Article

Factual Summary: To partially finance the purchase of a mutual fund company, the applicant obtained a standby letter of credit for $500,000 on behalf of the purchaser, which was headed by a close personal friend of the applicants, in favor of a bank which loaned funds for the acquisition. Although neither the beneficiary nor the applicants were aware of it, the contract to acquire the mutual fund company had become null and void prior to the issuance of the standby.

The head of the purchaser proceeded to use the funds from the loans (with the knowledge of the lender/beneficiary) for such things as a car for him-self, construction on his home, and expenses and re-imbursements for his brokerage company. None of the funds were used to acquire the mutual fund com-pany.

One month later, after the purchaser was placed in receivership, the issuer honored the beneficiary's demand under the standby and was re-imbursed by the applicants who brought an action against the beneficiary on various theories, alleging that the beneficiary had a duty to monitor disbursal of the funds so that they were used only for the in-tended purchase.

At trial, the jury found that a contract ex-isted between beneficiary and applicant that restricted use of the funds to the acquisition of the mutual fund company. The jury also found that the beneficiary had not breached that contract but had been negli-gent. The court entered a judgment on this verdict and awarded damages to the applicants. On appeal, reversed.

In seeking reversal, the beneficiary claimed that it owed no duty to the applicants on the underly-ing contract and, thus, could not be found negligent. The applicants contended that standard banking prac-tice required the bank to monitor the disbursement of loans made for particular purposes and the ben-eficiary owed them the duty to do so.

Legal Analysis:

1. Negligence: The appellate court first noted that, apart from the standby itself, there was no obligation between the applicant and the beneficiary. As a re-sult, any duty of the beneficiary's would have to arise from a condition in the standby that required the ben-eficiary to undertake such a task. It concluded that:

In the absence of any express provision in the plaintiffs' letter of credit requiring that defendant BB&T monitor the use made by [the purchaser and its president] of the loan proceeds to assure their use for the intended purpose of the loan, defendant owed plaintiffs no legal duty to do so.

Comment:

The provision suggested by the court would be surplusage with respect to the letter of credit obligation. Nonetheless, it would have helped the applicant in this situation had it been present. This situation may explain to L/C professionals why such language is often requested. It still does not justify it. Had there been a signed agreement between the parties, this litigation could have either been avoided or much more readily resolved.

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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.