Summary
In Dovenmuehle, Inc. v. East Bank, 563 P.2d 24 (Ct.App. Col. 1977), defendant bank on behalf of two individuals seeking a construction loan issued a letter of credit in favor of plaintiff lender.
Summary of this case from New Jersey Bank v. PalladinoOpinion
No. 76-406
Decided January 6, 1977. Rehearing denied January 27, 1977. Certiorari granted April 25, 1977.
In action by beneficiary of irrevocable letter of credit to recover payment from issuing bank, trial court entered judgment for the beneficiary, and bank appealed.
Affirmed
1. BILLS AND NOTES — Letter of Credit — Subject to UCC — Distinct From — Related Credit Devices. A letter of credit is subject to the provisions of the Uniform Commercial Code, and under the terms of the Code, letters of credit are conceived to exist in an "independent theoretical frame" distinct in nature from related credit devices.
2. Letter of Credit — Issuer — Must Honor Draft — In Compliance With — Terms of Credit — Regardless of Breach — Underlying Contract. An issuer of a letter of credit must honor a draft or demand for payment which complies with the terms of the relevant credit, regardless of a non-fraudulent breach of the underlying contract, for the letter of credit is primarily a contract between the issuer and the beneficiary, and liability arising on the part of the issuer is independent of the underlying contract between the beneficiary and the customer.
3. Letter of Credit — Wrongful Dishonor — Beneficiary May Recover — Full Amount. When there has been compliance with the terms of a letter of credit, wrongful dishonor by an issuer entitles the beneficiary to recover from the issuer the full amount of that letter of credit.
4. Letter of Credit — Bank's Obligation as Issuer — Not Affected By — Party to Underlying Contract — Forming Corporation. Where two individuals, in accordance with condition of loan agreement, procured an irrevocable letter of credit from a bank naming lender as beneficiary of the credit, the subsequent formation of a corporation by the two individuals affected only the relationship between themselves and the lender, and had no legal significance insofar as the bank's obligation to the lender as beneficiary of the letter of credit was concerned; consequently, evidence offered by the bank to prove the intent of the parties to the loan contract and custom and usage regarding certain financing was properly excluded.
5. Letter of Credit — Issuer — Not Guarantor — Underlying Contract — Unless So Stated. Unless the credit so states, an issuer of a letter of credit does not guarantee performance of the contract between the customer and the beneficiary; consequently, even though a beneficiary of an irrevocable letter of credit foreclosed its deed of trust and bid in the property for the unpaid balance owed to it by the customer, the issuer could not avoid payment of the credit on the theory that it was a surety or guarantor whose obligations had been discharged.
6. Letter of Credit — Import Clear — Extrinsic Evidence — Altering Terms of Agreement — Properly Excluded. Where the issuer of a letter of credit maintained that the beneficiary was required to advance the full amount of a loan commitment as a prerequisite to draws on the credit, but the clear import of the credit was to give the beneficiary access to the funds from the inception of the loan agreement, without a full advancement, since no extrinsic evidence was necessary to interpret the letter, and as the issuer's proffered testimony supporting its position would have altered the clear terms of the agreement, such testimony was properly excluded.
7. Letter of Credit — Refusal to Pay — Formally Placed on One Ground — Waiver — All Other Grounds. In cases involving a letter of credit, a refusal to pay formally placed on one ground will be deemed a waiver of all other grounds based on that letter of credit; accordingly, where an issuer refused payment solely on the grounds that work had been terminated on a construction project and that the certifications of a loan imbalance were ambiguous, the issuer's failure to specify the defect that calls by the beneficiary had not been made by draft precluded the issuer from later relying on this defense.
8. Letter of Credit — Independent of Other Contracts — Issuer Not Permitted — Make Determination — Beneficiary Has Performed — Underlying Contract. A letter of credit is the sole contract of the issuer with the beneficiary and is completely independent of other contracts, and the issuer is not permitted to go beyond the terms of the credit to determine if the beneficiary has performed in conformity with the underlying contract.
9. Letter of Credit — Enhances Contractual Latitude — Contract Principles — May Be Embodied — Terms of Credit. Letters of credit do not eradicate the contractual latitude afforded the parties, but are intended to enhance it since, within broad limits, an issuer and the beneficiary may agree that various conditions be satisfied by documentation prior to payment; accordingly, contract principles are not necessarily precluded from consideration if the parties embody them within the terms of the credit.
Appeal from the District Court of the County of El Paso, Honorable George M. Gibson, Judge.
Asher, Kraemer, Kendall Felt, Phillip A. Kendall, Sandy F. Kraemer, for plaintiff-appellee.
C. Lee Goodbar, Jr., Henry B. Eastland, for defendant-appellant.
The defendant East Bank appeals a judgment directed against it on the question of its liability under a letter of credit. We affirm.
