Letters of Credit

This survey concentrates on the most significant letter of credit (“LC”) issues addressed in cases decided in the United States in the year 2021.

Pre-Honor Cases

Pre-honor cases are those in which a dispute arises before a demand for payment under an LC has been honored.

Wrongful Dishonor

Wrongful dishonor actions typically involve a beneficiary claiming wrongful dishonor by an LC issuer, and they focus on whether: (i) the claim asserted is within the scope of U.C.C. Article 5, (ii) the issuer gave timely and sufficient notice of dishonor and the discrepancies stated in that notice justify dishonor, (iii) there are extraordinary reasons requiring or permitting dishonor, such as forgery or material fraud, injunction, governmental laws, orders or sanctions, or insolvency, and (iv) the claimant’s action for wrongful dishonor is effectively and timely filed against the issuer (or confirmer). Others such as an advising or nominated bank may be liable for the failure of the LC transaction to result in issuance and honor. This survey discusses several cases that address the issuer’s, confirmer’s, and advising bank’s obligations and the remedies available against them separately from wrongful dishonor.

Wrongful dishonor disputes based on facial compliance or preclusion issues continue to be resolved mostly outside the courts. This is attributable to the clarity with which U.C.C. Article 5 recognizes standard LC practice in examining presentations and giving notice of dishonor, including international rules incorporated by reference into an LC, such as the ISP and UCP. Published ICC, BAFT, and IIBLP materials and programs also provide guidance on international standard banking practice of banks that regularly engage in letter of credit transactions.

In wrongful dishonor litigation applying U.C.C. Article 5, the parties and the court should address whether the issuer’s undertaking was an LC, whether timely presentation was made to the issuer, and whether the issuer gave timely notice of dishonor identifying each discrepancy. Assuming that the issuer has not precluded itself from raising any discrepancy defense, the parties and the court would then address whether the applicable LC compliance standard was or was not met, i.e., the “strict” compliance standard based on the observance of standard LC practice as stated in U.C.C. sections 5-108(a) and (e). Finally, they should address whether an action and the damages sought are within the scope of Article 5 and, if so, whether it is brought timely against a party under Article 5’s one-year statute of limitations for recoveries allowed by Article 5.

Characterization Issues—Article 5 vs. Common Law

2021 included several reported opinions that treat the conditions, defenses, and limitations in Article 5 that should apply to claims against an issuer for wrongful dishonor as inapplicable or optional by allowing the beneficiary to proceed under breach of contract or other common law theories of recovery. In doing so, the opinions depart from the statutory goals of Article 5, starting with its intended treatment of an LC within its scope as “an idiosyncratic form of undertaking,” as well as overlook the well-established rule that where the U.C.C. has a specific provision that states an obligation and a remedy for breach, in many cases it displaces common law causes of action. We also discuss two international cases that deal with the question of characterizing a guarantee as an independent vs. suretyship undertaking.

Lost Original

In Windsor Township v. Tompkins Financial Corp., the court affirmed judgment on the pleadings in favor of the plaintiff who was required, but unable, to present the original LC to the defendant issuer. The Windsor Township opinion states at the outset that “[t]he instant case came before the Court as a complaint couched in breach of contract” and thereafter states “Vist’s objection to honoring the Letter of Credit is solely based on the fact that the Township never received or lost the original copy of the Letter.” The court stated that the issues in the case were not being decided under the U.C.C. and, because the parties agreed that an exact copy of the original LC had been presented to the issuer, the court relied on procedural law to support acceptance of the LC copy. To uphold its decision allowing presentation of a copy instead of the original of the letter of credit, the court did not apply U.C.C. section 5-108’s strict compliance standard, citing the 1978 opinion in Flagship Cruises, which applied a substantial compliance standard. That precedent and the substantial compliance standard that it applied were expressly rejected in the 1995 revision of Article 5. Authorities recognize that presentation of a copy instead of an original document called for by a letter of credit is a discrepancy justifying dishonor unless waived by the issuer.

