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Note: Midtown Land Partners, LLC (Beneficiary/Landlord) was a proxy for GGC Associates, LLC (Parent Company), being comprised of the same individuals. Beneficiary/Landlord leased commercial property in Henrico County, Virginia, USA, to W. Clay Hamner and Brian Fauver, the managing members of Southern Season, Inc. (Applicants/Tenants).Beneficiary/Landlord later assigned its interest in the lease to LM Retail, LLC (Assignee/Subsidiary), its wholly owned subsidiary. Under the lease, Applicants/Tenants were required to provide a USD 550,000 security deposit to Assignee/Subsidiary; Applicants/Tenants secured their obligations with a standby letter of credit in favor of Beneficiary/Landlord.

Applicants/Tenants struggled to pay rent on time, and requested that Assignee/Subsidiary reduce the rent obligations or release the standby to Applicants/Tenants. Assignee/Subsidiary refused, but later Assignee/Subsidiary and Beneficiary/Landlord proposed that Parent Company make an “equity contribution” to Applicants/Tenants, contingent on Applicants/Tenants making timely rent payments to Assignee/Subsidiary and leaving the standby in place. The USD 300,000 equity contribution was to be paid in monthly installments of USD 25,000 for a year.

There was also confusion about who held the standby. On three occasions, Assignee/Subsidiary asked Applicants/Tenants about the status of the standby but received no answer other than, that it should contact an entity named “Summit out of Denver” who was said to have bought the loan. When Assignee/Subsidiary contacted Summit, it learned “that it did not hold SSI’s LOC”.

Parent Company then sued Applicants/Tenants for actual and constructive fraud, and Applicants/Tenants motioned to dismiss for failure to state a claim. The United States District Court for the Eastern District of Virginia, Young, Magistrate Judge, granted the motion to dismiss counts of actual fraud and constructive fraud against Fauver and denied it for Hamner.

Applicants/Tenants attached what it claimed was the text of the standby to its motion to dismiss, but the Judge refused to consider it because “the document is not of unquestioned authenticity”, namely “[t]he ‘Applicable Law’ provision is incomplete to the extent that it fails to designate the state law governing the document. The document is neither signed nor dated by the issuer.” The Judge concluded that“[t]aken together, these deficiencies prevent the Court from determining that the Irrevocable Letter of Standby Credit is of unquestioned authenticity.”

Parent Company alleged that Applicants/Tenants committed actual and constructive fraud by omission because neither of the Applicants/Tenants discussed the status of the standby when Parent Company made any the USD 25,000 equity contributions. Applicants/Tenants, however, claimed that Parent Company did not plead fraud with the required particularity and could not plead the necessary elements to state a claim for fraud. Applicants/Tenants attached three additional documents to the motion: the Irrevocable Letter of Standby Credit, a copy of ISP98, and the Proof of Claim. The Judge ruled that the three documents would not be factored into his decision; the Irrevocable Letter of Standby Credit and ISP98 were not of unquestioned authenticity, were incomplete, and were unexecuted, while the Proof of Claim was not integral to the complaint. The Judge thus denied the motion to dismiss regarding constructive fraud because Applicants/Tenants were made aware of the particularities they were being accused of, including the failure to disclose the standby’s status in their communications with Parent Company and its affiliates.

However, the Judge granted the motion to dismiss for actual fraud because the complaint was deficient of facts that would sufficiently show that Applicants/Tenant’s omissions were intentional or knowing. While it is plausible that Applicants/Tenants should have known about the status of the standby or that the omissions were negligent, actual fraud requires that a defendant had actual knowledge or intent to mislead by omitting information.

Comment: Possession of the operative original is not a condition to drawing on a standby (unless it is a required document) but knowing it terms is critical. One wonders how the assignment could have been consummated without conveyance of the text of the standby.

Moreover, even if the Assignee/Subsidiary had the operative original, it could not have drawn on it unless the drawing rights under it were transferable and duly transferred even had there been an assignment of proceeds only the named beneficiary could draw on it.

Either the standby was not critical to the assignment or someone failed to do his homework.

[VLG/JPJ]

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