Article

Note: Posta Telgraf Teskilati Genel Mudurlugu (Principal State Agency/Local Beneficiary), a subdivision of the Turkish government, engaged Vendeka Bilgi Teknolojileri Ticaret Ltd. (Original Contractor), a Turkish company, to provide and install electronic components for a toll collection system. Original Contractor then entered into a service agreement with Federal Signal Technologies Group (Original Subcontractor) for certain computer software and hardware for the project. Later, 3M Company (Subcontractor/Standby Applicant) entered into an asset purchase agreement with Original Subcontractor whereby Original Subcontractor assigned the service agreement to Subcontractor/Standby Applicant. Subsequently, Principal State Agency/Local Beneficiary replaced Original Contractor with Tetra HGS Elektronic Sistemleri A.S. (Contractor) who continued to work on the project with Subcontractor/Standby Applicant.

Pursuant to the assumed service agreement, Subcontractor/Standby Applicant was required to secure its performance to Original Contractor who in turn was required to do the same for Principal State Agency/Local Beneficiary. Thus, Subcontractor/Standby Applicant pursued a “three-bank structure” or “back-to-back letters of credit” and applied for a USD 1,000,000 standby letter of credit (Standby) from HSBC Bank USA, N.A. (Standby Issuer) in favor of Turkiye Cumhuriyeti Ziraat Bankasi (Standby Beneficiary/Counter Standby Issuer), a Turkish bank, to induce Standby Beneficiary/Counter Standby Issuer to issue its letter of credit (Counter Standby) to Aktif Yatirim Bankasi (Counter Standby Beneficiary/Local Standby Issuer), another Turkish bank, which in turn issued its local guarantee (Local Standby) in favor of Principal State Agency/Local Beneficiary. The Turkish undertakings were presumably subject to Turkish law. The Standby was subject to ISP98 and New York law.

The terms of the Counter Standby required that a demand be supported by a written statement by Counter Standby Beneficiary/Local Standby Issuer certifying that it had received a demand in accordance with the terms of its own letter of credit (Local Standby) and that the demand was due to a failure of performance of the Original Subcontrator under the service agreement.

Shortly after the Counter Standby was issued, Standby Beneficiary/Counter Standby Issuer requested an amendment to the drawing conditions insisting that Counter Standby Beneficiary/Local Standby Issuer would not issue its letter of credit absent the amendment. Subcontractor/Standby Applicant consented to the amendment and Standby Issuer amended the Standby conditions to provide that Standby Beneficiary/Counter Standby Issuer “would be entitled to payment”:

upon receipt by [Standby Issuer] of [Standby Beneficiary/Counter Standby Issuer]’s first written demand via authenticated SWIFT. Such demand shall be supported by [Standby Beneficiary/Counter Standby Issuer]’s written statement certifying that [Standby Beneficiary/Counter Standby Issuer] ha[s] received a demand for payment under [Counter Standby] in accordance with [Counter Standby’s] terms.

The condition that the demand on the Counter Standby was due to a failure of the Original Subcontrator under the service agreement was accordingly removed.

On the expiry date of the Local Standby, Principal State Agency/Local Beneficiary made a full demand. At this point, Original Contractor had not worked on the project for nine months, but had unsuccessfully sought return of the undertaking issued on its behalf after it had been removed from the project. The demand on the Local Standby prompted two further demands: Counter Standby Beneficiary/Local Standby Issuer made a demand on the Counter Standby, triggering Standby Beneficiary/Counter Standby Issuer to make a demand on the Standby, stating that it had “received a valid demand for payment for USD 1,000,000 from [Counter Standby Beneficiary/Local Standby Issuer] under our [Counter Standby] in accordance with its terms.”

Subcontractor/Standby Applicant sued Standby Issuer to enjoin it from honoring the Standby citing “fraud in the transaction”. Subcontractor/Standby Applicant argued that Original Contractor had not defaulted on its obligations to Principal State Agency/Local Beneficiary under the main project and that Subcontractor/Standby Applicant itself had not defaulted on its obligations under the service agreement with Contractor. The United States District Court of the Southern District of New York, Gardephe, J., denied Subcontractor/Standby Applicant’s motion.

The Judge cited case law noting the four factors to be weighed in deciding whether to grant Subcontractor/Standby Applicant an injunction: (1) the “likelihood of success on the merits or sufficiently serious questions going to the merits to make them a fair ground for litigation”; (2) “irreparable injury in the absence of the injunction”; (3) “the balance of hardship between the plaintiff and defendant”; and (4) that “the court must ensure that the ‘public interest would not be disserved’ by the issuance of a preliminary injunction.”

