Factual Summary:

To secure its obligations under a loan, a standby was issued in favor of a broker and advised by a lender bank. The standby covered one year of payments under the loan, but was in force for seven years and was confirmed for the first year.

Uncertain that the language of the credit fully protected its position for the full seven-year credit, the lender communicated desired changes to the beneficiary which communicated with the applicant and issuer. As a result, the issuer indicated in a letter to the beneficiary that the standby would be "reavailable to you upon your receipt of our tested telex or amendment." Still unsatisfied, the lender pressed for further language changes. As a result, the issuer inserted the term "automatically" so that it read "automatically reavailable to you upon your receipt of our tested telex." A subsequent letter on a different matter in similar form was admitted by the issuer to be an amendment. The standby was subsequently transferred to the lender. When the applicant defaulted on the loan, the lender/secondary beneficiary drew on the standby, taking the position that the correspondence between the issuer and beneficiary constituted amendments to the credit, or, in the alternative, the issuer misrepresented the automatic reavailability of the credit.

The issuer refused to make any payments in excess of the face amount of the credit, and the second beneficiary brought suit to enforce the "automatic reavailability" of the credit.

The trial court, Black, J., granted summary judgement to the issuer. On appeal, the U.S. District Court reversed and remanded. In reversing, the appellate court noted that expert testimony could reveal an issue of fact as to whether the correspondence constituted amendments to the credit. Moreover, the court held that the confirmer's consent was not required to effectuate the amendments where the amendments had no affect on the confirmer, thus rejecting the trial court's interpretation of the UCP that an issuer could avoid its obligation on an amendment routed directly to the beneficiary but claiming that the confirmer had not consented. Additionally, the court held that no direct relationship between the issuer and second beneficiary was required for the second beneficiary to state a cause of action for fraud against the issuer.

On remand, the parties argued as to the effect of the language of the correspondence. In a trial without a jury, the court, Motz, J., granted judgement to the beneficiary. On appeal, the U.S. Court of Appeals for the Fourth Circuit, Butzner, J., affirmed the district court's decision.

Legal Analysis:

1. Interpretation of LC terms: Objective vs. Subjective:The issuer challenged the trial court's interpretation of the automatic renewal clause as an amendment, noting that the court found that the subjective intent of the author of the relevant letter was that it be a side agreement and not an amendment. The trial court concluded that the meaning of the letter should be determined objectively in the context of commercial practice, as indicated by UCC Section 1-205. To determine this practice, the court looked to the UCP to which the LC was subject, heard expert testimony, and ruled that the letter written on the issuer's stationery, referring to the LC number, and changing the terms of the LC to make it automatically renewable constituted an amendment which operated automatically without further amendment to extend the LC. The appellate court ruled that the evidence amply supported this conclusion.

2. Transfer: Independence of Transferee:The issuer argued that the transferee was subject to defense of fraud against the first beneficiary. Essentially, it contended that an LC transfer is a contractual assignment in which the transferee has no greater rights than the transferor. The trial court had concluded that the transferee was not an agent of the first beneficiary and that the issuer had not proven that the second beneficiary knew of the first beneficiary's fraudulent conduct or trickery.

Ruling that this conclusion was justified by the evidence, the appellate court ruled that "[a] transfer effectively substituted the transferee (in this instance BDS, which became the second beneficiary) for the first beneficiary (Suriel). The transfer creates a "direct relationship" between the issuer (Provident) and the second beneficiary (BDS).... This new relationship between the issuer and the second beneficiary gives rise to the independence principle, which makes letters of credit effective instruments of commerce by assuring the transferee that the credit is free of defenses against the original beneficiary." Looking to banking practice under which it was as sumed that transfers were independent, and that any other approach would destroy transferability, the appellate court affirmed, noting that the independence principle "means that the transferee (BDS) takes free of all defenses that the issuer (Provident) has against the first beneficiary (Suriel)."



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.