Article

Factual Summary: To assure payment of deferred annual premiums on its workers compensation and general liability policies for 1983 through 1988, the applicant caused six L/Cs to be issued in favor of defendant/beneficiary/insurer. Five of the L/Cs were issued by plaintiff/issuer. In 1989, plaintiff's five unsecured L/Cs, each covering one year's deferred premiums, were consolidated by agreement into a single unsecured US$ 3,000,000 L/C. Although it was understood by the issuer, applicant, and beneficiary that the new L/C was to assure payments from any one of the years, its text required presentation of a signed statement that payment was due for only the most recent of the years.

When the applicant later filed for bankruptcy, the beneficiary drew upon the L/C for the amount of US$ 3,000,000, presenting a signed statement that matched the language of the L/C, and the issuer paid. In fact, only US$ 150,000 was due for that policy year, but the aggregate amount due for all years exceeded the face amount of the credit.

The issuer subsequently brought this action alleging that the beneficiary breached its warranty under prior UCC 5-111(1) and committed fraudulent misrepresentation. Both parties moved for summary judgment on both theories, and the court granted beneficiary's motion and denied the issuer's.

Legal Analysis:

1. Warranty of the beneficiary under prior UCC - 5-111(1): The issuer contends that the beneficiary warranted that it complied with the conditions of the underlying transaction and that all statements were truthful. The beneficiary admitted that the statement was not literally true, but argued that issuer did not warrant the truthfulness of the statement, but only that the payment is due it under the credit and that there is no material fraud in the presentation.

The court concluded that the prior UCC Section 5-111 warranty did not go to the truthfulness of the statements made but only provided that the necessary conditions of the L/C had been met. It stated that "in the absence of language expressly making veracity a condition of the credit, so long as the beneficiary presents to the issuer documents which conform with the conditions of the L/C, the warranty of presentment under UCC - 5-111(1) is not breached." The court rejected the line of cases which held that the beneficiary made a warranty of truthfulness that included Mellon Bank, N.A. v. General Elec. Credit Corp.,F. Supp. 360 (W.D. Pa. 1989) andPubali Bank v. City Nat'l Bank,676 F.2d 1326 (9th Cir. 1982).

2. Warranty: Damages: The court implied that the beneficiary liability for breach of warranty does not exist where the issuer knew the parties' intention for the scope of the demand to encompass the entire debt owed and knew that the drawing statement was to reflect this intent. Under these circumstances, the court concluded that the result was not unfair to the issuer and implied that the issuer was estopped from asserting breach of warranty.

3. Warranty: The court also rejected the issuer's argument that the independence principle required that the prior Section 5-111 warranty be read as one of truthfulness. It noted that the issuer's resort to the independence principle was ironic since its application would produce a result different from that sought. Properly applied, the independence principle would require payment against a conforming presentation absent actual knowledge of fraud. The statement of default merely alluded to the obligation under the 1984 agreement and, at the time paid, the issuer had no knowledge of the terms of the agreement. It could have covered the entire obligation. As a result, the issuer observed the independence principle at the time of payment by not referring to the underlying agreement. Its attempt to recover afterward runs counter to the independence principle.

4. Interpretation: Reflect intention of the parties:Concluding that the terms of the default statement were ambiguous, the court interpreted the statement in a fashion that reflected the intention of the parties. The parties intention was to effect payment for six years of premiums owed, even though the literal wording of the drawing statement, based upon a drafting error, referred only to the 1984 agreement. The court found that the issuer may have thought that the 1984 agreement encompassed the 1983 premium and all subsequent premiums owed.

5. Fraudulent Misrepresentation by beneficiary in presenting false statements: The court concluded that, under its interpretation of prior 5-111, the default statement does not constitute a representation of fact. As such, it cannot be the basis for a fraudulent misrepresentation. Alternatively, the court held that there was undisputed evidence that the issuer did not rely on the purported misrepresentation, but acted in the belief that it reflected the agreement of the parties.

Comment:

This decision takes the best possible approach to the warranty theory under prior 5-111--it relegates it to an adjunct of fraud. The court is to be commended for its forthright rejection of the discredited notion of a warranty that the documents presented under the credit are "truthful." Warranty is a most inappropriate legal doctrine under which to permit the payment under a credit to be re-opened because it is not sufficiently nuanced to take into account the multi-faceted circumstances which surround payment. The equitable doctrine of subrogation serves this office far better, permitting the issuer to assert the rights of others (if they exist) and permitting the court to balance them against the rights of others rather than giving the issuer an independent right in its own stead. On the other hand, if the documents are fraudulent, the issuer has a cause of action on that basis, whether it be labeled an action for fraud or a warranty that the documents are not fraudulent. In either case, the issue is fraud.

In the instant case, if the applicant had had a right against the beneficiary based on the underlying contract, the issuer should have been able to assert it. Not having such a right, plaintiff should not be able to unravel payment based upon a theory of warranty stemming from the L/C.

The only troubling aspect of the opinion is the suggestion that the beneficiary warrants that the documents conform. While not germane to the case (where the documents conform), the prospect of this warranty undermining the preclusion rule looms terribly. Fortunately, the court did not venture down this road and, had it done so, it is likely that it would recognize that the preclusion rule displaces the Article 5 warranty in a UCP credit. Even under a UCC credit, there are issues of waiver and estoppel that must be considered.

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