Type of Lawsuit: Applicant sued for injunctive relief against beneficiary and issuer to prevent payment on an LC.

Parties: Plaintiff/Applicant/Buyer- Commco Tech., LLC a/k/a Broadstream Communica-tions Corp. (Counsel: James J. Tancredi, Day, Berry & Howard, LLP) Defendant/Beneficiary/Seller- Science Applications Int'l Corp. (Counsel: James R. Fogarty, Fogarty, Cohen, Selby & Nemiroff, LLC) Defendant/Issuer- U.S. Bank (Counsel: William S. Fish, Jr., Tyler, Cooper & Alcorn, LLP)

Underlying Transaction: Purchase of computer software and hardware.

LC: Irrevocable standby LC for US$ 7,120,000. Silent as to applicable rules. Decision: The U.S. District Court for the District of Connecticut, Janet C. Hall, J., affirmed the judgment of the U.S. Bankruptcy Court for the District of Connecticut, Shiff, J., vacating a temporary restraining order and denying injunctive relief.

Rationale: Where parties to an LC agree that an existing LC remains viable under a subsequent payment contract as collateral, the LC is enforceable.

Factual Summary: Applicant purchased computer software and hardware from beneficiary, and bank issued standby LC to assure payment. After a repayment dispute between applicant and beneficiary, both parties entered into a Settlement Agreement to restructure the debt and a corresponding Promissory Note issued by applicant. The beneficiary refused to agree to the insertion of a clause in the Promissory Note stating that the LC would be honored only "in the event the applicant fails to pay this note in full when due." The parties also incorporated into their Promissory Note a statement recognizing the beneficiary's right to draw on the LC "in whole or in part, at any time in order to partially satisfy amounts owed payee pursuant to this Note." Because the LC had expired by the time the applicant and beneficiary entered into the Settlement Agreement and created the Promissory Note, the applicant had the issuer extend the expiration date of the LC. The issuer charged the applicant a fee for the extension of the LC and the applicant did not contest this fee, even though it occurred after the execution of the Settlement Agreement and the Promissory Note. The beneficiary subsequently drew under the LC. The applicant rearranged its financial affairs and sued issuer and beneficiary in state court, obtaining a temporary restraining order (T.R.O.) prohibiting payment on the LC on the grounds that any attempt to draw by the beneficiary would be fraudulent because the Settlement Agreement stipulated that the LC only secured payments that were outstanding prior to the Settlement Agreement. The T.R.O. was granted on the grounds that the beneficiary's drawing would cause irreparable harm. Subsequently, the applicant commenced Chapter 11 (reorganization) bankruptcy proceedings and the case was removed to the U.S. federal court. On a motion by the beneficiary, the U.S. Bankruptcy Court vacated the state court's T.R.O. and denied the applicant's motion for permanent injunction. On appeal, affirmed.

Legal Analysis:

1. Fraud, Rev. Section 5-109: The applicant argued that the beneficiary "...knew that the Settlement Agreement and the Promissory Note were accepted in satisfaction of all pre-settlement prior billing claims and agreements...," making its drawing fraudulent and that the bankruptcy court "...erred in relying on evidence outside the four corners of the agreement because the release, waiver and merger language of the Settlement Agreement unambiguously establishes that the beneficiary waived all rights to seek satisfaction on prior billings". The appellate court rejected this argument, noting that under the literal terms of the LC, the beneficiary "...was entitled to draw on the Letter of Credit for unpaid billings, all of which were issued prior to the execution of the Settlement Agreement". It pointed out that while the Settlement Agreement contained a waiver for claims to "previous billings in exchange for the amount agreed upon is the Settlement Agreement," it also contained "...a provision requiring the execution of a Promissory Note through which the terms of the Agreement would be satisfied". Since the note, which was secured by the LC, "contained a provision which allowed 'the beneficiary to draw on the Letter of Credit, in whole or in part, at any time in order to partially satisfy amounts owed beneficiary pursuant to this Note," the appellate court concluded that it was necessary to read all the documents to determine whether the drawing was fraudulent 2001 LC CASE SUMMARIES The appellate court indicated that the ambiguity in the documents "makes it necessary, under Connecticut contract law, to look outside the Agreement to ascertain the intent of the parties...". The appellate court, therefore, determined "that it was not error for the Bankruptcy Court to conclude, by looking at extrinsic evidence, that the intent of the parties was that the Letter of Credit was intended to remain enforceable under the Settlement Agreement and could be drawn upon to satisfy the terms of the Promissory Note". The appellate court also determined that the beneficiary did not commit fraud in certifying that the drawing was due to unpaid billings. Looking to the Revised UCC Section 5-109, the court said that "the addition of the qualifier 'material' raised the burden of proof of the party seeking the injunction. The drafters of the revised code believed that injunctions were detrimental to the use of letters of credits sic and that the bulk of fraud cases were brought by parties whose complaints regarding underlying contracts did not rise to the level of fraud. Therefore, by raising the burden of proof, the drafters hoped to reduce the numbers of injunctions imposed and to ensure that injunctions would only be issued when the fraud involved is of such a serious nature that allowing collection of money under a letter of credit would be unjust," quoting 3 White & Summers, Uniform Commercial Code 26-10 (4 th ed.) (Treatise).

2. Injunction; Fraud: The court stated that "injunctive relief is warranted when the beneficiary has no right to draw upon the letter due to its behavior in the underlying contract and the statement to the bank allows such a beneficiary to fraudulently receive funds that it is not entitled to, to the detriment of the other party to the underlying contract". It concluded, however, that there were no such circumstances in the present case. "This is not a case is which the beneficiary called in a letter of credit after clearly not conforming with the terms of the contracts."

3. Fraud; Test: The court noted that the beneficiary "performed the services contracted for by the applicant". Because its conduct "could not be said to have vitiated the entire contract," the beneficiary "had a 'colorable' right to draw on the Letter of Credit, as such a right was secured by a provision of the Promissory Note. Clearly, the ambiguity of the documents and the intent of the parties to maintain the Letter undermines any argument that 'the circumstances 'plainly' show that the underlying contract forbids the beneficiary to call a letter of credit". The court recognized the certification that "it was drawing upon the Letter of Credit for past billings was not entirely accurate, under the language of the Settlement Agreement at paragraph 2, it was accurate in light of the parties' entire agreement. To the extent that it could be argued that the certification was all false, the court would not find any such falsity to amount to material fraud that 'was so serious as to make payment unjust'".


The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.