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To satisfy California’s workers compensation requirements for self-insurers, Circuit City Stores, Inc. was required to obtain a standby letter of credit in favor of California Self-Insurers’ Security Fund (Fund). Bank of America issued a standby letter of credit in the amount of USD 14,119,256 to satisfy workers’ compensation obligations. As a result, when Circuit City concluded all business operations in 2009, Fund drew on the standby in its full amount and was paid. Of the proceeds, the Fund only paid out USD 1.5 million to claimants, but it filed proofs of claims seeking USD 29 million on account of workers’ compensation obligations throughout 2009 and 2010.

In 2015, Alfred Siegel, Trustee of Circuit City Stores, Inc. Liquidating Trust, (Trustee) sued Fund to collect the excess letter of credit proceeds to which he believed the liquidating trust was entitled. This adversary proceeding was filed in the Circuit City Stores, Inc. bankruptcy proceeding and related to a standby letter of credit issued.

The Trustee took the position that many of these claims were unproven and contingent and the Fund agreed to withdraw all of the claims they made with prejudice. The Trustee sought to recover the remaining amount of USD 12,619,256 from the Fund. However, the Fund filed motions to dismiss the Trustee’s claims based on a lack of subject matter jurisdiction and for failure to state an adequate claim for relief.

The United States Bankruptcy Court for the Eastern District of Virginia, Huennekens, J., denied Fund’s motions to dismiss. The Judge disposed of the jurisdictional arguments, concluding that the court had jurisdiction over all aspects of the complaint and that, as a matter of law, the Trustee has posited an adequate claim for relief

The Fund also claimed that the Trustee did not have a plausible claim for relief as a matter of law. The Judge found that any excess proceeds of the letter of credit drawing were property of the Trustee’s bankruptcy estate under California Labor Code §§ 3701.3 and 3701.5. Under the U.S. Bankruptcy Code, the property of the estate is established on the Petition Date. The Judge noted that, “Under the ‘independence principle’ that applies generally to letters of credit, an issuer's obligation to the letter of credit beneficiary is independent from any obligation between the beneficiary and the issuer's customer. The issuer must honor the letter of credit upon a proper documentary presentation by the beneficiary. The issuer's obligation to pay under the letter of credit is not affected by any disputes between the beneficiary and the customer. As the letter of credit evidences the obligation of the issuer, the letter of credit and its proceeds are not considered as part of the bankruptcy estate and disbursement is not subject to the automatic stay.”

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