United Bank Ltd. v. Cambridge Sporting Goods Corp.

• Decision Date: 28 December 1976
• Citation: 41 N.Y.2d 254,360 N.E.2d 943,392 N.Y.S.2d 265
• Parties: , 360 N.E.2d 943, 20 UCC Rep.Serv. 980 UNITED BANK LIMITED et al., Respondents, v. CAMBRIDGE SPORTING GOODS CORP., Appellant.
• Court: New York Court of Appeals Court of Appeals

Page 265

392 N.Y.S.2d 265

41 N.Y.2d 254, 360 N.E.2d 943, 20 UCC

Rep.Serv. 980

UNITED BANK LIMITED et al., Respondents, v. CAMBRIDGE SPORTING GOODS CORP., Appellant.

Court of Appeals of New York.

Dec. 28, 1976.

Herbert Rubin and Bernard J. Wald, New York City, for appellant.

John J. Hayes, New York City, for respondents.

GABRIELLI, Justice.

On this appeal, we must decide whether fraud on the part of a seller-beneficiary of an irrevocable letter of credit may be successfully asserted as a defense against holders of drafts drawn by the seller pursuant to the credit. If we conclude that this defense may be interposed by the buyer who procured the letter of credit, we must also determine whether the courts below improperly imposed upon appellant buyer the burden of proving that respondent banks to whom the drafts were made payable by the seller-beneficiary of the letter of credit, were not holders in due course. The issues presented raise important questions concerning the application of the law of letters of credit and the rules governing proof of holder in due course status set forth in article 3 of the Uniform Commercial Code. In addition, we are called upon to determine whether it was proper for the trial court to permit respondents to introduce as direct evidence their responses to interrogatories served by appellant, as part of respondents' case-in-chief.

In April, 1971 appellant Cambridge Sporting Goods Corporation (Cambridge) entered into a contract for the manufacture and sale of boxing gloves with Duke Sports (Duke), a Pakistani corporation. Duke committed itself to the manufacture of 27,936 pairs of boxing gloves at a sale price of $42,576.80; and arranged with its Pakistani bankers, United Bank Limited United) and The Muslim Commercial Bank (Muslim), for the financing of the sale. Cambridge was requested by these banks to cover payment of the purchase price by opening an irrevocable letter of credit with its bank in New York, Manufacturers Hanover Trust Company (Manufacturers). Manufacturers issued an irrevocable letter of credit obligating it, upon the receipt of certain documents indicating shipment of the merchandise pursuant to the contract, to accept and pay, 90 days after acceptance, drafts drawn upon Manufacturers for the purchase price of the gloves.

Following confirmation of the opening of the letter of credit, Duke informed Cambridge that it would be impossible to manufacture and deliver the merchandise within the time period required by the contract, and sought an extension of time for performance until September 15, 1971 and a continuation of the letter of credit, which was due to expire on August 11. Cambridge replied on June 18 that it would not agree to a postponement of the manufacture and delivery of the gloves because of its resale commitments and, hence, it promptly advised Duke that the contract was canceled and the letter of credit should be returned. Cambridge simultaneously notified United of the contract cancellation.

Despite the cancellation of the contract, Cambridge was informed on July 17, 1971 that documents had been received at Manufacturers from United purporting to evidence a shipment of the boxing gloves under the terms of the canceled contract. The documents were accompanied by a draft, dated July 16, 1971, drawn by Duke upon Manufacturers and made payable to United, for the amount of $21,288.40, one half of the contract price of the boxing gloves. A second set of documents was received by Manufacturers from Muslim, also accompanied by a draft, dated August 20, and drawn upon Manufacturers by Duke for the remaining amount of the contract price.

An inspection of the shipments upon their arrival revealed that Duke had shipped old, unpadded, ripped and mildewed gloves rather than the new gloves to be manufactured as agreed upon. Cambridge then commenced an action against Duke in Supreme Court, New York County, joining Manufacturers as a party, and obtained a preliminary injunction prohibiting the latter from paying drafts drawn under the letter of credit; subsequently, in November, 1971 Cambridge levied on the funds subject to the letter of credit and the draft, which were delivered by Manufacturers to the Sheriff in compliance therewith. Duke ultimately defaulted in the action and judgment against it was entered in the amount of the drafts, in March, 1972.

