Article

Factual Summary:Applicant agreed to purchase a well-known manufacturer's blemished (cosmetically imperfect) and less desirable mud and snow tires from an independent Beneficiary for sale in the U.S. Applicant was induced by Beneficiary to make the purchase by the promise of future availability of a large quantity of more desirable highway/summer tires a few weeks after the initial purchase of snow tires. As the negotiations unfolded, Beneficiary pressured the Applicant to provide an LC for the winter tires by threatening to cancel the transactions.

Subsequent to issuance of the LC for the winter tires, Beneficiary provided Applicant with a list of the summer tires. The list did not, however, contain prices or the promised quantity. When the prices were stated, they were priced in French francs. When converted into U.S. dollars, the prices were in excess of maximum U.S. market prices for similar tires. Lists were sent on a number of occasions, each one deficient in some respect and, when the list was complete, it deviated from the promised deal for the summer tires.

After Applicant attempted to rescind the contract for the winter tires based on the failure to provide the summer tires as promised, it discovered that the designation attached to the winter tires "DA/2C", contrary to Beneficiary's representation that it merely indicated a place of storage, signified that "a large portion of the tires" did not meet U.S. Department of Transportation standards and could not be imported or sold in the U.S. In addition, Beneficiary's agents were found to have made false promises and representations with regard to the types of tires that would be made available for export, the price, and the quantities.

To prevent a drawing on the LC, Applicant sought injunctive relief. The trial court granted a temporary restraining order and, after a trial, entered a permanent injunction. On appeal to the intermediate appellate court, reversed. On appeal, reversed and the judgment of the trial court reinstated.

Legal Analysis:

1. Injunction, Adequate Remedy: The Applicant argued that it was not necessary to prove that there was no adequate remedy at law. The appellate court recognized that this exception applied in Ohio, in cases where a specific injunctive remedy is granted by statute. The court indicated that the provision in Revised UCC Section 5-109 addressing injunctive relief was such a provision, but noted that by its terms it indicated all other conditions for injunctive relief must be met. Accordingly, the court ruled that "in order for a court of competent jurisdiction to enjoin the issuer of a letter of credit from honoring a presentation under [Rev. Section 5-109], the court must find that the applicant has no adequate remedy at law."

2. Injunction, Adequate Remedy; Injunction, Availability of Damages: The Applicant alleged that it did not have an adequate legal remedy in any event. While the appellate court recognized that "courts usually find that the applicant has an adequate remedy at law where the alleged remedy is capable of being measured in pecuniary terms", it also noted that "the availability of a damage award is usually held to be inadequate where resort to foreign courts would be futile or meaningless, where the beneficiary is insolvent or may abscond with the money drawn, where honoring a draft would likely force the applicant into bankruptcy, or where the determination of damages would be difficult or speculative." The court indicated that its task in LC cases was to "strike the proper balance between preserving the integrity of the independence principle and preventing the fraudulent practices by beneficiaries." The court noted that in Ohio "[i]n order to be considered adequate, the legal remedy must 'be of such a nature that full indemnity may be recovered without a multiplicity of suits." Quoting Culver v. Rodgers, 33 Ohio St. 537, 545, 1878 WL 23, it stated that "[i]t is not enough that there is a remedy at law; it must be plain, adequate and complete; or in other words, as practical, and as efficient to the ends of justice and its prompt administration, as the remedy in equity." In addition, the court noted that damages must be able to be reasonably estimated and would not defeat an injunction where they were impossible or very difficult to ascertain. Among the factors the court considered were 1) the difficulty in determining the quantity of winter and summer tires that could have been marketed together as contemplated by the Applicant; 2) determining the number of tires that were marketable and not marketable in the U.S. given the "DA/2C" designation; 3) determining which tires were marketable overseas, 4) identifying the cost/ price differential; and 5) determining the precise number of tires offered or promised to the Applicant by Beneficiary. Coupled with the fact that the Beneficiary had not raised the adequate legal remedy issue at any time prior to trial, the court concluded that injunctive relief should not be refused on the basis that there was an adequate remedy at law.

3. Relationship between UCP500 and UCC Article 5: The court considered whether incorporation of UCP500 ousted the UCC. Distinguishing the rule in those states which had adopted the New York variation of Prior UCC Article 5 that ousted the UCC, the court noted that "parties will not be able to avoid all of Article 5's rules by incorporating the UCP into their undertaking", indicating that "both will apply concurrently in the event of any overlapping consistent provisions." The court indicated that the terms of the UCP would displace UCC Article 5 only in the instance of "overlapping inconsistent provisions on the same issue or subject." Consequently, the court ruled that the issue of the LC subject to the UCP did not render UCC Article 5 irrelevant.

