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Note: To secure its obligations under a commercial lease, Upper Iowa University (Lessee/Applicant) obtained a USD 500,000 letter of credit issued by Wells Fargo Bank, N.A. (Issuer) in favor of HV & Canal, LLC (Lessor/Beneficiary). Pursuant to the lease, the letter of credit had a term of five years and its value would be annually reduced by USD 100,000 absent default by Lessee/Applicant.

After one year and a USD 100,000 reduction, Lessee/Applicant requested that Lessor/Beneficiary accept a substitute LC issued by Bankers Trust. While Lessee/Applicant “never communicated the reason for the request” to Lessor/Beneficiary, Lessee/Applicant wanted its collateral with Issuer returned as Bankers Trust purportedly required no “deposit funds to obtain” the substitute LC. Ultimately, Lessor/Beneficiary rejected the request based on its preference to “keep the letter of credit with [Issuer]”. Claiming that the refusal constituted a breach, Lessee/Applicant ceased making lease payments and “removed from the premises collateral in which [Lessor/Beneficiary] had a perfected security interest.” Lessor/Beneficiary sued Lessee/Applicant for breach of contract and conversion. Lessee/Applicant counterclaimed for declaratory judgment and injunctive relief. When both parties moved for summary judgment, the trial court granted partial judgment in favor of Lessor/Beneficiary regarding breach of the lease. Prior to a bench trial to determine damages, the trial court granted judgment as a matter of law in favor of Lessee/Applicant on Lessor/Beneficiary’s conversion claim noting that, because Lessor/Beneficiary had already drawn on and received the remaining LC proceeds, a judgment in favor of Lessor/Beneficiary on its conversion claim would constitute an “impermissible double recovery”. Ultimately, the trial court awarded Lessor/Beneficiary USD 63,921 on its breach claim and USD 133,492 in attorneys’ fees. Lessee/Applicant appealed. The Arizona Court of Appeals, Perkins, Thompson and Winthrop, JJ., affirmed.

Lessee/Applicant argued that the trial court erred in denying it summary judgment on its breach claim because the refusal to accept a substitute LC constituted an express breach of the lease. The appellate court disagreed, however, noting that the lease was “entirely silent on substitution” of the LC; thus, the appellate court concluded that “because the Lease contained no language either allowing or prohibiting substitution of the Wells Fargo LOC, [Lessor/Beneficiary] did not breach an express provision of the Lease by denying [Lessee/Applicant]’s request.” Alternatively, Lessee/Applicant argued that the refusal was a breach of the implied covenants of good faith and fair dealing. Observing that Lessee/Applicant never explained its request for substitution and that Lessee/Applicant “knew [Lessor/Beneficiary] had bargained for the security of an LOC ‘substantially in the form’ of the original (Wells Fargo) LOC”, the appellate court affirmed the trial court’s summary judgment on the issue.

The appellate court affirmed the assessment of damages due to unpaid maintenance fees in favor of Lessor/Beneficiary, noting that the lease was unambiguous on the issue. The same result obtained regarding the trial court’s assessment of attorneys’ fees because the lease specifically allocated the costs of litigation on the “defaulting party”.

Excerpts of Commercial Lease:

[¶ 1(1)] “Security Deposit: Unconditional and Irrevocable Letter of Credit substantially in the form attached hereto as Exhibit ‘G’ having a term of five (5) years beginning on the Lease Commencement Date in the amount of Five Hundred Thousand and 00/100 Dollars ($500,000.00). The Letter of Credit shall be reduced by One Hundred Thousand and 00/100 Dollars ($100,000.00) on each of the first five (5) anniversaries of the Lease Term if there ha[ve] been no defaults by [Lessee/Applicant] under the terms of the Lease beyond all applicable notice and cure periods.”

[¶11(f)] “On the first anniversary of the Commencement Date and on each anniversary thereafter during the Lease Term (in each case following receipt of a written request for payment from [Lessor/Beneficiary]), [Lessee/Applicant] shall pay to [Lessor/Beneficiary] [USD]7,500 to reimburse [Lessor/Beneficiary] for routine maintenance and repair of such HVAC system during the prior year (the ‘HVAC Cap’), which HVAC Cap shall be increased by three percent (3%) on the second anniversary of the Commencement Date and each anniversary of the Commencement Date thereafter during the Lease Term.”

[¶33] “In the event that it becomes necessary for any party to employ an attorney to enforce any of the terms or provisions of this Lease, the defaulting party shall pay to the prevailing party all reasonable attorneys’ fees and court costs (if any) in connection therewith, the amount to be fixed by the court without a jury.”

[MJK]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.