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Letter of Credit Law Developments

Prepared for

CBA Commercial & Financial Transactions CommitteeJanuary 19, 2006Chicago, Illinois

by

Carter H. KleinJenner & Block LLP312 923-2950cklein@jenner.com

Letter of Credit Developments

CBA Commercial and Financial Transactions Committee

January 19, 2006 Chicago, Illinois

Carter H. Klein1

Jenner & Block LLP cklein@jenner.com

I. Background facts about letters of credit:

A. U.S. banks and U.S. branches of foreign banks had issued and outstanding over $500,000,000,000 in letters of credit at the end of second quarter of 2005. Most of this amount is in the form of standby letters of credit.

B. Over $1,000,000,000,000 in international trade is paid for each year by use of

letters of credit. C. There is a high degree of concentration of LC business in a handful of banks.

Although there are over 7,000 banks in the United States, 10 banks accounted for 75% of the dollar amount of all letters of credit issued by U.S. banks.

D. In order of precedence, these banks are JPMorgan Chase, Bank of America, Citibank, Wachovia, Suntrust, Bank of New York, US Bank, Key Bank, Wells Fargo, and Comerica Bank.

E. Although there are dozens of different uses for letters of credit, the largest dollar amount uses for letters of credit are as security posted by corporations and businesses to insurance companies for fronting workmens compensation insurance and other self-insured retention limits and by nonadmitted reinsurance companies to originating insurers to secure reinsurance obligations for capital adequacy and claims payment purposes.

• 1 Carter H. Klein is a partner at Jenner & Block LLP where he has practiced commercial law for the past 31 years. He is a member of the American College of Commercial Finance Lawyers, Chair of the American Bar Association’s Letter of Credit Subcommittee, Editor, Uniform Laws Annotated – Uniform Commercial Code Forms Annotated (Thomson/West), and a member of the editorial advisory board for Documentary Credit World. He participated in the drafting of the International Standby Practices (1998) and Revised Article 5 of the Uniform Commercial Code and is a frequent speaker and articles contributor on letter of credit and Uniform Commercial Code topics.

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II. Types of Letters of Credit: A. Commercial letters of credit to pay for goods in international trade. B. Standby letters of credit used as security for an obligation, including . 1. Direct pay 2. Nondirect pay or true standby C. Clean letters of credit (only a draft need be presented -- usually required by insurance companies). E. Automatically renewing / evergreen letters of credit 1. Automatically renews 2. Automatically renews and reloads F. Presentment letters of credit -- the original LC must be presented G. Nonbank issued letters of credit -- Target, Walmart, JC Penny’s, commercial factors, insurance companies H. Straight and negotiable letters of credit -- standbys are not usually negotiable I. Transferable letters of credit J. Advised and confirmed letter of credit

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III. Regimes Which Govern or Apply to Letters of Credit: A. UCP 500 (ICC Publication 500 -- 1993) 1. ISBP (International Standard Banking Practices) 2. eUCP (electronic presentments) 3. ICC Position Papers 4. IFSA Standard Banking Practice for the Examination of Documents B. ISP 98 (ICC Publication 590 -- 1998) C. UCC Revised Article 5 (also selected provisions of Articles 1 and 9) D. OCC Interpretation 12 CFR 7.1017 E. UNCITRAL Convention on Independent Bank Guarantees and Standby Letters of Credit (ratified by only 7 small countries) F. SWIFT

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IV. Uses of and Alternatives to Standby Letters of Credit: A. Uses. Standby letters of credit have been used to secure obligations in connection with the following types of transactions: 1. Workmen’s compensation insurance fronting arrangements 2. Surety bonds 3. Commercial paper 4. Municipal or IRD bonds 5. Power plant construction 6. Other construction contracts 7. Open account indebtedness 8. Government permits 9. Government contracts 10. Cable installation obligations 11. Purchase price holdbacks 12. Advance payment guarantees 13. Bank guarantees 14. Environmental clean-up 15. Executive compensation 16. Reinsurance obligations of nonadmitted reinsurers 17. Financial contracts such as SWAPs 18. Forward Contracts (e.g., power purchase agreements) 19. Clearing obligations (e.g. CBOT) 20. Road and subdivision improvements 21. Obligations to consumers or the public 22. Supersedeas in lieu of appeal bond 23. Pre-judgment attachment security 24. Injunction security 25. Preliminary arbitration awards 26. Office lease security 27. Equipment lease security 28. Securitizations 29. Oil for food and medicine (Iraq) 30. Exchange of prisoners (Cuba) 31. Others

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B. Alternatives to Letters of Credit 1. Surety bond 2. Financial guarantee insurance (MBIA, Ambac, ACA, FSA, FGIC) 3. Export insurance (Coface) 4. Cash deposits 5. Government securities collateral 6. Other collateral 7. Independent or other bank guarantee 8. Prepayment 9. Documentary collection 10. Open Account 11. C.O.D. 12. Set-off and netting 13. Structured finance and securitization

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V. UCP 600 A. For several years the UCP’s banking Commission has been working on a redraft of the UCP 500. 52 national committees and subcommittees were formed to study and obtain comments and suggestions on what changes should be made to the UCP 500. B. There was by no means universal support for revising the UCP 500. The UCP had been working for 10 years. The International Standard Banking Practices or ISBP consisting of 200 paragraphs was issued by the ICC Banking Commission only a few years ago (Oct. 2002), after many man-hours of work and input by a special ICC task force working with national committees in putting it together. The ISBP supplements, explains provisions of and in some cases, updates the UCP 500. After this recent great effort addressing current issues facing the UCP, why would a new UCP be necessary? In addition, a new UCP would mean retraining and re-educating bank personnel and corporate and business users of letters of credit, modifying forms and language to be used going forward, revising the ISBP, and undergoing a considerable transition period. C. It is now apparent that a new draft will be adopted by the ICC, whether called the UCP 600 or some other number. The first full draft was issued on November 5, 2005 and the national committees are submitting their comments on it, which are due in less than a week -- January 25, 2006. D. Set forth on the next several pages is a copy of an internet article prepared before the new draft UCP 600 was issued. It highlights some of the more significant changes in the UCP that were anticipated and discussed by the national committees. It is annotated with my comments on what the new draft actually does or does not say with respect to the anticipated changes outlined.

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UCP 600: The end in sight?

Roger Kreitman, Principal Consultant, Mantissa October 20052

At a recent meeting of the UK Export Forum, Gary Collyer, head of the ICC drafting group, gave a progress report on the drafting of the long-awaited UCP 600

It is clear that there are still strong differences of opinion among the country committees on a number of important issues. The drafting group tried to resolve these by putting various proposals to the vote; but many of these votes only served to highlight the absence of a clear consensus or majority view.

Meetings and discussions continue, and I have been told that a "more definitive" first draft of all the articles may be expected in the next few weeks.

In the meantime, here are some samples of the drafting group's current thinking. It should be emphasized that this is all highly provisional in nature, and that much may still change during the revision cycles that are scheduled for the next few months.

1. The expression 'on its face' (in the context of document examination) has long been a source of confusion - for example, it can be taken to mean the front of the document as opposed to the back. So the current thinking is that the next UCP will have no references to 'on its face'

It does. The phrase is retained in the latest draft.

