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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
2012 LC CASE SUMMARIES 725 S.E.2d 681 (S.C. April 11, 2012) [USA]
Topics: Injunction; LC Fraud or Abuse; Independence; US Rev. UCC §5-109
Type of Lawsuit: Applicant sued Beneficiary for fraudulent inducement and sued Issuer to enjoin Beneficiary from drawing on and Issuer from honoring the LC.
Parties: Lender/Beneficiary/Defendant/Appellant - Branch Banking and Trust Company Counsel: Frank R. Ellerbe III and Wilson W. McDonald (Robinson, McFadden & Moore)
Borrower/Developer/Applicant/Plaintiff/Respondent - Hook Point LLC
Counsel: Frederick A Gertz (Gertz & Moore); Thornwell F. Sowell and David Dick (Sowell, Gray Stepp & Laffittee)
Issuer - First Reliance Bank
Underlying Transaction: Loan agreement for real estate development purposes.
LC: USD 1,500,000 standby LC as security for a real estate development loan. Silent as to governing rules.
Decision: The Supreme Court of South Carolina, in an opinion by Pleicones, J., applying South Carolina's Revised UCC Article 5, reversed the preliminary injunction issued by the Lexington County Circuit Court, Keesley, J., which had enjoined Beneficiary from drawing and Issuer from honoring the standby.
Rationale: A injunction against honor is not appropriate when there is an ordinary contract dispute between applicant and beneficiary.
Article
Factual Summary: To assure repayment of a USD 5,100,000 loan and USD 2,000,000 line of credit for the development of a residential real estate subdivision, Borrower/Applicant obtained a standby letter of credit from Bank (Issuer) naming Lender as beneficiary. The terms of the loan stated that USD 500,000 of the USD 5.1 million dollar loan would be reserved by Lender for it to draw down the interest on the loan in case of default, and the commitment letter stated that the standby would be used as a "last resort" should Applicant default on its payments.
After construction was started, Developer/Applicant determined that market conditions were unfavorable for completion and defaulted on payments on the loan agreement, property taxes, interest and principal payments. Lender/Beneficiary gave Developer/Applicant several notices of default before accelerating the obligation and finally demanded payment on the standby for the full amount.
Developer/Applicant then sued Lender/Beneficiary and Issuer for a preliminary injunction. The trial court granted the preliminary injunction against Issuer and Beneficiary. On appeal, reversed.
Legal Analysis:
1. Preliminary Injunction: The Judge stated that under the independence principle "the obligations created in the letter of credit are independent of the obligations created in the underlying contract". Additionally, "the usefulness of a letter of credit depends on its being the virtual equivalent of cash". The Judge observed that the Revised UCC Section 5-109 (Fraud and Forgery) "effectively incorporates the requirements of the common law related to injunctions generally: that the movant show that irreparable harm will result and that no adequate remedy at law exists if the court refuses the injunction" when there is evidence of fraud.
2. LC Fraud or Abuse: The Judge noted that fraud and forgery created a "very narrow exception" to the independence doctrine when "the underlying transaction or the demand for payment is clearly a sham, and it is apparent that rigid adherence to the independence principle would facilitate what amounts to a scheme to defraud." In the instant case, Applicant claimed that Beneficiary fraudulently induced Applicant to apply for the loan, and then made a fraudulent claim on the LC. Applicant claimed that in the "commitment letter" given to Applicant by Beneficiary, the LC would be used as a "last resort for interest carry," and that Beneficiary drew on the Letter too early. However, the Judge found that "by its terms, [the LC] requires only that [Beneficiary] represent that [Applicant] has failed to perform its obligations..." [Internal quotations omitted]. The Judge held that the "last resort" language was "intended merely as an accommodation to the principals that [Beneficiary] would not seek to draw on the LC for interest until the reserve had been exhausted...the draw on the LC was sought not only to recoup interest but as a result of multiple defaults that caused [Beneficiary] to invoke the acceleration of the entire debt." The Judge ruled that the case involved "an ordinary contract dispute", that there was no forgery or fraud when Beneficiary sought draw on the LC, and that Beneficiary has "not only a colorable claim but an undeniable basis in fact for asserting its rights under the letter of credit."
Text:
The following terms appeared in the Letter of Credit:
"BB&T was permitted to make draws upon presentation of a draft accompanied by:
1) The original letter of credit. 2) A notarized, sworn statement by the Beneficiary, or an officer thereof, that a) The Borrower has failed to perform its obligations to the Beneficiary under the Loan Agreement and Promissory Note dated November 16, 2007, executed between [Hook Point and BB&T] b) The amount of the draft does not exceed the amount due to the Beneficiary under the obligations and; c The signer has the authority to act for the Beneficiary with regard to the Letter of Credit."
[JEB/kae/cmh]
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