Suretyship vs. Independent Undertaking

While not argued under Article 5 of the U.C.C. or the ISP, an English court and a French court each decided the issue of whether a guarantee was an independent undertaking or a suretyship obligation. The English case is Shanghai Shipyard Co Ltd v Reignwood International Investment (Group) Company Limited, and the French case is McNeil & NRM Inc. & SA Audi Bank France v. Kolon DACC Composite, Ltd. If the undertaking is an independent obligation commonly known as a first demand guarantee or bank guarantee, the advantage to the beneficiary is that it need not prove that it is entitled to payment in order to obtain payment; the beneficiary’s timely documentary demand and, where called for or if the URDG governs the guarantee, presentation of a certification of default, is usually sufficient to entitle the beneficiary to payment. On the other hand, if the undertaking is determined to be a suretyship obligation or accessory guarantee, the guarantor can resist payment until after a court determines by proof that a default has occurred entitling the beneficiary to the amount demanded or drawn under the guarantee. That is the position the guarantors took in the Shanghai Shipyard and Audi Bank cases.

In the Shanghai Shipyard case, a $170 million long-term irrevocable and unconditional guarantee was issued by a non-bank entity to ensure payment for an oil drilling ship that took three years to construct. When it came time to pay the installment due at turnover of the constructed ship, the purchaser and guarantor refused to pay on the ground that the ship had serious defects and was not constructed according to specifications. The guarantee at issue read like a well-drafted corporate guarantee might read as commonly used in the United States, except that it provided that payment need not be made until an arbitration is resolved if arbitration is demanded. Further, the guarantor was the original purchaser of the ship but later became the guarantor when the purchase contract was transferred to a special purpose vehicle (”SPV”) established by the guarantor. The court declined to liken the guarantee of the SPV’s purchase obligation to a corporate guarantee or suretyship obligation. After discussions of and quoting the language of numerous English cases on the subject, the court determined that the guarantee was independent and that arbitration was not timely demanded so that the right to withhold payment on that basis was lost. The case has created uncertainty in English courts about the proper criteria to use to determine if a guarantee is independent.

In McNeil & NRM Inc. & SA Audi Bank France v. Kolon DACC Composite, Ltd., an advance payment guarantee was issued by a French bank to a Korean purchaser of sophisticated manufacturing equipment. When progress on the development and manufacture of the machinery ordered was delayed for extended periods of time, the Korean beneficiary requested the manufacturer–applicant to return its advance payment. When the manufacturer refused to do so, the beneficiary claimed under the bank guarantee. The applicant applied to the Paris Commercial Court to stop payment by arguing that the bank guarantee was not an independent guarantee used in international transactions but a contract of guarantee that is co-extensive with the principal contract so that payment should only be made after an arbitral award settling the contract dispute between the applicant and beneficiary, i.e., that a default was first proven. The bank guarantee issued by Bank Audi used wording indicating the intention of the bank to pay upon a proper demand for payment, i.e., before proof of default. The French court confirmed that the demand under the guarantee and its payment were only subject to the condition of a declaration by the beneficiary of a contractual default by the supplier. Payment was not conditioned on any other event of a contractual nature, including the materiality of the alleged breach of contract.

While distinguishing independent undertakings (LCs) from dependent undertakings (guarantees) has been a significant problem outside the United States, the 1995 revision of U.C.C. Article 5 greatly diminished the problem in the United States. The publication of Restatement (Third) of Suretyship & Guaranty contemporaneously with the promulgation of Article 5 of the U.C.C. recognized the effort to separate LC obligations from suretyship or accessory guarantee obligations.

Damages

In Vanpoy Corp. S.R.L. v. Soleil Chartered Bank the court awarded “breach of contract” damages against a bank that issued an undertaking identified as a standby letter of credit and later refused full payment after receiving a request for drawdown by SWIFT messages from the beneficiary’s bank. It is unclear from the opinion if there was a “presentation” under a letter of credit. It is also unclear from the opinion whether the bank’s undertaking was a suretyship undertaking. What is clear is that the Vanpoy opinion does not mention U.C.C. Article 5 or any LC practice rules but does mention that the underlying export sale contracts and invoices were included as part of the beneficiary’s summary judgment motion.

Statute of Limitations

Three 2021 cases decided whether U.C.C. section 5-115’s one-year statute of limitations or a longer common law statute of limitations applies to three different types of actions involving letters of credit—Zions Bancorporation, N.A. v. JPMorgan Chase Bank, N.A., Puget Soundkeeper Alliance v. APM Terminals Tacoma LLC, and Viele v. Williams. Puget Soundkeeper and Viele were post-honor cases and are discussed below under that heading.