2. Time limits for examination of documents. The current formulation is 'a reasonable time, not to exceed seven banking days'. The phrase 'reasonable time' will probably be removed. It is hoped that the maximum time for examination will be reduced to either five days or six days.

Five days is the time limit; reasonable time requirement is removed. The 5 day maximum period for examination of documents does not depend on any upcoming expiry date or latest date for presentation.

3. There has been extensive discussion on whether UCP should refer to the issuers, advisers of L/Cs etc. as banks or as parties. Current thinking is that the term 'banks' should be retained, notwithstanding the recognition by the ICC that non-banks can issue L/Cs - as is commonplace for larger US companies when dealing with suppliers in Asia.

• 2 Bold italicized comments after numbered discussion points are comments by Carter Klein based on the November 5, 2005 draft of the UCP 600.

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The term “bank” is retained, but is defined as not limited to an entity traditionally known as a bank or other financial institution.

4. There is a majority view that that the practice of discounting deferred payment undertakings should be recognized by the new UCP. However the drafting of an appropriate article will require considerable thought!

Deferred payment is now recognized.

5. It is likely that the obligations of the Advising bank will be expanded. At present the Advising Bank only has to verify the authenticity of the L/C that it has been advised. In the next UCP, it may also have to certify that the document that it advises to the beneficiary is the same as the document that it has received.

It is so expanded. In addition, the advising bank must give notice to the issuer without delay if it is not going to advise and must give notice without delay if it cannot verify the authenticity of the credit.

6. Beneficiary's response to an amendment. The current UCP presents a problem for document examiners, in that there is no obligation on the beneficiary to explicitly accept or reject an amendment. It follows that only by examining the documents can the bank determine whether the beneficiary is seeking to comply with the amended L/C or the original one! Current thinking is that the new UCP will put the onus on the beneficiary to accept or reject the amendment. However it is not clear how this issue should best be handled.

The beneficiary “should” give notice of acceptance or rejection of amendments, but can manifest its acceptance by drawing in conformity with the credit as amended. The issuer cannot revoke amendments offered to the beneficiary.

7. The issue of inconsistency within the document dataset remains difficult to resolve. There is a general recognition that many minor variations between the data elements in documents should, when put in their correct context, not constitute discrepancies. On the other hand it is very difficult to express such an aim in the form of a practical rule. The input from the various country committees included a number of very frank admissions from some banks in Asia that re-examination of documents represented a very significant source of fee income!

Two alternatives are offered --

A. data in documents required for presentation when read in context of itself, the credit and international banking standards, need not be identical but must not conflict with data in that document, any other required document, or the credit;

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B. data in documents required for presentation when read in context of itself, the credit and international banking standards, need not be identical but must not conflict with data in that document or the credit.

The difference in the second alternative is eliminating conflicts between different documents -- the most frequent grounds for dishonor of draws presented under commercial letters of credit.

8. Notice of refusal. The current UCP only gives the examining bank two options in the event of discrepancies - hold documents pending instructions from the applicant or return the documents. The current thinking is that the new UCP will introduce two further options: (1) handle the documents according to prior instructions given by the presenter; (2) hold the documents whilst seeking a waiver from the applicant - which is what many banks do now as a matter of convenience. The first of these options covers the case where the beneficiary wants to be consulted before the bank acts on the applicant's waiver - because if the market price for the goods has increased, the seller now has an opportunity!

Both further options have been added to the latest draft of the UCP.

9. Negotiation needs to be redefined in the new UCP. A new definition is in preparation.

It includes payment or agreement to pay against presentation; it excludes merely forwarding the documents without committing to pay.

10. The future of ISBP. Of the 200 paragraphs in ISBP, a significant proportion will be carried over in some form into UCP 600. This raises the question of what now happens to ISBP. It is not sensible to revise ISBP until there is some experience of how the new UCP is working. There is also the question of the status of those provisions in ISBP which do not merit incorporation into UCP. There will be a temptation to regard these as somehow carrying less force than hitherto, and it may be necessary to re-assert the significance of ISBP as a set of recommendations for good practice.

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When will it be ready? So when can we expect the definitive UCP 600? The current target dates are approval of the final draft around October 2006, with implementation in July 2007. However this is dependent on a swift resolution of all the remaining contentious issues; so slippage of these dates is quite possible.

The latest draft which is the first full draft of UCP 600, was issued on November 5th, 2005. Comments from the 52 National Committees on this draft are due no later than January 25th, 2006. Target effective date is January 1, 2007.

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VI. Case Law Developments A. Injunction Against Draw or Honor

1. Necessity of Showing Fraud:

In re Tabernash Meadows, LLC, 2005 WL 375660 (Bankr. D. Col. 2005). In this case, a $250,000 letter of credit was issued to Tabernash to secure the applicant’s obligations to purchase lots under a real estate purchase agreement. The lots were to be developed from raw land by Tabernash. Tabernash was not successful in developing the lots in question, filed a Chapter 11 case, took the position in bankruptcy on occasion that it rejected the real estate purchase contract, and defaulted on obligations it owed to the water and sanitation district for the subdivision. The district obtained relief from the stay and foreclosed its lien on the property, including the lots to be purchased. Tabernash nevertheless sought to draw on the letter of credit because the applicant did not purchase the undeveloped lots. A temporary injunction was issued while the parties underwent mediation of their dispute. When that failed, the bankruptcy court entered a permanent injunction against Tabernash’s drawing on and the issuing bank’s honoring draws on the letter of credit. The court engaged in a lengthy discussion of letter of credit law. It noted that courts are generally reluctant to enjoin L/C draws and discussed the standard of fraud in the caselaw. The court overcame the problem that there was no fraud in the documents by adopting the view accepted by many courts that the fraud can be in the underlying transaction, and need not be merely fraud arising from the documents presented. While noting that the fraud to justify an injunction against a draw must be material and egregious, the court also noted that the law of fraud is not static and the courts have, over the years, adapted it to the changing nature of commercial transactions in our society. Under the evolving standard of fraud espoused by the court, the court noted that fraud can exist when a beneficiary so egregiously misperforms his duties under the underlying contract as to essentially destroy it or when a party attempts to gain the benefit of a credit or a contract without discharging his own obligations in the transaction.. Here the court found that the beneficiary had failed to perform and made performance of the underlying contract impossible. Accordingly, the beneficiary had no colorable right to expect honor and no basis in fact to support a right to honor. Tabernash’s performance actions had so clearly violated its own duties under the contract, that the court could find no reasonable basis for the debtor to enforce the contract against the applicant so as to demand payment on the L/C provided under the terms of the contract. Levin v. Meagher, 2004 Cal. App. LEXIS 7060 (Cal. App. 2004). The buyer of a business posted a $331,000 standby letter of credit to assure repayment of a line of credit on which the seller remained liable as guarantor after the closing. The sale agreement required that either the loan be repaid or the seller’s guarantee be released by a date certain. The original loan was repaid four days prior to the deadline, but the bank’s computer records did not show the payoff by the deadline