Plaintiff Dovenmuehle, Inc., entered into a loan agreement with Ronald Silverman and Ronald Mesec in connection with a construction project. By the terms of the agreement, Dovenmuehle was to provide a construction loan of $2,000,000, to Mesec and Silverman, who were in turn to procure an irrevocable letter of credit in the amount of $130,000 in favor of Dovenmuehle. The letter of credit was a condition precedent to the disbursement of any loan proceeds and was designed to "provide for the total anticipated cash needs" for the project.
In March 1974, East Bank issued an irrevocable letter of credit naming Dovenmuehle as beneficiary and providing that the letter was for a "loan imbalance" as described in Dovenmuehle's loan commitment. Drafts on the credit were to be accompanied by signed certifications that the amount drawn was required to cover the loan imbalance.
The project was subsequently commenced, Dovenmuehle supplying funds, as the construction progressed, to Pinion Springs Condominiums, Inc., a corporation wholly owned by Mesec and Silverman. Prior to completion, however, Dovenmuehle foreclosed on the property even though it had not at that point advanced the entire amount of funding contemplated in the loan agreement. Dovenmuehle thereafter made demands for payment against the letter of credit. East Bank refused to honor the calls and this litigation ensued.
I.
East Bank raises various assignments of error with respect to the trial court's rulings on evidentiary matters, the interpretation of the terms of the letter of credit, and the applicability of common law principles to this case. We conclude the trial court committed no error.
[1] The instrument in dispute here is subject to the provisions of the Uniform Commercial Code. See §§ 4-5-102(1) and 4-5-103(1)(a), C.R.S. 1973. Under the terms of the Code, letters of credit are conceived to exist in an "independent theoretical frame" distinct in nature from related credit devices. Section 4-5-101, C.R.S. 1973 (Official Comment); and see, J. White R. Summers, Uniform Commercial Code § 18-2 (1972). As the law relative to letters of credit is yet developing, careful attention must be devoted to the "fundamental theories" underlying these transactions in construing the article. Section 4-5-102, C.R.S. 1973 (Official Comment).
East Bank's allegations of error in this case are predicated essentially on the assumption that common law rules of contract interpretation govern the function of letters of credit. Therefore, the bank argues, no substitution of customers could be made without its consent, parol evidence as to the intent of the parties was admissible, and the circumstances of the underlying relationship between the beneficiary Dovenmuehle and Mesec and Silverman were necessary to a resolution of the issue of its liability. These arguments are unpersuasive.
[2,3] The contractual relationships arising from a letter of credit are clearly delineated by Code provisions. An issuer such as East Bank "must honor a draft or demand for payment which complies with the terms of the relevant credit," regardless of a non-fraudulent breach of the underlying contract. Section 4-5-114(1), C.R.S. 1973. The letter of credit is primarily a contract between the issuer and the beneficiary, and liability arising on the part of the issuer is independent of the underlying contract between the beneficiary and the customer. See Hyland Hills Metropolitan Park Recreational District v. McCoy Enterprises, 38 Colo. App. 23 554 P.2d 708; Section 4-5-114, C.R.S. 1973 (Official Comment). When there has been compliance with the terms of the credit, wrongful dishonor entitles the beneficiary to recover from the issuer the full amount of the letter of credit. Section 4-5-115, C.R.S. 1973.
[4] In view of the principles above, the trial court correctly held that the purported modification of the contract occurring when Mesec and Silverman formed the Pinion Springs Corporation was immaterial to East Bank's liability to Dovenmuehle. Mesec and Silverman, the customers designated in the credit, remained the original customers; the formation of the corporation affected only the relationship between Dovenmuehle and its debtor, a fact which had no legal significance insofar as East Bank's obligation to Dovenmuehle was concerned. See Asociacion de Aucareros v. United States National Bank, 423 F.2d 638 (9th Cir. 1970). Consequently, the evidence offered by East Bank to prove the intent of the parties to that contract or custom and usage regarding the financing of the project was properly excluded. See §§ 4-1-205(4) and 4-5-109(c), C.R.S. 1973.
[5] East Bank also argues that inasmuch as Dovenmuehle had foreclosed its deed of trust and bid in the property for the unpaid balance owed to it, East Bank was not further obligated under the credit. This argument assumes that East Bank occupied the position of a surety or guarantor with regard to the obligation owed Dovenmuehle by Mesec or Silverman. However, the Code provides that unless the credit so states, an issuer does not guarantee performance of the contract between the customer and the beneficiary, § 4-5-109(1)(a), C.R.S. 1973.
Consequently, East Bank could not avoid payment of the credit on the theory it was a surety or guarantor whose obligation had been discharged.
II.
