Opinion ID: 1625318
Heading Depth: 1
Heading Rank: 10

Heading: issues

Text: In order to determine whether the issuing banks may be enjoined from paying under the letters of credit, the following issues must be decided: 1. What is the meaning of fraud in the transaction, in R.S. 10:5-114(2), as applied to standby letters of credit which are used to secure bank financing? 2. Whether such fraud occurred in this case, entitling plaintiffs to the injunctive relief provided for in R.S. 10:5-114(2)(b)? The right to enforce payment of drafts issued under a letter of credit is governed by R.S. 10:5-114, which provides: (1) An issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying contract between the customer and the beneficiary. The issuer is not excused from honor of such a draft or demand by reason of an additional general term that all documents must be satisfactory to the issuer, but an issuer may require that specified documents must be satisfactory to it. (2) Unless otherwise agreed when documents appear on their face to comply with the terms of a credit but a required document does not in fact conform to the warranties made on negotiation or transfer of a document of title or of security or is forged or fraudulent or there is fraud in the transaction. (a) the issuer must honor the draft or demand for payment if honor is demanded by a negotiating bank or other holder of the draft or demand which has taken the draft or demand under the credit and under circumstances which would make it a holder in due course and in an appropriate case would make it a person to whom a document of title had been duly negotiated or a bona fide purchaser of a security; and (b) in all other cases as against its customer, an issuer acting in good faith may honor the draft or demand for payment despite notification from the customer of fraud, forgery or other defect not apparent on the face of the document but a court of appropriate jurisdiction may enjoin such honor. (3) Unless otherwise agreed an issuer which had duly honored a draft or demand for payment is entitled to immediate reimbursement of any payment made under the credit and to be put in effectively available funds not later than the day before maturity of any acceptance made under the credit. Since the issues of this case are res nova in Louisiana, it is necessary to briefly define the letter of credit and examine its background and commercial significance. A letter of credit is a written engagement by the issuer, usually a bank, to honor demands for payment which comply with the terms of the credit. A letter of credit involves at least three parties: the party requesting that the letter of credit be issued (customer); the party issuing the letter of credit (issuer); and the party in whose favor the letter of credit is issued (beneficiary). (Footnotes omitted). Hawkland & Holland, UCC Series § 5-101:02 (Art 5). Traditionally, letters of credit have been used to finance international sales transactions. When used in this conventional fashion the credit is often designated a commercial letter of credit. In a typical sale of goods transaction, involving a commercial letter of credit, the buyer (customer) requests his bank (issuer) to issue a letter of credit in favor of the seller (beneficiary). The seller/beneficiary is then entitled to draw on the letter of credit upon presentment of certain documents. The documentary evidence submitted to the issuing bank, such as a bill of lading, is proof that the goods have been shipped by the seller. The fundamental purpose of the letter of credit in the commercial context is to assure the seller/beneficiary that he will be paid for his goods. Without the letter of credit, the international seller might only have the buyer's promise as an assurance of payment. The letter of credit allows the seller to replace the customer's obligation to pay with the commitment of a bank to pay drafts under the letter of credit. The letter of credit is separate and distinct from the underlying transaction. Therefore, the issuer's duty to honor properly documented drafts is unrelated and independent of the underlying obligation. This rule of independent contracts, sometimes referred to as the independence principle, is embodied in R.S. 10:5-114(1), which provides that: An issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying contract between the customer and the beneficiary.... Courts throughout the country have consistently applied the independence principle to letter of credit transactions. The reasoning behind the courts' strict application of the independence rule is accurately stated in Intraworld Industries, Inc. v. Girard Trust Bank, 461 Pa. 343, 336 A.2d 316, 323 (1975): The great utility of letters of credit flows from the independence of the issuer-bank's engagement from the underlying contract between beneficiary and customer. Long-standing case law has established that, unless otherwise agreed, the issuer deals only in documents. If the documents presented conform to the requirements of the credit, the issuer may and must honor demands for payment, regardless of whether the goods conform to the underlying contract between beneficiary and customer. Absent its agreement to the contrary, the issuer is, under the general rule, not required or even permitted to go behind the documents to determine if the beneficiary has performed in conformity with the underlying contract. (Citations omitted). In recent years, the letter of credit has been extended beyond its traditional usage in the sale of goods context. One of these applications has been labeled a guarantee or standby letter of credit. The letters of credit obtained by the plaintiffs were standby letters of credit. The standby letter of credit has been utilized extensively to secure bank financing for business ventures. In this context the letter of credit guarantees the repayment of a loan. When used to secure bank financing, the standby credit differs from the commercial credit in several respects. First, the event which triggers payment in the standby situation is a default on the underlying loan. The customer knows that the standby letter of credit will not be drawn on unless there is troubleusually default on a loan made by the beneficiary. In contrast, the commercial credit is triggered by the shipment of goods and the presentation of documents which verify the shipment. A second difference exists with regard to the beneficiary under the credit. In the commercial context, the seller is the beneficiary and he has the corresponding right to draw on the letter of credit. In contrast, when the credit secures a loan, the lending bank is the beneficiary. There are several reasons why lending banks find it desirable to utilize letters of credit to secure the repayment of loans. First, the credit transfers the responsibility of payment from the customer to the issuing bank. Thus, the lending bank is assured payment unless the issuing bank becomes insolvent. Second, the credit is thought to offer an expeditious means of obtaining payment after default on a loan. Upon default, the lending bank merely submits affidavit evidence that the default occurred, and it may then draw on the standby letter of credit. In recent years the standby letter of credit has emerged as a unique financial device capable of accomplishing a variety of guaranty functions. Cf. Paster v. National Republic Bank of Chicago, 76 Ill.2d 139, 28 Ill.Dec. 535, 538, 390 N.E.2d 894, 897 (Ill.1979); Verkuil, Bank Solvency and Guaranty Letters of Credit, 25 Stan.L.R. 716, 721 (1973). Although the U.C.C. provisions were primarily intended to focus on commercial letters of credit, the drafters intended for the Code to permit such novel applications. R.S. 10:5-101, U.C.C. Comment 1; R.S. 10:5-102, U.C.C. Comment 2. R.S. 10:5-102(3) provides that the letter of credit provisions in Chapter 5 are not intended to inhibit the future development of the laws governing letters of credit. Therefore, in deciding cases involving novel applications of letters of credit, we are authorized to consider the manner in which the courts of our sister states have decided such cases.