Article

Note: As part of eleven sale-leaseback transactions regarding power plant units in Maryland, several entities (collectively, Owner Lessors)1 acquired undivided interests in the Morgantown and Dickerson power facilities and leased those interests to GenOn Mid-Atlantic, LLC (Lessee), a wholesale power company. Under each leaseback agreement, Lessee and Owner Lessors executed separate Lease and Participation Agreements requiring Lessee to provide “qualified”2 security to Owner Lessors against Lessee’s default. Accordingly, Lessee provided eleven letters of credit issued by JPMorgan Chase Bank, N.A. (JPMorgan) in favor of Owner Lessors. Those letters of credit were subsequently “replaced” with LCs issued by Natixis, New York Branch (Issuer) pursuant to a Payment Agreement between Lessee and Natixis Funding Corp. (Issuer Affiliate/Applicant). Under the Payment Agreement, Lessee paid Issuer Affiliate USD 131,466,787.56 while Issuer Affiliate/Applicant applied for and promised to reimburse Issuer for any amounts drawn by Owner Lessors under the Natixis LCs. The LC terms provided that Owner Lessors could demand payment in the event that Lessee either defaulted, failed to timely pay rent, or failed to provide within 30 days of expiration or termination, qualified replacement security.

Apparently, the JPMorgan LCs had not expired when Issuer issued the replacement LCs. Several Morgantown Owner Lessors demanded payment on five JPMorgan LCs “issued to them, on the grounds that those letters of credit were expiring within 30 days and that [Lessee] had failed to provide replacement qualifying credit support”, asserting that Issuer’s LCs were collateralized by Lessee’s assets contrary to the participation agreements. JPMorgan honored the demands totaling USD 125,000,000.Repeating their claim of unqualified credit support, the same Morgantown Owner Lessors subsequently demanded payment on the LCs issued by Issuer. Issuer honored for USD 125,000,000 but “later discovered that the five draw requests were not proper and that they should not have paid them.” Issuer then sent a notice purporting to cancel the remaining LCs in 60 days. Owner Lessors who had not previously made any demands for payment then did so “on the grounds that the [Issuer] letters of credit had been terminated and that there was no replacement qualifying credit support.”

Issuer and Issuer Affiliate/Applicant sued all eleven Owner Lessors3 in a multicount complaint seeking orders stating (1) that the demands made were fraudulent justifying dishonor; (2) alternatively, that, even if Issuer were bound to pay, “Owner Lessors disgorge the funds to [Issuer Affiliate/Applicant]”; and (3) that Owner Lessors “return all amounts previously improperly drawn”. Issuer also sought alternative equitable claims of unjust enrichment and money had and received. Owner Lessors moved to dismiss the complaint and Issuer moved to compel Owner Lessors to participate in discovery. The Supreme Court of New York, Masley, J., dismissed the complaint.

While facts alleged in Issuer’s complaint were to be taken as true and any inferences construed in its favor, the Judge noted that where documentary evidence contradicted those allegations, such as the LC terms and presented documents, Issuer’s complaint would not be afforded the same analysis. Citing New York’s adoption of UCC Article 5 (Letters of Credit), the Judge noted that the independence principle as stated in Section 5-103 requires that “the obligations of the issuer of a letter of credit must be separate from, or independent of, the performance or breach of any contract relating to” the LC. Issuer argued that demands made by Owner Lessors were fraudulent due to “certain surrounding circumstances.” The Judge disagreed, however, citing New York’s adoption of UCC 5-109 which states the “narrow” fraud exception to LC independence as requiring material fraud. Based on Issuer’s complaint, the Judge noted that “[n]one of the three grounds for fraud alleged by [Issuer]…demonstrate the existence of material fraud or fraud in the transaction.” Issuer attempted to argue that by referencing the underlying Lease and Participation Agreements, its obligation to pay was dependent on more than the demands made by Owner Lessors. The Judge rejected that argument as no LC “expressly” incorporated those agreements but merely referenced them in providing for when Owner Lessors could demand payment, i.e., where Lessee failed to timely provide “replacement qualifying credit support”.

As for Issuer’s remaining allegation of material fraud, the Judge noted that it was “belied by the documentary evidence.” Issuer argued that Owner Lessors had “attempted to draw a large amount” by “fraudulently taking advantage of a drafting error” as Owner Lessors knew that Issuer’s liability was limited to USD 130,000,000. The Judge disagreed, however, noting that a “literal reading” of the LCs established that Issuer’s potential liability exceeded USD 200,000,000. Moreover, the Judge rejected Issuer’s argument that Owner Lessors had made an admission in the bankruptcy proceedings of Lessee regarding their knowledge of “an aggregate cap” by again referencing the independence principle found in UCC 5-103 and stating that “[e]ach of the [Issuer] letters of credit are independent of each other. None of them includes a provision capping the amounts that could be drawn based on prior draws on another [Issuer] letter of credit.”

The Judge dismissed Issuer’s final equitable claims on the basis of being “fatally defective, primarily on the ground that an express contract governing the underlying dispute exists”, namely, the LCs themselves. Furthermore, Issuer Affiliate/Applicant’s claim of a “quasi contractual relationship” between Issuer and Owner Lessors based on the Payment Agreement between Lessee and Issuer Affiliate/Applicant was rejected by the Judge, again noting the independence of the LCs having been issued by Issuer and not its affiliate. Having failed to allege a plausible claim of material fraud, the Judge dismissed Issuer’s and Issuer Affiliate/Applicant’s complaint.

[MJK]

1
Specifically, Morgantown OL1 LLC, Morgantown OL2 LLC, Morgantown OL3 LLC, Morgantown OL4 LLC, Morgantown OL5 LLC, Morgantown OL6 LLC, Morgantown OL7 LLC (collectively, Morgantown Owner Lessors); and Dickerson OL1 LLC, Dickerson OL2 LLC, Dickerson OL3 LLC, and Dickerson OL4 LLC (collectively, Dickerson Owner Lessors).

2
The opinion notes that “qualified” security under the leases meant that Lessee would obtain “irrevocable, unconditional, [security]…not collateralized by [Lessee]’s assets.”

3
Dickerson Owner Lessors individually pursued four summary judgment in lieu of complaint actions against Issuer for wrongful dishonor. See e.g., Dickerson OL2 LLC v. Natixis, No. 652399/2018, 2019 WL 2299900 (N.Y. Sup. Ct. May 30, 2019) (granting judgment in favor of Dickerson OL2 LLC on its claim of wrongful dishonor and incorporating discussion of instant case against Owner Lessors referenced as the “Natixis action”).

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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.