Factual Summary: Piedmont Operating Partnership, L.P. (Beneficiary) leased office space to Alliance Bank (Applicant). Applicant provided Beneficiary with a standby LC in the amount of USD 500,000 issued by Union Bank of California, N.A. (Issuer) as security for the lease. In turn, Applicant deposited USD 500,000 with Issuer as collateral for the LC.

In February 2009, the Commissioner of Financial Institutions of the State of California closed Applicant and appointed the FDIC as receiver. Pursuant to a purchase and asset assumption agreement, the FDIC sold Applicant's assets, as is, to California Bank & Trust (Applicant's Successor). The deposit with Issuer was among the assets sold.

In May 2009, the FDIC notified Issuer that pursuant to 12 U.S.C. § 1821(e), it was disaffirming the agreement between Issuer and Applicant concerning the LC. The FDIC demanded that the collateral for the LC be released to it immediately. Issuer did not comply.

The FDIC then disaffirmed the lease. Despite that the monthly rent of USD 73,754.44 was current, Beneficiary filed a claim for USD 901,065 for future rent for the one-year period following the disaffirmance. In addition to filing that claim, Beneficiary presented a sight draft to Issuer demanding the proceeds of the LC. Issuer honored the draft and paid Beneficiary, drawing down the account of Applicant's Successor.

Applicant's Successor sued both Beneficiary and Issuer, alleging that Beneficiary was not entitled to draw upon the LC after the FDIC had disaffirmed the lease and that Issuer wrongfully honored after it had already received a disaffirmance notice from the FDIC. Issuer settled with Applicant's Successor and the case proceeded against Beneficiary. The Orange County Superior Court entered judgment in favor of Beneficiary and awarded Beneficiary approximately USD 395,000 in attorney's fees. Applicant's Successor appealed that judgment. On appeal, the Court of Appeal of California, Moore, J., reversed.

Legal Analysis:

1. FDIC/FIRREA. The appellate court ruled that because the FDIC had disaffirmed the lease and the letter of credit-which was authorized by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA)-Beneficiary had no claim to the LC proceeds or the security deposit. The court also held that the fact that the funds had been transferred to Applicant's Successor did not change its analysis-FDIC was authorized by FIRREA to disaffirm the LC, it did so, and it then transferred the asset to Applicant's Successor. Beneficiary had no claim for unpaid rent, and pursuant to FIRREA, it could not maintain a claim for future rent; as such, it had no entitlement to the LC proceeds.

2. Standing. The appellate court ruled that Applicant's Successor had standing to bring a claim under Rev. U.C.C. § 5-110 (Warranties) for breach of warranty. The court rejected Beneficiary's argument that Rev. U.C.C. § 5-110 did not provide standing to Applicant's Successor because the warranties at issue in that section run in favor of the "applicant". Instead, the court ruled that the FDIC succeeded to "all rights, titles, powers, and privileges" of Applicant, and the FDIC in turn assigned all of the FDIC's "right, title, and interest" in and to the USD 500,000 deposit to Applicant's Successor. As such, the court ruled that Applicant's Successor "stands in the shoes" of Applicant for the purposes of Rev. U.C.C. § 5-110 and could bring the claim.

3. Statute of Limitations. Beneficiary argued that if there was a breach of a warranty, it occurred at the latest on 26 June 2009 when Issuer received Beneficiary's sight draft. Since the Complaint was not filed until 29 June 2010, Beneficiary argued that the action was barred by the one-year statute of limitations stated in Rev. U.C.C. § 5-115 (Statute of Limitations). The court disagreed. It ruled that the warranties stated in Rev. U.C.C. § 5-110 are not made when the Beneficiary presents a demand, but instead they are made when the drawing is honored. Since Issuer honored the drawing on 1 July 2009, the action was not time-barred.

4. Post-Honor Warranties; U.S. Rev. U.C.C. § 5-110. Addressing the substance of Applicant's Successor's claim, the appellate court ruled that because Beneficiary's right to make a claim for future rents had been extinguished by FIRREA, Beneficiary had no right to draw under the LC and Beneficiary breached its warranty to Applicant under Rev. U.C.C. § 5-110 (Warranties).

5. Attorney's Fees; U.S. Rev. U.C.C. § 5-111(e). Because Applicant's Successor was the prevailing party in an action brought pursuant to Rev. U.C.C. § 5-110, the appellate court concluded that Applicant's Successor was entitled to attorney's fees pursuant to Rev. U.C.C. § 5-111 (Remedies).



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.