The Appellate Division of the Supreme Court of New York, First Department, recently reversed a trial court’s order denying summary judgment in favor of plaintiff letter of credit beneficiaries under irrevocable standby letters of credit (“SLCs”), directing the trial court to enter judgment in plaintiffs’ favor and against the issuer.
A copy of the opinion is available at: Link to Opinion
The SLCs were issued as part of a licensing agreement under which plaintiffs granted one defendant, as licensee, the exclusive rights to use certain trademarks on sportswear apparel in the United States and Canada for a fixed period of time. The second defendant, who was the licensee’s parent company, signed the agreement as guarantor.
The licensee defaulted under the amended licensing agreement, and the defendant issuer of the SLCs refused to honor plaintiffs’ demand for payment, claiming that they failed to comply strictly with the terms of the SLCs.
The plaintiffs moved for summary judgment on their breach of contract claim, but the trial court denied the motion because an amendment to the license agreement had been backdated, constituting a misrepresentation, and the plaintiffs had not proven as a matter of law that they had complied with a requirement in the SLCs under which the plaintiffs were required to send an authenticated Society for Worldwide Financial Telecommunication (SWIFT) message from defendant issuer confirming that plaintiffs had fulfilled their “commitment towards the account party.”
On appeal, the Court first pointed out that licensee and guarantor had breached the agreement by failing to make minimum guaranteed royalty payments, finding that the purpose of the SLCs was to ensure that plaintiff licensors had an easily accessible remedy in the event of another default.
As you may recall, the beneficiary of a SLC must prove that it strictly complied with the terms of the SLC in order to recover on its claim that the issuer wrongfully refused to honor its request to draw down the SLC. Under New York law, the corollary to this rule is that the terms of the SLC must be clear, and all ambiguities are construed against the issuer.
The Court first considered whether the plaintiffs’ presentation complied with the SLC requirement that plaintiffs submit an authenticated SWIFT message from the issuing bank confirming that plaintiffs had fulfilled their “commitment” towards the account party.
The plaintiff licensors argued that all they had to do was to sign the amended licensing agreement as part of the restructuring of the parties’ original transaction, and this requirement was satisfied when the defendant issuer sent a SWIFT message to plaintiffs’ bank confirming that it had received the fully executed agreement. The defendant issuer, on the other hand, argued that it was to be the sole arbiter of whether plaintiffs had fulfilled their commitment towards defendant licensee under the amended licensing agreement.
The Court found that the language of the SWIFT message requirement in the SLC was ambiguous because the word “commitment” was not defined, and made no reference to the underlying amended license agreement, unlike other requirements of the SLC, which referenced the “underlying contract and this SLC.”
Construing this ambiguity against the issuing bank, the Court concluded that the plaintiff licensors’ interpretation of the SLCs was the more reasonable one in light of the purpose of the amended license agreement, which was to restructure the debt owed to the plaintiffs as the result of the defendant licensee’s default under the original licensing agreement. The Court held that plaintiffs fulfilled their commitment to the defendant licensee and guarantor by signing the amended licensing agreement, and once the issuer sent the SWIFT message acknowledging receipt of the signed amended licensing agreement, that SLC requirement was satisfied.
The Court added that to hold otherwise would run afoul of the “independence principle,” the conceptual foundation on which letters of credit are built, which provides that the issuing bank’s obligation to honor a draft drawn on a letter of credit by the beneficiary is separate and distinct from any obligation of the bank’s customer towards the beneficiary under their agreement, as well as separate and distinct from any obligation of the issuer to its customer under their agreement.
The Court reasoned that the independence principle is what makes a letter of credit preferable to a surety bond, because the issuer cannot assert the defenses that an ordinary guarantor can based on the transaction underlying the letter of credit. The Court further noted that a letter of credit would no longer be commercially useful if the issuer could look beyond the terms of the letter of credit to the underlying contractual dispute between its customer and the beneficiary.
The Court then rejected the issuer’s argument that it was excused from honoring the SLCs because the plaintiffs backdated the amended licensing agreement, reasoning that while the fraud exception codified in the Uniform Commercial Code provides that an issuing bank may refuse to honor documents that are facially valid, but are forged or materially fraudulent, or if honoring payment would facilitate fraud by the beneficiary on the issuer or applicant, this exception to the independence principle is narrow and only available on a showing of intentional fraud.
The Court held that the backdating of the underlying amended license agreement by the plaintiffs by approximately two weeks had nothing to do with the terms of the SLCs, which required that the plaintiffs submit claim letters and audited statements from an independent accounting firm. According to the Court, because the underlying transaction was valid, the backdating did not excuse the issuing bank from paying on the SLCs.
Finally, the Court rejected the other technical presentation discrepancies urged by the defendant issuer to refuse payment on the SLCs, reasoning that the strict compliance standard does not require that the documents presented by the beneficiary be exact in every minute detail that could mislead the issuer to its detriment.”
Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
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Email: rwutscher@mwbllp.com
Admitted to practice law in Illinois
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