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date when the seller-beneficiary and his attorney made inquiry. Some of the bank’s personnel maintained that until the bank’s computer records reflected the payment, the guaranty was not released. The bank’s loan officer handling the account, however, provided the applicant-buyer with a signed statement that the loan had been paid which the applicant provided to the beneficiary along with a detailed account of how and when the loan was paid off. When the beneficiary presented a draw on the letter of credit, the applicant obtained a temporary restraining order which was affirmed on appeal. The issue on appeal was whether a material fraud was involved and what the standard for that fraud should be – was intent to deceive or scienter a necessary element. Since the statement accompanying the draw request that the loan had not been repaid was false, the court held that a sufficient showing of fraud had been made based on the false statement, even though the beneficiary arguably had no fraudulent intent. The court applied the test of “no basis in fact” for payment and “no bona fide claim to payment” based on Intraworld Industries, Inc. v. Girard Trust Bank, 336 A.2d 316 (Pa. 1975), which the court noted was an objective and not a subjective test. Since the applicant had paid the loan, the beneficiary had no bias to draw and therefore was enjoined. Aztec, Inc. v. S.A. Toffulutti, 336 F. Supp.2d 578 (M.D.N.C. 2004). The French purchaser of road construction equipment gave notice of its intent to draw on a letter of credit posted in lieu of a 10% performance bond after it encountered numerous problems of compliance such as customs clearance, lack of steering axles, lack of warning decals, missing mud flap, electrical circuit problems and reflectors and lights that did not comply with European standards. The letter of credit required a statement that the asphalt plant the beneficiary had purchased does not meet the specifications set out in the contract. The applicant sought to enjoin the draw on the letter of credit on the ground that it had substantially and satisfactorily performed its obligations. The court denied injunctive relief because (i) the applicant’s claim of irreparable harm from having to litigate in France was spurious because the applicant consented to jurisdiction and mediation in France in the underlying sales contract, (ii) the beneficiary would be deprived of the benefit of its bargain, (iii) the letter of credit was issued as a performance guarantee and it was doubtful that the applicant would succeed in showing that the drawing was unwarranted or fraudulent, (iv) the amount of the drawing was limited to 10% of the contract price, so it would not deprive the applicant of the basis of its bargain, and (v) the applicant’s argument that the beneficiary was using the threat of a draw on the letter of credit to harass and extract services for which it did not contract was rejected because it was a risk knowingly encountered when it gave the standby as part of the agreed upon exchange between the parties. The result reached in the case appears correct, but unfortunately the court failed to discuss the absence of a showing of material fraud required by UCC §5-109.

2. Injunction Against Bank Holding Draft

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Daiwa Products, Inc. v. NationsBank, N.A., 885 So.2d 884 (Fla. App. 2004). Buyer-applicant purchased goods that were never shipped by the beneficiary with a $229,665 letter of credit that was advised through an advising bank that was a lender to the beneficiary. The beneficiary presented fraudulent documents and a draft to the advising bank. The applicant sought to enjoin the issuing bank from paying and posted bond. The advising bank intervened and sought to dissolve the injunction. The trial court did so and the appellate court affirmed on the ground that the advising bank was a holder in due course of the draft called for by the letter of credit, even though the documents were fraudulent. Because the advising bank had a number of regular prior transactions with the beneficiary, and this one was no different, the court applied prior UCC 5-114(2)(a) to uphold the draw. The court overlooked whether the advising bank was a nominated bank. This case illustrates the problems that courts have in deciding what the significance is of a draft in letter of credit cases. The court also did not discuss whether the draft was made payable to the advising bank or endorsed to it. If the advising bank were not a nominated bank, it would not be entitled to assert the benefits of prior UCC 5-114(2)(a) or revised UCC 5-109.

3. Insolvent Beneficiary.

Hendricks v. Bank of America, 398 F.3d 1165 (9th Cir. 2005). The beneficiary, Mutual Indemnity (Bermuda), Ltd. appealed an injunction issued against Bank of America preventing it from honoring Mutual Indemnity’s draw down of a letter of credit posted by the owners of an insurance agency providing insurance products, including workmen’s compensation policies, to roofing contractors. Mutual Benefit providing underwriting, risk management and other services and reinsurance. The applicants were to reimburse Mutual Benefit for any losses incurred in the program and two letters of credit secured those losses. The applicants filed a fraud action in Chicago against Mutual Benefit for its alleged fraudulent underwriting and claims mishandling practices. Mutual Benefit obtained dismissal of this action based on a forum selection and choice of law clause selecting Bermuda as the forum and governing law. The Seventh Circuit affirmed. The applicants brought an injunction action against Bank of America in California shortly after they filed in Illinois. The district court in California held that the dismissal applicants action in Illinois did not estop them from suing the issuing bank in California because Mutual Benefit was not a necessary party to that action. The injunction stayed .the draw until final resolution of the merits of underlying claims either in Illinois or Bermuda or until April 14, 2006. The Bank did not appeal, but Mutual intervened and did. The appellate court indicated that the injunction as a practical matter did not impede Mutual’s ability to protect its interests. Because the injunction action was “not about the merits” of the applicant’s claim, the Ninth Circuit held that the venue selection clause did not require the letter of credit dispute to litigated in Bermuda under Bermuda law. The Ninth Circuit also found that there was a likelihood of success on the merits in showing fraud because affidavits showed that Mutual consistently under-reserved claims and misrepresented the extent of the applicants’ liability for

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program losses. The court also found irreparable injury was likely if the draw on the L/C were not enjoined because Mutual was in serious financial straits based on affidavits and deposition testimony. Hendricks v. Comerica Bank, 2004 WL 2940879 (6th Cir. 2004). This is a parallel case to the Hendricks discussed above, except the issuer of the letter of credit sought to be enjoined was Comerica Bank and the result was dramatically different. Although the trial court in this case enjoined the draw, the Sixth Circuit reversed, holding that financial loss is not enough to show irreparable harm to justify an injunction, especially on an international letter of credit. The Ninth Circuit’s holding is directly opposite that of the Sixth Circuit and the Ninth Circuit chose not to follow it, distinguishing the Comerica case on the procedural ground that it was not properly argued before the Ninth Circuit court on appeal. Most courts would hold that irretrievable financial loss is irreparable damage. B.C. Ltd. v. KPMG, Inc., [2004] 238 D.L.R. (4th) 13 (B.C.Ct. App.) [Canada]. Beneficiary was a bankruptcy trustee for a bankrupt repair warranty corporation which was the beneficiary of a clean letter of credit securing the applicant’s exterior 5-year stucco facing warranty. Even though no claim on the warranty was made, the trustee sought to draw on the letter of credit for the benefit of the state, believing the letter of credit to be like a cash deposit. The applicant sought an injunction which the trial court refused and the appellate court granted with one judge dissenting. The appellate court determined from the underlying transaction and documents that the letter of credit was security for the warranty. In the absence of a breach of the warranty, the beneficiary would have no basis for drawing and therefore the draw would be a fraud justifying an injunction. The dissenting judge took the position that the underlying agreement permitted a draw at any time to allow the beneficiary to hold cash instead of the letter of credit. The majority also wrestled with the issue of whether the fraud had to be documentary, i.e., false documents, but concluded that fraud in the underlying transaction was sufficient. The court is correct in its analysis of the law – that even a clean letter of credit drawing can be fraudulent. If there were no arguable basis to draw, a drawing would amount to fraud. All Star Advertising Agency, Inc. v. Reliance Insurance Company, 898 So. 2d 369 (La. 2005). In this case the applicant sought an injunction against the receiver of Reliance Insurance Company from drawing on letters of credit securing All Star’s obligations to Reliance, including obligations to cover retrospective premium adjustments based on audits and loss experience arising from All Star’s workers’ compensation coverage Reliance provided. Pursuant to a Retrospective Premium Endorsement plan, All Star agreed to pay Reliance an estimated standard premium that would be adjusted through periodic audits and loss experience to determine the actual premium. All Star posted a $225,000 letter of credit issued by Bank One to secure its obligations to Reliance. The parties disputed the purpose of the letter of credit. Reliance claimed that All Star provided the letter of credit as security for deductibles on claims owed under

