Factual Summary:

To assure repayment of a loan from the beneficiary to seller/borrower, buyer applied for a standby LC payable to the beneficiary. After default on the loan, the beneficiary drew on the standby and was paid, applicant reimbursed the issuer and sought subrogation of beneficiary's rights against borrower/seller, but was refused. Applicant then brought an action against various parties including an action against the beneficiary for equitable subrogation of its rights against the borrower/seller. The trial court dismissed the applicant's action against the beneficiary. On appeal, the trial court decision was reversed and remanded to determine whether subrogation was appropriate in this case.

Legal Analysis:

1. Impact of Revised UCC § 5-117 on Availability of Subrogation under the Prior Code: The beneficiary argued that subrogation was not available under Prior UCC Article 5, which applied to the standby in this case because Revised § 5-117 specially permits subrogation. The court rejected this argument, noting that the prospective approach of Revised UCC Article 5 had no bearing on whether or not subrogation was available before it came into force. In so denying, the court rejected the rationale of Shokai v. United States National Bank of Oregon, 126 F.3d 1135 (9th Cir. 1997) which concluded that because the revision expressly allowed subrogation, the legislature must have believed that the prior law did not permit subrogation. "The fact that the legislature provided that all those amendments would apply prospectively hardly reflects a judgment on the existing state of the law with respect to each or any of them ... . Although the legislature sought to clarify the law for letters of credit issued after the effective date of the act, the text, context, and the legislative history of the 1997 act do not suggest that the legislature made any judgment about the parties' right to equitable subrogation for letters of credit issued before the act's effective date."

2. Equitable Subrogation under Prior UCC Article 5: The beneficiary argued that under Prior UCC Article 5, subrogation was not available in any event to the applicant of a letter of credit because the applicant was primarily liable on the letter of credit and subrogation is only available to persons that are secondarily liable. The appellate court noted that the courts that considered this question have been divided. It concluded that the availability of subrogation was the better approach under Prior UCC Article 5. The court noted that since payment had been made on the LC, there was no danger to the independence principle in granting subrogation. It concluded that subrogation better took into account "the substance of the transaction rather than its form", and that, like suretyship, payment was, in effect, only available on default were subrogation to be available after payment on the LC. Moreover, the court noted that the revisers of the Article concluded that the availability of subrogation was a superior approach.



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.