Article

Factual Summary:Issuer's agreement to issue a US$ 1 million standby LC permitted Issuer to obtain reimbursement from an escrow account held as collateral for payments under the LC. Pursuant to the agreement, Applicant requested Issuer to invest the subject funds in a CD but Issuer never issued a certificate to represent the investment. Several years later, Applicant filed a petition under Chapter 7 of the US Bankruptcy Code for liquidation. Subsequently, Beneficiary drew on the LC. At that point, Issuer requested that the trustee for Applicant make available US$ 1 million to reimburse it. Although the trustee refused, Issuer honored the LC, retained the escrow funds, and sought relief from the automatic stay in order to apply the fund to the pre-petition obligations of Applicant. The Bankruptcy Court granted summary judgment to Applicant. On appeal, the district court affirmed. On further appeal from the district court, the circuit court reversed and remanded.

Legal Analysis:

1. Perfection: The bankruptcy court ruled that Issuer had failed to perfect its interest in the fund 79 2002 LC CASE SUMMARIES because Issuer never created a certificate to represent the CD as required by UCC Article 9, the applicable law governing security interest in personal property. The appellate court ruled "since there was no negotiable instrument issued, the subject funds cannot be characterized as a CD", relying on comments in a subsequent revision of UCC Article 9 and which is not governed by the security interest statute. The court stated that the subject funds can be characterized as a "deposit account", which is "a demand, time, savings, passbook or like account maintained with a bank, savings and loan association, credit union or like organization, other than an account evidenced by a CD." The issuer perfected its security interest in the "deposit account" under the applicable law, that of the common law pledge, by physical transfer of the fund to the control of the bank to secure its debt. By extending the LC to Beneficiary, Applicant offered funds as security and transferred the funds to the Issuer, thereby satisfying the requirements of a pledge.

2. Substance of Transaction: Applicant contended that Issuer relinquished its security interest in the subject funds by investing them in a CD. The appellate court stated that since the "substance instead of the form of a transaction must control in its interpretation and in determining the rights or liabilities of the parties... , it is clear that the substance of the transaction was the creation of a letter of credit." The court noted Applicant's agreement "...to deliver...to [Issuer] as security for [Applicant's] obligations and liabilities hereunder...such collateral security as [Issuer] may request."

The court further stated that "the substance of the transaction was the extension of credit by the [Issuer] in consideration for a security interest in subject funds deposited by [Applicant.]." The court concluded that "While it is true that [Issuer] invested the subject funds in a CD in response to [Applicant's] request, this fact does not alter the substance of the transaction between the parties. [Issuer] did not relinquish its security interest in the subject funds by investing them in a CD. Had [Applicant] not requested investment, or if [Issuer] refused the request, the substance of the agreement between the parties would be the same; the only difference would be that [Applicant] would have earned no interest."

Comment:

1. It should be noted that a subsequent review of US UCC Article 9 would cover a non-negotiable or uncertified CD. Rev. UCC § 9-102 Official Comment 12 (2000).

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