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Note: To facilitate its construction of a condominium, DB NPI Century City, LLC (Debtor) obtained a USD 9,356,000 loan from East West Bank (Creditor). In turn, Debtor secured the loan by tendering a deed of trust, three guarantees and a commercial security agreement to Creditor. After a re-appraisal of the real property’s value, Creditor demanded additional security. Accordingly, Debtor/Applicant applied for and obtained a USD 841,280 standby letter of credit from Wells Fargo Bank (Issuer) in favor of Creditor/Beneficiary. To draw on the standby, Creditor/Beneficiary was required to submit a written demand to Issuer stating that “[t]he amount claimed by [Creditor/Beneficiary] represents and covers the unpaid indebtedness including principal, interest and all charges and expenses incurred due to [Creditor/Beneficiary] arising from the granting of banking facilities to [Debtor/Applicant].”

Debtor/Applicant subsequently defaulted on the underlying loan and Creditor/Beneficiary made a full demand on the standby, which was honored. Creditor/Beneficiary then “sold the defaulted loan” to Legendary Investors Group No. 1, LLC (LIG); Creditor/Beneficiary also assigned to LIG the loan documents and all “other instruments and agreements in connection with any of the foregoing in or under which [Creditor/Beneficiary] has any right, title or interest.” LIG then assigned those same interests to its wholly owned subsidiary Legendary Century City (LCC). That assignment included the deed of trust which apparently listed T.D. Service Company of Arizona (Substitute Trustee) as substitute trustee. Substitute Trustee then foreclosed on the deed of trust and LCC acquired the property “with a credit bid of slightly more than” USD 2,000,000, about one-third of Debtor/Applicant’s loan balance.

The foreclosure sparked nearly ten years of litigation, beginning with Debtor/Applicant’s complaint against Creditor/Beneficiary, LIG, LCC and Substitute Trustee seeking an injunction to prevent the foreclosure. Moreover, Debtor/Applicant argued that the drawing down of the standby “satisfied the more than [USD] 6 million still owing on the construction loan and extinguished the right to exercise the power of sale and foreclosure on the property.” Nevertheless, the foreclosure took place and Debtor/Applicant voluntarily withdrew its first complaint. Subsequently, Debtor/Applicant sued Creditor/Beneficiary which resulted in a settlement; LIG, however, argued that the settlement in favor of Debtor/Applicant constituted “collateral under the commercial security agreement” and LIG demanded the proceeds. Debtor/Applicant interpleaded the funds to a Texas court which stayed the action pending resolution of the Californian proceedings. Debtor/Applicant had filed a complaint alleging wrongful foreclosure against LIG, and, after a protracted pre-trial phase, the trial court entered judgment on the pleadings dismissing the wrongful foreclosure claim citing California’s U.C.C. Article 5 section 115 one-year statute of limitations regarding letters of credit. After resolving several other issues, including issues of attorneys’ fees, the trial court entered its final judgment. The parties cross-appealed. The California Court of Appeal, Dunning, Manella and Collins, JJ., affirmed in part and reversed in part.

As Debtor/Applicant had argued in its original complaint, the foreclosure on the assigned deed of trust was wrongful because by Creditor/Beneficiary having drawn on the LC, any of its remaining loan obligations were extinguished pursuant to the specific representations required by the LC terms and conditions (i.e. “unpaid indebtedness”).LIG, however, argued that California’s statute regarding the one-year limitations period for LCs precluded Debtor/Applicant’s claim. The trial court agreed with LIG noting that U.C.C. section 5-111 broadly applied to any action to enforce rights relating to LCs and thus the complaint was untimely despite accepting the conclusion that Creditor/Beneficiary’s demand on the LC extinguished Debtor/Applicant’s debt.

In reversing that decision, the appellate court first looked to California’s adoption of U.C.C. Article 5 (Letters of Credit), specifically section 5-103 which states the independence principle and noted that the issues in the present case concerned the relationship between the LC applicant and beneficiary. In this way, the appellate court noted that “[a]lthough [Debtor/Applicant] may have framed the dispute with LIG as ‘arising out of’ a transaction involving a letter of credit…the rights and obligations it seeks to enforce are based on its loan obligations to [Creditor/Beneficiary] and are not within the scope of California’s letter of credit law”. Thus, while the appellate court agreed that dismissal of the complaint based on section 5-111 was inappropriate, it stated that “[a]ny remedies [Debtor/Applicant] may have against LIG must arise out of the construction loan agreement, promissory note, and deed of trust, not the letter of credit.” Debtor/Applicant, however, continued to base its arguments on the LC and not the underlying loan documents. The appellate court concluded that “six years into this litigation, [Debtor/Applicant] has yet to articulate what facts it might allege to state a cause of action for wrongful foreclosure” and denied Debtor/Applicant leave to amend its complaint.

[MJK]

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