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The Business Lawyer

Fall 2023 | Volume 78, Issue 4

Letters of Credit

Carter H Klein

Letters of Credit

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The Annual UCC Letter of Credit Survey identifies and discusses legal cases from the previous year involving letter of credit issues, disputes of bank issuers, confirmers, advisers, beneficiaries, and applicants.

This survey concentrates on the most significant letter of credit (“LC”) issues addressed in cases decided primarily in the United States in the year 2022 and also comments on the proposed 2022 UCC Amendments affecting Article 5.

The discussion in this survey can be broken down into five sections: (1) new developments—2022 UCC Amendments affecting LC practices; (2) threshold issues addressed by courts such as whether an LC or U.C.C. Article 5 applies and questions such as jurisdiction, sovereign immunity, governing law, and venue in LC cases; (3) pre-honor LC cases that include issuer dishonor due to noncompliance of documents presented, proper and timely notice of dishonor, draws made after expiration, fraud justifying dishonor or injunction against honor, sanctions and regulatory orders preventing honor, force majeure affecting the issuing bank, assertion of set-off rights by the issuing bank, improper assignment or transfer by the beneficiary, statute-of-limitations bar, and other causes claimed to justify or require dishonor, usually in the context of claims of injunction, wrongful dishonor, or breach of contract of the LC brought by the beneficiary; (4) post-honor cases of reimbursement opposed by claims of wrongful honor and disputes between the beneficiary and the applicant based on breach of the underlying contract which the LC supports, breach of warranty under U.C.C. section 5-110, subrogation under U.C.C. section 5-117, and other legal theories; and (5) LC cases worthy of note, including liability of the advising bank, supersedeas LCs, valuation of LC-supported claims in bankruptcy, and injunctive or declaratory relief requiring LCs to be posted.

2022 UCC Amendments

Subject to their enactment, the 2022 UCC Amendments will affect LC transactions in three ways. First, the formal requirements for an LC in U.C.C. section 5-104 have been revised to comport with modern technology. Instead of requiring an authentication by written signature, agreement of the parties, or standard bank practice, an LC or its confirmation, advice, transfer, amendment, or cancellation may be issued in any form that is a “signed record.”

Second, Official Comment 3 to U.C.C. section 5-116(c) was expanded to include the ISP and the URDG as well as later editions of the UCP as rules that supplement and modify Article 5 LC rules other than the nonvariable provisions of Article 5.

Third, the proposed 2022 UCC Amendments will amend section 5-116 to affirm the separate juridical status of bank branches and reject the decision of Zeeco, Inc. v. JPMorgan Chase Bank, which mistakenly determined that Oklahoma law governed a bank guarantee issued by a JPMorgan Chase Bank, N.A. (“JPM”) branch in India because the credit agreement between the applicant and JPM office in Oklahoma chose Oklahoma law to govern their relationship. The 2022 UCC Amendments insert a separate subparagraph (d) to section 5-116 providing that a branch of a bank is considered a separate juridical entity based on the address indicated in the branch’s undertaking from where the LC was issued.

Threshold Issues

Jurisdiction. Two cases of import were decided in 2022 on the issue of jurisdiction in LC actions: Project Stewart LLC v. JPMorgan Chase Bank, N.A., and Mashreqbank PSC, N.Y. Branch v. Indian Overseas Bank. In both cases, the court determined whether the issuing bank was subject to the jurisdiction of the court where the beneficiary was located based on the sufficiency of the issuer’s contacts with that jurisdiction arising out of the LC transaction on which suit was based. The cases followed the generally accepted rule in U.S. LC cases that where the LC is silent on jurisdiction, the issuance of an LC to the beneficiary alone is not enough to confer jurisdiction to require the issuer to appear in the beneficiary’s jurisdiction.

In the Project Stewart case, although the LC was issued to the beneficiary located in Seattle, the only other contacts of JPM as issuing bank in Washington relating to the LC transaction were conversations from JPM out-of-state offices with the beneficiary. The LC was issued from Chicago, processed and payable in Tampa, and JPM conversations concerning it originated from JPM’s LA office.