The present proceeding was instituted by the Pakistani banks to vacate the levy made by Cambridge and to obtain payment of the drafts on the letter of credit. The banks asserted that they were holders in due course of the drafts which had been made payable to them by Duke and, thus, were entitled to the proceeds thereof irrespective of any defenses which Cambridge had established against their transferor, Duke, in the prior action which had terminated in a default judgment. The banks' motion for summary judgment on this claim was denied and the request by Cambridge for a jury trial was granted. Cambridge sought to depose the petitioning banks, but its request was denied and, as an alternative, written interrogatories were served on the Pakistani banks to learn the circumstances surrounding the transfer of the drafts to them. At trial, the banks introduced no evidence other than answers to several of the written interrogatories which were received over objection by Cambridge to the effect that the answers were conclusory, self-serving and otherwise inadmissible. Cambridge presented evidence of its dealings with Duke including the cancellation of the contract and uncontested proof of the subsequent shipment of essentially worthless merchandise.

The trial court concluded that the burden of proving that the banks were not holders in due course lay with Cambridge, and directed a verdict in favor of the banks on the ground that Cambridge had not met that burden; the court stated that Cambridge failed to demonstrate that the banks themselves had participated in the seller's acts of fraud, proof of which was concededly present in the record. The Appellate Division affirmed, agreeing that while there was proof tending to establish the defenses against the seller, Cambridge had not shown that the seller's acts were 'connected to the petitioners (banks) in any manner.' The Appellate Division also held that CPLR 3117 'seemingly' authorized the introduction of the challenged interrogatories into evidence.

We reverse and hold that it was improper to direct a verdict in favor of the petitioning Pakistani banks. We conclude that the defense of fraud in the transaction was established and in that circumstance the burden shifted to petitioners to prove that they were holders in due course and took the drafts for value, in good faith and without notice of any fraud on the part of Duke (Uniform Commercial Code, § 3--302). Additionally, we think it was improper for the trial court to permit petitioners to introduce into evidence answers to Cambridge's interrogatories to demonstrate their holder in due course status.

This case does not come before us in the typical posture of a lawsuit between the bank issuing the letter of credit and presenters of drafts drawn under the credit seeking payment (see, generally, White and Summers, Uniform Commercial Code, § 18--6, pp. 619--628). Because Cambridge obtained an injunction against payment of the drafts and has levied against the proceeds of the drafts, it stands in the same position as the issuer, and, thus, the law of letters of credit governs the liability of Cambridge to the Pakistani banks. ¹ Article 5 of the Uniform Commercial Code, dealing with letters of credit, and the Uniform Customs and Practice for Documentary Credits promulgated by the International Chamber of Commerce set forth the duties and obligations of the issuer of a letter of credit. ² A letter of credit is a commitment on the part of the issuing bank that it will pay a draft presented to it under the terms of the credit, and if it is a documentary draft, upon presentation of the required documents of title (see Uniform Commercial Code, § 5--103). Banks issuing letters of credit deal in documents and not in goods and are not responsible for any breach of warranty or nonconformity of the goods involved in the underlying sales contract (see Uniform Commercial Code, § 5--114, subd. (1); Uniform Customs and Practice, General Provisions and Definitions (c) and article 9; O'Meara Co. v. National Park Bank of N.Y., 239 N.Y. 386, 146 N.E. 636; Laudisi v. American Exch. Nat. Bank, 239 N.Y. 234, 146 N.E. 347; Rosenfeld v. Banco Internacional, 27 A.D.2d 826, 278 N.Y.S.2d 160; Imbrie v. Nagase & Co., 196 App.Div. 380, 187 N.Y.S. 692; Frey & Son v. Sherburne Co., 193 App.Div. 849, 853, 184 N.Y.S. 661; American Steel Co. v. Irving Nat. Bank, 2 Cir., 266 F. 41; 1955 Report of N.Y. Law Rev.Comm., vol. 3, Study of Uniform Commercial Code, pp. 1654--1655). Subdivision (2) of section 5--114, however indicates certain limited circumstances in which an issuer May properly refuse to honor a draft drawn under a letter of credit or a customer may enjoin an issuer from honoring such a draft. ³ Thus, where 'fraud in the transaction' has been shown and the holder has not taken the draft in circumstances that would make it a holder in due course, the customer may apply to enjoin the issuer from paying drafts drawn under the letter of credit (see 1955 Report of N.Y. Law Rev.Comm., vol. 3, pp. 1654--1559). This rule represents a codification of precode case law most eminently articulated in the landmark case of Sztejn v. Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631, Shientag, J., where it was held that the shipment of cowhair in place of bristles amounted to more than mere breach of warranty but fraud sufficient to constitute grounds for enjoining payment of drafts to one not a holder in due course (see, also, Bank of Montreal v. Recknagel, 109 N.Y. 482, 17 N.E. 217; Dulien Steel Prods. v. Bankers Trust Co., 2 Cir., 298...