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other policies issued at a later point in time. When Reliance presented a premium adjustment to All Star demanding an additional $415,428.00, All Star filed for a TRO in Baton Rouge to enjoin Reliance from drawing on the letter of credit. The petition was denied. This case exemplifies a problem corporations have that issue large letters of credit to insurers for backing self-insured retention limits on workers compensation insurance. Normally these letters of credit are clean letters of credit; no draw certificate needs to accompany them. When the insurer becomes insolvent, the fear is that the receiver will draw on them for whatever claims, no matter how unjustified, the insurer has, or worse, to create a pool of funds for unsecured creditors.

4. Return of Proceeds.

New Wastech Corp. v. Waste Technologies International, 2005 WL 1189693 (Cal.App. 2005). In this case, a $3 million letter of credit issued by East West Bank was delivered to WTI as beneficiary to secure NWC’s orders for equipment and materials for a water treatment facility. The L/C allowed WTI to draw, and WTI drew, $1.78 million upon presentment of a certificate of equipment order. The funds were transferred to WTI’s account at Bank of America. East West then received a letter from the equipment manufacturer that it had not yet received an order from WTI for the equipment and demanded return of the funds drawn. When they were not forthcoming, NWC filed a mandatory injunction action requiring WTI to return the funds. Most of the funds were returned by WTI. East West claimed that it was not aware of any restriction on use of the funds upon their return, so it applied them to loans by NWC. WTI also filed suit counterclaims against NWC, which had become insolvent, and against East West Bank, alleging a conspiracy to obtain return of funds. Two trial courts were involved. The one that ordered the funds returned dissolved its injunction and return order against WTI and instead ordered East West Bank to return the drawn funds to WTI.

B. Landlord Letters of Credit

In re Stonebridge Technologies, Inc., 430 F.3d 260 (5th Cir. 2005). This case, decided on November 8, 2005, allows a landlord to keep the proceeds of a draw on a letter of credit to secure lease rental obligations of a bankrupt tenant, notwithstanding that the draw amount exceeded the cap on damages recoverable under Section 502(b)(6) of the Bankruptcy Code. That Section limits the lessor’s claim against a bankrupt tenant’s estate to the lesser of (A) actual damages for the unexpired term rentals or (B) the greater of one years rent or the lesser of (x) 15% of the unexpired lease term rentals or (y) 3 years rent. Unlike other courts, such as In re PPI Industries, 324 F.3d 197 (3d Cir. 2003); In re Mayan Networks Corp., 306 B.R. 295 (9th Cir. BAP 2004) and AB Liquidating Corp (see below), the Fifth Circuit held that the cap only applied to any claim the lessor filed for payment of damages for unexpired lease term rent from the estate, and did not limit the amount that the lessor could recover under the letter of credit issued to

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secure the debtor’s performance under the lease if the lessor was not pursuing a claim against the bankrupt’s estate. The case has implications for issuing banks in light of the “concurring” opinion in Mayan Networks, which suggests that the issuer should pay the draw, the landlord need not disgorge amounts drawn in excess of the cap, but that the issuing bank cannot recover from the applicant-bankrupt tenants estate the excess amount -- a very troubling line of reasoning for issuing banks. The Fifth Circuit did not address the Mayan Networks issue. AB Liquidating Corp., 416 F.3d 961 (9th Cir. 2005). About two years ago a concurring opinion was rendered in the case of In re Mayan Networks, 306 B.R. 295 (9th Cir. BAP 2003) that sent tremors through the letter of credit community because the judge opined that in light of UCC §5-117 granting subrogation rights to issuers and applicants, letters of credit were like powerful guaranties rather than independent undertakings. As a result, this judge opined that the issuing bank should be denied reimbursement rights under its letter of credit when the bankrupt applicant-tenant posted a letter of credit with its landlord that exceeded the cap on the landlord’s damages under the lease allowed under Section 502(b)(6) of the Bankruptcy Code. That section limits a landlord’s recovery from a bankrupt tenant to the greater of (i) 1 years future rent or (ii) the lesser of 15% of the unexpired lease rentals or three years rent. The concurring judge would enrich the landlord at the expense of the issuing bank. The Ninth Circuit, which is a higher court than the Ninth Circuit Bankruptcy Appellate Panel, was confronted with this same issue in the above-cited case. It held however, that although the letter of credit amount counts towards the cap just like a cash security deposit held by the landlord, the landlord must disgorge rather than the issuing bank being denied its right to recover on collateral posted by the bankrupt tenant-applicant. This is a welcome relief to those banks that issue letters of credit to landlords and are concerned about the concurring opinion in Mayan Networks. Many bankruptcy counsel think the concurring opinion is correct. It is possible that other courts in different Circuits could reach a different result. Issuers of landlord letters of credit should consider waiving subrogation rights in their letters of credit to avoid the import of the concurring opinion in Mayan Networks.

250 LLC v. Photopoint Corp (USA), 131 Cal. App.4th 703, 32 Cal.Rptr.3d 296 (2005). Under the California Code Section 1950.7, a landlord can offset against a security deposit only the amount of accrued and unpaid rent due at the time the letter of credit was to be returned. The tenant, however, could waive the limitation on the landlord’s right to offset against the tenant’s security deposit to include other and future damages. In this case, the court held that the tenant had not waived its statutory protections and the landlord could not circumvent those protections by drawing on a letter of credit posted in lieu of a cash security deposit. For purposes of the statute protecting a tenant’s rights from offset against its security deposit posted with the landlord, a letter of credit is to be treated as the equivalent of a cash security deposit. The independence principle did not override the California statute and the protections it afforded to tenants. See also

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Sherwood Partners, Inc. v. EOP Marina Business Center, 2005 WL 1594858 (Cal. App. 2005)(similar issue raised about use of letter of credit to avoid strictures of Cal. Code Sec. 1950.7, but issue not decided).