In the Zions Bancorp case, JPMorgan Chase Bank, N.A. (“JPM”), as confirming bank, refused to fully honor conforming documents presented because the applicant had obtained injunctions in Brazil against Banco Bradesco as issuing bank and JPM enjoining honor of 50 percent of the amount drawn on the LC. Zions Bank filed its complaint against JPM more than one year after dishonor and expiration of the letter of credit. New York law governed JPM’s confirmation of the LC. The California court mistakenly determined that U.C.C. section 5-115’s one-year statute of limitations did not apply because the letter of credit at issue was governed by the UCP and because Zions Bank filed suit for breach of contract instead of wrongful dishonor under Article 5.

Zions Bancorp, Windsor Township, and Vanpoy were not decided under applicable Article 5 law; they do not treat the unpaid undertakings as within the scope of U.C.C. Article 5 but rather as contracts (but not as suretyship contracts). Neither the issuer nor the beneficiary of a letter of credit within the scope of U.C.C. Article 5 should be able to avoid or circumvent application of section 5-108 (strict compliance), section 5-111 (remedies against an LC issuer), or section 5-115 (statute of limitations) by pleading contract claims or defenses that would be available if the undertaking were a common law contract rather than an LC. Otherwise, the carefully crafted rules governing rights, duties, and liabilities of financial institutions in LC transactions set forth in Article 5, the UCP, and the ISP could be readily circumvented.

Fraud Defenses and Injunctions

U.C.C. section 5-109 applies to a presentation of documents that on their face comply with the terms of the letter of credit. Notwithstanding a facially compliant presentation, section 5-109 allows the issuer or applicant to assert a defense or claim that a required document is forged or materially fraudulent or that honor would facilitate a material fraud by the beneficiary. Issuers are not legally obligated to raise a fraud defense and are reluctant, if not unable, to do so. Accordingly, most LC fraud claims decided by courts are raised in emergency actions brought by applicants to obtain injunctive relief to prevent honor when a drawing is about to occur or be honored.

U.C.C. section 5-109 dictates how U.S. courts should balance an LC’s independence from the underlying transaction while at the same time providing a way to deter a fraudulent drawing. Few U.S. cases enjoin beneficiaries from presenting and issuers from honoring complying draws on LCs based on claims of forged or materially fraudulent presentations, a tribute to the specificity with which the LC fraud exception is addressed in section 5-109 and in its official comments and to the imposition of fees and costs on an applicant or issuer that unsuccessfully invokes the LC fraud exception.

Erroneous Legal Conclusion vs. Factual Misrepresentation

In TC Skyward Aviation U.S., Inc. v. Deutsche Bank AG, New York Branch, the issuer dishonored a facially complying presentation made under a $12,020,000 LC one day after the applicant filed for bankruptcy even though no regularly scheduled lease payments were in default. When sued by the beneficiary for wrongful dishonor, the issuer defended on the basis that because the beneficiary had no colorable basis to draw, the drawing was materially fraudulent under U.C.C. section 5-109(a)(2). The LC secured a lease of an inventory of spare parts for Boeing 777 aircraft, on which payments were being made on time. Although the lease had an acceleration clause in the event of bankruptcy, as a bankruptcy law matter, acceleration was prevented by the ipso facto clause of the Bankruptcy Code. The LC required the following signed statement to be made for a drawing: “THE AMOUNT OF USD X HAS BECOME DUE AND PAYABLE BY THE APPLICANT UNDER THE LEASE.” While the language could have been made clearer on the effect of bankruptcy and the ipso facto clause on the right to draw, the court granted summary judgment against Deutsche Bank, stating that the allegation of fraud was based on plaintiff’s legal interpretation of the effect of bankruptcy on the underlying contract, and was not a statement that misrepresented facts justifying the “narrow” fraud exception to the issuer’s duty to honor conforming draws. In effect, the court held that a showing of wrongful intent was necessary and not present because the draw was based on a legal conclusion interpreting a lease in bankruptcy.

