Court Opinion

ID: 8917545
Source: CourtListenerOpinion
Date Created: 2022-11-27 05:42:02.800921+00
Date Added: 2024-06-11T17:09:07.705993
License: Public Domain

ADAMS, Circuit Judge,
dissenting from the judgment of affirmance.
I would reverse the judgment of the district court, inasmuch as I do not believe that the conduct complained of in this case amounts to “fraud in the transaction” as that term has been defined under Pennsylvania law. Moreover, I believe that the decision announced by the Court today will increase the pressure on financial institutions to dishonor letters of credit, thus making less certain the underpinnings of many commercial transactions.
I
Letters of credit provide an effective, efficient, and economic means of guaranteeing payment to a seller of goods or services. For a fee, the issuer, usually a bank, *1217commits itself to pay a certain sum when the seller, the beneficiary, satisfies the terms and conditions set out in the letter of credit.
Three distinct contracts are bound up in such credit transactions: the underlying sales agreement between the seller and the buyer; the credit agreement between the bank and its customer (the buyer) specifying the latter’s obligation to reimburse the bank when it honors a draft drawn on the letter; and the agreement between the bank and the beneficiary, the letter of credit itself, obligating the bank to pay the beneficiary upon satisfaction of the formal conditions set down in the letter. This last agreement is usually independent of the other contracts. See Insurance Company of North America v. Heritage Bank, 595 F.2d 171, 173-74 (3d Cir.1979); H. Harfield, Letters of Credit 77-78 (1979). Thus, the letter of credit is designed to assure the beneficiary of prompt payment upon presentation of the relevant documents. Disputes as to the underlying sales contracts are separate matters to be resolved by the parties to those agreements, the buyers and the sellers.
II
The issuer’s obligation to honor a draft drawn on a letter of credit when that draft is accompanied by conforming documents is codified at 12A P.S. § 5-114(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 for sale or other contract between the customer and beneficiary.
Pennsylvania law, which governs this diversity action, reinforces the notion that a letter of credit is independent of the underlying transaction by permitting the issuer to honor a demand for payment despite notification by the customer that there has been a “fraud in the transaction,” even though, under such circumstances, “a court of appropriate jurisdiction may enjoin such hon- or.” 12A P.S. § 5-114(2)(b).
Because of the centrality of letters of credit to modern commercial transactions, the Pennsylvania Supreme Court has “narrowly limited” injunctions against the honoring of a letter of credit to those instances of wrongdoing that “so vitiate the entire transaction that the legitimate purposes of the independence of the issuer’s obligation would no longer be served.” Intraworld Industries, Inc. v. Girard Trust Bank, 461 Pa. 343, 359, 336 A.2d 316, 324-25 (1975). The majority today recognizes the Intraworld standard, but then holds that a seller, who submits certified but disputed invoices, commits a fraud that vitiates the entire transaction, thus justifying a bank in dishonoring a letter of credit. This conclusion, I believe, misreads Intraworld and threatens the stability of letter-of-credit transactions.
In Intraworld, the Pennsylvania Supreme Court affirmed a trial court’s refusal to enjoin the honor of a draft under an international letter of credit. Intraworld sought an injunction on the basis of a “fraud ... not apparent on the face of the documents,” alleging that the lease, for which the letter of credit stood as a guarantee of payment, had been terminated. 461 Pa. at 359, 336 A.2d at 324. The court refused to determine the beneficiary’s entitlement to payment under the lease, explaining that this entitlement involved a collateral dispute between the parties to the lease that did not affect the agreement between the bank and the beneficiary under the letter of credit. The bank was obligated to scrutinize carefully all documents submitted by the beneficiary, “but once it determined that the documents conformed to the requirements of the credit, it bore no responsibility for the performance of the lease obligations or the genuineness of the documents.” 461 Pa. at 364, 336 A.2d at 327. The parties to the lease naturally retain their full rights to have the contractual dispute settled in a court of law, but it would “place an issuer in an intolerable position if the law compelled it to serve at its peril as an arbitrator of contract disputes between customer and beneficiary.” Id. In the case at hand, the *1218majority’s opinion, in my view, will put issuing banks in the intolerable position the Pennsylvania Supreme Court sought to avoid. The majority has, in addition, fallen victim to what the principal drafter of Article 5 of the Uniform Commercial Code has called the almost irresistible temptation to expand the notion of fraud. Such expansive interpretations are “disastrously inappropriate in a commercial letter of credit transaction.” H. Harfield, Letters of Credit 5 (1979).
