A. The Standby Letter-of-Credit Transaction
Figure 24.1 - Standby Letters of Credit
Nobel Insurance Co. v. First Nat'l Bank (DOC | TXT | HTM)
Figure 24.2 - Form Standby
Letter of Credit
Wood v. State Bank
B. Problems in Standby Letter-of-Credit Transactions
1. Bankruptcy of the Applicant
In re Ocana
2. The Issuer’s Right of Subrogation
CCF, Inc. v. First National Bank
(In re Slamans)
Problem Set 24
Problem Set 24
24.1. Archie Moon (a bookdealer friend that you’ve been
representing for some time) sends you a telecopy one morning that
includes a proposed agreement with one of his major suppliers. The
agreement states that Archie “at all times will maintain a clean standby
letter of credit from a bank reasonably satisfactory to Seller.” Archie
has called his banker at Safety Central Bank, who has agreed to issue a
letter of credit in the appropriate amount if Archie allows the bank to
maintain possession of some certificates of deposit that Archie owns.
Archie has no problem with that arrangement, and wants to know if you
have any concerns about the letter of-credit provision quoted above.
24.2. Jodi Kay is working on a possible construction loan to
Chancellor Investments, a long-time developer in her area that has
suffered some hard times recently. Because Jodi has never done any
business with Chancellor before, she is highly motivated to get the
transaction for her bank. Jodi’s bank ordinarily insists on a personal
guaranty for at least one-quarter of the construction-loan amount, even
for the most attractive projects from the most reputable developers.
Jodi’s concern is that the principal of Chancellor Investments (Olive
Chancellor) has suffered some financial reverses during the last several
years that make Jodi doubt Olive’s ability to cover the $500,000
guaranty that would be standard in this transaction. When Jodi raised
that concern with Olive, Olive responded that she understood Jodi’s
concern. Olive asked if Jodi would be willing, in lieu of the guaranty,
to accept a $500,000 letter of credit from SecondCity Bank, Chancellor’s
principal bank. Olive faxed SecondCity’s letter-of-credit form to Jodi,
who says it is identical to a form that you have approved in the past.
Jodi is completely satisfied with SecondCity’s financial strength. Is
there any other reason that you can see why Jodi should be concerned
about accepting a standby letter of credit as a substitute for a
guaranty?
24.3. Jodi followed your advice in Problem 24.2 and the loan
transaction went forward without incident. Several months later,
however, you read in the newspaper one morning of a bankruptcy filing by
Chancellor Investments. Accordingly, you are not surprised later that
afternoon to receive a phone call from Jodi. She tells you that she has
just spoken with the general contractor on the project, who tells her
that he could finish the project for $300,000. Jodi started by calling
Olive to tell her that she plans to pursue her remedies as forcefully as
possible to get the $300,000. Jodi became concerned when she received a
telecopied letter from Olive’s attorney advising her that any action
against Olive or the SecondCity letter of credit would violate the
Bankruptcy Code’s automatic stay. What do you advise? 11 U.S.C. §§ 105,
362(a)(3).
24.4. Stacy Vye (the Wessex Bank loan officer) calls you about a $40,000 standby letter of credit that one of
her less experienced loan officers issued several weeks ago. The letter
of credit was issued for the benefit of Timothy Fairway at the behest of
Stacy’s customer Damon Wildeve. Fairway had agreed to build some
customized cabinetry for Wildeve’s office. This morning, Fairway called
Stacy to tell Stacy that Fairway would be drawing on the letter of
credit because Wildeve refused to pay when Fairway delivered the
cabinets to Wildeve yesterday. When Stacy called Wildeve, Wildeve told
Stacy that he was sorry but that his business had done so poorly that he
had no money to pay Fairway. A few minutes ago, Fairway appeared at
Stacy’s office with a draft on the letter of credit. Because the draft
appeared to be in order, Stacy paid it.
Stacy is concerned because the loan officer that issued the letter of
credit (Clym Yeobright) arranged for reimbursement by having Wildeve
pledge $50,000 of Wildeve’s stock in Tram Whirl Airlines (TWA). Because
of TWA’s bankruptcy last week, that stock is now completely worthless.
Stacy wants to know what she can do to get paid if, as appears likely,
Wildeve has no money to pay her. UCC §§ 2-702(2), 5-117(a); 11 U.S.C. §§
509(a), 546(c).
24.5. Before she leaves, Stacy asks about a problem that she has
on another one of her letters of credit. Wessex Bank issued a standby
letter of credit for the benefit of Bulstrode Bank. Stacy issued the
letter of credit to back up the obligation of Tertius Lydgate to repay a
construction loan for a new medical office building that Lydgate has
under construction, but neglected to take any collateral securing
Lydgate’s obligation to reimburse Wessex if it should be forced to pay
on the letter of credit. In addition to the letter of credit from Stacy,
Bulstrode took a lien on the office building to secure Lydgate’s
obligation to repay the loan. Because Lydgate’s financial affairs have
collapsed, Lydgate has fallen into default on the loan from Bulstrode.
Accordingly, Bulstrode last week presented a draft on the letter of
credit to Stacy. In response to the draft she issued a check to
Bulstrode in the full amount of the loan from Lydgate.
Thinking it was a routine matter, Stacy hired one of your associates to
attempt to obtain reimbursement from Lydgate. Stacy assumed that Wessex
would be subrogated to Bulstrode’s lien against Lydgate’s office
building and that Wessex could use that lien to take the office building
from Lydgate. It turns out, however, that a state statute requires
mortgage creditors to release liens whenever they receive full payment
of their loans. Hence, Bulstrode released the lien on the building the
day after Bulstrode received payment of the loan from Wessex.
(a) Does that release by Bulstrode mean that Wessex has lost its
right to use that lien to pursue Lydgate? UCC § 5-117 & comment 2.
(b) Would the same thing be true if Stacy had acted as a
guarantor instead of having Wessex issue a letter of credit? In
pondering that question, assume that the guaranty would have been in the
form set out in Assignment 20, except that it also would have included a
defeasance provision like the one set out in Assignment 21. Continuing
Guaranty § 10.
24.6. Bulstrode issues a standby letter of credit related to an
issue of bonds by General Motors. The letter of credit incorporates
ISP98 by reference. The letter of credit conditions payment on
presentation of a draft described as follows: "The draft must include
the exact wording that follows: 'General Motors has failed to make a
payment on its Series C 20-year bonds maturing January 1, 2006.'"
General Motors defaults on the bonds. Subsequently, the beneficiary
of the letter of credit submits a draft that states: "General Motors has
failed to make a payment on its Series C 20-year bonds maturing January
1, 2006." Is Bulstrode obligated to pay? UCC § 5-108(a) & comment 1; UCP
art. 13(a); ISP98 Rule 4.09.
24.7. In a weak moment last summer, you agreed to serve on a
committee considering revisions to the ICC Uniform Customs and Practice
for Documentary Credits. (One of your partners suggested that it might
be a good way to attract some new clients.) Your first task on the
committee is to consider differences between that document and ICC
ISP98. You have been asked to write an analysis of two of the ISP
provisions. The first of the provisions is Rule 4.09, at issue in the
previous problem. The second is Rule 4.08, which provides that a standby
letter of credit is presumed to require a demand for payment even if the
letter of credit does not call for it. As you know, those rules differ
from the rules set out in UCP art. 13, which include no analogous
requirement for specific documents and contemplate examination under
“international standard banking practice.”
Do you see any basis for either of the two distinctions? Would your
recommend revising the UCP to bring it into conformity with ISP98?
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