The Judge explained that Subcontractor/Standby Applicant sufficiently demonstrated irreparable harm because it would not likely recover proceeds from Original Contractor as its assets were frozen by creditors. Moreover, the Judge considered it “unlikely” that Subcontractor/Standby Applicant could recover from Principal State Agency/Local Beneficiary or Counter Standby Beneficiary/Local Standby Issuer as both were “instrumentalities of the Turkish state” and any action against them in the U.S. is “likely barred by the Foreign Sovereign Immunities Act”. The Judge further considered the political uncertainty following the 2016 attempted coup in Turkey and found that “it is uncertain whether any judicial remedy would be available to [Subcontractor/Standby Applicant] in Turkey, particularly as against instrumentalities of the Turkish state.”

The Judge then turned to the issue of “likelihood of success on the merits” regarding an injunction. After exploring the independence principle of letters of credit, he noted that the Standby was subject to ISP98 and New York law. While ISP98 does not provide for a fraud exception (See ISP98 §1.05), “such an exception has been codified under the New York Uniform Commercial Code.” Citing the Official Commentary to the New York Uniform Commercial Code § 5-109(a), the Judge stated that “fraud must be found either in the documents or must have been committed by the beneficiary on the issuer or applicant” and the “fraud must be material.”

The Judge concluded that Subcontractor/Standby Applicant had not demonstrated a likelihood of success on its claim that Standby Beneficiary/Counter Standby Issuer engaged in fraud. The Judge explained that the amended Standby did not require Standby Beneficiary/Counter Standby Issuer to provide documentation of Counter Standby Beneficiary/Local Standby Issuer’s demand, as Subcontractor/Standby Applicant argued. The amended Standby only required a written statement certifying that Standby Beneficiary/Counter Standby Issuer had received a complying demand under its own undertaking. Because Subcontractor/Standby Applicant consented to the amendment of the Standby, the undertaking was no longer tied to Original Contractor’s performance in terms of the service agreement. Thus, the Judge thus found that Subcontractor/Standby Applicant had not demonstrated a likelihood of success on its claim that Standby Beneficiary/Counter Standby Issuer engaged in fraud.

Subcontractor/Standby Applicant, however, also referred to Principal State Agency/Local Beneficiary’s conduct and argued that where “an intermediary bank beneficiary and an ultimate beneficiary are both part of the same government”, fraud by the ultimate beneficiary (here, Principal State Agency/Local Beneficiary) should be imputed to the intermediary bank beneficiary (here, Standby Beneficiary/Counter Standby Issuer). To investigate the claim that alleged fraud committed by others could be imputed to Counter Standby Beneficiary/Local Standby Issuer, the Judge referred to the contract between Original Contractor and Principal State Agency/Local Beneficiary. According to that contract, Original Contractor was entitled to demand a return of security only when, inter alia, it “obtain[ed] [a] clearance certificate from [the] Social Security Institution [of Turkey].” No such clearance certificate, nor a suitable “no lien affidavit” had been obtained. In a letter from Principal State Agency/Local Beneficiary to Original Contractor it was explained, however, that under Turkish law, Original Contractor needed to obtain a “no lien affidavit” from the Social Security Institution, otherwise security (here, the Local Standby) would be drawn down to settle any debts and the remainder of cash, if any, would be returned. Therefore, a demand on the Local Standby was made because it was to expire and no amendment to extend its validity period was forthcoming. This could be seen as “a plausible, non-fraudulent explanation”.

Although Subcontractor/Standby Applicant sufficiently showed that there was a risk of irreparable harm if no injunction were granted, Subcontractor/Standby Applicant failed to show a likelihood of success on its claim of fraud by Counter Standby Beneficiary/Local Standby Issuer (or on the part of Principal State Agency/Local Beneficiary that could be imputed to Standby Beneficiary/Counter Standby Issuer). The motion for a preliminary injunction against Standby Issuer was denied and a temporary restraining order previously granted against Standby Issuer was vacated.

Comment: The opinion does not indicate the basis on which a temporary restraining order was granted against Standby Issuer, nor why it continued for 22 months before it was lifted. Also, it should be noted that for a preliminary injunction under New York UCC Rev. Art. 5-109(b)(4), it is required that the “applicant is more likely than not to succeed under its claim of forgery or material fraud and the person demanding honor does not qualify for protection under subsection (a)(1).”

[WMIV/KM]

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