Note: As part of a subcontract to excavate steam tunnels for heating at the University of Wisconsin- Madison campus (USA), Henshue Construction, Inc. (Subcontractor) provided a USD 500,000 standby letter of credit in favor of Terra Engineering & Construction Corp. (Contractor) to be drawn in case of default to assure Subcontractor's ability to indemnify Contractor for any loss. When the excavation site flooded due in part to Subcontractor's negligence, Subcontractor claimed on its Commercial General Liability insurance policy which paid a portion of the loss to Contractor, and made plans to repair the damage. Contractor, however, terminated the subcontract, made the necessary repairs itself, and also drew down and was paid the full amount of the standby.

Subcontractor then sued Contractor for breach of contract seeking among other remedies, repayment of the standby proceeds, and Insurer intervened. The Circuit Court for Dane County Wisconsin, Genovese, J., entered judgment on a jury verdict in favor of Subcontractor for USD 1,081,196. The jury had reached a special finding that Contractor should repay to Subcontractor the amount that it was paid under the standby. On appeal, the Court of Appeals of Wisconsin, Lundsten, P.J., affirmed judgment regarding the standby and the case was remanded for adjustment on other issues.

Contractor argued that there was no evidence showing that Issuing Bank's payments on the letter of credit created a corresponding obligation on the part of Subcontractor to Issuing Bank and that, therefore, the proceeds of the standby were never Subcontractor's property and could not be evidence of its damages. The appellate court disagreed, ruling that direct evidence that Contractor's draw-down created a corresponding debt owed by Subcontractor to Issuing Bank is not necessary. "Based on the above evidence and common sense, the jury could find that the agreement between [Subcontractor] and [Issuing Bank] was that, if [Issuing Bank] paid out funds on the letter of credit to [Contractor], such action necessarily created a corresponding duty on [Subcontractor's] part to reimburse [Issuing Bank]." Therefore, the appellate court ruled that no direct evidence was necessary when such an arrangement is the only sensible conclusion.

Comment: It is curious why the court struggled to find an implied right of reimbursement, straining to interpret the various contracts. Apparently neither the court nor the parties had reference to prior UCC Section 5-114(3)(Issuer's Duty and Privilege to Honor; Right to Reimburse) which was in effect in Wisconsin at the time of issuance of the LC and which provided "Unless otherwise agreed an issuer which has duly honored a draft or demand for payment is entitled to immediate reimbursement of any payment made under the credit and to be put in effectively available funds not later than the day before maturity of any acceptance made under the credit."



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.