C. Letters of Credit in Bankruptcy.

1. Right to Proceeds: Issuer vs. Applicant’s Bankruptcy Estate.

In re Spring Ford Industries, Inc., 2005 WL 984180 (Bankr. E.D.Pa. 2005). A $1,000,000 letter of credit was issued by PNC Bank for the account of Spring Ford Industries to the Pennsylvania Bureau of Workers Compensation to secure Spring Ford’s self insurance obligations. The L/C was drawable if notice of its nonrenewal is sent. Pursuant to agreement with PNC, the applicant entered into a trust fund arrangement to hold the debtor’s monies for payment of claims by the Bureau. The Bureau was authorized to direct application of proceeds in the fund. Only a demand was required to effect a draw. The LC was drawn upon after the applicant became bankrupt and the proceeds were deposited in the trust fund, claims were paid, and a $440,000 surplus remained. PNC filed an adversary proceeding to recover the surplus. PNC argued that the surplus monies belonged to it because under letter of credit law an issuer pays its own funds when draws are made, not the applicant’s. The court agreed that the independence principle keeps the debtor from having a direct interest in the proceeds, but noted that once the letter of credit is drawn and the proceeds deposited in a trust fund under the control of the Bureau, bankruptcy law, the Bureau and the trust fund agreement itself determine who gets the proceeds. The trust arrangement expressly provided that creditors of the debtor had no claim against the funds in the trust. Thus PNC had no rights to them. The trust arrangement also identified the debtor as having a reversionary interest in the funds. Thus the funds were given over to the debtor’s bankruptcy estate to pay creditors generally and not just PNC.

In re Tricord Systems, Inc., 2004 U.S. Dist. Lexis 18456 (D. Minn. Aug. 27, 2004). An evergreen standby letter of credit to secured a lease of two telephone systems. The giving of notice of nonrenewal of the letter of credit constituted a default under the lease entitling the beneficiary to draw on the letter of credit. The applicant filed for Chapter 11, the issuer gave notice of nonrenewal and the beneficiary drew at the same time the applicant was able to satisfy its obligations under the leases by selling the telephone systems to the beneficiary. The bankruptcy court granted the issuer permission to obtain reimbursement from the applicant for the draw and the applicant sought recovery from the beneficiary for the amount the beneficiary drew on the letter of credit since it now had free use of the telephone systems without a further lease obligation and also held the letter of credit draw proceeds. The district court remanded the case to the bankruptcy court for a determination of whether the amount of the draw exceeded the amount the beneficiary was entitled to.

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New Wastech Corp. v. Waste Technologies International, 2005 WL 1189693 (Cal.App. 2005). A $3 million letter of credit issued by East West Bank was delivered to WTI as beneficiary to secure NWC’s orders for equipment and materials for a water treatment facility. The L/C allowed WTI to draw, and WTI drew, $1.78 million upon presentment of a certificate of equipment order. The funds were transferred to WTI’s account at Bank of America. East West then received a letter from the equipment manufacturer that it had not yet received an order from WTI for the equipment. East West then demanded return of the funds drawn. When they were not forthcoming, NWC filed a mandatory injunction action requiring WTI to return the funds. Most of the funds were returned by WTI to East West. East West claimed that it was not aware of any restriction on use of the funds upon their return, so it applied them to loans by NWC. WTI also filed suit counterclaims against NWC, which had become insolvent, and against East West Bank, alleging a conspiracy to obtain return of funds. Two trial courts were involved. The one that ordered the funds returned dissolved its injunction and return order against WTI and instead ordered East West Bank to return the drawn funds to WTI. The order was affirmed on appeal. The trial court was trying to restore the parties to the status quo prior to the first mandatory injunction, so issued a second one while dissolving the first one.

D. Automatic Extensions.

1. Outside Expiration Date.

J.P. Morgan Trust Company, N.A. v. U.S. Bank, N.A., 2005 WL 1899394 (E.D. Wisc. 2005). JPMorgan Trust Company (“Morgan”) acting as trustee issued bonds to bondholders to finance acquisition and operating costs of a commercial buffalo farm run by the Cheyenne River Sioux Tribe. Morgan as trustee held three types of security for the bondholders: a one year automatically renewable standby letter of credit issued by U.S. Bank that contained an outside expiration date of three years; a security interest in slaughterhouse equipment and the herd; and a mortgage on land. The trust indenture provided that if Tribe defaulted, Morgan had to look first to the herd and equipment, second to the mortgage and third to the letter of credit. To effect a draw on the letter of credit, the letter of credit provided for documentary evidence indicating either that the Tribe had defaulted on its bond payments and that Morgan had foreclosed on the herd, equipment and land, or that the issuer had declined to automatically renew the credit. After buffalo operations commenced, the Tribe defaulted in payment on the bonds. Although the final expiration date of the letter of credit was fast approaching, Morgan had not yet attempted to foreclose on the herd or equipment or on its mortgage. Nevertheless, Morgan submitted a draw for the full amount of the credit on May 14, 2003, one day before final expiration, certifying that the issuer had declined to permit the credit to automatically renew. Although the issuer had not sent Morgan a non-renewal notice, Morgan contended that it received a non-renewal notice because the letter of credit itself stated that “in any

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event this letter of credit shall not be automatically extended beyond May 15, 2003., the final expiration date.” The draw was not honored and Morgan filed suit for wrongful dishonor. U.S. Bank cross claimed against the applicant for indemnity and reimbursement in the event it was found liable. The applicant cross claimed against Morgan for its wrongful draw. The court engaged in a background discussion of the purpose, structure and operation of letters of credit. The court started with the rule of construction that the decision whether to pay should be based solely on comparing the documents submitted to the terms of the credit. Thus, when a credit’s terms are clear and unambiguous, a court should not construe them at all. The letter of credit language read as follows: PAYMENT UNDER THIS LETTER OF CREDIT IS AVAILABLE BY DRAFTS AT SIGHT TO BE ACCOMPANIED BY EITHER OF THE FOLLOWING DOCUMENTS: A) STATEMENT FROM [MORGAN] CERTIFYING THAT THE CORPORATION IS IN DEFAULT AND THAT [MORGAN] HAS FORECLOSED THE SECURITY INTEREST AND MORTGAGE AND THAT THE PROCEEDS FROM SUCH FORECLOSURES WERE INSUFFICIENT TO CURE THE DEFAULT] OR; B) OUR NON-RENEWAL NOTICE. The automatic renewal provision provided for certified mail notice of nonrenewal at least sixty days prior to the then current expiry date. The provision went on to state: UPON RECEIPT BY YOU OF SUCH NOTICE OF NON-RENEWAL YOU MAY THEN DRAW HEREUNDER WITHIN THE THEN CURRENT EXPIRY DATE, AND UP TO THE THEN AVAILABLE AMOUNT BY PRESENTATION OF YOUR DRAFT DRAWN ON US AT SIGHT ACCOMPANIED BY A WRITTEN STATEMENT FROM THE TRUSTEE STATING THAT “WE HEREBY CERTIFY THAT WE HAVE RECEIVED NOTICE FROM [U.S. BANK] THAT THEY DO NOT INTEND TO EXTEND THEIR LETTER OF CREDIT NO. S103966 BEYOND THE CURRENT EXPIRATION DATE.” IN ANY EVENT THIS LETTER OF CREDIT SHALL NOT BE AUTOMATICALLY EXTENDED BEYOND MAY 15, 2003, THE FINAL EXPIRATION DATE. The court noted an ambiguity as to whether both a nonrenewal certificate and nonrenewal notice must accompany a nonrenewal draw. However, the court determined that it need not resolve this ambiguity unless it agreed with Morgan