Following the same rule but coming to the opposite determination, jurisdiction was found in New York in the Mashreqbank case where the New York branch of Mashreqbank was located. Indian Overseas Bank had several contacts with New York which the court found satisfied personal jurisdiction requirements under New York’s long-arm jurisdiction statute. The Indian bank nominated Mashreqbank’s New York branch to confirm Indian Overseas Bank’s LC, designated Wells Fargo in New York to be the reimbursing bank, and provided for reimbursement of Mashreqbank to take place in New York through a correspondent account there.

Prior Pending Action and Forum Nonconveniens. In the Mashreqbank case, the Indian Overseas Bank also sought to dismiss the lawsuit brought against it in New York on the grounds of a prior pending action between the beneficiary and the applicant in India and that New York was an inconvenient forum to resolve the LC suit. The court rejected the argument of prior pending action; the New York suit was based on an LC that was an obligation of the issuing bank to the confirming bank independent of the issues and evidentiary proofs concerning the disputes between the applicant and the beneficiary. The court also denied the Indian bank’s forum nonconveniens argument because modern communications and transportation available did not make the case too burdensome for the Indian bank to defend in a New York court.

Sovereign Immunity in LC Related Transaction. While not directly an LC case, the district court in Preble-Rish Haiti, S.A. v. Republic of Haiti concluded that an oil purchasing company owned by the government of Haiti had waived sovereign immunity by agreeing to arbitrate disputes under its contracts, by agreeing to post LCs to support payment, and because the property of the Haitian company in the United States against which attachment was sought was used for commercial activity. The Fifth Circuit reversed, holding that a waiver of sovereign immunity under the Foreign Sovereign Immunities Act of 1976 (“FSIA”) must be specifically expressed so that none of the factors listed by the district court, including providing for the use of an LC, waived sovereign immunity.

LC or Independent Guarantee vs. Accessory Guarantee. A guarantee without a set of rules governing it, such as the ISP or the URDG, is frequently subject to dispute as to whether it is an independent undertaking or an accessory guaranty subject to suretyship defenses. Last year’s Survey reported on such a case—the English court decision of Shanghai Shipyard Co Ltd v Reignwood International Investment (Group) Company Limited, interpreting whether the buyer’s $170 million payment guarantee to the Chinese builder for construction of an oil exploration vessel was an independent undertaking like a demand guarantee or was a suretyship obligation subject to defenses to payment based on vessel warranty defects. The case was accepted for appeal to the English Supreme Court, but unfortunately was settled before a ruling, leaving issues unresolved for bankers and commercial users of international guarantees that do not incorporate a set of rules such as the URDG or ISP to reinforce their independent nature.

Pre-Honor Cases

Injunctions against Draw and Honor. Notwithstanding a facially compliant presentation, U.C.C. section 5-109 allows the issuer to dishonor or the applicant to enjoin a drawing under an LC if it can show 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 on their own and are reluctant and frequently not in a position of knowledge of the underlying facts and actions of the parties to be able to do so. Accordingly, most LC fraud claims decided by courts are filed by applicants in emergency injunctive actions.

Few U.S. cases enjoin beneficiaries from presenting and issuers from honoring complying drawings under LCs based on claims of forged or materially fraudulent presentations because applicants must meet all section 5-109 conditions to obtaining injunctive relief for fraud and the non-prevailing party must pay its own, the issuer’s, and beneficiary’s attorneys’ fees.

In Lummus Technology Heat Transfer B.V. v. Credit Agricole Corporate Investment Bank, a New York court entered a restraining order which, by stipulation, became a preliminary injunction against the New York branch of Credit Agricole from honoring a draw under its EUR 5,116,800 “advance pay” LC issued to a Russian company. The equipment ordered was to be used for heat treating operations of the Russian beneficiary’s oil refinery. The complaint requesting injunctive relief alleged that EU sanctions resulting from Russia’s invasion of Ukraine prevented the Dutch manufacturer from delivering the equipment ordered, triggering the force majeure clause of the underlying contract which excused performance while the sanctions continued in effect.

Sanctions applied against Russian aviation companies were invoked by UniCredit Bank as confirming bank to decline honoring over $69,000,000 in conforming drawings on its confirmations of Sberbank’s LCs issued to Irish and English aircraft leasing companies to support aircraft leases to Russian aviation company lessees. After the invasion of Ukraine, the lessors terminated the aircraft leases and submitted conforming draws on UniCredit’s confirmations of the LCs securing the leases. When UniCredit declined to honor the draws on account of sanctions regulations, the leasing company beneficiaries filed suits in Europe for wrongful dishonor.

