Article

Factual Summary: To assure repayment of deductible amounts under various insurance policies issued by Insurer, Purchaser was required to obtain a "clean irrevocable evergreen letter of credit." Issuer issued a standby in favor of Insurer/Beneficiary in the amount of USD 1,376,998.

When Purchaser filed for bankruptcy, and subsequently ceased operations, Insurer/Beneficiary drew on the standby for USD 100,000, received by 17 March 2011, which Issuer refused to honor, stating on 31 March 2011, "(1) '[Beneficiary] [had] not submitted any supporting documentation to [Issuer]'; (2) 'the amount requested was for a settlement of a claim made pursuant to an automobile policy'." Insurer/Beneficiary then sued Issuer for wrongful dishonor and for declaratory judgment in its favor. The court granted Beneficiary's motion for summary judgment on these claims.

Legal Analysis:

Compliance: Beneficiary argued that it was entitled to summary judgment on grounds that its drawing was proper under the LC. The court applied the well-established standard in LC law that an LC is a separate contractual obligation between an Issuer and Beneficiary and so long as documentation presented in draw requests comply with the LC terms, Issuers have an obligation to honor the drawing irrespective of the underlying transaction between the Beneficiary and Applicant or the Issuer's own contractual relationship with Applicant. The court ruled that Beneficiary's drawing complied with the terms of the LC. The court conceded that the UCP allows for Issuers to refuse honoring a drawing where documents do not appear to comply with the terms of an LC, but noted that Beneficiaries must be notified within seven days of the Issuer receiving the request. The court ruled furthermore that the Issuer did not give its refusal notice within the seven-day deadline.

LC Fraud: Issuer argued that it refused to honor Beneficiary's draw request because honoring the request would have facilitated a "material fraud" under the UCC. Issuer claimed that Beneficiary's court settlement was improper and that Beneficiary had no right to draw down on the LC. While the court recognized the material fraud exception, it applied the standard that the Issuer must give evidence not only that Beneficiary may have made a mistake but also that it intentionally committed fraud. The court's reasoning pointed to the efficacy of only allowing inquiries into the underlying transaction in LC law in circumstances of material fraud, and found that the Beneficiary acted properly. The court also ruled that the Beneficiary's court settlement was appropriate in light of Applicant's bankruptcy proceedings and also that the settlement was not made in bad faith with respect to Beneficiary's contractual obligations to Applicant. Finding that the Issuer provided no evidence of the Beneficiary's bad faith or fraud, the court ruled that the Issuer wrongfully refused to honor the Beneficiary's drawing.

Bankruptcy: Issuer argued that Beneficiary never sought relief from the bankruptcy court's automatic stay, nor requested bankruptcy court approval of Beneficiary's settlement. However, the Issuer provided no evidence that the Beneficiary violated the bankruptcy court's automatic stay but rather the court found that the Beneficiary was entitled to settle a claim in accordance with its contractual obligations with Purchaser, regardless of Purchaser's financial status. The court referenced the particular fact that tort plaintiffs in Louisiana are entitled to recover against an insurer, not the debtor, which is where the Beneficiary settled its claim. The court further ruled that LCs are not property of the debtor's bankruptcy estate and are thus not included in the automatic stay. The court refused to allow Issuer's claim that Beneficiary's settlement of the tort claim was inappropriate given Purchaser's pending bankruptcy proceedings.

Declaratory Judgment: Beneficiary sought declaratory judgment in which the court would declare that the Issuer is obligated to honor and pay Beneficiary the amount of any sight draft within seven banking days from the day of the Issuer's receipt of a drawing on the LC. The court ruled that declaratory judgment in Beneficiary's favor was appropriate, given that the instant case was the second lawsuit between the parties regarding an ongoing controversy over the LC. In the first lawsuit between the parties, Kaplan, J. did not grant declaratory judgment because he believed that the Issuer would terminate the LC following payment of the court-ordered drawings. However, because Issuer did not terminate the LC and because there had been two subsequent drawings requested by Beneficiary that had not been honored by Issuer, the court ruled that it was appropriate to grant declaratory judgment in Beneficiary's favor, ordering that Beneficiary was entitled to payment on compliant drawings made under the LC.

Text of Standby

"By order of our client, [Applicant], we hereby establish this Irrevocable Letter of Credit No. 0706035392 in your favor for an amount up to but not exceeding the aggregate sum of One Million Three Hundred Seventy Six Thousand Nine Hundred Ninety Eight Dollars ($1,376,998), effective immediately, and expiring at the offices of the [Issuer] on June 1, 2009 unless renewed as hereinafter provided.

. . . .

Funds under this Letter of Credit are available to you against your sight draft(s), drawn on us, bearing the clause "Drawn under Credit No. 0706035392".

. . . .

This Letter of Credit sets forth in full the terms of our undertaking. Such undertaking shall not in any way be modified, amended or amplified by reference to any document or instrument referred to herein or in which this Letter of Credit is referred to or to which this Letter of Credit relates and any such reference shall not be deemed to incorporate herein by reference any document or instrument.

. . . .

We hereby agree with the drawers, endorsers and bona fide holders of drafts drawn under and in compliance with the terms of this credit that such drafts will be duly honored upon presentation to the drawee. The obligation of [Issuer] under this Letter of Credit is the individual obligation of [Issuer], and is in no way contingent upon the reimbursement with respect thereto." .

. . .

The Letter of Credit further provides that, "[e] xcept as otherwise expressly stated herein, this credit is subject to and governed by the Laws of the State of New York and the 1993 revision of the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce (Publication 500) [(the "UCP")] and, in the event of any conflict, the Laws of the State of New York will control."

Comments:

Form of Standby. The standby contains a provision stating that the standby shall not be modified by a collateral document. This provision is not only superfluous but raises questions regarding the scope of the exclusion. The formula regarding "drawers, endorsers and bona fide holders of drafts" is antiquated and appears to permit negotiation of the draft to anyone, a result probably not contemplated by the issuer or applicant.

[ALC]

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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.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.