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that the letter of credit itself constituted notice of nonrenewal. The court held that the letter of credit itself was not notice of nonrenewal, the issuing bank knew that and therefore the draw certification was false or fraudulent under old UCC Sec. 5-114(2), which is still law in Wisconsin, the only state not to adopt Revised Article 5. The court thought it clear that notice required had to affirmatively state that the issuer would not extend the letter of credit for any additional period. The letter of credit stated that the issuing bank may extend it for up to three additional periods, so it was not an affirmative statement of nonrenewal. Also the final expiration date was only for automatic extensions. Since the bank could extend voluntarily for additional periods, the existence of a final extension date was not a notice of nonrenewal. The court also noted that treating the L/C itself as notice of nonrenewal would create absurd results -- allowing the beneficiary to draw upon receipt of the credit. Interestingly, prior to drawing, an employee of the issuer answered Morgan’s queries to the effect that Morgan’s interpretation was correct. The court held that an erroneous interpretation of the letter of credit does not bind the issuing bank, nor was there evidence of reliance. U.S. Bank avoided a pitfall..

2. Ambiguity.

Bath Iron Works Corp. v. West LB, 2004 WL 784856 (S.D.N.Y. 2004). This letter of credit provided for renewal as follows:

THIS STANDBY LETTER OF CREDIT, SHALL BE REDUCED BY 95 PERCENT ... (USD 26,201,950), UPON PRESENTATION TO ISSUING BANK BY ACCOUNT PARTY OF A CERTIFICATE OF SUBSTANTIAL COMPLETION COUNTERSIGNED BY A PURPORTED AUTHORIZED OFFICER OF THE BENEFICIARY. REDUCTION SHALL BE IN THE FORM OF AN AMENDMENT WITH THE ORIGINAL SENT TO THE BENEFICIARY THROUGH ADVISING BANK. *2 THIS LETTER OF CREDIT, IN THE AMOUNT OF 5 PERCENT ... (USD1,379,050) SHALL BE EXTENDED (THE "EXTENSION") WITHOUT AMENDMENT FOR ONE YEAR FROM THE EXPIRATION DATE (BEING [AUGUST 30, 2000) OR THE DATE OF SUBSTANTIAL COMPLETION UPON PRESENTATION BY ACCOUNT PARTY OF THE CERTIFICATE OF SUBSTANTIAL COMPLETION COUNTERSIGNED BY A PURPORTED AUTHORIZED OFFICER OF THE BENEFICIARY, OR ANY FUTURE EXPIRATION DATE THAT IS CONSISTENT WITH THE PERFORMANCE AND WARRANTY REQUIREMENTS IN THE CONTRACT BETWEEN THE BENEFICIARY AND ACCOUNT PARTY WITHOUT NOTICE FROM US, PROVIDED THAT THE EXTENSION SHALL ONLY BECOME EFFECTIVE AFTER PAYMENTS, AGGREGATING TO NOT LESS THAN ... (USD25,851,950) HAVE BEEN MADE TO THE ACCOUNT PARTY UNDER THE LETTER OF CREDIT ... ISSUED IN FAVOR OF THE ACCOUNT PARTY FOR THE ACCOUNT OF THE BENEFICIARY IN CONNECTION WITH THE SUPPLY OF THE ... DRY DOCK TO THE BENEFICIARY. IN NO EVENT SHALL THIS STANDBY LETTER OF CREDIT BE EXTENDED FOR A PERIOD LONGER THAN EIGHTEEN (18) MONTHS PAST THE DATE APPEARING ON THE SIGNED CERTIFICATE OF SUBSTANTIAL COMPLETION. WestLB New York moved to dismiss plaintiff's wrongful dishonor and breach of contract claims. Defendant argued that summary judgment is appropriate as to the plaintiff's claims because the letter of credit is unambiguous -- according to

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the letter of credit's terms, it was to expire on August 30, 2000 unless Bath paid $25,851,950.00 under the Nations Bank letter of credit, which it hadn’t. The court found that an ambiguity existed in the language of the letter of credit that precluded summary judgment. While it was uncontested that the standby letter of credit for 95% of the value of the transaction expired on August 30, 2000, the court found a number of unresolved issues in connection with the interpretation of the letter of credit. For example, the court found that it was unclear whether the payment of $25,581,950.00 was required prior to August 30, 2000 in order for Bath to avail itself of the 5% extension if such a payment were in fact necessary. These ambiguities resulted in an unresolved issue of material fact. Therefore, summary judgment on this issue is denied until the parties establish a more complete record with regard to the parties' intent, relevant trade practices and prior relations of the parties, if any -- not very comforting to the issuing bank.

E. Attorneys’ Fees. (See article attached). 1. Prior to Revised Article 5.

East Girard Savings Assn v. Citizens National Bank, 593 F.2d 598 (5th Cir. 1979). In this wrongful dishonor case the issuer dishonored the beneficiary successfully sued for wrongful dishonor and was awarded its attorney’s’ fees by the trial court. The judgment for wrongful dishonor was upheld on appeal, but the appellate court reversed the award of attorneys’ fees to the plaintiff-beneficiary, noting that Texas follows the rule that attorney’s fees are not recoverable unless the underlying contract provides for their recovery or there is a statue permitting them to be awarded. Since the letter of credit here did not provide for recovery of attorney’s fees (most letters of credit do not) and no statutory provision awarded them, the award of those fees was reversed.

2. By Agreement.

J.P. Morgan Trust Company, N.A. v. U.S. Bank, N.A., 2005 WL 1899394 (E.D. Wisc. 2005). This case is discussed at length above under automatic renewal. It also shows the power of the issuing bank’s reimbursement agreement. Even though the applicant had nothing to do with Morgan’s draw and even though the issuing bank was successful in defeating the wrongful dishonor claim, it had to go through a lawsuit to get that result. Under Wisconsin’s old Article 5 of the UCC it had no express right to attorneys’ fees from Morgan. It did have that right against it’s applicant under the Bank’s reimbursement agreement. That agreement provided in pertinent part: “Reimbursement/Indemnities. Except for [the Bank’s] own willful misconduct or wanton disregard of the Applicant’s rights hereunder, Bank shall have no responsibility to, and Applicant unconditionally and irrevocably indemnifies Bank against each and every claim, demand, liability, loss, cost or expense which the Bank may incur (or be entitled to collect) arising out of the issuance and handling of any Credit and any transactions related to the Credit, the collection of any

