Article

Factual Summary:: Repayment of a loan from Beneficiary to Applicant for an aggregate amount of $150,000,000 was to be made in sixteen equal quarterly installments. To secure the loan, Applicant's parent corporation issued a guaranty, and bank issued a revolving standby letter of credit. The credit provided that Issuer

"... open[s] our irrevocable revolving Letter of Credit no. LCG9400036 in favor of you, [beneficiary], for account of [Applicant], up to USD 11,500,000.00 payable against your sight draft drawn on us accompanied by your signed statement stating that the amount drawn on us represents the principal, interest thereon, default interest thereon and all related amount which has become due payable to you by [the Applicant] under the terms of the Agreement under Ref. No. GWE-1229 between [the Applicant] and you dated September 16, 1994 ("Agreement"), and that such payment has not been fully made by [Applicant] and that the amount received from us will be applied in satisfaction of such payments.

This Letter of Credit shall be revolved and reinstated every three months within the period of validity of this Letter of Credit mentioned below."

When Applicant failed to pay an installment due, Beneficiary demanded immediate repayment of the outstanding balance from Applicant's parent company, and presented documents under the letter of credit. Issuer paid the amount of that installment as demanded.

After having paid the first installment for US$ 11.5M, the Korean Deposit Insurance Corporation which controlled Issuer informed Beneficiary and the New York Superintendent of Banks that it interpreted the credit to require reimbursement by Applicant before further payments were due. Nonetheless, Beneficiary made another drawing of US$ 11.5 million which Issuer refused to pay, claiming that it had not been reimbursed by Applicant for the previous payment and that the amount available under the credit was otherwise exhausted.

Issuer based its claim on the language in the first paragraph of the LC stating that Issuer opened a "revolving letter of credit ... in favor of [Beneficiary], for the account of [Applicant], up to USD 11,500,000.00", and that because there is no plain language entitling Beneficiary to make multiple drawings that in the aggregate exceed US$ 11.5M, the total amount of the credit is capped at US$ 11.5M, until Applicant reimburses Issuer thus reinstating the availability of the LC for future drawings.

After an exchange of letters in which Issuer took the position that its obligation to make further payments under the standby was contingent on replenishment of the credit by Applicant, Beneficiary brought an action against Issuer for wrongful dishonor and anticipatory repudiation, seeking damages, or declaratory relief in the alternative. On Beneficiary's motion, the trial court entered summary judgment for it, awarding damages in the amount of US$ 12,468,875 (US$ 11.5M plus interest from December 30, 1999) and US$ 68,756,400.58 (the remaining balance of the loan, US$ 64,108,532.01 plus interest from February 15, 2000). The intermediate appellate court affirmed. On appeal, affirmed.

Legal Analysis:

1. Letters of Credit, Purpose: The appellate court stated, "Letters of credit are commercial instruments that provide a seller or lender (the "beneficiary") with a guaranteed means of payment from a creditworthy third party (the "issuer") in lieu of relying solely on the financial status of a buyer or borrower (the "applicant") (see Centrifugal Casting Mach. Co. v American Bank & Trust Co., 966 F2d 1348, 1352 [10th Cir 1992]). Historically, letters of credit have been used to assure predictability and stability in mercantile transactions by diminishing a seller's risk of nonpayment and a buyer's risk of nondelivery due to insufficient funds (see Voest- Alpine Intl. Corp. v Chase Manhattan Bank, 707 F2d 680, 682 [2d Cir 1983])."

2. Standby Letters of Credit: Noting the evolution of standbys, the appellate court indicated that their purpose was "to provide security in the event of a default in payment owed under a separate agreement, such as a loan. ... A letter of credit serving this objective is referred to as a "standby" letter of credit because it is payable only upon proof of the applicant's nonperformance or default. ... Stated another way, a commercial letter of credit substitutes as the primary means of payment, while a standby letter of credit is used secondarily after the beneficiary fails to obtain payment from the applicant ...".

3. Standby Letters of Credit: The appellate court noted that "[t]he importance of letters of credit in international trade and financing cannot be overstated. At least five separate sets of model laws have been promulgated to govern their use: (1) article five of the Uniform Commercial Code, (2) the Uniform Customs and Practice for Documentary Credits (UCP 500), (3) the United Nations Convention on Independent Guarantees and Standby Letters of Credit, (4) the Uniform Rules for Demand Guarantees, and (5) the International Standby Practices 1998 (ISP98)."

4. Revolving Credit: The appellate court noted that "they can "revolve" by periodically replenishing credit lines upon the occurrence of a specified condition or event, thereby allowing the beneficiary to make additional draws in satisfaction of sums still owed by the applicant."

5. Revolving Credit; Automatic: The appellate court noted that "[t]he focus of the dispute is whether the letter of credit revolves automatically or conditionally. More specifically, do the terms of the letter of credit require that subsequent draws be honored by [Issuer] without regard to repayment by [Applicant], or are future draws contingent on [Applicant] repayment of funds disbursed during the prior quarter? [Issuer] position is that the instrument is unclear as to whether an additional $11.5 million was automatically available at the beginning of each three-month interval or was conditioned upon [Applicant's] repayment of previously utilized credit. It notes that the document does not set forth the total amount of the ... loan ($150 million), but refers only to $11.5 million. As a result, [Issuer] maintains that its exposure was limited to the latter amount. Furthermore, although [Issuer] concedes that a repayment condition does not appear in the letter of credit, it nevertheless asserts that the use of the term "revolved" in a standby letter of credit implicitly imposes a duty upon the applicant to reimburse the issuing financial institution for utilized credit before further credit can be renewed and reused by the beneficiary. Consequently, [Issuer] claims that the document is ambiguous because it is susceptible of both interpretations. We disagree."