Foreign Court Injunction Against Honor

In Zions Bancorp, JPM as confirming bank did not pay Zions Bank as assignee of the beneficiary beyond 50 percent of the amount drawn on the LC confirmed by JPM on the ground that doing so was enjoined by a Brazilian court. The injunction was obtained in Brazil by the Brazilian buyer against JPM as confirmer as well as against the Brazilian bank issuer. The court did not discuss U.C.C. Article 5 defenses or claims on which the injunction was based (e.g., fraudulent drawing). The facts and procedural status of the case, however, raise the question of whether a confirming bank may defend on the ground of substantive and procedural law based on foreign sovereign compulsion and the recognition of foreign court orders compelling dishonor of LC obligations. The court did not discuss the merits of JPM’s defense on compulsion, which is of considerable interest because there are very few reported decisions on the treatment of foreign court interference with the independence of LC obligations. This issue and the previous leading case in the United States were the subject of extensive discussion in The Business Lawyer survey of 2006 LC cases.

Article 5 vs. Incorporated UCP600

Of immediate concern in Zions Bancorp is the mistreatment of ordinary LC issues. The opinion on the defendant bank’s motion to dismiss concludes that a confirmed LC, despite its express choice of New York law, is not governed by New York’s U.C.C. Article 5 if it also states that it is subject to UCP600. Treating all of New York’s U.C.C. Article 5 as displaced by UCP600 contradicts section 5-116(c) as it was revised and became effective in New York in 2000 (and in the forum state of California in 1997). That subsection deliberately rejected New York’s then non-uniform total deference to UCP.

The Zions Bancorp opinion treats Article 5 as wholly inapplicable and not simply as displaced by any conflicting UCP600 provision. Accordingly, the opinion disregards the section 5-115 one-year statute of limitations and section 5-111 on remedies against issuers (including confirmers). Plaintiff Zions Bank was the assignee of LC proceeds with the rights and remedies under New York’s sections 5-114 and 5-111(c) of an assignee who has been recognized by the confirmer’s consent to assignment, but is also subject to the section 5-115 one-year limitations period, as well as any meritorious defense the confirming bank has against the beneficiary’s right to honor based on the Brazilian court injunction discussed above.

Insolvency of the Issuer

If a bank or credit union becomes insolvent, under powers granted to the receiver under federal law, the FDIC, as receiver, in its discretion, can disaffirm or repudiate the institution’s outstanding letters of credit which it determines are burdensome and interfere with the orderly administration of the insolvent financial institution’s estate. The beneficiary of an LC which has been disaffirmed or repudiated may file a claim for damages against the estate of the insolvent financial institution, provided that its claim under the LC had already matured at the time the receivership commenced. The FDIC’s and NCUA’s power to disaffirm and repudiate letters of credit was shown in Lexon Insurance Co. v. FDIC. That case demonstrates the need for beneficiaries to select financially sound banks as letter of credit issuers, to monitor the issuer’s credit standing, to obtain a provision in their underlying agreement allowing the LC to be drawn on or replaced if a credit downgrade event occurs, and to act with promptness to require the LC issuer to be timely replaced or draw on the LC before, and not after, the issuer’s receivership.

In Lexon, Lexon Insurance issued approximately $11 million in bonds to the Bureau of Ocean Energy Management securing obligations of Linder Oil Company. Linder’s reimbursement obligation to Lexon was supported by two automatically renewable LCs issued by First NBC of Louisiana totaling $9,985,000. First NBC was placed into receivership. The FDIC as receiver for NBC disaffirmed the two Lexon LCs six months thereafter as burdensome contracts that would interfere with the orderly administration of the insolvent bank’s estate. The LC applicant, Linder Oil, also filed for bankruptcy, leaving Lexon exposed without a source of reimbursement for claims on its sizable bonds. Lexon argued that the FDIC had no power to reject letters of credit because they were not “contracts” within the meaning of 12 U.S.C. § 1821(e), that Lexon had actual damages in the full amount of the LCs based on its bond exposure, and that the FDIC did not act within a reasonable time to reject the LCs issued to Lexon. The court rejected all three arguments: relying on Granite Re, Inc. v. National Credit Union Administration Board for rejecting the first; noting that no evidence of any actual damages at the time of receivership was presented to reject the second; and analyzing the facts and circumstances of the receivership to reject the third. Because the First NBC LCs automatically extended while it was under a consent decree with the FDIC prior to receivership which prevented First NBC from extending further credit on loans classified as loss or doubtful, Lexon argued that the FDIC was negligent by not enforcing the decree. The court rejected that argument as well, noting first that the FDIC in its corporate capacity did not have a duty to Lexon as a third party to prevent the letters of credit from renewing, and second, that the consent decree did not affect or prevent renewal of existing lines of credit for the same amount as opposed to extending new additional credit to the applicant.