The dispositive question in this litigation is whether there was compliance with the terms of the letter of credit relative to Dovenmuehle's attempted call. See §§ 4-5-103(1)(a) and 4-5-114(1), C.R.S. 1973. The trial court found such compliance and we agree with this finding.
[6] East Bank maintains that the reference in the credit to Dovenmuehle's loan commitment required Dovenmuehle to advance the full $2,000,000 as a prerequisite to draws on the credit. However, the commitment states unambiguously that the cash needs for the project were "anticipated" and the credit was a condition to any disbursement of funds. The clear import of the clause is that Dovenmuehle was to have access to the funds represented by the credit from the inception of the project. No extrinsic evidence was necessary to interpret the letter, and as East Bank's proffered testimony would have altered the terms of the agreement, that testimony was properly excluded. Light v. Rogers, 125 Colo. 209, 242 P.2d 234 (1952).
With regard to the additional requirement in the credit that drafts be accompanied by signed certifications of a loan imbalance, the trial court found that while there was a loan imbalance as contemplated in the credit and Dovenmuehle submitted proper certification to this effect, the demand was not in compliance with the credit inasmuch as no draft had been presented. However, the trial court further concluded that East Bank had, under the circumstances, waived its right to insist on the formality of a draft.
In its replies to Dovenmuehle's several demands, the bank refused payment solely on the grounds that work had terminated on the project and that the certification was ambiguous. Defendant raised no objection that the call had not been made by draft.
[7] The rule followed in federal courts, and the rule which we adopt here, is that in cases involving letters of credit, a refusal to pay formally placed on one ground will be deemed a waiver of all others based on the letter of credit. Barclays Bank D.C.O. v. Mercantile National Bank, 481 F.2d 1224 (5th Cir. 1973). To permit an issuer to evade payments for extended periods of time under the credit without affording the beneficiary an opportunity to remedy the defect in its demand comports neither with principles of fairness nor with the justifiable expectations of parties engaged in commercial enterprises. Barclays Bank D.C.O. v. Mercantile National Bank, supra. East Bank's failure to specify this defect in Dovenmuehle's demand while asserting other grounds precluded the bank from relying on this defense to Dovenmuehle's suit.
III.
East Bank last contends that even assuming contrary rules are established in other jurisdictions, a preferable view, which should be followed in this state, is that traditional principles of contract law concerning the intent of the parties, and interpretation and modification of agreements should apply with respect to letters of credit, regardless of the terms of the credit. This argument misconstrues both the plain language of the Code and the policy underlying its provisions.
[8] Federal courts have consistently adhered to the position that a credit is the "sole contract of the bank with the [beneficiary] and is completely independent of other contracts." Savage v. First National Bank Trust Co., 413 F. Supp. 447 (N.D. Okla. 1976); see also Fidelity Bank v. Lutheran Mutual Life Insurance Co., 465 F.2d 211 (10th Cir. 1972). The clear majority of state courts ruling on the question have concluded that an issuer is not permitted to go beyond the terms of the credit "to determine if the beneficiary has performed in conformity with the underlying contract." See Hyland Hills Metropolitan Park Recreational Dist. v. McCoy Enterprises, supra, and Intraworld Industries, Inc. v. Girard Trust Bank, 461 Pa. 343, 336 A.2d 317 (1975) and authorities cites therein. We do not interpret Steinmeyer v. Warner Consolidated Corp. 42 Cal. App. 3d 515, 115 Cal. Rptr. 57 (1974), upon which East Bank relies, to hold to the contrary.
In addition, the commercial utility of letters of credit lies precisely in their independence from the contract between the customer and the beneficiary. The beneficiary is assured of prompt payment of the debt and business transactions are accordingly facilitated. Thus, the purpose of the letter of credit requires that this unique feature be preserved by courts. Intraworld Industries, Inc. v. Girard Trust Bank, supra.
[9] Finally, East Bank fails to consider a second purpose sought to be effectuated by the Code. Letters of credit do not eradicate the contractual latitude afforded the parties, but are intended to enhance it. Within broad limits, an issuer and the beneficiary may agree that various conditions be satisfied by documentation prior to payment. See, e.g., § 4-5-114(1), C.R.S. 1973; and Comment, "Unless Otherwise Agreed" and Article 5: An Exercise in Freedom of Contract 11 St. Louis U.L.J. 416 (1967). As a result of such flexibility, contract principles are not necessarily precluded from consideration if the parties embody them within the terms of the credit.
East Bank's assertion that affirmance of trial court's decision will "cause confusion in the commercial world" is, in light of the foregoing, without merit. Had custom and usage been intended as a means of construing the credit here, the parties were at liberty to insert a clause to such effect.
Judgment affirmed.
JUDGE KELLY and JUDGE STERNBERG concur.