Article

Factual Summary: The applicant caused a letter of credit to be issued to facilitate the purchase of the beneficiary's stock in a produce company. Using the credit of the purchased company, the applicant obtained a line of credit from another bank and purchased a cashier's check which listed the remitter as both the applicant and the corporation. The applicant used the cashier's check to purchase a certificate of deposit (CD) in his own name which he pledged as security for the letter of credit. Subsequently, the produce company filed for protection under Chapter 11 of the Bankruptcy Code (reorganization) and defaulted on its contract with the beneficiary. The beneficiary drew on the letter of credit and the issuer honored and enforced its security interest in the CD.

Applicant's Chapter 11 trustee brought an action against the issuer to challenge the allegedly fraudulent transfer of the funds used to purchase the CD as security interest for the L/C. The bankruptcy court held that the issuer was an immediate transferee in a fraudulent transfer of the applicant's funds. The bankruptcy court ruled that because the applicant could have returned the cashier's check at any time prior to delivering it to the issuer, the issuer's receipt of the cashier's check constituted a fraudulent transfer of funds because the transfer failed to "provide [the applicant] with a 'reasonable equivalent' to its loss of $1,500,000 in cash" under 11 U.S.C. 548(a)(2)(A). Upon appeal by the issuer, affirmed.

Legal Analysis:

1. Issuer Dominion Over Funds: The issuer was found to have complete dominion over funds deposited in its bank in the name of the applicant which were pledged as security under a letter of credit, and therefore was a transferee in the fraudulent transfer of those funds into its bank.

The appellate court upheld the bankruptcy court's finding that, although the evidence was inconclusive as to whether the applicant was insolvent as of the date of the transfer of US $1,500,000 funds for the purchase of the CD, the transfer effectively rendered the applicant insolvent. Central to the court's ruling that the issuer was a transferee in this fraudulent transfer of funds was the issuer's ability to exercise complete control over the funds once they were deposited in its bank. The issuer argued that because the applicant used the cashier's check to purchase a CD "dedicated to funding the letter of credit payable to [beneficiary]," the issuer had "no right to exercise dominion and control over the CD until its right to do so matured upon the honoring of its letter of credit obligation to the [beneficiary]." The court ruled that the issuer did in fact hold "dominion and control" over the funds and was "not merely holding funds which it had a contractual obligation to pledge to [the applicant] or another party" because the cashier's check was made out to the issuer, and once deposited in the issuer's bank, the issuer "had dominion over the funds." The court ruled that once the CD was deposited, regardless of in whose name it was deposited, the issuer could exercise complete control over the use of the funds. The court agreed with the lower court's ruling that since the delivery of the cashier's check to the issuer "must be viewed as a transfer," the issuer was "a transferee and not a mere conduit." Therefore, the issuer's appeal was denied.

Comment:

In a perfect world, an issuer should be able to rely on assurances from an applicant's attorney that the funds used would be the applicant's personal funds rather than those of a potential bankruptcy candidate. However, assurances from either an applicant' attorney or from those within the issuer's legal department that the transaction is sound, does not absolve an issuer from its responsibility to assure that the remittance came solely from the applicant. The cashier's check in this case clearly noted that both the corporation as well as the applicant were remitters of the funds. Therefore, issuer was on notice that the funds securing the credit were not solely those of the applicant but also those of the corporation requiring the issuer to ensure that the corporation would receive value for funds it was providing.

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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.