Article

Note: In 2004, Arrowhead General Insurance Agency (Agent/Applicant) and Lincoln General Insurance Company (Insurer/Beneficiary) entered into an agreement, under which Agent/Applicant acted as Insurer/Beneficiary’s managing general agent (the Agreement). Under the Agreement, Agent/Applicant was to underwrite policies and collect premiums for certain lines of insurance. To persuade Insurer/Beneficiary to enter into the Agreement, Agent/Applicant promised to post a standby letter of credit as security, so that “in the event of default on the financial obligations required by the Agreement, [Insurer/Beneficiary] shall be entitled to offset monies owed by [Agent/Applicant] using [Agent/Applicant]’s security.” At Agent/Applicant’s request, U.S. Bank National Association (Issuer) issued a standby letter of credit for USD 500,000.00 in favor of Insurer/Beneficiary. The standby initially expired on 30 June 2010, but contained an extension clause that allowed the standby to be automatically extended for one year, unless Issuer notified Insurer/Beneficiary in writing by courier at least 60 days before expiration.

In 2009, Insurer/Beneficiary terminated its agreement with Agent/Applicant, but Agent/Applicant continued to fulfill various contractual obligations. In September 2013, Insurer/Beneficiary initiated arbitration proceedings against Agent/Applicant, raising claims of indemnification and breach of contract regarding certain unexonerated surety bonds (“preclosed bonds”) that Agent/Applicant allegedly had terminated under the parties’ prior written agreement. While the arbitral panel ruled in favor of Insurer/Beneficiary on the indemnification claims, the panel denied all claims “with respect to the breach of contract claim relating to the preclosed bonds.” Following the arbitration award, Agent/Applicant submitted a “Notice of Termination of Managerial Responsibilities” to Insurer/Beneficiary along with a spreadsheet listing USD 1,583,282.25 in uncollected premiums due on active bonds. In November 2015, Insurer/Beneficiary was ordered into liquidation, and a statutory Liquidator was appointed to “take possession of [Insurer/Beneficiary’s]… property, business, and affairs.”

In March 2016, Issuer notified Insurer/Beneficiary that the letter of credit would not be extended beyond 30 June 2016. Referencing the USD 1,583,282.25 in uncollected premiums subsequent to arbitration, Liquidator, acting on Insurer/Beneficiary’s behalf, drew the full amount of the letter of credit.

Agent/Applicant then petitioned for declaratory judgment and moved to enjoin Insurer/Beneficiary from drawing on the letter of credit, asserting that Insurer/Beneficiary’s justification for drawing on the letter of credit was barred by claim and issue preclusion based on the previous arbitration award. The U.S. District Court for the Middle District of Pennsylvania, Conner, J., granted Agent/Applicant’s motion for a preliminary injunction, and ordered Agent/Applicant to post a bond in the amount of USD 500,000.00 as security.

The decision to grant preliminary injunction was influenced by four factors:

“(1) whether the movant has shown a reasonable probability of success on the merits; (2) whether the movant will be irreparably injured by denial of the relief; (3) whether granting preliminary relief will result in even greater harm to the nonmoving party; and (4) whether granting preliminary relief will be in the public interest.”

Furthermore, the Judge stated that the movant “bears the burden of establishing that the greater balance of these factors weighs in its favor.”

On the issue of whether Agent/Applicant, as the movant, showed a reasonable probability of success on the merits, Agent/Applicant had to show that Issuer/Beneficiary’s claim for drawing on the letter of credit “ha[d] no basis in fact,” and therefore “no bona fide claim to payment.” The Court stated that the key inquiry was “whether [Insurer/Beneficiary] is estopped from asserting that [Agent/Applicant] defaulted under the Agreement by failing to pay premiums which postdate the period subject to arbitral review.” The Court relied on a four-part test to determine whether a party is collaterally estopped from relitigating an essential issue concluded in a prior judgment:

“An issue will be precluded if: (1) the issue decided in the prior adjudication was identical to the issue presented in the later action; (2) there was a final judgment on the merits; (3) the party against whom collateral estoppel is asserted was a party or in privity with the party to the prior adjudication; and (4) the party against whom collateral estoppel is asserted had a full and fair opportunity to litigate the applicable issue in the prior adjudication.”

