Note: To settle outstanding litigation, former business partners entered into a Settlement.31 2001 LC CASE SUMMARIES Agreement that was a "fully integrated unambiguous contract". The Settlement Agreement required that an LC for US$1.7 million be issued in favor of one party. A further dispute subsequently arose over two oral agreements, one prior to and the other subsequent to the written contract. The beneficiary drew on the LC issued by the First National Bank of Chaska, Minnesota, which "checked with [applicants] before paying on the letter of credit and then began an interpleader action without paying." Instead, the proceeds of the LC were deposited into the registry of the court. The trial court granted summary judgment to the applicants on the contract dispute but ordered the proceeds of the LC, which had expired in the meantime, paid to the beneficiary since "there was no argument by the parties that this sum would have to be paid." It also awarded attorney's fees to the applicants pursuant to Revised UCC Section 5- 111(e) on the basis of "a breach of warranty in the beneficiary's presentation on the LC." Section 5- 111(e) provides that "reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article." On appeal, the Court of Appeals of Minnesota, Klaphake, J., in an "unpublished opinion" affirmed the award of summary judgment but reversed the award of attorney's fees. Relying on Revised Section 5-110(a), the appellate court correctly reasoned that a warranty is made only if the presentation is honored. Since there was no honor, it concluded that "the issuing bank cannot defend its dishonor or failure to pay by claiming a breach of warranty by the beneficiary." The appellate court rejected applicant's argument that the warranty arose because the beneficiary was eventually paid the proceeds from the registry of the court. The appellate court justified this "narrow" interpretation of the parties' contract on the ground that "letters of credit are strictly construed for compliance with their terms." It concluded that because the beneficiary's presentation was not honored, it made no warranties and the applicants were not "prevailing parties" within the meaning of Section 5-111(e).

Comment: The "narrow" interpretation of Revised UCC Section 5-111(e) is troubling although the conclusion may well be appropriate. That it is difficult from the opinion to determine whether it is appropriate underlines the problems with the court's analysis. The court is certainly correct in its conclusion that no warranty arises unless there has been honor. The UCC Section 5-111(e) provision awarding attorney's fees to the prevailing party was intended to visit the costs of LC litigation on the party who was found to have improperly caused it, however, without regard to honor. It was intended to be available in a case of wrongful dishonor as well as breach of warranty. The award is not discretionary. The issue, however, is who prevails on the LC-related issue. In this case, it appears that the beneficiary made a presentation that complied on its face with the terms and conditions of the LC. The issuer did not pay after having "checked with the applicants" and interpled the funds. The bank's action makes a mockery of the LC. Its obligation is independent of that of the applicants and it is to pay against a complying presentation immediately, and not eventually. It is an LC and not a judgment bond to be paid after the dust settles. On receiving a presentation, the bank had two options: (1) pay or dishonor; (2) refuse or defend based on fraud. The applicants could have sought injunctive relief but did not do so. If the bank did not timely dishonor, it would be precluded from refusing to pay unless LC fraud was proven. Assuming that there was no proper dishonor and no fraud - neither of which is suggested in the opinion - the issuer's failure to honor was wrongful. That the beneficiary was required to litigate to obtain its funds should have entitled it to the portion of the fees required in responding to the bank on the LC issues regardless of whether or not it sought refuge in an interpleader action. This award should have been against the bank.

While the court correctly grasps the technical issue that the beneficiary has not made a warranty until honor, it misses the point of Section 5-111(e). If the court concluded that the drawing was without colorable basis, then the applicants (or possibly, the issuer) should have been awarded the fees related to the LC issue. In either eventuality, an award of fees would have been appropriate. As it stands, the opinion rewards banks that avoid making the hard LC decisions that are part of the business and, in effect, undermines Revised Section 5-111(e) which was intended to introduce further rigor into the system.


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.