Filed: December 17, 1998

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

No. 97-2025

(CA-91-3179-JFM)

Banca del Sempione,

Plaintiff - Appellee,

versus

Provident Bank of Maryland,

Defendant - Appellant.

ORDER

The court amends its opinion filed November 12, 1998, as

follows:

On page 2, section 1, line 6 -- counsel’s name is corrected to

read “Alec W. Farr.”

For the Court - By Direction

/s/ Patricia S. Connor

Clerk
PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

BANCA DEL SEMPIONE,

Plaintiff-Appellee,

v.

PROVIDENT BANK OF MARYLAND,

Defendant-Appellant.

and

SURIEL FINANCE N.V.,

No. 97-2025

Defendant,

JEANNE FARNAN,

Party in Interest.

UNITED STATES COUNCIL ON

INTERNATIONAL BANKING,

INCORPORATED,

Amicus Curiae.

Appeal from the United States District Court

for the District of Maryland, at Baltimore.

J. Frederick Motz, Chief District Judge.

(CA-91-3179-JFM)

Argued: April 10, 1998

Decided: November 12, 1998

Before LUTTIG and WILLIAMS, Circuit Judges, and

BUTZNER, Senior Circuit Judge.

_________________________________________________________________

Affirmed by published opinion. Senior Judge Butzner wrote the opinion, in which Judge Luttig and Judge Williams joined.

_________________________________________________________________
COUNSEL

ARGUED: Philip K. Howard, HOWARD, DARBY & LEVIN, New

York, New York, for Appellant. Warren Lewis Dennis, PROSKAUER ROSE, L.L.P., Washington, D.C., for Appellee. ON BRIEF:

Daniel M. Mandil, HOWARD, DARBY & LEVIN, New York, New

York; Larry J. Gebhardt, James T. Heidelbach, GEBHARDT &

SMITH, Baltimore, Maryland, for Appellant. Alec W. Farr, Orrie

Dinstein, PROSKAUER ROSE, L.L.P., Washington, D.C., for Appellee. Brian J. Downey, Annandale, Virginia, for Amicus Curiae.

_________________________________________________________________

OPINION

BUTZNER, Senior Circuit Judge:

Provident Bank of Maryland appeals the district court's judgment

entered in favor of Banca Del Sempione (BDS) after a bench trial

conducted pursuant to remand. We affirm.

I

The facts are stated in detail in previous opinions, Sempione v. Suriel Finance, N.V., 852 F. Supp. 417 (D. Md. 1994) (Sempione I,

Black, C.J.), and Sempione v. Provident Bank, 75 F.3d 951 (4th Cir.

1996) (Sempione II). Briefly the record discloses that Rock Solid

Investment (RSI), Provident's customer, sought a $6,700,000 loan

from Suriel. The loan agreement required RSI to obtain a standby letter of credit (LOC) to secure payment of interest. The LOC was to be

irrevocable, unconditional, transferable, and annually renewable in

the amount of $750,000 for a period of seven years. Suriel arranged

to borrow funds from BDS to make the loan to RSI, and BDS insisted

that the LOC securing interest must be renewable each year for the

life of the loan.

Provident arranged for Manufacturers Hanover Trust to confirm the

LOC for one year. Manufacturers provided that if its confirmation

expired while the LOC was in existence, the LOC would be available

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from Provident. BDS satisfied itself that Provident had sufficient

assets to honor the LOC.

Manufacturers sent its confirmation to Suriel and BDS, which was

acting as Suriel's advisory bank. BDS objected to the terms of the

LOC because extension beyond one year was dependent on the maintenance of collateral for the LOC. Suriel voiced these objections, and

in response Provident wrote a series of letters. The letters withdrew

the condition pertaining to collateral and provided that the LOC shall

be "automatically reavailable to you upon your receipt of our tested

telex."

The LOC contained a clause expressly making it transferable. At

Suriel's request, Manufacturers, acting as "transferring bank," transferred the LOC in its entirety from Suriel, the first beneficiary, to

BDS, the second beneficiary. Manufacturers notified Provident of the

transfer.

