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Factual Summary: Benchmark Bank (Issuer), issued two letters of credit in favor of the Village of Sugar Grove (Beneficiary) to secure Hannaford Farms, LLC's (Applicant) obligations to improve certain real property for the Village. The first LC was issued in September 2004 in the amount of USD 2,454,807, and the second was issued in June 2006 in the amount of USD 4,538,634. The LCs obligated Issuer to pay Beneficiary upon demand certifying that Applicant had defaulted in its obligations. The LCs each expired one year after their issuance, but each contained evergreen clauses by which the expiry dates of the LCs were extended. Regardless, Issuer also appears to have periodically amended the LCs to state expiry dates through 2010, and to reduce the amount of the LCs as Applicant fulfilled portions of its obligations.

In connection with the LCs, Applicant executed mortgage notes in Issuer's favor for the face amount of the LCs. The notes had maturity dates corresponding to the expiry dates of the LCs. New notes were executed as the LCs were amended.

In October 2009, Beneficiary, citing defaults by Applicant, presented sight drafts to Issuer demanding payment in the amount of USD 2,077,675.13-an amount that reflected the reductions in the amounts of the LCs. Issuer dishonored, prompting Beneficiary to file this lawsuit for wrongful dishonor in state court in Illinois.

On December 4, 2009, Issuer was closed and the FDIC was appointed its receiver. The FDIC removed the case to federal court after it was substituted as the named defendant for Issuer. Beneficiary submitted a proof of claim to FDIC, claiming that it should be categorized as a depositor of Issuer and seeking the full face amount of the LCs. The FDIC allowed the claim but characterized Beneficiary as a general creditor, not a depositor. Beneficiary disputed that characterization, and on June 12, 2012, the FDIC denied Beneficiary's deposit insurance claim, reasoning that the LCs were not deposits as defined by the applicable statute. Beneficiary asked the United States District Court for the Northern District of Illinois to overturn that decision.

Legal Analysis:

1. "Deposits" Under the Federal Deposit Insurance Act: The Judge first compared the case to FDIC v. Philadelphia Gear Corp., 476 U.S. 426 (1986), in which the Supreme Court of the United States held that a standby letter of credit backed by a contingent mortgage note is not a "deposit" according to the Federal Deposit Insurance Act (12 U.S.C. § 1813(l)(1)). Like the notes in Philadelphia Gear, the notes in this case secured Applicant's contingent reimbursement obligations. As such, they did not constitute deposits, under the Act and Beneficiary's status was as a general creditor of Issuer.

2. Security for Contingent Reimbursement Obligations: The Judge rejected Beneficiary's argument that the LCs themselves constituted "advance" or "draws" on the notes, such that the funds "advanced" were due immediately. Instead, the Judge held that no funds were ever paid by Issuer, but instead, the parties simply contemplated future advances. The Judge also rejected Beneficiary's argument that the fact that it submitted its demands to Issuer before Issuer had been closed meant it had qualified as a depositor. The Judge held that, despite that Beneficiary had presented its demands prior to the closure, Issuer had never actually paid any funds to Beneficiary, and the reimbursement obligations secured by the notes were still contingent. The Judge also rejected Beneficiary's argument that because Issuer held a security interest in real property, the notes were non-contingent. Instead, the Judge held that Issuer merely held a security interest and had the right to foreclose if Applicant failed to repay. Finally, the Judge rejected Beneficiary's argument that because Issuer failed to notify it of any discrepancies within seven days, it had waived any such discrepancies (apparently referring to Rev. UCC § 5-108), and the sight drafts were transformed into deposits. The Judge held that the mere fact that Issuer was obligated to pay Beneficiary did not transform the sight drafts into deposits.

Comment:

1. In an earlier opinion in this same case, the Court had referenced Philadelphia Gear and held that it might apply to foreclose Beneficiary's argument that it was entitled to status as a depositor. See Village of Sugar Grove v. FDIC, No. 10 C 3562, 2011 WL 3876935 (N.D. Ill.Sept. 1, 2011) [USA] (2012 ANNUAL SURVEY OF LETTER OF CREDIT LAW & PRACTICE 540). Because the 2011 opinion addressed a jurisdictional argument and the evidentiary record had not been developed, that opinion did not address the application of Philadelphia Gear in any great detail and in fact, held that Beneficiary might be entitled to depositor status. The 2013 opinion helpfully clarifies the application of Philadelphia Gear to this case.

[JAM/pt]

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