The Court found Insurer/Beneficiary should be estopped from its assertion, favoring Agent/Applicant. The Court further concluded that Insurer/Beneficiary’s claim for drawing on the LC was “likely without basis in fact,” and Agent/Applicant therefore established likelihood of success on the merits with respect to its claim.

On the issue of irreparable harm, the Judge stated that Agent/Applicant must prove that the harm may only be effectively contained through immediate injunctive relief and the injury cannot be compensated by monetary damages. Although Insurer/Beneficiary’s liquidator assured that any proceeds from the standby would be segregated in a separate account expressly established for secured funds, consequent to Insurer/Beneficiary’s insolvency, “the imminent transfer of funds to an insolvent beneficiary is sufficient to support an award of injunctive relief.” The Court found the record supported that Agent/Applicant would not recover its USD 500,000.00 if Insurer/Beneficiary wrongly drew on the letter of credit, and therefore held that Agent/Applicant met the burden of proof for irreparable harm.

On the issue of balancing hardships, the Court confirmed that the requiring Agent/Applicant to post an appropriate bond as security in the amount of the expiring letter of credit ameliorated Insurer/Beneficiary’s foremost concerns. Thus, the potential harm of granting injunctive relief to Insurer/Beneficiary did not outweigh the potential benefits to Agent/Applicant, and the Court held injunctive relief should not be denied on the basis of balancing hardships.

On the issue of public interest, the Court concluded that public interest would be “best served by equitable relief which safeguards the financial interests of both parties and preserves the status quo pending resolution of the underlying claims.” Having determined that all the factors weighed in favor of Agent/Applicant, the Court granted Agent/Applicant’s motion for preliminary injunction.

The agreement between the two parties that was terminated by Insurer/Beneficiary contained a mandatory arbitration clause. Insurer/Beneficiary filed a motion to compel arbitration. On 5 October 2016, the U.S. District Court for the Middle District of Pennsylvania, Conner, J., denied Insurer/Beneficiary’s motion to compel arbitration, rendering moot and dismissing Agent/Applicant’s motion to stay arbitration.

Comment:

  1. The decision fails to refer to U.C.C. § 5-109 (Fraud and Forgery) or consider whether there was material fraud. While the Judge’s conclusion that there was “likely” no factual basis for the drawing may constitute a finding of fraud, it is not clear from the opinion (or absolutely) why that is.

  1. The standby terminated on 30 June 2016, and the order was dated 28 June 2016. The opinion does not make it clear what would happen if the bond was not in place by the expiration of the standby. Presumably it would expire and Insurer/Beneficiary would be without collateral protection.

  1. Because there was no drawing, but only a threat to draw, the issue of whether and how the Liquidator can draw did not arise. Under U.C.C. § 5-113 (Transfer by Operation of Law), the Liquidator could draw in its own name or that of the Insurer.

Text of Standby: The opinion contained the following excerpts from the standby:

  1. “It is a condition of this letter of credit that it shall be considered automatically extended without amendment for one year from the present or any future expiration date unless we notify you in writing by courier at least sixty (60) days prior to any such expiration date that this letter of credit will not be renewed.”

  1. “This original letter of credit must accompany the drawing . . . Drafts drawn under this credit must bear the clause: ’Drawn under [Issuer] Irrevocable Standby Letter of Credit Number SLCPPDX04725.’. . . Further, the letter certifies that ²draft(s) drawn and/or documents presented and negotiated under and in compliance with the terms of this irrevocable standby letter of credit will be duly honored upon presentation to us . . . [Agent/Applicant] permitted the letter to renew annually from June 2010 through June 2015."

[EM/AWL]

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