Article

Prior History: Papio Keno Club, Inc. v. City of Papillion, 2000 Bankr. LEXIS 364 (B.A.P. 8 th Cir. 2000)(S.D.N.Y. Mar. 6, 2000) [U.S.A.]; abstracted at 2001 Annual Survey 255.

Note: In September 1992, beneficiary, City of Papillion, and applicant, Papio Keno Club, Inc., entered into a contract whereby the applicant agreed to manage the beneficiary's keno-type lottery system for assurance of performance. The contract required the applicant to maintain a cash reserve that was to be returned on termination. The contract also required that the applicant obtain a standby LC for US$ 250,000 which it did. Contemplating the addition of a new game, the parties amended the contract to establish a $200,000 jackpot for the game. To provide the cash reserve, the applicant began making deposits into a separate account and continued to do so until it withdrew the balance to purchase a certificate of deposit ("CD"). Financial statements indicated that the withdrawal was earmarked for the new game's US$ 200,000 jackpot that was contemplated and later agreed to by the parties. Due to a deteriorating relationship, beneficiary demanded that the CD's balance be transferred into its name, taking the position that the CD represented the cash reserve required by the agreement. Upon compliance with beneficiary's request, the beneficiary determined that the applicant had failed to adhere to the terms of the underlying agreement because the value of the CD was less than the required cash reserve. The beneficiary then drew on the LC in the amount of US$ 80,670 to cover the shortfall. The issuing bank paid and then demanded reimbursement from the applicant. Applicant, however, was unable to cover the drawing, and the issuer gave notice that it was terminating the LC. Citing numerous instances of the applicant's noncompliance with the underlying agreement, the beneficiary requested and the issuer paid the remaining balance of the LC. The beneficiary then terminated the underlying contract. The applicant filed for bankruptcy protection under Chapter 11 (reorganization) and claimed the proceeds of the LC from the beneficiary in an adversary bankruptcy proceeding. The U.S. Bankruptcy Court for the District of Nebraska, Mahoney, J., ordered the beneficiary to return those proceeds not due on the underlying agreement. On appeal, the U.S. Bankruptcy Appellate Panel for the U.S. Court of Appeals for the Eighth Circuit, Hansen, J., affirmed after correcting a mathematical error. The 8th Circuit rejected the beneficiary's argument that the independence principle applied. The court stated that "the independence principle 'protects only the distribution of the proceeds of the letter of credit...and does not address claims respecting the underlying contract'", citing In re Graham Square, Inc., 126 F.3d 823, 827-28 (6 th Cir. 1997).

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