Setoff Against Assignee of LC Proceeds

There is authority that the issuer of an LC can assert a setoff of debt owed to it by the beneficiary against the beneficiary’s draw on the issuer’s LC. U.C.C. section 5-114 provides that an acknowledged assignee of LC proceeds is limited to what the issuer would otherwise be obligated to pay to the LC beneficiary–assignor. Accordingly, the assignee of proceeds of an LC should ordinarily be subject to the issuer’s right of offset against the beneficiary. One way to avoid the issuer’s offset rights as an assignee of the LC’s proceeds is to obtain a clear waiver of the right of offset from the issuer.

That was the question in BNP Paribas, Singapore Branch v. Natixis, New York Branch. There, the court ordered the issuer of a standby letter of credit to pay the amount demanded by the acknowledged assignee of the beneficiary’s right to LC proceeds. The issuer’s refusal to pay the acknowledged assignee was based on the issuer’s contractual right of setoff against the beneficiary–assignor. The court held in a parallel case that the issuer’s setoff right was waived in the issuer’s SWIFT message acknowledging the setoff. The court deemed the issuer’s acceptance of this message as an “unequivocally clear” waiver of setoff rights by the issuer. These two cases were decided under New York’s summary procedure for enforcement of an instrument for the payment of money only. They do not mention the U.C.C. or any ICC rules. Given that the claimant is a mere assignee of LC proceeds, these two cases would not qualify as U.C.C. section 5-111(a) wrongful dishonor cases.

Liability of Advising Bank for Issuer’s Wrongful Dishonor

In ERA Capital L.P. v. Soleil Chartered Bank, the plaintiff sued Soleil Chartered Bank and Soleil Capitale Corporation (together, Soleil) as the LC issuer for wrongful dishonor and breach of contract and also Regions Bank for negligence and breach of fiduciary duty for failing to conduct sufficient due diligence on Soleil. Soleil unsuccessfully objected to the forum and to the sufficiency of ERA Capital’s pleadings. Regions Bank unsuccessfully argued that its liability was determined by U.C.C. Article 5, which limits the role of a bank that undertakes to advise another bank’s LC, but does not undertake to confirm it or to give value under it. The court denied Regions Bank’s motion to dismiss because ERA Capital’s complaint was based on alleged oral statements made by Regions Bank personnel about Soleil on which ERA Capital relied to its detriment and not on Regions Bank’s limited undertaking under U.C.C. section 5-107(c) or UCP Article 9. Issuing banks routinely require applicants to accept in writing full responsibility for the selection as well as conduct of other banks, but banks requested to advise or otherwise act on another bank’s LC do not routinely require written agreements documenting the differences between confirming bank and advising bank obligations to the beneficiary.

Oral Commitment to Act as Nominated Bank and Facilitate Beneficiary’s Assignment of LC Proceeds

In Lamda Solutions Corp. v. HSBC Bank USA, N.A., Lamda, a broker, sued HSBC as nominated bank for breach of contract, promissory estoppel, and breach of U.C.C. section 5-114 for committing, but failing, to consent to assignment to the Mexican iron ore producer of proceeds of an Industrial and Commercial Bank of China (“ICBC”) commercial letter of credit for Chinese purchases from Lamda of 80,000 metric tons of iron ore. Lamda alleged lengthy negotiations and numerous inquiries by HSBC and responses by Lamda leading up to HSBC’s “commitment” to act as a nominated bank and facilitate an assignment by Lamda of the LC’s proceeds, including Lamda’s opening an account at HSBC in New York City, sending $30,000 to China to pay for costs of issuance of the ICBC LC, structuring the transaction with HSBC, and negotiating the form of assignment agreement. After HSBC asked for an explanation about Lamda’s calculation of the purchase price on the transaction, HSBC decided, without explaining its reasons, not to proceed further. Lamda claimed all issues had been adequately resolved. The court dismissed the complaint for failure to plead that HSBC entered into a binding agreement, because it lacked sufficient factual allegations of an offer, promise, and unconditional consent by HSBC to commit to an assignment agreement relating to the proceeds of the ICBC LC. The case exemplifies the desirability of obtaining a pre-agreement acknowledgment that there is no commitment or agreement until the committed party signs one.

