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Note: National Union Fire Insurance Company (Insurer/Beneficiary), a New York company, issued several workers’ compensation policies with high deductibles in an aggregate total of USD 2,390,000 to Monarch Consulting, Inc., the predecessor of Monarch Payroll, Inc. (Insured/Applicant), a California corporation. Subsequently, Insurer and Insured/Applicant entered into a “Payment Agreement” whereby Insured/Applicant obtained a standby letter of credit issued by Sterling Bank (First Issuer) in favor of Insurer/Beneficiary for the aggregate total of deductibles.

The opinion stated that First Issuer informed Insured/Applicant that the standby had been “cancelled.”1 Insurer/Beneficiary immediately drew on the standby for the full amount of USD 2,390,000.00. The opinion implied that it was paid.

Subsequently, Insured/Applicant requested a new payment agreement if Insurer/Beneficiary would return the full cash proceeds that it now held. Insurer/Beneficiary agreed to wire the cash proceeds to Insured/Applicant’s account pursuant to a new payment contract in exchange for LCs in an acceptable form. When UBS was proposed as issuer, Insurer/Beneficiary agreed and the parties also agreed on a draft format. The opinion stated that Insurer/Beneficiary then received what it categorized as “three placeholder letters of credit” from UBS in an aggregate amount of USD 2,390,000. Each LC contained a conspicuous all-caps disclaimer stating that the letter “is not operative and will only go into effect once USD 2,390,000.00 is received by UBS AG, New York Branch…Once the funds are received, we will issue an amendment rendering this Letter of Credit operative. Should we not receive the funds and issue our amendment by April 29, 2015, then this Letter of Credit will be null and void.”

Insurer/Beneficiary wired the funds to Insured/Applicant’s account at First Issuer, but Insured/Applicant did not deposit the funds with UBS until after the 29 April deadline, rendering the “Placeholder” LCs “null and void” by their terms. Nor did Insured/Applicant return the funds.

Insurer/Beneficiary then sued Insured/Applicant for fraud, conversion, and breach of contract. On Insured/Applicant’s first motions, the United States District Court for the Southern District of New York, Castel, J., dismissed Insurer/Beneficiary’s claims for fraud and conversion, but granted Insurer/Beneficiary’s motion for partial summary judgment for breach of contract.

The Judge stated that Insurer/Beneficiary’s fraud and conversion claims were dismissed because Insurer/Beneficiary failed to allege independent facts constituting separate liabilities arising from the alleged breach of contract. In effect, the claims for fraud and conversion were “nearly identical” to the underlying breach of contract claim.

The Judge, however, concluded that undisputed facts revealed that the new payment agreement required Insurer/Beneficiary to wire the cash collateral to First Issuer in consideration for Insured/Applicant’s promise, which was to then deposit those funds with UBS making the placeholder LCs operative.

The Judge rejected Insured/Applicant’s argument that it fully performed the contract by supplying the placeholder LCs to Insurer/Beneficiary stating that “[i]t would be absurd and commercially unreasonable to enter into a contract that gives [Insured/Applicant] a $2,390,000 windfall in exchange for unenforceable placeholder letters.” The Judge likewise rejected as irrelevant Insured/Applicant’s argument that Insurer/Beneficiary was negligent in wiring the funds to First Issuer instead of to UBS, and ruled that Insured/Applicant itself had instructed Insurer/Beneficiary to wire the funds to First Issuer.

Comment: Applicant’s argument is clever. The Insurer/Beneficiary did accept the LCs tendered and wired the funds to Applicant, not second issuer, on receipt of them. To justify its conclusion, the court resorts to the deceptive term “Placeholder LCs” and interpretations of the argument based on commercial reasonableness, windfall, and achieving a practical interpretation of the parties’ intent.

While the court’s analysis is practical and makes common sense, a more principled basis than the Insurer’s intent would be comforting. Happily, this case involves contractual intent, a field already hopelessly confused, and not LC jurisprudence.

One cannot help but think that an expressly qualified reply would have been appropriate, not to mention arranging for a more dependable method of transferring the funds in a way that would prevent their misapplication.

[MJK]

1
It appears that this communication was a notice of non-extension (the opinion describes the standby as “evergreen”) because an issuer cannot independently “cancel” a LC without the beneficiary’s consent, although it is unclear why this notice was given to the applicant rather than the beneficiary.

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