Tales of Whoa!

RMA Journal, The, Nov, 2003 by Michael L. Weissman

On the Docket: Issuer of a letter of credit is liable to the beneficiary for dishonoring a draw for reasons unrelated to the documents presented with draw.

In Amwest Surety Insurance Co. v. Concord Bank, 248 F. Supp. 2d 867 (E.D. Mo. 2003), Concord issued an irrevocable letter of credit for $1.2 million with Amwest Surety as beneficiary at the request of CMR Construction, Inc. CMR had asked Amwest to issue a payment and performance bond to secure CMR's performance of a construction project--the Argyle Parking Garage--for the City of St. Louis. Amwest required the letter of credit as collateral security for its payment and performance bond.

Other documents related to the project were executed concurrently with the letter of credit. A disbursement agreement stipulated that all funds paid by the City of St. Louis for the project were to be disbursed by a professional construction disbursement company. The only funds to be paid directly to CMR--amounts approved by the city's construction manager--were to be paid through the disbursement company. Parties to this agreement were CMR, Amwest Surety, St. Louis Disbursing Corp., and Contractor Disbursement Services. A letter of direction directed that all payments made under the construction contract should be sent to Enterprise Bank for deposit in an account established for the disbursement agreement.

Despite the terms of the disbursement agreement, in the spring and summer of 2000 the city made two payments totaling $80,000 to CMR instead of depositing the money in Enterprise Bank. St. Louis Distribution Corp. warned the city that these misdirected payments jeopardized coverage under the Amwest bond. The city did not heed the warning and, in September 2000, sent payments totaling $481,122.90 directly to CMR. The following month relations among the parties had deteriorated so badly that the Argyle Parking Garage project was shut down.

On November 17, 2000, Amwest presented a sight draft for $1.2 million to Concord with the written certification required by the terms of the letter of credit, which included a statement that Amwest had not been released from liability on its bond. On the advice of counsel, Concord refused to honor the draft. Fifteen days after receiving the sight draft and certification, Concord's attorney sent a notice to Amwest stating that the reason was Amwest's failure to satisfy the terms of the letter of credit. The notice asserted that Amwest was released from its liability on the payment and performance bond because of information "which is well known and documented by Amwest." Concord amplified its assertion, citing the city's misdirection of funds as the basis for Amwest's release from liability. At no time did Concord return the original letter of credit, sight draft, and certification to Amwest.

On December 15, 2000, Amwest sued Concord for wrongful dishonor. Noting that the letter of credit was governed by UCP 500, the court agreed.

1. The court ruled that the dishonor was untimely, since Article 14 of UCP 500 states that notice of dishonor of a draft must be given no later than the close of the seventh banking day following receipt of the draft. Concord took 15 days to dishonor.

2. The notice of dishonor was declared defective because it did not state all of the discrepancies on which the dishonor was based. Concord asserted that one reason it dishonored the draft was that it doubted Amwest's ability to fulfill its reimbursement obligation, but the notice of dishonor made no mention of this.

3. The notice of dishonor was deemed defective because it failed to comply with Article 14 of the UCP, which requires not only notice of all discrepancies but also whether the documents are being held at the disposal of, or are being returned to, the presenter. Concord's notice did not touch on this point.

4. Most important, the dishonor, which invoked the city's misdirection of funds, called for a legal interpretation of documents other than those presented with the sight draft. The court said there was a violation of the most basic rule governing letters of credit--the independence principle. Indeed, the court said, "Concord Bank decided to dishonor the sight draft, relying upon its own independent review of the underlying contractual relationships and actions by non-parties, and its own 'legal' research regarding Amwest's rights under the performance and payment bonds... This research and the reliance thereupon violated the 'independence principle' and the relevant provisions of the UCC and the UCP 500."

What's the point? Issuers of letters of credit that are subject to UCP 500 should become familiar with its requirements and under no circumstances should they base the dishonor of a draft on documents not contemplated by the terms of the letter of credit unless they are certain the underlying transaction is permeated with fraud.

Contact the author by e-mail at Michael.Weissman@ bridgeviewbank.com or by telephone at 773-975-5308.

[c] 2003 by RMA. Weissman is EVP and General Counsel of the Bridgeview Bank Group and counsel to the Chicago law firm of Holland & Knight, LLP. He has prosecuted civil and bankruptcy matters on behalf of many financial institutions.