Post-Honor Cases

Disputes that arise after the issuer honors an LC typically focus on: (i) whether the issuer is entitled to reimbursement, indemnification, subrogation, or other recovery from the applicant or, in some cases, from the beneficiary or other presenter, or (ii) whether the applicant or beneficiary may have impaired or enhanced rights against each other based on honor of the LC.

Statute of Limitations Cases

In Viele v. Williams, suit was filed on behalf of Beth’s Bail Bonds, Inc. as applicant of an LC issued to the Arkansas Bail Bondsman Licensing Authority (“ABBLA”), alleging negligence, conspiracy, conversion, and breach of contract by the LC issuing bank that paid the beneficiary’s demand and then applied the applicant’s CD collateral to reimburse itself. The court affirmed summary judgment under U.C.C. section 5-115’s one-year statute of limitations because the complaint was filed over three years after the LC was honored and the applicant’s complaint was in substance a claim for wrongful honor under Article 5. The court rejected the applicant’s attempt to circumvent Article 5’s one-year time bar by “couching” its claim for wrongful honor as common law causes of action. The applicant argued, unsuccessfully, that the bank’s reimbursement of itself from a CD pledged as collateral allowed for a valid and separate cause of action not subject to U.C.C. section 5-115’s one-year statute of limitations.

Under a fairly complex set of facts and parties, in Puget Soundkeeper Alliance v. APM Terminals Tacoma LLC, APM Terminals sought to add as a party counterclaim defendant the Tacoma Port employee who presented a draft and certificate to draw on a letter of credit procured by APM to secure its lease obligations to Tacoma Port in connection with its operations at the port facilities which had recently terminated. The employee was alleged to have committed fraud and converted LC proceeds by his action. The Port Authority argued that the alleged wrongful draw on the letter of credit was in effect a breach of warranty claim covered by U.C.C. section 5-110 and therefore was barred by U.C.C. section 5-115’s one-year statute of limitations. The court agreed that the fraud claim was barred by Article 5’s one-year statute of limitations, noting that fraudulent drawing is covered by U.C.C. section 5-109. As to the conversion claim, the court held otherwise, because that claim was possibly based on an underlying common law duty not to convert the applicant’s funds.

It should be noted that the section 5-110 warranties (of no fraud and no violation of underlying agreement) are made by the beneficiary of an honored drawing and that the opinion in Puget Soundkeeper does not explain the treatment of the Tacoma Port’s individual officer as an LC beneficiary. Also, there was apparently no allegation of breach of any of the section 5-110 warranties by the individual officer. The opinion’s reliance on sections 5-110 and 5-115 is explained by its citation to and lengthy discussion of an en banc Washington Supreme Court opinion that concluded that the section 5-110(a)(2) warranty “creates an auxiliary cause of action to protect the applicant from wrongful drawings by the beneficiary in cases where the applicant lacks a common law contractual basis for his claims.” Further, “whether that auxiliary cause of action displaces [the applicant’s] common law claims, thereby rendering them claims that ’arise under’ Article 5 and are subject to its limitations period, accordingly depends on whether his claims are based on an underlying contract . . . or some independent duty owed by [the beneficiary to the applicant].”

Subrogation

In Solferini as Trustee of Corradi S.p.A. v. Corradi USA, Inc., Banca Nazionale del Lavoro S.p.A. (“BNL”) issued an $800,000 LC at the request of the Italian applicant, Corradi S.p.A., to Bank of the West to secure an $800,000 loan to the applicant’s subsidiary, Corradi USA. When Corradi S.p.A. became bankrupt, Bank of the West drew on the BNL LC for the full amount; BNL, in turn, was only able to recover an amount (in Euros) equal to $115,667 in Corradi S.p.A.’s bankruptcy proceeding. Solferini, as trustee for the bankrupt applicant Corradi S.p.A., sued its U.S. subsidiary for recovery of the $800,000 benefit it had received on theories of equitable subrogation, statutory subrogation under U.C.C. section 5-117, and quantum meruit. The district court rejected these claims and the Fifth Circuit affirmed, denying subrogation for any amounts under section 5-117 because subrogation was not properly pled in the trustee’s complaint. The complaint pled the subrogation right of the unreimbursed issuer, and the trustee raised too late its claim to be subrogated as an applicant that arguably partially reimbursed the issuer.

