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AMERICAN EMPLOYERS INS. v. PIONEER BK. & TRUST

United States District Court, Northern District of Illinois, E.D


December 18, 1981

AMERICAN EMPLOYERS INSURANCE COMPANY, PLAINTIFF,
v.
PIONEER BANK AND TRUST COMPANY, DEFENDANT.

The opinion of the court was delivered by: Shadur, District Judge.

MEMORANDUM OPINION AND ORDER

American Employers Insurance Company ("American Employers") sues Pioneer Bank and Trust Company ("Pioneer") alleging the wrongful dishonor of drafts presented under each of three irrevocable letters of credit issued by Pioneer. American Employers has moved for summary judgment and Pioneer has filed a cross motion to dismiss the Complaint. For the reasons stated in this memorandum opinion and order, Pioneer's motion is denied and American Employers' motion is granted in part and denied in part.

Facts

On November 1, 1974 Pioneer (the issuer) issued an Irrevocable Letter of Credit (the "1974 Letter") in favor of American Employers (the beneficiary) for the account of Jenkins Industries, Inc. ("Jenkins," the customer). Under its terms the 1974 Letter was automatically extended from year to year unless Pioneer provided American Employers with 30 days' notice before an anniversary date. Payment under the 1974 Letter was conditioned upon American Employers' presentation of a sight draft demanding payment and an accompanying statement:

  that [American Employers], as Surety, have
  executed one or more bonds on behalf of Jenkins
  Industries, Inc. and that a claim has been made
  or a situation exists under which, in the sole
  judgment of [American Employers], claim may be
  made or loss or expense sustained under said bond
  and that monies represented by [American
  Employers'] drafts are required in the discretion
  of [American Employers] for its protection under
  said bond(s) or for payment of premiums.

  On May 21, 1975 Pioneer issued two additional Irrevocable Letters of Credit (the "1975 Letters") employing the identical set of terms and conditions. They differed only in their principal amounts and in their being issued for the account of "Jenkins Industries, Inc., a general partner, and S & A Mining Associates, a limited partner," rather than Jenkins alone.

On July 23, 1981*fn1 American Employers July 21 and accompanying statements dated July 23, demanding payment under each of the letters of credit. Each statement referred to the execution of bonds on behalf of Jenkins, and each draft directed Pioneer to charge Jenkins' account.

Under Ill.Rev.Stat. ch. 26, § 5-112(1) ("Section 5-112(1)") Pioneer had until the close of business July 28 to honor American Employers' demand. When Pioneer failed to do so American Employers filed suit July 29.

American Employers' Contentions

American Employers asserts that:

    (1) All three letters of credit remained in
  effect in 1981 because Pioneer had never given
  notice of cancellation.

    (2) American Employers provided Pioneer with a
  sight draft and accompanying statement in full
  compliance with each letter of credit.

    (3) Pioneer's failure to respond amounted to a
  dishonor of the demand.

    (4) American Employers is therefore entitled to
  full payment under the terms of the letters of
  credit.

As this opinion will reflect those arguments are, with a single (though important) limitation, unanswerable as a matter of law.

Pioneer's Responses

Pioneer counters with a number of defenses. For the most part they are little short of frivolous.

Initially Pioneer seeks dismissal because American Employers asks specific performance though it has an adequate remedy at law. That argument is wholly groundless, given the prayer for damages in each of the Complaint's three counts.

Pioneer next points to claimed defects in the documentation presented by American Employers:

    (1) Each of the 1975 Letters requires a sight
  draft accompanied by a statement that American
  Employers as surety has "executed one or more
  bonds on behalf of Jenkins Industries, Inc., a
  general partner, and S & A Mining Associates [S &
  A], a limited partner. . . ." Pioneer asserts the
  actual sight drafts and statements are
  insufficient because they disclose bonds issued
  on behalf of Jenkins alone.

    (2) All three letters of credit call for a
  statement that "a claim has been made or a
  situation exists under which . . . claim may be
  made or loss or expense sustained. . . ." Pioneer
  attacks American Employers' statement as
  insufficient because it did not adequately
  explain the existing situation giving rise to the
  potential claim.