RSI posted $800,000 collateral to secure the Provident LOC. An

official at Provident, however, allowed the collateral to be withdrawn

from time to time in order for RSI to pay interest on the loan. Eventually the collateral was exhausted, and RSI was unable to pay the interest.

After several drawings by BDS for interest under the transferred

LOC, Manufacturers dishonored a subsequent draw because it was in

excess of the amount confirmed. Upon Provident's refusal to pay

BDS directly, BDS instituted this action. This court reversed a summary judgment in favor of Provident and remanded the case for an

evidentiary hearing. On remand, the district court held that the LOC

obligated Provident to pay interest to BDS for the life of the loan;

Provident has appealed. The district court also held that BDS was not

entitled to recover punitive damages and attorney fees; BDS has not

cross appealed these aspects of the district court's judgment.

II

The primary issue raised by Provident is whether a letter Provident

wrote was a side letter--as Provident contends--or an amendment to

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the LOC--as BDS contends. Although Provident sent a series of letters to Suriel, the district court considered Provident's letter of September 26, 1989, to be dispositive. This letter provided in part:

RE: Standby Letter of Credit No. 99205

Provident Bank of Maryland hereby agrees as follows with

regard to our obligations under Standby Letter of Credit No.

99205 and in conformity with our commitment dated July

21, 1989:

"If you should draw on us your interest draft as set

forth, the amount of $750,000 shall be automatically reavailable to you upon your receipt of our

tested telex or amendment provided this Letter of

Credit shall not have terminated."

Sempione II, 75 F.3d at 956. The author of this letter testified, and the

court found, that he intended the letter to be a side agreement and not

an amendment to the LOC. BDS, on the other hand, believed that the

letter was an amendment to the LOC and acted upon that belief.

The district court held that the subjective intent and beliefs of the

parties were not controlling. Instead, the district court held that the

intent of the parties and the meaning of Provident's letter should be

objectively ascertained in conformity with the official comment to

MD. Code Ann. Com. Law § 1-205 (UCC § 1-205), which teaches

that the meaning of a document must be determined by the language

the parties used and their actions in the context of commercial practices. To plumb the meaning of the language and commercial practices, the district court turned to the Uniform Customs and Practices

for Documentary Credits (UCP 1983, ICC 400, in effect at the time

of this transaction), which is a code whose scope is"to be proved as

facts." Md. Code Ann. Com. Law § 1-205(2) (UCC § 1-205(2)). The

LOC expressly provided that it was subject to the UCP.

Both parties introduced the testimony of expert witnesses on these

subjects. The district court, after carefully explaining its reasons,

decided that the experts presented by BDS correctly explained that

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according to the practices, usages, and customs of bankers, Provident

amended the LOC to make it automatically renewable each year without conditions. The experts also explained that a "tested telex" was

simply a ministerial act which did not impose a condition on the

LOC. The letter was written on Provident stationery; it referred by

number to the LOC that Provident had issued; it changed the terms

of the LOC from one year as originally issued to an LOC that was

"automatically renewable" if BDS found it necessary to draw on their

interest draft. We conclude that the evidence amply supports the district court's conclusion that Provident amended the LOC to make it

available to BDS for the life of the loan.

III

The second issue raised by Provident is

whether a party (i.e. Suriel) that acquired a letter of credit

amendment by deceit can then transfer it free of defenses,

as if the letter of credit were a negotiable instrument.

Provident argues that it may use the defenses it had against Suriel, the

transferor of the LOC, against BDS, the transferee. Provident also

insists that Suriel was BDS's agent and that BDS was not a holder in

due course and therefore cannot claim the protection accorded a negotiable instrument. Provident claims that BDS was an "involved beneficiary." As such, Provident argues, BDS was in control of the

transaction and is accountable for Suriel's conduct. Provident asserts

that a transfer of an LOC is treated as a contractual assignment and

a transferee cannot have rights greater than the transferor.

