Article

Contract to Provide LC; Participation Agreements; Bankruptcy

Note: In order to create a US$ 50 million commercial paper program, applicant entered into a letter of credit agreement (LCA) with creditor, under which creditor would issue certain irrevocable letters of credit for the account of the applicant. On the same day that the LCA was signed, creditor and participant entered into a "participation agreement" in which creditor sold participant an "undivided interest and participation to the extent of 22.5% ... in and to the Letters of Credit and the obligations of the [Applicant] in respect to the Letters of Credit under the [LCA] ... ."

When the applicant filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, it owed $15 million to issuer under the LCA. In a settlement between the participant and the debtor, the two parties "agreed that if [participant] is allowed to file a separate claim for its participation interest ... then forty percent of that claim will be paid in full while the remaining sixty percent will receive the same treatment as all other unsecured creditors. On the other hand, if [participant] is not allowed to file its own claim, it will be paid 22.5 percent of any recovery that creditor receives on account of its LCA claim." The difference of whether participant was able to file its own claim was approximately $950,000.

In order to protect its interests under the participation agreement, the participant claimed that it had an "undivided interest" in applicant's financial obligations, could collect monies directly from the applicant, and was entitled to the $3,375,000. The participant contended that it had obtained an undivided interest from the creditor (as evidenced by the proportionate risk of loss) that allowed the participant to collect payments from the applicant. Further, it contended that other documents disclosed the complete terms of the participation agreement. The liquidating trustee maintained that participant's claim should be disallowed because "the LCA, the participation agreement, and the case law regarding participation agreements do not support [participant's] assertion that it may assert a claim directly against the [applicant] because [participant] is not a creditor of the [applicant]."

U.S. District Court Judge, Gallet, J., granted the motion of the liquidating trustee and dismissed the participant's "blunderbuss defense," stating that the participant and creditor specifically chose the unambiguous terms of the participation agreement, and that because those terms were unambiguous, additional documents would be inadmissible.

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