Factual Summary:Pursuant to an agreement whereby applicant would manage and administer beneficiary's keno-type lottery system, the cash reserves maintained for the game were to be returned to the applicant on termination. Applicant obtained an irrevocable LC in lieu of a performance and payment bond.

When applicant failed to maintain required cash reserves, the beneficiary drew on the LC to supplement them and, when the LC was not replenished, drew the balance as a result of a further default. The LC provided for drawing by the beneficiary when applicant was in default of the underlying agreement.

Applicant, as of August 1997, possessed Certificate of Deposit ("CD") for US$169,330. Due to a deteriorating relationship, beneficiary demanded that the CD's balance be transferred into the beneficiary's name, stating that the CD represented the cash reserve required by the agreement. The applicant compiled, whereupon the beneficiary became aware that the CD balance was less than the required amount. Pursuant to the agreement, beneficiary drew on the LC in the amount of US$ 80,670 to make up the difference between the CD balance and the required cash reserve. The issuing bank paid and then demanded reimbursement from the applicant. Applicant was unable to cover the drawing and the issuer gave notice that it was terminating the LC.

The applicant then filed for bankruptcy protection under Chapter 11 (reorganization) and claimed the proceeds of the LC from the beneficiary in an adversary bankruptcy proceeding, and the Bankruptcy Court ordered the beneficiary to return those proceeds not due on the underlying agreement. On appeal, affirmed with correction of a math error.

Legal Analysis:

1. Independence Doctrine: The beneficiary argued that it is irrelevant whether or not the beneficiary completed its end of the transaction and that the applicant is not entitled to the funds paid to the beneficiary by the issuer because applicant had no property interest in the LC or its proceeds based on the independence principle. Noting that the independence principle is "two-way" in nature, the appellate court declined to apply the proposition to this situation.

The court stated that "[i]f the [beneficiary's] breach of the agreement is irrelevant to the [issuer's] obligation to pay on the letter of credit, the source of the funds must also be irrelevant to the [applicant's] right to recover on the breach of contract claim". The real issue becomes whether, under the lottery agreement or a breach of the terms of the agreement, the applicant was entitled to the return of the funds, "regardless of the source of the funds".

Concluding that the beneficiary was obligated to reimburse the applicant pursuant to the underlying transaction, the appellate court upheld the trial court's order that they be paid to the beneficiary.



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.