for the full amount of [the] letter of credit.

Each draft must bear on its face the clause 'Drawn under Irrevocable Letter of Credit No. 96412 dated February 17, 2012.'

This Irrevocable Letter of Credit is not assignable and replaces any prior Letter of Credit."

Relying on this letter signed by Issuer's President, as it had on prior written and oral communications, Lender/Beneficiary extended the loan.

When Borrower defaulted on the loan, Lender/Beneficiary drew on the standby on 14 May and 24 May 2012. On 22 May 2012, Issuer replied to the first presentation in a letter from its attorney stating that "it refused to honor the 'purported Letter of Credit' for several reasons, including that [Issuer] never authorized the letter of credit, that honoring the demand would cause a 'material fraud' on [Issuer], and that [Lender/Beneficiary] had notice of that fraud and participated in it." Issuer did not reply to the 24 May 2012 demand letter.

Issuer then sued Issuer's President, Lender/Beneficiary, and another person claiming to be a beneficiary of another of its letters of credit in the Tennessee state courts seeking a declaration that it was not obligated on the LCs because Issuer's President lacked authority, Lender/Beneficiary had knowledge of Borrower and Applicant's financial difficulties, and of improper relationships between Borrower and Issuer's President. In addition, Issuer alleged "that the letters of credit were not occasioned by the requirements for corporate action by [Issuer]. They were done entirely outside of the typical [Issuer] procedures without notice or knowledge of...[Issuer]; they were not placed on the books of ... [Issuer] as an obligation or otherwise; they were not reviewed by any committees or exposed to any other oversight of...[Issuer] as would be the case of such an obligation; they were beyond [Issuer's President]'s authority/ they were above and beyond the permitted lending limits to...[Borrower]; they were hidden by [Issuer's President] from regulatory oversight and audit review; and they were done in secret and were shielded from the usual and customary practices of [Issuer]." Issuer also raised defenses based on "fraud, lack of good faith, lack of consideration, violation of warranties, waiver and estoppel, defects in [Lender/Beneficiary]'s demand letters, and [Issuer's President]'s lack of authority. [Issuer] assert[ed] claims against [Issuer's President] for negligence, willfulness, fraud, and breach of fiduciary duty."

Lender/Beneficiary subsequently sued Issuer in federal court in Alabama for wrongful dishonor. Issuer moved to dismiss for lack of personal jurisdiction. The US District Court for the North District of Alabama, Northwestern Division, Smith, J. granted the motion and dismissed the action.

The Judge concluded that Lender/Beneficiary had failed to prove that Issuer, which was located in Tennessee, had purposefully established such minimum contacts with Alabama so as not to offend traditional notions of fair play and substantial justice. Lender/Beneficiary argued that Issuer's President's "communications with [Lender/Beneficiary] over the course of three years - including contacting [Lender/Beneficiary] at its offices in Alabama, directing multiple written and telephonic communications to those offices for the purpose of persuading [Lender/Beneficiary] to issue the loan to [Borrower], issuing a letter of credit to [Lender/Beneficiary] in Alabama, and repeatedly renewing that letter of credit - constitute constitutionally significant 'minimum contacts' with the State of Alabama, and that all of those contacts are related to the claims asserted in [Lender/Beneficiary]'s complaint."

Issuer responded that the standby was issued in Tennessee, the dishonor being complained of occurred in Tennessee, and that all communications with the Lender/Beneficiary were undertaken from Tennessee.

The parties agreed that in light of a long line of previous cases, personal jurisdiction "could not be based on its issuance of a letter of credit to [Lender/Beneficiary] on behalf of [Borrower]." Lender/Beneficiary sought to distinguish these cases by observing that it had renewed loans based on seven renewals of standbys and not one isolated instance. The Judge rejected this argument, noting that "[t]his court sees no reason to assign more significance in the personal jurisdiction analysis to the renewal of a letter of credit than to issuance of such a letter, even if the letter of credit was renewed several times."

Lender/Beneficiary also argued that the case involved fraud by Issuer's President aimed at Lender/Beneficiary. The Judge rejected this argument, noting that the complaint had alleged wrongful dishonor and not fraud.

Comment: It should be noted that Central Bank did not reply to the 24 May demand. Would the preclusion doctrine (part of Tennessee's LC statute under its version of Revised UCC § 5-108) apply?

[JEB/so]

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