Factual Summary: To assure payment to the Beneficiary of an LC issued by a U.S. federal savings bank, the Federal Home Loan Bank of New York issued a separate LC in favor of Beneficiary naming the issuer of the first LC as Applicant. The second LC required "a certification that issuer of first LC owed, but had not made payment on the primary letter of credit." Beneficiary made two drawings on the LC accompanied by the required certification and was paid. The first drawing was for work it had completed under the agreement and the second one was to "preserve its security for sums due under the agreement" because the LC was due to expire. The issuer of the first LC (Applicant for the second) sued Beneficiary for breach of statutory warranty under Prior UCC Section 5-111, alleging that it breached the warranty "by falsely certifying in its draw...that [it] was entitled to payment...." Applicant moved for summary judgment. The trial court denied Applicant's motion with respect to the first drawing and granted it with respect tot the second drawing.

Legal Analysis:

1.Independence Principle, Strict Compliance: Applicant asserted that the sole issue before the court was "whether beneficiary breached its warranty under Prior UCC § 5-111(1) by falsely certifying in its draw on the ...LC that beneficiary was entitled to payment from applicant and beneficiary had not received payments. Beneficiary disputed Applicant's claim, arguing that it was entitled to payment pursuant to the underlying agreement. Beneficiary alleged that it was undisputed that it had not received payments for amounts due under the agreement for work it had performed and thus it was entitled to draw on the confirming LC. Applicant, however, claimed that there were certain defects in the work performed by Beneficiary. Moreover, Applicant argued that Beneficiary was required to make a drawing request upon the original LC before it could draw upon the confirming LC. Beneficiary, however, presented a letter from it to the Applicant confirming that it "would be entitled to make a draw request directly to the Federal Home Loan Bank of New York". 2001 LC CASE SUMMARIES The court stated that "fundamental to the letter of credit transaction is the principal that 'the issuing bank's obligation to honor drafts drawn on a letter of credit by the beneficiary is separate and independent from any obligation of its customer to the beneficiary under the sale of goods contract and separate as well from any obligation of the issuer to its customer under the agreement'" citing First Commercial Bank v. Gotham Originals, Inc., 64 N.Y.2d 287, 486 N.Y.S.2d 715, 475 N.E.2d 1255. The court declined to grant summary judgment with respect to the first drawing. It noted that "the law in New York is clear; to draw on a letter of credit, the beneficiary need only establish that it has strictly complied with its essential requirement." Banque Worms v. Banque Commerciale Privee, 679 F. Supp. 1173 (SDNY 1988).

2. Contract Law: The court noted that "letters of credit are unique commercial instruments and are governed by their independendent rules. Traditional contract principles only apply to the extent that they do not interfere with these rules."

3. Independence: The court concluded that beneficiary was in strict compliance of the terms of the LC when it submitted the first drawing certificate and thus the independence principal validated the first draw. The court remarked that "This independence principle infuses the credit transaction with the simplicity and certainty that are its hallmarks. The letter of credit takes on a life of its own as manifested by the fact that in credit operations all parties concerned deal in documents, not in goods, services, and/or other performances which the documents may relate."

4. Prior UCC § 5-111; Warranty: Regarding the second drawing, the court concluded that "it is clear that [beneficiary] was not in strict compliance when it attempted 'to preserve its security for sums due under the agreement,'" and concluded that applicant was entitled to damages for breach of warranty. The court noted that according to Prior UCC § 5-111 "the beneficiary warrants to the issuing bank the truth of the statements necessary to draw on the credit."

Comment : While the remarks on the independence principle are welcome, they have less force in a post honor situation. It would seem that the court looked beyond the face of the LC with respect to both drawings. This relevance, however, is with respect to the nature of the claim, breach of LC warranty. This odd provision should not be used to create an independent cause of action where there is no claim on the underlying transaction. Hopefully, the court was satisfied that the Applicant had a cause of action on its contract with Beneficiary. Therefore, it would have been helpful to understand whether or not the beneficiary had a right to the proceeds as security based on the underlying transaction and not LC law.


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.