The facts of the case of Zions Bancorporation, N.A. v JPMorgan Chase Bank, N.A. discussed in last year’s Survey raise the issue of a Brazilian court’s injunction against JPM (which has a Brazilian branch) from honoring draws on its U.S. branch’s confirmation of Banco Bradesco’s LC issued to a U.S. equipment seller. The case settled before the court had the opportunity to discuss the defense of compulsion based on a foreign court order, an issue of considerable interest because of the scarcity of reported decisions on the treatment of foreign court interference with the independence of LC obligations.

Wrongful Dishonor. Wrongful dishonor disputes based on compliance of documents with the terms of the LC 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 under the UCP and ISP rules incorporated by reference into an LC and in ICC, BAFT, and IIBLP publications, and programs providing guidance on international standard LC banking practices.

Lost Original. The rules dealing with lost originals include the strict compliance rule of U.C.C. section 5-108(a) and, depending on which regime the LC incorporates, ISP98 Rules 3.12 and 4.15 or UCP600 Articles 2 and 17. Options that beneficiaries should consider when dealing with “presentation LCs” include: (1) refuse to accept presentation LCs; (2) provide in the LC a mechanism for its replacement (e.g., issuance of a duplicate original) if the original cannot be produced; or (3) take steps to safeguard the original.

As reported in last year’s LC Survey, the trial court in Windsor Township v. Tompkins Financial Corp. accepted the beneficiary’s argument that an “exact copy” suffices to obligate the issuer to honor a draw under its UCP500 presentation LC. The beneficiary pled and the trial court applied contract law and the rule of substantial compliance rather than letter of credit law and the rule of strict compliance to reach its result. On appeal, the appellate court applied the strict compliance rule of U.C.C. section 5-108(a), reversed the trial court, and upheld the issuer’s right to dishonor Windsor Township’s drawing because a copy rather than the original LC was presented to effect a drawing.

Capping Issuer’s LC Obligations. In the case of In re GenOn Mid-Atlantic Development, L.L.C., GenMa operated two coal fired generating plants leased from entities that required rent security and prohibited liens on the assets of GenMa. To avoid the lessors’ no-lien covenants and provide required rent security, GenMa entered into a Payment Agreement with Natixis Funding Corporation (“NFC”) to provide SBLCs collateral assurance to the lessors of its generating plants. GenMa paid NFC $130 million plus a $1.4 million LC fee to provide Natixis Bank LCs to the lessors as required security for their power plant leases. The LCs provided for $130 million in draws per lease period, the maximum amount that the lessors were entitled to in one lease period, but the LCs did not cap the aggregate amount of all draws on the LCs for all lease periods. NFC and not GenMa was to reimburse Natixis for the draws on the Natixis LCs. To avoid GenMa’s no-lien covenants with its lessors, the Payment Agreement stated that the $130 million payment was “in full,” upfront, and “irrevocable,” that GenMa renounced any “interest, claim, reversionary or residual interest” in the payment, that “NFC would bear all risk and reward on the payment,” that NFC would receive “‘any returns, interest, gains[,] or other earnings’ that accrued,” that NFC would assume all risk of losses from payments, and that the $130 million was “indefeasibly paid by [GenMa] to NFC.” The lessors examined the structure and declared it a lease default and drew $125 million on the Natixis LCs after which GenOn filed for bankruptcy. Natixis, realizing it was still exposed for future rental periods, terminated the LCs, giving sixty days’ notice as the LCs required to terminate them. Before the sixty-day period expired, lessors presented drawings under the Natixis LCs for another $50 million. Natixis refused to honor those draws. Instead, Natixis and NFC sued the lessors, their indenture trustee, and GenMa for indemnification, mistake, reformation, and breach of an implied covenant of good faith. The bankruptcy court, the district court, and the Fifth Circuit all found that NFC’s losses arose from Natixis drafting its LCs without an aggregate $130 million cap for all drawings made under all LCs issued, and that under the Payment Agreement, GenMa did not violate the no-lien warranty and was not required to indemnify NFC for the losses incurred.

