Article

Evidence, Set Off, Bankruptcy

Note: At the time of the Eastern Air Lines bankruptcy, First Fidelity Bank had issued a standby on behalf of Eastern which was secured by a CD and funds on deposit at the bank. When Eastern demanded all its funds, the bank refused to return the funds securing the LC and filed a motion for protection from the automatic stay imposed when the bankruptcy proceedings commenced. When the beneficiary subsequently drew on the LC and the issuer paid, the issuer and Eastern agreed that the bank could apply approximately US$ 8,600,000 of the monies levied to setoff this obligation. The court noted that the bank's right to setoff in order to protect the funds for an LC was recognized even before the 1995 case of Citizens Bank of Maryland v.Strumpf, 516 U.S. 16 (1995), in which the United States Supreme Court clarified Section 553(a) of the Bankruptcy Code and indicated the circumstances in which a creditor was entitled to setoff.

In a subsequent adversarial proceeding against the bank by bondholders who alleged that the bank had failed in other respects to act in a timely fashion and was imprudent in handling Eastern's affairs and protecting the bondholder's interests promptly by seeking a protective order, the bondholders sought to disclose to the jury the bank's actions in protecting its LC reimbursement rights as evidence of its ability to act in a timely manner when its own interests were at stake.

The bank resisted disclosure and filed a Motion in Limine designed to exclude the evidence of the setoff of the amount paid under the LC because it was irrelevant. Noting that the admissibility of evidence is governed by Fed. R. Evid. 401, 402, and 403, the court stated that the judge has the discretion to determine the relevancy of evidence and the degree to which it would prejudice the adverse party. Under Fed. R. Evid. 401, relevant evidence is considered to be "any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence."

Accordingly, the court ruled that the evidence was inadmissable because it was irrelevant in the terms of Fed. R. Evid. 403. It found that the similarities between the bank's filing of motions for adequate protection with respect to the funds related to the LC and the trust were only "skin deep" because of the distinct differences in the nature of the LC and the trust. "[I]n the letter of credit setting, [the issuer's] collateral for any amount it might have to pay out under the letter consisted of the funds that [the applicant] had on deposit with the bank. If [the applicant] withdrew those funds, the [issuer's] collateral would vanish in the twinkling of an eye, lost without hope." On the other hand, the collateral for the bondholders was a fleet of aircraft valued at US$ 681,800,000, which exceeded the aggregate value of the outstanding bonds in the trust which were valued at $453,765,000. Hence, the bondholder's trust was overvalued with an "equity cushion" greater than $228,000,000. In addition, the court found that the tangibility of the collateral would be available in subsequent actions. The bondholder's contention was therefore "undermined by [the issuer's] practical necessity to move immediately in the letter of credit setting."

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