American Employers first retorts that Pioneer has waived the right to argue the demand did not conform to the letters of credit. There is no doubt that Pioneer dishonored American Employers' demand. Section 5-112(1) provides:*fn2

  A bank to which a documentary draft or demand for
  payment is presented under a credit may without
  dishonor of the draft, demand or credit

  (a) defer honor until the close of the third
      banking day following receipt of the
      documents; and

  (b) further defer honor if the presenter has
      expressly or impliedly consented thereto.

      Failure to honor within the time here
      specified constitutes dishonor of the draft
      or demand and of the credit.

Pioneer did not honor the demand within the time provided and American Employers did not agree to an extension.

Not only did Pioneer dishonor the draft, but it never gave American Employers a statement of its reasons for doing so. American Employers says that failure constitutes a waiver under First Arlington National Bank v. Stathis, 90 Ill. App.3d 802, 46 Ill.Dec. 175, 413 N.E.2d 1288 (1st Dist. 1980). There Stathis had entered into an agreement to sell real estate to a group of investors, who caused First Arlington National Bank (the "Bank") to issue a letter of credit in favor of Stathis. When the investors defaulted on their obligation to pay Stathis, Stathis demanded payment of the Bank. Four days after the demand the Bank wrote Stathis refusing to pay the letter of credit, explaining how his accompanying statement had not satisfied the conditions of the letter. Several days later the Bank again wrote Stathis another letter stating an additional reason for its refusal to honor his demand.

On appeal the Bank argued not only the reasons originally provided to Stathis but two additional requirements of the letter of credit Stathis had not satisfied. As to the objections the Bank had raised only after suit was filed, the court held (90 Ill. App.3d at 812, 46 Ill.Dec. at 183, 413 N.E.2d at 1296):

  We note, however, that plaintiff made none of
  these objections in its correspondence with
  Stathis wherein it originally refused to honor
  the credit. Those objections were therefore
  waived and cannot now be asserted.

American Employers urges that Pioneer has similarly waived all objections to its demand.

That argument has force as to many kinds of defective compliance by a beneficiary. In First Arlington the Bank was held to have waived all objections not specifically stated in its pre-litigation refusal to honor the letter of credit. It should follow a fortiori that an issuer's failure to present any objections waives all objections. If First Arlington were not so applied, the issuer would be better off to raise no objections. But the whole point of requiring a response is to enable the beneficiary to correct any curable defects. By failing to provide any indication of why an issuer is dishonoring a demand the issuer forces the beneficiary to file suit. See Barclays Bank D.C.O. v. Mercantile National Bank, 481 F.2d 1224, 1236-37 (5th Cir. 1973).

First Arlington is further supported by the Illinois Code comment to Section 5-114:

  A party may be precluded from raising the issue
  of conformity on grounds of waiver or estoppel.
  Continental National Bank v. National City Bank,
  69 F.2d 312 (9th Cir. 1934); Lamborn v. National Bank
  of Commerce, 276 U.S. 469, 48 S.Ct. 378 [72 L.Ed.
  657] (1928); Consolidated Sales Co. v. Bank of
  Hampton Roads, 193 Va. 307, 68 S.E.2d 652 (1952).

Other jurisdictions are in accord. Barclays Bank D.C.O. v. Mercantile National Bank, 481 F.2d 1224 (5th Cir. 1973); Chase Manhattan Bank v. Equibank, 550 F.2d 882 (3d Cir. 1977).

How does First Arlington serve American Employers? As to the 1975 Letters, not at all. If the disparity between the Letters' terms (bonds on behalf of Jenkins and S & A) and the actual bonds (solely on behalf of Jenkins) is material, American Employers could not have cured that flaw had Pioneer identified it in response to the demand for payment. Waiver notions would therefore play no part in evaluating Pioneer's failure to state that reason for dishonoring the drafts.

