Article

Factual Summary:The owner of a professional minor league hockey league team, pursuant to its lease agreement with a hockey arena, applied to a bank for a standby letter of credit in the amount of US$ 300,000 in favor of Beneficiary, the stadium authority, to guarantee payment of rent.

The LC required two documents as a condition for payment: "A notarized statement purportedly signed by an authorized representative of the beneficiary," stating:

"We hereby certify that [Applicant] is in default of Section 4(a) of the Arena Lease Agreement between the Beneficiary, the State of Louisiana, and [Applicant]."

and a second notarized statement signed by the same stating:

"We hereby certify that the Contract administrator of [Beneficiary] has certified that on or before October 29, 1999 improvements to the Arena (including but not limited to a properly functioning ice surface, 17,500 unobstructed seats, functioning lighting, sound and scoreboard, and locker, training and coaching rooms) were sufficiently completed for the presentation of a game of professional ice hockey."

After Applicant failed to make its rent payments in a timely manner for the 2000-2001 season, Beneficiary declared the lease to be in default. Applicant responded, alleging that Beneficiary's calculation for the rent was off by approximately $33,000. Beneficiary answered this allegation claiming that its calculations were correct, and prepared to draw on the LC.

In the meantime, Applicant had obtained a temporary restraining order against Issuer and Beneficiary. It alleged that the documents presented contained false representations and that honoring the LC would cause permanent and irreparable damage. Although the trial court granted a temporary restraining order based on the petition, it was dissolved after the preliminary injunction hearing. The trial court found that "no fraudulent representation made by the [Beneficiary] in its certification to the [Issuer]."

Since Applicant was unable to obtain an injunction from other judges, Beneficiary presented documents and Issuer honored the LC. On Appeal, affirmed.

Legal Analysis:

1. Independence Principle; Practice: Quoting from the 2002 Annual Survey of Letter of Credit Law & Practice, the appellate court stated that: "The law of letters of credit developed from decade-long efforts to simplify and harmonize procedures surrounding commercial practices. The goal was to identify and articulate practices, and to develop formulae and forms that reflected these practices. The central theme of the practice of letters of credit is the principle that the letter of credit be independent from the underlying commercial contract."

2. Practice; Custom: The appellate court noted that: "The laws governing letters of credit have always followed from the customary banking practices and uses. Because the commercial instrument exists to promote and encourage business deals, a practiceoriented approach should be taken in their interpretation."

3. Compliance: Noting that "[i]n essence, letters of credit place the documentation representing the goods and money in an uninterested third-party's hands", the court stated that "[a]ccusations of minor inconsistencies or unimportant discrepancies in the presentation of documents, which bank practitioners normally overlook, are not sufficient to defeat a properly conforming request."

4. Fraud; Material Fraud: The appellate court stated that, "only if the misrepresentations amounted to 'material fraud', would issuance of an injunction be justified" citing Rev. UCC Section 5-109. In seeking to determine what constituted "material fraud", the court looked to the Official Comments of Revised UCC Article 5.

The court considered each of the allegations of fraud raised by Applicant and considered whether they met the standard of materiality.

a) The court noted that Applicant had "called into dispute the calculation of the rent and whether or not the arena was sufficiently completed. Specifically called into question is whether or not [Applicant was] given credit for $8,350 remaining in suite deposits, $22,271 in unpaid seasonal tickets sales for suite holders, and the approximate sum of $2,500 in settlement for the final ice show. These sums were not deducted from the $216,527 which was drawn upon pursuant to the standby letter of credit."

The court rejected the contention that these complaints amounted to material fraud, stating: "The ability of [Applicant] to prevail on such claims is not to be determined in these proceedings to enjoin the payment on a letter of credit. These claims if valid should be brought in an action for breach of contract against [Beneficiary], which is to be viewed as a separate contract from the letter of credit contract between [Issuer] and [Beneficiary]."

b) The court noted that Applicant "argues that the arena may have been short a few of the 85 2002 LC CASE SUMMARIES 16,968 unobstructed seats." In rejecting this point, the court stated "Even assuming this to be the case, nowhere is there an accusation of a material deficiency of seats. The record reveals that seats were not a problem in the presentation of [Applicant's] hockey season. Therefore, the alleged deficiency of seats would not amount to material fraud, that would cause us to issue an injunction or order the return of the monies paid."

c) The court noted that Applicant complained that "the showers, sauna, laundry and Jacuzzi in the locker room were not finished, as well as lack of lighting in the offices. These facts caused [Applicant] to transport their equipment daily from the Municipal Auditorium." The court responded that "Nonetheless, this did not prevent the ice hockey games from being played and [Applicant's] use of the arena. We find, as the trial court did, that lacking a Jacuzzi, sauna and showers, as well as having some offices that were not complete does not constitute fraud so serious as to make it obviously pointless and unjust to permit [Beneficiary] to obtain the rent for use of the arena via collecting on the letter of credit."

d) Applicant also "called into question the safety of the arena. Specifically we found in the record that there are problems with the smoke detectors at 'Waffle Slab' and the suite level concourse lacks fire alarm notification speakers."

The court responded that the governmental Office of Public Safety had "granted a Temporary Use and Occupancy Certificate to the arena provided that certain conditions were met."

In concluding that Applicant's arguments had "no merit", the court observed that: "While the alleged unfinished state of the offices, the lack of Jacuzzi, sauna, laundry and showers, as well as the disputes over the amount of rent owed and the building permits may be classified as breaches of contract, they cannot be the basis for an injunction issued on a standby letter of credit and a finding of material fraud, which would make us order the rent collected to be returned."

The court stated further that, "assuming the beneficiary has not in fact fulfilled every aspect of the underlying lease agreement, what is stated in the documents presented for the letter of credit does not reach the status of 'material fraud.'" The court concluded that "we find the exception of 'material fraud' in the underlying contract does not apply because the arena was functional and hosted an entire season of ice hockey."

Comment:

1. This decision wrestles with the difficult question of what constitutes material fraud for purposes of interfering with payment on a LC. It is quoted at length because it provides specific details about the issues being raised.

2. Is there a breach of the contract between the applicant and beneficiary? Perhaps, depending on the standard by which performance is to be measured. Even if there is, the damages can be measured in discrete amounts that would reduce the recovery. There is no suggestion that the stadium authority would not be able to pay an award in the amounts being raised by the applicant.

3. The real question, however, as the court appreciates, is whether there is LC fraud. The recital of the standard is one thing. The application of the standard to the facts is another. Here, the court has properly looked at this dispute in light of the fact that there has been performance of the rental contract for a year and that these problems do not provide a basis for concluding that it is fraudulent to make a statement that the rent is due.

4. Whether credits need to be allowed and monies repaid to the beneficiary by the applicant is not relevant to the LC nor to its issuer. The Issuer is to be commended for resisting and defending this claim.

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