Article

Factual Summary: Under an exclusive regional automobile distributorship agreement in place since 1975, the franchisee was required to provide a letter of credit to assure payment for automobiles ordered pursuant to a pre-negotiated quota.

Originally, the parties used the LC as a payment mechanism, with the franchisor delivering documents entitling the franchisee to possession of the cars in drawing on the LC. Several years later, the parties agreed to use a standby to provide assurance that cash payments would be made for the cars and three standbys were maintained at any one time. By 1990, the parties agreed that the three credits would be commercial rather than standby to avoid added fees imposed by capital adequacy requirements. There were, however, several draw downs to satisfy bank regulators that the credits were indeed commercial and not standbys.

The terms of the agreement were described by the court as "inartfully drawn many years ago in contemplation of a much simpler commercial relationship". The court noted that the terms of the contract had "very little to do with how the parties have done business for the better part of two decades". The franchisee became fearful that its franchise would be terminated by the franchisor as had been the case with many other U.S. franchises. As a result, the relations between the two became increasingly difficult.

The franchisee insisted that its interpretation of the literal terms of the contract be followed, while the franchisor responded by asserting its own "utterly inconsistent reading of the relevant provisions". The resulting impasse led to this litigation.

The franchisor demanded that:

the LC "(1) expressly permit [beneficiary] to make partial draw downs based of partial shipments of [applicant's] total order; (2) be payable to [beneficiary] upon issuance in an amount sufficient to cover the full cost of the cars ordered; (3) expire no sooner than the end of the fourth month after the month in which the relevant purchase order was submitted; (4) be transferable; (5) contain no term that assesses transfer charges to [beneficiary]; (6) contain no language that prevents draw down unless [beneficiary] delivers precisely the models and colors of cars ordered by [applicant] or that requires [applicant's] inspection of the vehicles as a condition precedent to draw down; (7) be payable on presentation of documents to [applicant's] bank, without delivery of documents to [applicant] of approval of draw downs by [applicant]; and (8) be issued by a bank acceptable to [beneficiary]".

The franchisee, on the other hand, insisted:

"(1) ensuring that [applicant] has the right to inspect delivered vehicles prior to any draw down on the letters of credit, to verify that deliveries match the model codes and colors of cars ordered by [applicant]; (2) requiring [beneficiary], before draw down, to deliver a written notice to [applicant] stating the vehicle identification number (VIN) or vehicle order number (VON) for each vehicle ordered and a commercial invoice identifying each vehicle by model code, color and price; (3) requiring [beneficiary] to present to [applicant's] bank, as draw down documents, vehicle title certificates, a bill of sale conveying title to each vehicle and commercial invoices identifying all vehicles by model code, color and price; (4) prohibiting the draw down of any letter of credit until the first day of the second month following its posting (i.e., if the letter of credit is posted in January, it cannot be drawn down until March 1) and providing that each letter of credit will automatically expire at the end of the second month following its posting (i.e., if posted in January, then expiring at the end of the day on March 31); and (5) allowing [applicant] to charge [beneficiary] for any costs [applicant] incurs if [beneficiary] transfers its rights as beneficiary under a letter of credit".

The trial court denied the franchisee's motion for preliminary injunction and partial summary judgment and granted summary judgment to the franchisor dismissing portions of the action.

Legal Analysis:

1. Underlying Contract: "acceptable" LC: The applicant argued that the term "acceptable" in the contract meant only that the beneficiary had the right to approve the issuer. The court concluded that this interpretation was "unpersuasive". Quoting the franchisor's expert, Dennis Noah, with approval, the court indicated that "'acceptable to [beneficiary]' as used in Article 7(3) 'means not only that BENEFICIARY must be satisfied with the soundness and credit rating of the bank issuing the LC, but also [with] the feasibility and technical competence of the LC". The court ruled that the franchisor "BENEFICIARY has the right under the DA to have a form of letter of credit which is acceptable to it, as long as that form is commercially reasonable and consistent with the DA".

2. Underlying Contract: Unfettered Discretion with Respect to LC Terms: Rejecting the applicant's argument that the contract terms as interpreted by the beneficiary would grant the beneficiary unfettered discretion with respect to the LC, the court indicated that there remained a requirement that the beneficiary act in a commercially reasonable manner. "A fairly implied limitation on this discretion is that it may not demand terms that contravene the letter of the DA or the intention of the parties at the time they entered into that contract".

3. Underlying Contract: Prior Inspection of the Goods: The court rejected the applicant's argument that a commercially reasonable LC would have to permit inspection acceptance of the cars prior to any draw down on the credit. The court stated that this result was not required under the contract nor the Uniform Commercial Code which permits payment before tender of the goods.

4. Underlying Contract: Misreference to Acceptances: The franchisee called the court's attention to a clause of the contract, arguing that it need not post additional credits until after acceptance. The clause provided:

Within seven days after each letter of Credit becomes an acceptance, the [applicant] shall order for the next month of the contract year an additional 1/12 of the annual minimum requirement as set forth in Exhibit B hereof. The order shall be accompanied by a domestic, irrevocable Letter of Credit in favor of [beneficiary].

Of this clause, the court stated, "I would like to think that this provision made sense when it was drafted; it does not make sense today. The one and only thing on which everyone-the parties and all their experts-currently agree is that this language is nonsense." It noted that "Because the parties have been employing [applicant's] letters of credit as security, not using them as a mechanism to effect payment, since 1981, they have never had to consider what the obtuse language in the [underlying contract] about an 'acceptance' might mean in the context of multiple deliveries and draw downs."

5. Role of Course of Dealing in Interpretation of LC Contract Clause: Noting that the parties had avoided a literal interpretation of the contract for many years and expressing its own reluctance to interpret it, the court rejected the interpretation advanced by the franchisor. It also declined to rely on the actual conduct of the parties during the course of their dealings. "[T]here is no denying that this eminently sensible arrangement is not reflective of the relevant language in the [underlying contract]".

Comment:This case provides strong reinforcement, if any is needed, to the importance of carefully drafting payment terms in a manner that will permit continued viability.

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