The district court noted that Maryland law describes an agency

relationship as "manifestation of consent by one person to another

that the other shall act on his behalf and subject to his control, and

consent by the other so to act." Restatement (Second) of Agency

§ 1(1) (1958); accord Patten v. Board of Liquor License Comm'r, 107

Md. App. 224, 238, 667 A.2d 940, 947 (1995). Suriel was a borrower

and BDS a lender. BDS was entitled to secure the payment of interest

on the contemplated loan by insisting that Suriel obtain a LOC containing terms acceptable to BDS. In passing along to Provident the

terms BDS required, Suriel was simply acting as a borrower anxious

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to get a loan. The district court's conclusion that Suriel was not

BDS's agent is consistent with Mellon Bank, N.A. v. Ternisky, 999

F.2d 791, 797 (4th Cir. 1993). There is no justification for vacating

it.

The district court found that Provident had not proved sufficient

evidence to establish that BDS knew or had reason to know of Suriel's conduct, which the district court described as "trickery." We perceive no reason for setting this finding aside.

A letter of credit "can be transferred only if it is expressly designated as `transferable' by the issuing bank." UCP Article 54(b); Md.

Code Ann. § 5-116(1) (UCC § 5-116(7)). A transfer effectively substitutes the transferee (in this instance BDS, which became the second

beneficiary) for the first beneficiary (Suriel). The transfer creates a

"direct relationship" between the issuer (Provident) and the second

beneficiary (BDS). See Sempione II, 75 F.3d at 964; Algemene Bank

Nederland, N.V. v. Soysen Tarim Urunleri Dis Ticaret Ve Sanayi,

A.S., 748 F. Supp. 177, 181-82 (S.D.N.Y. 1990). This new relationship between the issuer and the second beneficiary gives rise to the

independence principle, which makes letters of credit effective instruments of commerce by assuring the transferee that the credit is free

of defenses against the original beneficiary. John F. Dolan, The Law

of Letters of Credit, ¶10.05 (1996) (hereafter Dolan).

The district court's opinion is consistent with the independence

principle. Article 3 of the UCP establishes the independence principle

of letters of credit as follows:

Credits, by their nature, are separate transactions from the

sales or other contract(s) on which they may be based and

banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s)

is included in the credit.

In San Diego Gas & Elec. Co. v. Bank Leumi, 50 Cal. Rptr. 2d 20,

24 (Cal. App. 1996), the court emphasized that the independence

principle is essential to the utility of letters of credit in commercial

transactions. The district court properly implemented that principle by

applying it to the facts of this case. This concept or principle means

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that the transferee (BDS) takes free of all the defenses that the issuer

(Provident) has against the first beneficiary (Suriel). Cf. Cromwell v.

Commerce & Energy Bank, 464 So. 2d 721, 732, 736 (La. 1985);

Brown v. United States Nat'l Bank, 371 N.W.2d 692, 700 (Neb.

1985); article 3 UCP. A succinct statement of the independence principle is found in Dolan, ¶ 10.05: "Thus, although it is true that the

transferable credit is not a negotiable instrument, it is not necessarily

true that the transferee cannot have greater rights than those of the

first beneficiary."

Provident relies on a statement in the official comment to Md.

Code Ann. § 5-116 (UCC § 5-116) in which it is stated: "If it [LOC]

is so designated [i.e. expressly designated as assignable or transferable], the normal rules of assignment apply . . .." This comment is

correct with respect to assignments. But Provident cites neither cases

nor texts that support the notion that the normal rules of assignment

apply to the transfer of a letter of credit.

In light of the ambiguous comment to section 5-116, it becomes

important to consider the practices and customs of banks engaged in

international transactions involving letters of credit. An expert witness retained by BDS had been employed by Morgan Guaranty Trust

Company of New York in the letter of credit department for 37 years.