The Soleil Bank Cases. Soleil Chartered Bank (“SCB”), was defendant in a half-dozen suits alleging wrongful dishonor of its LCs issued to support payment for shipments of seafood or other products and services. Three reported SCB LC cases were decided prior to 2022 and three more were decided in 2022: Vanpoy Corp., S.R.L. v. Soleil Chartered Bank; Shandong Yuyuan Logistics Co., Ltd. v. Soleil Chartered Bank; and Kuliarchar Sea Foods (Cox’s Bazar) Ltd. v. Soleil Chartered Bank.

Set-Off Against Assignee’s Claim to LC Proceeds. 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 that makes a conforming draw. Accordingly, unless waived, an assignee of proceeds of an LC may be subject to the issuer’s right of offset against the beneficiary. The clarity of such a waiver was the question decided in the BNP Paribas v. Natixis cases. The court found that Natixis as issuer waived set-off rights against BNP as assignee in the issuer’s acknowledgment sent to BNP via SWIFT.

Right to LC Payment Denied. In Prada USA Corp. v. 724 Fifth Fee Owner LLC, Prada’s lease with the owner permitted the owner to exercise a “suspension option,” which allowed it to suspend Prada’s lease on notice so that the landlord could redevelop the premises within a particular timeframe, during which Prada would be excused of its rental obligation; the agreement also entitled Prada to receive as much as $5 million as well as a $25 million letter of credit (the “suspension payment”) in the event it vacated the leasehold during the course of the suspension period. Although the lessor gave notice of its intent to exercise the suspension option, it revoked it before Prada vacated the premises. On this basis, the court determined that no suspension period occurred, plaintiff ’s right to relief from its rental obligation was not triggered, and Prada was not entitled to terminate the lease and receive the suspension payment, including the payment under the LC.

Right to Air Waybill When LC Draw Refused. Under commercial LCs used to pay for goods shipped in international trade, if the draw to pay for goods shipped is dishonored, the beneficiary-seller or its bank retains control of the bill of lading and thereby the goods shipped. In UPS Supply Chain Solutions, Inc. v. Directed Electronics, Inc., two air waybills were issued by UPS for the same shipment—one to the buyer and one to the issuing bank, the latter so that seller and its bank could control the goods if the LC draw were dishonored. Dishonor occurred, the goods could not be reclaimed by the seller or its bank because the buyer obtained them through the first air waybill, the buyer refused to pay the seller for the goods shipped based on a credit owed to it from previous shipments, the seller became insolvent, and the seller’s bank in Korea recovered from UPS the amount it lost financing the seller. UPS then turned to the buyer for recovery, arguing, inter alia, equitable indemnity. Because UPS was at fault for issuing two bills of lading for the same cargo shipment, recovery was denied.

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 rights or claims against the other based on honor of the LC.

Issuer’s Right to Reimbursement Upheld. Three cases reported in 2022 upheld the issuer’s right to be reimbursed for drawings paid under its LCs notwithstanding wrongful honor claims and defenses raised by the applicants: In re Spiegel, GVC Ltd. v. Valley National Bank, and Amboy Bank v. M.V.N. Homes Inc.

Indemnification for LC Draws. Great Lakes Dredge and Dock and NASDI Holdings as sellers of NASDI, LLC, a demolition and site redevelopment company, were entitled to a judgment for $20,934,028 from the purchasers of their company as the amount drawn under a presale $30,000,000 LC issued to Zurich Insurance as support for the sellers’ obligation to indemnify Zurich for amounts paid under payment and performance bonds on a major bridge project in progress at the time of the company’s sale. Under the purchase agreement, the purchasers were obligated to indemnify the sellers for any claims on the bonds or draws on the LC supporting them. More than two years after the company’s sale, the buyers failed to finish the project, Zurich made payments under its bonds to do so, and drew for more than $20,000,000 on the LC posted presale by the sellers. The Delaware Supreme Court rejected the purchaser’s argument that their indemnity obligations expired two years after sale of the company, noting that the purpose of the indemnification provision in the sale contract was to protect the sellers for as long as the bonds and LC were outstanding on the project the buyer assumed.