Neither party has provided any real assistance on that score. American Employers simply asserts without support that Pioneer "has misconstrued the language" of the 1975 Letters. But at best the Letters are ambiguous. On a summary judgment motion all reasonable inferences from the facts are to be drawn against the movant. This Court can reasonably posit a situation exemplified by the following scenario:*fn3

    It is not uncommon for a limited partnership to
  be entered into between a general partner whose
  major contribution is the rendition of services
  and a limited partner whose entire contribution
  is financial and who does not want to place his
  or its total resources at the risk of the
  venture. Assume a general partner with limited
  resources (in this hypothesis Jenkins) that
  invests say $20,000 in a partnership that goes
  into a $1 million deal, so that the limited
  partner (here S & A) invests $980,000. Jenkins'
  2% interest in the partnership is of course worth
  $20,000. Under such circumstances a bank might
  well commit itself on a letter of credit looking
  to the $1 million net worth partnership (so that
  it would underwrite bonds issued on behalf of
  Jenkins as general partner and S & A as limited),
  but not on a letter of credit supported by Jenkins'
  $20,000 partnership interest and any other net
  worth Jenkins had (all that the bank could look to
  where the bond had been issued solely on Jenkins'
  behalf).*fn4

American Employers must suffer the consequences of its failure to eliminate any such possible factual issue, which could make its performance fatally non-conforming.

Pioneer however has also given the Court nothing to act on except its own speculation. When a summary judgment motion is filed Fed.R.Civ.P. ("Rule") 56 calls for affidavits to negate — or to pose — "genuine issues of material fact." Pioneer like American Employers has not explained anything of the circumstances of issuance of the 1975 Letters, anything that would cast light on the meaning of their terms. Its reply memorandum for the first time states (and not via affidavit at that) some of the facts — incomplete even then — as to S & A. Nonetheless, because the burden is on American Employers on its motion, Pioneer must prevail to this limited extent.

On the other hand, as to the alleged flaw in American Employers' statement as to potential claims on the bonds (a matter that applies to all three letters of credit):

    (1) First Arlington requires the conclusion that
  Pioneer has waived its right to complain of that
  item, at worst a curable defect.

    (2) Pioneer's position on the merits is
  baseless in any event. American Employers
  complied precisely with the terms of the letters
  of credit, and each of them specifically vested
  American Employers with the "sole judgment" and
  the "discretion" to make the determination as to
  potential claims. Pioneer seeks to rewrite the
  letter of credit, and this it cannot do.

Accordingly Pioneer must lose on this point as to the 1974 Letter and, if in the future American Employers can overcome the Jenkins-S & A problem, as to the 1975 Letters as well.

This opinion next turns to three more Pioneer defenses that were not waived by its silence at the time of dishonor. Each of them, though, is devoid of substance:

(1) In 1977 Jenkins underwent a reorganization under Chapter 11 of the Bankruptcy Act. Pioneer asserts:

  Since the obligations of the parties may have
  been modified in the Chapter 11 proceeding the
  terms of the letters of credit may also have been
  modified. It was therefore necessary for Pioneer
  to ratify and reaffirm the letters of credit in
  order for them to continue in force and

  effect. Absent the request by plaintiff or
  Pioneer to ratify these letters of credit, they
  were cancelled by operation of law and are no
  longer in force or effect.

But that precise argument was rejected in First Arlington, where the beneficiary of the letter of credit had renegotiated the underlying transaction with certain of the customers (90 Ill. App.3d at 808, 46 Ill.Dec. at 180-81, 413 N.E.2d at 1293-94):

  In this regard, we note that an issuing bank is
  said to deal in documents and not in contract
  performance [citation omitted] and is under a
  duty to examine with care the documents submitted
  by the beneficiary to determine whether they
  comply on their face with the terms of the
  credit. [Citation omitted]. `Generally, if the
  documents presented conform to the requirements
  of the credit, the issuer is not required or even
  permitted to go behind the documents before
  honoring the demands for payment' [citations
  omitted], and `[i]f a conforming presentation of
  documents is made, the issuer of a credit is
  obligated to pay without reference to the rights
  and obligations of the parties to the underlying
  contract' [citations omitted]. Thus, the
  obligation of the issuer to pay the beneficiary
  is completely independent of the underlying
  agreement between the beneficiary and the bank's
  customers. . . .