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Drafts or documents under the Credit, or any act or mission by the Bank in connection with this Agreement . . . however and whenever arising. Applicant hereby waives any claim, defense, setoff, deduction and/or suspension of performance regarding Applicant’s obligations under this Agreement or regarding any Credit based upon any actions or inactions of the Bank or any third party, except the Bank’s willful misconduct or wanton disregard of Applicant’s rights hereunder. * * * “Expenses and Attorneys’ Fees. Applicant will reimburse the Bank for all attorneys’ fees and all other costs, fees and out-of-pocket disbursements (including fees of the Bank’s inside counsel and outside counsel) incurred by the Bank in connection with any Credit, and the enforcement of this Agreement and the collection of any monies due the Bank hereunder.” The Applicant argued the she was not liable to reimburse the Bank for its attorneys fees because of the Bank’s willful misconduct in erroneously interpreting the letter of credit. The court denied the applicant’s defense to the issuing bank’s claim for attorneys fees for two principal reasons. First, unlike the indemnity provision, the attorneys’ fees provision in the reimbursement agreement did not contain a carve-out for willful or wanton conduct. “Thus, even if the Bank committed willful misconduct or acted in wanton disregard of [the applicant’s] rights, [the applicant] would still be liable for the Bank’s expenses and attorneys’ fees.” [!!!] In addition, the court pointed out that no duty the bank may have owed the applicant was breached or wantonly disregarded. Finally, the court held Morgan liable for breach of warranty under old UCC Section 5-111(1) which states that a beneficiary by presenting a documentary draft or demand for payment warrants to all interested parties that the necessary conditions of the credit have been complied with.” The court held that this provision enables an applicant to proceed against a beneficiary who falsely certifies that the conditions of the credit have been satisfied. Because Morgan did falsely certify, the court held it liable for the applicant’s damages which included the attorneys’ fees applicant was required to pay to U.S. Bank as issuer. The court reserved ruling on the applicant’s claim for her own attorneys’ fees. Had revised Article 5 of the UCC applied, under UCC Sec. 5-111(e) the applicant undoubtedly would have received those as well. Schnappup v. Yauck, 701 N.W.2d 653 (Wis.App. 2005). In this case, Yauck agreed to post a letter of credit to secure 120 months of settlement payments. The L/C posted had a one year expiration date but was automatically renewable and drawable if notice of nonrenwal were sent. Notice of nonrenewal was sent at the end of the first year of the settlement. For some unexplained reason, Schnappup

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did not draw on the L/C, but after it expired filed a suit for specific performance requiring an L/C to be posted by Yauck for the full remaining term of the settlement sufficient to cover the payments yet to be made under it. Yauck argued that the language of the settlement agreement only required it to post a letter of credit sufficient so that Schnappup could draw on it and receive payment for the entire settlement amount and that if Schnappup failed to draw when he could have done so when notice of nonrenewal was sent, that was not Yauck’s problem, because he had already fulfilled his obligation to supply a letter of credit as required by the settlement agreement. The trial court agreed with that argument, but on appeal the appellate court did not. A fair reading of the settlement agreement required Yauck to provide an L/C to secure his settlement payments for the duration of the settlement. In the settlement agreement, Yauck agreed to pay Schnappups attorneys fees and costs “if a dispute arises under the irrevocable letter of credit, regardless of the nature of the dispute and regardless of whether or not the Schnappups prevail in whole or in part.” The court awarded attorneys’ fees to the Schnappups as well.

2. UCC §5-111(e)

Section 5-111(e) of Article 5 of the UCC provides for the mandatory award of attorneys fees to the prevailing party in any case in which remedy is sought under Article 5 of the UCC:

“Reasonable attorneys fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this Article.”

Arguably, any action based on a provision of Article 5 will give rise to the award of attorneys fees under this provision, including wrongful dishonor (5-111(a)); wrongful honor (5-111(b)); injunction (5-109); improper advising (5-107(c); 5-111(c)); wrongful amendment or cancellation (5-106(b)); breach of warranty of presentment (5-110); wrongful failure to recognize a transfer (5-112; 5-113); failure to recognize an assignment of proceeds or misapplication of the proceeds after an assignment (5-114); and subrogation claims arising out of letters of credit (5-117). Any attorney confident that his client’s position is sound and that he will prevail should try to couch his claims as arising under Article 5 of the UCC so that he can recover attorneys fees as well the substantive relief sought. c Until recently, few litigants have taken advantage of this provision and courts have not spoken on it with any frequency. The prediction is that it will be recognized with increasing frequency. Several states have altered Section 5-111(e), such as New York (attorneys’ fees are discretionary, not mandatory); New Jersey (provision deleted); Wyoming (only plaintiff may recover attorney’s fees). Wisconsin has not yet adopted Revised Article 5 and so has no attorneys fees provision in its version of Article 5.

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Western Surety Company v. North Valley Bank, 2005 WL 1545775 (Ohio App. 2005). The applicant caused North Valley Bank to issue an automatically renewable standby governed by the UCP in favor of a surety company in consideration of surety’s issuance of a bond to the state lottery commission to secure the applicant-grocer’s right to sell lottery tickets. The letter of credit provided that upon receipt by the beneficiary of a notice of nonrenewal, the surety could present its draft on the L/C for the full amount if accompanied by a certification that the surety has not been released from past and future liability on its bond. Three years after the bond was issued, the issuing bank sent notice of nonrenewal, the surety attempted to draw on the letter of credit, certifying that it had not been released from liability on its bond. The issuing bank refused the draw. At trial the issuing bank supplied affidavits to the effect that the surety had not incurred any liability and had not shown any claims had been made against it such that its bond would be in jeopardy. The trial court entered summary judgment against the issuer and awarded attorneys fees. The appellate court upheld that award, citing the independence principle for upholding the trial court’s decision on the merits, and Section 5-111(e) for upholding the trial court’s award of attorneys’ fees.

F. Strict Compliance 1. Consistency Requirement -- ISP Standby

Middlesex Bank & Trust v. Mark Equipment Corp., 2005 WL 446035 (Mass. Super. Crt. Feb. 14,2005). In this case a bank issued an letter of credit to the City of Lowell subject to the ISP to secure a contractors performance of a contract to demolish a building. The draw trigger on the letter of credit required a draft and a certification that the owner of the building was entitled to terminate the contract pursuant to cited provisions in the demolition contract after the expiration of any applicable notice and cure periods and after notice of intent to draw was given by the City. After construction was well along, asbestos was found on the site and demolition was ordered stopped, notice of intent to terminate the demolition contract was sent, and the City issued a notice of intent to draw. The applicant sought to enjoin the draw and the trial court issued an order that required the parties to extend the letter of credit another 90 days. No presentment was made on the letter of credit prior to its ordered extension. Instead of extending the letter of credit, the bank issued a second letter of credit on the same terms as the first but with a later expiration date. On the eave of expiration of the second letter of credit, the City presented draw documents including a certificate called for by the second letter of credit. The certificate erroneously contained in its heading a reference by date of issue to the first expired letter of credit instead of the second letter of credit being drawn upon. The draft accompanying the draw certificate contained the current correct issue date of the letter of credit being drawn upon. The issuing bank filed a motion to ask the court to enjoin itself from honoring the draw, that motion was denied, the issuing bank honored the draw, and the applicant then filed an action against the issuing bank for wrongful honor.