Lease Cases. If a landlord draws under an LC posted to support the tenant’s lease obligations and the tenant contests the basis or amount of the draw, the tenant may file suit to recover the drawing as wrongful or excessive. Many lease wrongful draw cases resulted from mandated COVID-19 shutdowns or restrictions on use of the leased premises. Almost unanimously, New York courts upheld the landlord’s right to draw under an LC supporting its lease—a testament to the reliability of LCs and the careful drafting of leases. Such cases decided in 2022 include Thor 680 Madison Ave. LLC v. Qatar Luxury Group S.P.C. and Experience NY Now Inc. v. 126 West 34th Street Associates L.L.C.

LC Cases of Note

LCs in Bankruptcy or Insolvency. Two cases occurred in 2022 of significant interest involving LCs in bankruptcy of the applicant or insolvency of the issuer: In re Sears Holdings Corp. and The Wall Guy, Inc. v. FDIC.

The Sears case involved a $395 million valuation dispute between first and second lien holders on Sears’ assets. The claims at issue included LC reimbursement obligations of Sears to the first lienholders for their LCs they issued to support Sears indemnity obligations to its workmen’s compensation (WC) insurers. Because WC claims take a long time to settle or finalize and quantify, the court rejected the second lienholders’ argument that the first lienholders’ LC-related claims should be valued at zero because they were contingent future claims. The court also rejected the second lienholders’ fallback argument that the first lienholders’ LC claims should be valued based on what actual draws on the LCs occurred after the petition date; the Bankruptcy Code required the claims to be valued at the time of their allowance.

In the Wall Guy case, a creditor of the failed bank obtained a judgment against the bank before it failed, which judgment was appealed with mortgages on the bank’s property as supersedeas collateral. While the appeal was pending, the bank failed, and the FDIC sold real estate which was supersedeas collateral and substituted an LC as supersedeas support. The judgment creditor challenged the sufficiency of the LC as substitute collateral and the right of the FDIC to sell the real property. Based on the initial supersedeas agreement which governed posting mortgages, the court determined that the FDIC acted properly and denied the judgment creditor’s claims.

Duty to Post LC. Several cases were decided in 2022 imposing a duty on or ordering a party to post or procure an LC to support indemnity obligations to a surety company or obligations to complete municipal improvements. These cases include: Fidelity Deposit Co. of Maryland v. Amaazz Construction Grp. LLC, MLCJR, LLC v. PDP Group, Inc., and Village of Kirkland v. Kirkland Properties Holding Co., LLC I.

Supersedeas LCs. If drafted properly and their operation understood by the parties and the court, LCs can be used in lieu of a supersedeas bond to act as security for a judgment pending appeal to stay its execution. Doing so makes sense for the judgment debtor. It may save the surety bond premiums when the judgment debtor posts the LC directly with the court. In some cases, the judgment debtor has an already existing or readily available LC credit facility. For the judgment creditor, allowing an LC to be posted as collateral can have advantages of instant liquidity if the judgment is affirmed and, in some cases, avoids the automatic stay if the judgment debtor files for bankruptcy after the judgment is affirmed.

In 2022, a number of supersedeas LC cases were decided, some on the basis of court rules or case law allowing LCs to be posted as supersedeas, some by agreement of the parties, and some on the basis of the way the LC was drafted. The cases are: Conroad Associates L.P. v. Castleton Corner Owners Association, Inc., State Auto Property & Casualty Ins. Co. v. Sigismondi Foreign Car Specialists, Inc., Probatter Sports, LLC v. Sports Tutor, Inc., Crain v. Crain, In re Stephens, In re Spiegel, and The Wall Guy, Inc. v. FDIC.

James G. Barnes, a long-time partner/senior counsel with Baker & McKenzie LLP and author/coauthor of this Letters of Credit survey for many years, retired on June 30, 2022. The letter of credit community is grateful for his over fifty years of contributions reporting on and improving letter of credit law and practice.

The author thanks Christopher S. Byrnes of the Institute of International Banking Law and Practice (IIBLP) and editor of Documentary Credit World (DCW) for his continuing assistance and Wayne Barnes of Texas A&M University School of Law for his careful edits and review of this survey.