The leading case on fraud in the letter of credit context remains Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup.Ct.1941). In Sztejn the court enjoined the honor of a draft drawn on a letter of credit because the beneficiary had intentionally failed to ship any of the goods ordered by the buyer. It is this kind of egregious fraud that the court in Intraworld pointed to in concluding that an injunction is proper only if the beneficiary has no bona fide claim to payment. 461 Pa. at 359-60, 336 A.2d at 325.
In the case before us, the beneficiary had shipped merchandise of the type and quality ordered by the buyer. The sole dispute between seller and buyer concerns the terms of an oral agreement reached after the seller had fully performed its obligations under the sales contract. In holding that non-performance of the subsequent agreement constitutes fraud in the Sztejn sense, the majority’s opinion will put pressure on financial institutions to go beyond the transactions they normally must monitor in discharging their obligations under letters of credit.
The cardinal precept that a letter of credit is independent of, and to be construed without reference to, other contracts or arrangements, excludes adjudication of collateral controversies. A showing, however convincing, that there has been a breach of a collateral contract has no relevance to a dispute about the proper performance of a letter of credit contract. A transaction within the purview of Section 5-114 must, therefore, be so intimately related to the independent letter of credit contract as to be an implied term of that contract.
H. Harfield, Letters of Credit, 84-85.
To conclude that disputed oral agreements reached after one party has fully performed are so intimately related to the independent credit contract as to be an implied term would mean that issuing banks could never be sure of the terms of the agreement governing their obligations under letters of credit. Banks would constantly be drawn into litigation in which the primary dispute is between the beneficiary and the disappointed customer who already has an adequate remedy at law in a' breach of warranty action. See 12A P.S. § 5-111.
Ill
Another facet of the Court’s opinion causes concern. When an invoice, certified as unpaid according to the terms of a letter of credit, is in fact known to have been paid, the issuing bank, according to the majority, is relieved of its obligation to honor the accompanying draft. Slip op. at 1209.
Here, the record shows that the only notice of the beneficiary’s alleged fraud received by the bank prior to dishonor was a telephone statement by an employee of the customer that the invoices in question had been paid and that the customer did not want the draft to be honored. This hardly amounts to the bank’s knowing, in fact, that the invoices had been paid.
The district court was able to find fraud only after it had reviewed facts developed at an extensive trial and had answered some difficult questions of law. Although this kind of litigation is not appropriate, in my view, when the submitted documents conform on their face to the terms of a letter of credit and although the trial court defined “fraud in the transaction” too expansively, the court did have a fully developed record on which to base its judgment that the customer had committed fraud. The same is not true of the bank, and if the letter of credit is to have the desired effect, financial credit institutions should not be *1219placed in the position of having to develop such a record.
The majority opinion appears to conflate the powers and responsibilities of credit institutions and those of trial courts. Declaring itself bound by Pennsylvania law, the majority correctly asserts that a court may enjoin honor of a draft drawn on a letter of credit when it discovers fraud going to the heart of the transaction. But then citing a comment appended to U.C.C. § 5-114(2), Slip op. at 1211, n. 7, the majority goes on to conclude that a bank may also refuse to honor a draft under such circumstances. I am wary of drawing such a conclusion. The comments to the Uniform Commercial Code are notoriously difficult to assess,1 and given the cautionary note sounded in Intraworld, I would await additional guidance from the Pennsylvania courts before relying on a comment to establish principles regulating commercial transactions of such obvious import to the Commonwealth.
IV
In sum, I believe that the conduct of the seller here, however questionable, is not the kind of fraud that would justify the grant of an injunction against the honor of a letter of credit. In any event, because of the role letters of credit play in modern commerce, disappointed parties to the transactions underlying these letters should be compelled to resolve their disputes in a court of law. Equitable injunctions restraining banks from honoring letters of credit should be confined to narrowly limited circumstances so as to preserve the integrity and efficiency of this method of financing commercial transactions.
Accordingly, I respectfully dissent.

. See Skilton, Some Comments on the Comments to the Uniform Commercial Code, 1966 Wis.L.Rev. 597.