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Relying on the fact that the heading was not contained in the quoted language for the draw certification specified by the letter of credit, and ISP Rule 4.03 that documents need only be examined to determine if they comply with the requirements of the letter of credit, the court ruled that the issuing bank properly honored the draw. While acknowledging the applicability of the strict compliance standard under UCC 5-108, the court stated that an issuing bank “may not reject a demand for payment on the basis of a hypertechnical reading of a letter of credit,” citing Exotic Traders Far East Buying Office v. Exotic Trading USA, Inc., 717 F.Supp. 14, 16 (D. Mass. 1989), and “a variance between documents specified and documents submitted is not fatal if there is no possibility that the documents could mislead the paying bank to its detriment, citing Flagship Cruises, Ltd. v. New England Merchants National Bank, 569 F.2d 699, 705 (*1st Cir. 1978). Query whether the result would have or should have been the same under UCP 500. The Court felt that the draw certification would have been sufficient without the reference to the correct letter of credit, therefore the fact that it contained an incorrect reference when the draft contained the correct reference to the date of issue of the letter of credit being drawn upon made the error immaterial. It should also be noted, although not mentioned in the court’s reasoning for upholding denying the applicant’s claim of wrongful honor, that the certification language in both the LC and presumably the draw documents contained a reference by LC number to the correct LC, i.e., the LC being drawn upon.

G. Letter of Credit as a Bond or Cash 1. Cash

Hataway v. Estate of Nichols, 893 So.2d 1054 (Miss. 2005). In this case, to bid on property the bidder was required to pay cash for it. The plaintiff brought to the auction a letter of guaranty from his bank which stated: “Our customer, Ms. Freddie Hataway, has requested this letter of guarantee from BancorpSouth in order to support her bid for the above-referenced auction. The bid is not to exceed $72,000 and we guarantee that the good funds will be made available upon receiving clear title to the above referenced parcels.” The court misconstrued the above letter as a letter of credit even though it was not labeled as such, contained no requirement of a documentary presentation and contained solely nondocumentary conditions. The court would have allowed the “letter of credit” to constitute a cash equivalent to enable Ms Hataway to bid at the auction but for the fact it required clear title to the property as a condition of making funds available. Because a second lien sale may have been involved, the court held that this condition disqualified the “letter of credit” as a suitable cash equivalent for the auction.

2. Letter of Credit as a Bond

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Entercomm Communications Corp. v. Royce International Broadcasting Corp., 2005 WL 648065 (Cal. App. 2005). In this case, a $7.5 million letter of credit was posted in lieu of a bond by the plaintiff pending an appeal of an order of specific performance to convey a radio station to compensate the defendant for its damages in the event the order of specific performance was reversed. It was affirmed, and the plaintiff sought to recover the costs of issuance of the LC, which the parties had stipulated could be used in lieu of an appeal bond. The court read the statute providing for taxing and allowing costs of appeal to include the fee for issuance and maintenance of a letter of credit pending the appeal in lieu of an appeal bond. Since posting an appeal bond frequently requires the appellant to procure a letter of credit to back the appeal bond, allowing the appellant to post a letter of credit directly will save it duplicate premiums or fees. That the court interprets the appeal bond statute to allow the applicant to recover the L/C premium in this situation is sensible and helpful to the litigants. This case supports the statements made in the draft preamble of the Model Supersedeas Letter of Credit project sponsored by the letter of Credit Subcommittee of the American Bar Association. Northe Pointe Insurance Co. v. Steward, 697 N.W.2d 173 (Mich. App. 2005). This case is to the same effect as the Entercomm case discussed above, except in this case the letter of credit was posted to the surety to secure the appellant’s reimbursement obligation to the surety company in case the appeal bond were called upon to pay the judgment appealed from. At issue was $82,041.55 in costs related to letters of credit issued by Comerica Bank as collateral for a $2,325,000 appeal bond issued by Travelers Casualty and Surety Company. The court noted that there was a split of authority on this issue in Michigan and in other jurisdictions. Some federal courts allow the letter of credit fee to be taxed as costs when backing an appeal bond if or to the extent that the costs of the letter of credit and the appeal bond combined are the same as would be the costs of an uncollateralized appeal bond. Some state courts allow both premiums to be recovered. A minority of jurisdictions has refused to allow LC fees as costs. The court came up with a rule which stated that the premiums for an LC would be taxed as costs if they were reasonable and did not exceed the cost of a bond if the LC were posted in lieu of the bond. The court held that were the LC was posted to back the issuance of the bond, the combined fees have to be reasonable and in no event exceed the costs of an uncollateralized bond. When the appellant produced affidavits that sureties did not and would not issue uncollateralized bonds, the court held the combined fees reasonable. After the Chase and Citicorp suits for $2 billion against Enron’s sureties on its prepaid contracts, it is little surprise that sureties are requiring collateral to back their bonds. Ross v. National Center for employment of the Disabled, 2005 WL 1252588 (Tex. App. 2005). In this bizarre case, a $1.2 million letter of credit issued by JPMorganChase Bank was posted as a supesedeas bond by Access Healthcare in 1998 litigation in Arizona between two entities controlled by a Richard Ross (the

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“Tamarack Entities”) and Access after Tamarack obtained a judgment against Access. The judgment was affirmed by the Ninth Circuit, so the letter of credit could be drawn upon by Tamarack. Access shareholders then sued Ross in Texas for fraud and obtained a $5 million judgment against him, but Arizona courts refused to recognize it. Ross proved to be very elusive, the shareholders, presumable sensing that the costs of pursuing Mr. Ross exceeded their capacity to pay for the chase, assigned their claim judgment to the National Center for Employment of the Disabled. Access’s attorney innovatively sought a turnover order from the Texas court requiring Tamarack to turnover the letter of credit to make the proceeds available to satisfy the judgment. Even though Ross was not complying with various enforcement orders or appearing in court, Ross’ attorneys argued that the court could not order turnover of assets held by a nonjudgment debtor. Access requested and the trial court ordered that not only should the letter of credit be turned over, but also that JPMorganChase Bank was ordered to turn over the proceeds if the letter of credit were drawn upon on the ground that Ross, as sole shareholder of Tamarack, actually controlled all its funds, including the letter of credit. The Tamarack entities were not joined as parties and were not alleged to be alter egos of Ross. The letter of credit was drawn upon and Chase placed the proceeds into the registry of the Texas court. The appellate court affirmed the turnover on the ground that Ross was ordered to turn over the stock of Tamarack, and had he done so, control of the letter of credit proceeds could have been obtained in that manner. This is an unpublished opinion and deservedly so.

H. Presentment Letters of Credit

1. Grunwald v. Wells Fargo Bank, No. 5-625 / 04-0641 (Ia. App. Nov. 23, 2005). Where the letter of credit expressly required the draw presentation to be accompanied by the original of the letter of credit, the issuing bank properly denied the demand for payment. The beneficiary argued that it was standard practice for banks in the Midwest to accept photocopied letters of credit when the beneficiary certifies that the original has been lost, stolen or destroyed. The appellate court held that the express terms of the letter of credit requiring the original accompany the draw, and the strict compliance standard, justified the dishonor. Note that the ISP has a rule to deal with such situations, but the decision to issue a replacement letter of credit is discretionary with the issuing bank. ISP Rule 3.12.

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VII. Attorneys Fees in Letter of Credit Cases -- See attached article from Documentary Credit World.