4. Impact of UCP500 on UCC Article 5 in Case of Fraud: Beneficiary argued that incorporation of UCP500 preempted the UCC provisions on fraud, relying on UCP500 Article 3 Sentence 2. It provides "Consequently, the undertaking of a bank to pay, accept and pay Draft(s) or negotiate and/or to fulfil any other obligation under the Credit, is not subject to claims or defenses by the Applicant resulting from his relationships with the Issuing Bank or the Beneficiary." It also cited UCP400/500 Compared, ICC Publication No. 511 (1993), for the proposition that "Article 3 was amended in 1993 for the express purpose of breaking the UCP's long-standing silence on the issue of fraud in order to counteract the effect of the foregoing decisions." The appellate court noted that "the overwhelming weight of authority is to the effect that Article 5's fraud exception continues to apply in credit transactions made subject to the UCP. These courts hold in one form or another, that the UCP's failure to include a rule governing injunctive relief for fraud does not prevent the applicant from obtaining such relief under Article 5. Stated variously, these courts recognize that there is no inherent conflict between the UCP's statement of the independence principle and Article 5's remedy against honor where fraud is charged. Instead, this is merely a situation where Article 5 covers a subject not covered by the UCP." The court characterized Beneficiary's arguments as "ingenious but 73 2002 LC CASE SUMMARIES unavailing." It reviewed the text of UCP, Publication 511 which it labeled "official comments", and secondary sources concluding that there were no intentions to address the issue of fraud, and ruled that Revised UCC Section 5-109 "remains applicable in the credit transaction made subject to the UCP."

5. Fraud in the Underlying Transaction; Rev. §5-109(b): The court considered whether an injunction was proper when there was fraud by the beneficiary in the underlying transaction. Noting that this issue had been debated under prior UCC Section 5-114, the court observed that the revision "refocuses the court's attention away from the particular transaction in which the fraud occurred and toward the level of fraud committed." Reviewing the text of the Code and its Official Comments, the court ruled that "material fraud committed by the beneficiary in either the letter of credit transaction or the underlying sales transaction is sufficient to warrant injunctive relief under [Revised UCC Section 5-109(b)] which "clarifies that only 'material fraud' by the beneficiary will justify injunction against honor."

6. Material Fraud, Standard: After reviewing the Official Comments and cases cited in them, the court concluded that "'material fraud' under [Rev. UCC Section 5-109 (b)] means that fraud that has so vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation can no longer be served."

7. Material Fraud, Application: Relying on the trial court's finding of fact by clear and convincing evidence, the appellate court found the facts to be so compelling that Beneficiary's actions were "sufficiently egregious to warrant injunctive relief under the 'material fraud' standard of [Revised UCC Section 5-109]." Specifically, it focused on Beneficiary's (1) unloading winter tires on the Applicant by promising a large quantity of summer tires knowing that Applicant would not agree to purchase the winter tires without false promises of summer tires at a future date, (2) failing to correct a series of materially fraudulent promises and representations about the summer tires for the purpose of inducing Applicant to buy the winter tires and present the LC before Applicant discovered the scheme, and (3) lying about the designation of the tires as fit for the U.S. market by misrepresenting the code as an inventory code. Based on these key facts, the court determined that a drawing would "effectively deprive the Applicant of any benefit in the underlying arrangement"; there was no basis in fact; and it was pointless and unjust to permit Beneficiary to draw on the LC. It stated that Beneficiary's conduct "so vitiated the entire transaction that the only purpose served by invoking the independence principle . . . would be to transform the LC into a fraudulent seller's Holy Grail, which once obtained would provide cover for fraudulent business practices in the name of commercial expedience." The appellate court criticized the decision of the intermediate appellate court as construing the fraud exception "so narrowly as to preclude relief where the beneficiary's fraudulent conduct occurs solely in the underlying transaction. Thus, the [intermediate court] relied on the right cases for the wrong reasons. As a consequence, the [intermediate court] declined to address the issues of agency and fraud in the underlying contract, holding instead that the trial court should not even have taken evidence on these issues."

Comment:

1. There are many portions of this opinion to applaud. The court usefully reviews the relationship between the UCP and UCC Article 5. It correctly concludes that courts must look to Article 5 with respect to questions of letter of credit fraud. It also dismisses the tired debate, now outdated, regarding whether there can be relief where there is fraud in the transaction as opposed to the LC drawing, properly noting that the test is now whether or not there is material fraud.

2. On the subject of material fraud, the court offers restatements of prior formulae which are probably as adequate a statement of the rule as is possible in the abstract. However in applying its standard to the facts, the court runs into trouble. The actions of the Beneficiary, if the allegations are correct, were certainly unsavory. It made misrepresentations that induced the Applicant to enter into the contract for sale regarding the availability of summer tires which were, in fact, not available at competitive prices. It affirmatively lied regarding the meaning of codes which, if explained, would indicate that the tires could not be brought into the U.S. and sold. All of these matters amount to breach of the underlying sales contract and may justify rescission under applicable law.

3. Without more, however, it may be wondered whether the Beneficiary's actions amount to LC fraud. Had there been no winter tires, there would be no doubt, but the court does not indicate that its decision turns on this basis. Likewise, the equation of non-existence of the tires with the inability to deliver the tires to the U.S. might amount to LC fraud. Fraudulent inducement to enter into a contract, however, is not generally regarded as LC fraud. Nor are lies and misrepresentations about quality or quantity where there is some commercially viable transaction. In addition, the use of pressure tactics is simply not LC fraud. Nor is the combination of these matters.

4. As an aside, the court was incorrect in its descriptions of ICC Publication 511, [UCP 400/500 Compared] as "official comments". While the analogy to the UCC is worthy, it is incorrect. UCP 400/500 Compared is not an official publication of the ICC Banking Commission. It is not even a commentary of the Working Group. Rather, it represents the opinions of the then - Chair of the Banking Commission, who was a member of the Working Group.

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