Article

Factual Summary:

Applicant and beneficiary entered into a self-insurance program in 1986 whereby the applicant would pay premiums based on actuarial projections to the beneficiary, execute a note to cover anticipated losses and create a fund collateralized by a letter of credit for the payment of losses exceeding those anticipated and covered by deductibles.

Later that year a dispute arose concerning the amount owed by the applicant to the beneficiary in connection with the program. The beneficiary claimed it was owed over $800,000 while the applicant placed the amount around $84,000. As a result, the applicant changed insurers, but the dispute was not settled.

In 1994 and 1995, the beneficiary again proposed similar insurance programs to the applicant which the applicant accepted. New letters of credit, notes, and funds were created for each policy term. During this period, negotiations concerning the disputed amount from 1986 commenced. In 1996, when the applicant informed the beneficiary that it was taking its insurance business elsewhere, the beneficiary drew over $1,000,000 under the 1994 letter of credit to pay for the 1986 disputed debt.

The applicant then filed suit against the beneficiary, alleging, among other claims, fraud in the transaction and obtained a temporary injunction preventing the beneficiary from making any other draw on a letter of credit for debts claimed to be owed from a different policy year (i.e. the beneficiary could not make a draw for a debt due from the 1994 policy under the 1995 letter of credit). Additionally, the beneficiary was ordered to give the applicant's counsel 60 days notice prior to making a draw under any of the credits. On appeal, affirmed.

Legal Analysis:

The court first noted that the temporary injunction must stand unless it could be shown that the trial court had clearly abused its discretion in issuing the order.

The beneficiary argued that the trial court erred in granting the injunction because it had not followed the requirements of Texas' version of prior UCC 5-114. In issuing the injunction the trial court stated that it had not reached the issue of whether there had been "fraud in the transaction" within the meaning of prior 5-114(b)(2). The appellate court, however, held that prior 5-114 did not apply to the case since the beneficiary had not been enjoined from making a drawing under any of the letters of credit. According to the court's reasoning, the beneficiary could still make a drawing for a 1995 debt under the 1995 letter of credit upon 60 days' notice to the applicant.

The beneficiary argued that the injunction amounted to a ruling that the contracts did not allow for cross-collateralization; and, without a finding of fraud, no injunction should issue to prevent such a usage of the credits. The court disagreed and stated that the injunction merely disallowed draws for other purposes until the issue of cross-collateralization could be determined. Moreover, the court had already decided that prior 5- 114 did not apply to the case.

The court further found that the applicant had satisfied the common law test for the issuance of an injunction: a probable right of recovery; an imminent, irreparable harm; and no adequate remedy at law.

In finding that the applicant had demonstrated a probable right of recovery, the court noted that the independence principle did not prevent it from looking at the terms of the underlying insurance agreement because the letter of credit had already "served its purpose" and the question was whether or not the beneficiary had a right to keep the funds. The court then noted that the beneficiary was not entitled to "self-help" to settle its dispute and the record contained no evidence of its rights to the funds.

The court also found that the ability of the beneficiary to continue to make large draws against the credits could result in imminent harm and irreparable injury to the applicant's reputation and credit. Indeed, the applicant's vice president of risk management testified that draws upon letters of credit indicate that the company is not paying its bills. Since the court found that there was no adequate remedy at law for a damaged reputation, it affirmed the issuance of the injunction.

Comment:

An injunction which prevents honor of a complying presentation under a letter of credit is one within the scope of prior UCC Section 5-114(2) whether the order limits the scope of the drawing or prevents any drawing. No such order should be issued unless the court determines that the requisite degree of letter of credit fraud is present. In this case, it appears that this determination was not made. As a result, the injunction was improperly granted. If the beneficiary could have made a facially compliant drawing and if there was no fraud in the transaction, any dispute must be resolved between the parties to the underlying transaction.

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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.