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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
1997 LC CASE SUMMARIES 126 F.3d 823 (6th Cir. 1997)
Topics:
Bankruptcy; Proceeds of a Letter of Credit; Independence Principle; Prior UCC 5- 116.
Type of Lawsuit:
Trustee in bankruptcy sued beneficiary of a letter of credit for return of the proceeds to the bankruptcy estate.
Parties:
Plaintiff/Trustee in bankruptcy for applicant- Michael Demczyk
Defendant/Creditor/Beneficiary- The Mutual Life Insurance Company of New York.
Counsel:
For Plaintiff: Kenneth L. Gibson, Weick, Gibson & Lowry, Cuyahoga Falls, Ohio.
For Defendant: Stephen L. Black, Graydon, Head & Ritchey, Cincinnati, Ohio.
Underlying Transaction:
Loan commitment fee for a construction loan.
LC:
Standby for US$ 332,000. Silent as to the UCP.
Decision:
The U.S. Court of Appeals for the Sixth Circuit, Ryan J., reversed and remanded to the U.S. District Court for the Northern District of Ohio for a determination on whether the commitment fee was an earned fee; reversed the district court's ruling that the commitment fee was not property of the estate, and affirmed the district court's ruling that the defendant must recalculate its damages on remand.
Rationale:
The independence principle did not apply where the action was for returnof a fee and not return of the proceeds of the letter of credit and the fee must be considered part of the bankruptcy estate even though the fee was paid by means of the LC.
Article
Factual Summary:
To fulfill its obligation to pay a loan commitment fee under a loan application, the applicant had a $332,000 letter of credit issued in favor of a potential lender. The beneficiary then approved the loan, but the closing on the loan never took place despite several time extensions. Pursuant to the loan application, the beneficiary made a presentation under the LC. After the presentation was honored, the applicant filed for bankruptcy under Chapter 11 and sought recovery of the commitment fee. Prior to trial, the petition was converted to a Chapter 7 bankruptcy and a trustee was appointed for the applicant.
The bankruptcy court assumed that under Ohio law the commitment fee was an impermissible penalty. As such, it ruled that the applicant could not sue for its return and could also not recover the fee in the form of the proceeds of the letter of credit because of the independence principle. Additionally the bankruptcy court found that the fee was paid out of the issuer's funds on behalf of the debtor, and, therefore, was not part of the bankruptcy estate.
On appeal, the district court affirmed the bankruptcy court's decision on "slightly different grounds." The district court agreed that the fee was indeed paid out of the assets of the issuer, but further found that since the mortgage given by the applicant to the issuer to finance the letter of credit was worthless, nothing of value had been transferred from, or could be restored to the bankruptcy estate. On appeal to the 6th Circuit, reversed and remanded.
Legal Analysis:
1. Bankruptcy: Action to Recover Proceeds: The applicant, in its appeal, agreed that the payment from the issuer to the beneficiary was shielded by the independence principle. However, the applicant argued that once that payment was made, the issuer had no right to retain those proceeds. The applicant argued that its claim arose from the underlying loan commitment agreement and not the letter of credit. The court agreed and noted that "there is no principled reason for allowing a challenge to the underlying contract when the fee is paid in cash, and not allowing such a challenge after the fee is paid via a standby letter of credit." Accordingly, the court reversed the district court's decision and found that the independence principle did not apply to this case.
The court went on to rule that the commitment fee was not a penalty, and therefore not illegal under Ohio law. The court noted that the 4.2% fee adequately represented damages that a financial institution would incur when securing the funds for such a sizable loan. However, the court noted that its decision did not resolve the issue of whether or not the fee was an "earned fee" as the issuer had argued. The court stated that the issuer's assertion seemed to contradict the language in the application which stated that the fee would be returned to the applicant upon execution of the approved loan. Accordingly, the court remanded the issue of whether the commitment fee was an earned fee to the district court.
2. Bankruptcy: Property of Estate: The court next addressed the issue of whether the letter of credit proceeds were property of the bankruptcy estate. The district court had found that because the collateral for the letter of credit was worthless, there was nothing of value for the estate to recover. The appellate court disagreed and stated that the district court erred in equating consideration with collateral. In so doing, the court looked to Ohio's version of prior U.C.C. 5-105 which provides that no consideration is needed to establish a letter of credit. The court also found that the applicant's mere promise to reimburse the issuer was of value. Moreover, the court ruled that the applicant was seeking return of the commitment fee and not the proceeds of the letter of credit. As such, since the fee could have been recovered in a debtor's cause of action. the court found the fee to be part of the bankruptcy estate.
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