He also served on international committees that dealt with letters of

credit. The district court credited this expert's testimony because of

his broad experience in every aspect of letters of credit. Some of the

letters of credit that he had the responsibility of issuing were transferable under the UCP. He testified: "As a matter of custom and practice

the industry looks at the transfer to the second beneficiary as a separate undertaking, as a separate independent undertaking." JA 1907.

Speaking of Provident's argument that an issuer's (Provident's)

defense against the first beneficiary (Suriel) could be asserted against

the second beneficiary (BDS), he testified: "In my opinion, if this

view was to be taken it would destroy transferrable Letters of Credit

because the second beneficiary wouldn't be able to determine, without a lot of effort, whether he has a good claim against the issuer

under that separate undertaking that was transferred to him." JA 1908-

09. He also testified that he never heard any banker or member of a

letter of credit committee express a view in accord with Provident's

argument.

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We conclude that the district court properly decided that any

defense Provident had against Suriel could not be asserted against

BDS.

IV

A brief outline of the structure of the loan is helpful in understanding the parties' dispute about damages. The principal was secured by

the Guaranteed Investment Fund (GIF), consisting of zero coupon

bonds. BDS purchased the bonds on account of the borrower, and part

of the proceeds of the loan reimbursed BDS. The loan agreement

authorized BDS to sell the bonds at any time. At the end of the sevenyear term of the loan, the loan was discharged without further payment.

The Provident LOC secured the interest. After a short bridge loan

from a third party, RSI deposited some of the proceeds of the loan to

secure the letter of credit, but Provident allowed RSI to deplete the

deposit in order to pay interest. The loan agreement gave the borrower

the right of anticipation after five years subject to certain conditions,

but neither Suriel nor RSI complied with these conditions.

The borrower was obligated to pay interest on the "unpaid principal

balance" of the loan. Provident argues that when BDS sold the zero

coupon bonds, the principal of the loan was reduced, the borrower's

obligation to pay interest was reduced, and the obligation of the LOC

was also reduced. BDS argues that the GIF was the collateral for the

loan and that the loan agreement gave it the right to "sell, discount,

trade, or assign the proceeds of the Guaranteed Investment Fund

(GIF) anytime during the loan term." JA 3907. Sale of the bonds,

BDS argues, did not reduce the principal of the loan but rather was

an exercise of the right, which the loan agreement granted, pertaining

to the GIF.

The district court ruled that BDS sold the bonds pursuant to the

loan agreement and that, consequently, Md. Code Ann. § 9-504 (UCC

§ 9-504), which governs the sale of collateral, was inapplicable. The

district court concluded that the sale of the zero coupon bonds did not

effect the right of BDS to claim interest on the entire principal. It reasoned that the GIF, not the bonds, was the collateral securing the note

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and that the sale of the zero coupon bonds was not a sale of the GIF.

Moreover, at the maturity of the loan, the borrower had the right to

demand that the GIF was the sole source for repayment of the loan,

regardless of the nature and amount of the GIF's assets. The borrower

owed nothing more. In the words of the loan agreement, the "repayment obligation shall be non-recourse to the other assets of Borrower." JA 3907.

Because the GIF, and not the zero coupon bonds, was the collateral

for the loan, the sale of the zero coupon bonds was not a sale of the

collateral. Therefore, the entire loan amount was still unpaid after the

sale, and BDS could still collect interest on the entire unpaid principal. As the district court observed, the transaction was not as onerous

as it appears at first blush. Although RSI had to pay interest as a part

of the loan proceeds it never received, it did not have to repay the

principal of the loan.

RSI defaulted by failing to pay interest as it became due. The loan

agreement provided for default interest at the rate of 5% above interest on the loan. The district court held that BDS should recover interest at the default rate after RSI defaulted. The court recognized,

however, that the LOC has a $750,000 annual cap, and it denied

recovery of interest in excess of the cap.

We affirm the district court's judgment pertaining to Provident's

liability and the measure of damages including prejudgment interest

and a limited amount of default interest.

AFFIRMED

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