Pioneer must fail on the same grounds. Jenkins' Chapter 11 reorganization can in no way affect Pioneer's obligation to American Employers under the letters of credit.

(2) On August 16, 1977 American Employers notified Pioneer of three potential claims under the letters of credit. Pioneer argues that by waiting until 1981 to make its demand American Employers is barred by laches, but:

    (a) Pioneer presents no authority to support
  that position. It cites only the inapplicable
  decision in National Surety Corporation v. Midland
  Bank & Trust Corporation, 408 F. Supp. 684 (D.N.J.
  1976). National Surety involved a letter of credit
  subject to a statutory limitation of one year.
  Plaintiff's claim was held barred because the court
  held that statute applicable even to letters of
  credit otherwise automatically renewable on an
  annual basis. Plainly the holding is in apropos
  here. Indeed whatever force it might have had is
  wholly vitiated by the fact (mentioned by neither
  counsel) that the District Court was reversed on
  precisely that point, 551 F.2d 21 (3d Cir. 1977).

    (b) More significantly, laches must involve an
  unreasonable delay in the assertion of a claim
  that acts to a party's prejudice. Neither of
  those conditions is present. First, there is
  nothing to support the proposition that the
  passage of time was unreasonable. As of any
  anniversary date Pioneer was free to terminate
  its further exposure on the letters of credit. It
  did not do so. In fact American Employers sent
  two letters to Pioneer, on November 13, 1978 and
  October 6, 1980, confirming that the letters of
  credit were still in force. Pioneer was silent.
  Second, Pioneer shows no prejudice generated by
  the "delay" in demanding payment under the
  letters of credit.*fn5 It contends only that had
  it been aware of American Employers' claim
  earlier it would have taken action as to the
  Jenkins reorganization. But as already discussed,
  the Jenkins bankruptcy proceeding is irrelevant
  to Pioneer's duty to American Employers. Pioneer
  cannot escape the clear contractual obligation of
  the irrevocable letters of credit.

(3) Pioneer makes one last attempt to extract a defense from the Jenkins reorganization. It says this Court, as a court of equity, should not assist a party with unclean hands because:

  plaintiff has had the opportunity to remedy the
  situation which is apparently resulting in the
  forfeiture of the surety bonds. Plaintiff could
  have assisted Jenkins in completing the project
  relating to the issuance of the surety bonds and,
  therefore, avoid the forfeiture of these bonds.
  Instead, plaintiff elected to allow the surety
  bonds to be forfeited and to look to Pioneer and
  Jenkins for payment.

That argument again ignores the nature of Pioneer's obligation to American Employers: independent of and unaffected by the Jenkins reorganization. As the court put it in Baker v. National Boulevard of Chicago, 399 F. Supp. 1021, 1024 (N.D.Ill. 1975) (cited in First Arlington, 90 Ill. App.3d at 807, 46 Ill.Dec. at 179, 413 N.E.2d at 1293):

  Three separate agreements are involved in the
  issuance of a letter of credit by the bank for
  the benefit of a beneficiary. . . . The first is
  the contract between the beneficiary . . . and
  the customer . . . which is the agreement
  underlying the letter of credit. Under the second
  contract, the customer procures a letter of
  credit, often from a bank, in return for
  consideration or collateral. The third agreement
  consists of the bank's agreement to pay the
  beneficiary the amount of the letter of credit,
  if the beneficiary complies with the terms of the
  credit.

If Pioneer wished to be informed of bankruptcy proceedings involving its customer Jenkins, it was free to provide for that contingency in the letters of credit. Pioneer fails to state a valid defense of unclean hands.

Conclusion

Pioneer's motion to dismiss the Complaint is denied. As for American Employers' motion, except for the single issue affecting the 1975 Letters, there is no genuine issue of material fact. American Employers is entitled to a judgment as a matter of law as to the 1974 Letter. American Employers' motion for summary judgment under Rule 56 is granted as to liability on the 1974 Letter.


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