Factual Summary: In a previous unrelated action, transferee bank was awarded US$5,264,399 against bank for wrongful dishonor.

During the course of litigation, the bank incurred over $2 million in attorney fees. On notification, the bank notified its insurer of the litigation. The insurer acknowledged receipt and appointed counsel. It also informed the bank that "[C]overage for this suit falls under the [Check Stop Payment Liability] endorsement to your policy. The limit of insurance on this endorsement is $100,000, subject to a deductible of $2500 per claim. The total amount of damages sought by the plaintiff is in excess of your policy limits and, therefore, any judgment rendered against you in excess of your policy limits will not be covered." The insurer also notified the bank that the damages sought by transferee were in excess of the policy limit. The insurer informed the bank it was reserving the right to "disclaim coverage," and also maintained its right to refuse to pay any part of the judgment, although a subsequent letter indicated "there does exist a potentiality of coverage with respect to Count III (Wrongful Dishonor of the Letter of Credit Under the UCC) as a result of Special Endorsement VI (Check Stop Payment Liability)."

When judgment was entered against the bank, the insurer refused to pay, and the bank therefore brought an action against its insurer to enforce payment. The trial court found that the clauses of the insurance policy did not compel the insurer to pay "because the endorsement contained an exclusion that withheld coverage for liability assumed by [the bank] under any agreement to be responsible for a loss," and, on cross-motions for summary judgment filed by the parties, found for the insurer. On appeal, vacated and remanded.

Legal Analysis:

1. Insurance: Duty to Defend: The trial court had rejected the bank's claim on the ground that it was "simply beyond imagination that the Check Stop Payment Liability containing a $100,000 limit of liability was intended to impose 'potential liability' upon [the insurer] for millions of dollars in fees and costs for defending [the bank] in a sophisticated commercial transaction into which it voluntarily entered." Noting that "the duty to defend is broader than the duty to indemnify", the appellate court reversed.

In his Dissent, Wilkins, J., urged that the policy was ambiguous as to a duty to defendant and that it was not the duty of the courts to determine the terms of contracts when those terms are not expressed within the contract.

2. Independence Principle: The policy excluded "liability assumed by [the bank] under any agreement to be responsible for a loss." The bank argued that "a letter of credit is a primary obligation undertaken independently from the obligations of third parties." The trial court concluded that "the exclusion applied because [the bank] was not entitled to draw upon the letter of credit unless [the bank's] draft was accompanied by a certification that [the applicant] had defaulted on its obligation to pay [the bank] interest pursuant to the underlying loan agreement. This certification was made an express condition of any draft drawn on the letter of credit. Accordingly, the district court concluded that, because a draft could be honored only if accompanied by the certification of a default in the underlying loan, [the bank's] dishonor of the draft resulted in a "liability assumed by the insured under [an] agreement to be responsible for a loss." In reversing, the appellate court noted that "[T]he fact that drafts drawn on the letter of credit had to be accompanied by documentation certifying that the underlying loan agreement was in default did not transform the letter of credit into an agreement to answer secondarily for the loss of another. Indeed, [the bank] would have been obligated to honor a draft whether an underlying loss had occurred or not." It noted that even if the transferee of the beneficiary "had falsely certified the occurrence of the default when it presented a draft, [the bank] would not have been relieved of its duty to honor the draft."


The agonizingly protracted path of litigation spawned by this dispute is poignant testimony to the advantages of arbitration by LC experts.



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.