The court of appeals also affirmed the award of $272,127.50 in attorneys’ fees to the defendant Corradi USA as the prevailing party under U.C.C. section 5-111(e) in its defense against the inaptly pled statutory subrogation right of an unreimbursed issuer (as distinguished from the possibly apt, but unpled, subrogation right of an applicant that has reimbursed the issuer). The district court, after the mandate issued, on motion of Corradi USA, Inc. added another $120,895.10 in attorneys’ fees plus costs incurred by Corradi USA, Inc. on appeal.

LC Errors to Avoid

Four cases were decided in 2021 which touch upon specialized situations where what was done in the LC transaction or its aftermath had repercussions—three for the issuer and one for the beneficiary.

Protecting the Issuing Bank in the Applicant’s Bankruptcy

In the case of In re Kimmel’s Coal & Packaging, Inc., litigation arose from a section 363 sale under the Bankruptcy Code, where the purchaser’s obligation to replace a prepetition environmental security LC for mining on leased land or to assume the debtor’s reimbursement obligation was dependent on the purchaser of a bankrupt coal company’s assets and business obtaining transfer of the debtor’s permits for coal mining on the leased land in question. The section 363 bankruptcy sale order provided for all the debtor–applicant’s assets, including the issuing bank’s collateral, to be sold to the purchaser free and clear of the issuing bank’s liens and security interests in them. The court initially held that under the terms of the parties’ agreement to the section 363 order, the purchaser was obligated to apply for permits to replace the LC in question even though transfers of permits depended on the landlord’s transferring the leases for mining land which had not occurred. In the later opinion, the court held that the purchaser of the bankrupt seller’s coal operations and business was contractually obligated to apply for and accept transfer of whatever portion of the permits that it could even if that portion is something less than 100 percent. A clearer drafting of the section 363 sale terms could have avoided the issuer’s problem of having its bankrupt debtor’s assets pledged to secure its outstanding LC transferred free and clear of the issuer’s liens without its LC being replaced and terminated or the reimbursement obligations assumed or collateralized by the purchaser.

Fraudulent Transfer by Use of LCs

In another bankruptcy case, In re Essar Steel, the court found that substantial amounts of the debtor’s estate were transferred to foreign affiliates via draws on LCs on which the debtor was the applicant. The officers of the applicant were sued for breach of their fiduciary duty in facilitating the LC transfers at a time when the U.S. applicant was insolvent.

Inability to Use IRAs Pledged as LC Collateral

In Cassidy v. Signature Bank, the court found that IRA account collateral pledged to secure the applicant’s LC reimbursement obligation could not be offset by the issuing bank to satisfy other debt owed to it. The basis of the court’s holding was that the pledge agreement specifically denied setoff rights against retirement account collateral and under Illinois law IRA accounts are considered to be “special deposits” creating a trust relationship between the depositor and the bank which cannot be used to satisfy general indebtedness.

Late Response to LC Complaint

In White Stag Aircraft Leasing U.S. LLC v. JP Morgan Chase Bank, N.A., the court accepted the issuing bank’s argument of excusable neglect for failing to timely file a response to a beneficiary’s complaint alleging breach of the LC issuing bank’s obligations. That allowed a default judgment to be vacated and the issuer to plead that the presentation made under its LC did not strictly comply with the terms of the LC and that the complaint was filed beyond the one-year statute of limitations for filing an action for wrongful dishonor.

LC Transaction Red Flags

Letter of credit scams of various types keep occurring. Any party, especially a party unsophisticated in letter of credit transactions, that is approached to participate in an LC transaction where the returns are too good to be true, should avoid them. These include so-called prime bank instruments, monetizing letters of credit, advance fees paid into unsafe escrow arrangements that allow the defrauding party to remove funds unilaterally, and many other schemes.

Three cases reported in 2021 involved substantial amounts of money through use of an LC in questionable transactions or with questionable parties or arrangements. In two of them, extraordinary commissions were to be earned, and in the third, $2.5 million in advance fees were to be placed in escrow with a sole practitioner pending release of a $500 million LC. All the cases led to litigation and losses. The features of these cases—large brokerage fees and sole practitioners involved with acting as escrow agent for $500 million LCs—are red flags or warnings indicating unreal expectations or possible scams.