6. Interpretation of LC; Constriction: In interpreting how LCs are to be construed, the appellate court stated "[w]e have long adhered to the principle that letters of credit must be strictly construed and performed in compliance with their stated terms ... The reason for this rule is rooted in the very purpose of a letter of credit: "[b]y conditioning payment solely upon the terms set forth in the letter of credit, the justifications for an issuing bank's refusal to honor the credit are severely restricted, thereby assuring the reliability of letters of credit as a payment mechanism" (Voest-Alpine Intl. Corp. v Chase Manhattan Bank, 707 F2d at 682). Thus, to make an issuing bank's payment obligation conditional, the parties must clearly and explicitly set forth that requirement on the face of the letter of credit ... A corollary to these rules, as with all written agreements, is that ambiguity does not arise from silence, but from "what was written so blindly and imperfectly that its meaning is doubtful" (Trustees of Freeholders & Commonalty of Town of Southampton v Jessup, 173 NY 84, 90 [1903]."

7. Revolving LC: The appellate court ruled that "the language of the instrument - this "letter of credit shall be revolved and reinstated every three months within the period of validity" - unequivocally establishes that [Applicant's] credit line of $11.5 million was automatically renewed in relation to time, specifically the beginning of each of the 15 fiscal quarters. Significantly, no conditions are placed upon this cycle of revolution and reinstatement; the letter of credit does not require that [Applicant] repay previously utilized credit before [Issuer] renews its credit line. The document also does not expressly limit the aggregate amount of credit that [Beneficiary] could draw upon during the entire period of the letter's validity. Although it is true, as [Issuer] contends, that the instrument refers to a credit limit "up to" $11.5 million rather than the total amount of the ... loan, that reference must be read in conjunction with the automatic quarterly renewal period.

Calculating [Issuer]'s maximum obligation then becomes a simple matter of multiplying $11.5 million by the number of fiscal quarters covered by the letter of credit. Therefore, a literal reading of the instrument, as required by our precedent ... leads us to conclude that [Beneficiary] was entitled to draw up to $11.5 million per quarter under the automatically revolving standby letter of credit irrespective of [Applicant's] failure to reimburse [Issuer] for previous payments made to [Beneficiary]."

8. Revolving LC: Issuer had argued that "the term "revolving" inherently preconditions credit renewal upon the applicant's repayment of funds previously disbursed by the issuer of the letter of credit." The appellate court stated "[t]hat term, as experts for both parties acknowledged, does not have a single accepted definition. Its meaning should be derived from the context in which the term is used (see International Standby Practices, ISP98 Rule 1.10[c][ii]). A letter of credit can revolve in different ways - in relation to time, value, repayment or the presentation of certain documents - or by a combination of factors, depending upon the language used in the instrument ... Here, viewing the word "revolving" in the context in which it appears in the letter of credit, it is clear that renewal is based upon the passage of time, specifically three months. There is simply no reference in the instrument to repayment by [Applicant]."

9. "Revolve" Defined: Issuer had relied heavily on a definition in the Glossary of John Dolan's "The Law of Letters of Credit. The appellate court characterized this reliance as "misplaced. Although the treatise's glossary definition of "revolving credit" (id., at G-35) suggests that an issuer is not obligated to honor a subsequent draft until it is reimbursed by the applicant, it is entirely silent on the question of whether such a repayment condition should be implied when it is not explicitly incorporated into the instrument itself. Indeed, the cases cited under the definition address commercial letters of credit involving the sale or delivery of goods which contained express conditions affecting the extension or reinstatement of credit (see Venizelos, S.A. v Chase Manhattan Bank, 425 F2d 461, 467-468 [2d Cir 1970] [proof that total shipment met minimum weight requirement]; Banco Nacional De Credito Ejidal, S.A. v Bank of Am., 118 F Supp 308, 309-310 [N.D. Cal 1954] [notice of reinstatement]; Trans-Global Alloy, Ltd. v First Natl. Bank of Layfayette, 490 So2d 769, 771 [La Ct App, 3d Cir, 1986] [deadline for shipment]). In this case, however, the document does not condition the renewal of the credit."

10. Non-Documentary Conditions: The appellate court noted that its approach to strict compliance "is consistent with the non-documentary conditions doctrine embodied in article 13 of the UCP 500." The court listed the documentary requirements of the LC and stated "[t]he instrument requires nothing further; it does not call for [Beneficiary] to supply proof that [Applicant] repaid [Issuer] for the previous quarter's credit, nor does it make [Issuer's] credit obligation to [Beneficiary] contingent on reimbursement from [Applicant] covering prior draws."

Comment:

1. This decision is important and valuable for LC law and practice. It reinforces the rule that LCs will be interpreted in accordance with the meaning that their terms are given in the LC community. It should serve as a warning to issuers that they should not issue credits when they do not understand the ramifications of their undertakings.

2. The decision is interesting for its references to ISP98, possibly the first judicial recognition of these rules and certainly the first interpretation of the rules. The court properly construes ISP98 Rule 1.10(c)(ii) to the effect that the context of a reference to revolving or being reinstated is critical to the meaning of the terms.

3. Unfortunately, several of the general remarks of the court could be more precise. The reference to standbys as arising from default or non-performance and to the standby as "secondary" are understandable in a loose sense but will be taken in a more strict sense to contain meanings that this casual reference could not have intended to convey. Standbys are not always default undertakings and, whether or not they are is irrelevant to their independent character. Virtually every financial standby has a direct pay clause which is not linked either to default or nonperformance. Nor is it correct to describe a standby as "secondary" since to the issuer the obligation is primary. Indeed, it is due to confusion over the misuse of this term that much of the confusion over the availability of subrogation has arisen.

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