First Commercial Bank v. Gotham Originals, Inc.

• Citation: 64 N.Y.2d 287,486 N.Y.S.2d 715,475 N.E.2d 1255
• Parties: , 475 N.E.2d 1255, 53 USLW 2440, 40 UCC Rep.Serv. 582 FIRST COMMERCIAL BANK, Respondent, v. GOTHAM ORIGINALS, INC., Appellant, et al., Respondent.
• Decision Date: 12 February 1985
• Court: New York Court of Appeals

Page 715

486 N.Y.S.2d 715

64 N.Y.2d 287, 475 N.E.2d 1255, 53

USLW 2440,

40 UCC Rep.Serv. 582

FIRST COMMERCIAL BANK, Respondent, v. GOTHAM ORIGINALS, INC., Appellant, et al., Respondent.

Court of Appeals of New York.

Feb. 12, 1985.

Gerald M. Kleinbaum, New York City, for appellant.

Thomas F. Clauss, Jr., Brooklyn, and Stephen A. Weiner, New York City, for First Commercial Bank, respondent.

OPINION OF THE COURT

SIMONS, Judge.

This is a special proceeding instituted pursuant to CPLR 6221 to determine adverse claims to attached property. The disputed property consists of funds and assets held by respondent Bank Leumi Trust Company of New York. Petitioner, First Commercial Bank, claims the proceeds because Bank Leumi accepted drafts it presented in the amount of $70,978.50 which had been drawn in connection with a letter of credit. Respondent Gotham Originals, Inc., the customer of Bank Leumi which obtained the letter of credit, claims that Bank Leumi may not transfer the proceeds because the court enjoined it from doing so before it honored the drafts. Petitioner bases its claim to the funds on the provisions of Uniform Commercial Code § 4-303(1)(a) ¹ which provides that legal process comes too late to suspend the bank's duty to pay an item if it comes, as this order did, after the bank has accepted it. Gotham contends, however, that the restraining order was timely under section 5-114(2)(b) of the Code ² because the order was served upon the Bank before it honored the drafts. The Code defines honor as "to pay or to accept and pay" (Uniform Commercial Code § 1-201[21] ). Thus, the order was untimely under section 4-303 because Bank Leumi had accepted the drafts before enjoined but timely under section 5-114 because it had not yet honored them. The Appellate Division held that under these circumstances section 4-303 prevails. ³ We agree and therefore affirm its order.

I

In June 1981 respondent Gotham Originals, Inc. agreed to purchase approximately 24,000 pairs of ladies leather and snakeskin shoes from Teng Shih Industries Company, Ltd., and other Taiwanese shoe manufacturers. To finance the purchase, it obtained an irrevocable letter of credit from Bank Leumi designating Teng Shih Industries as beneficiary and petitioner First Commercial Bank, a banking corporation organized under the laws of the Republic of China and having its principal place of business in Taipei, as advising bank. The total amount of the letter of credit, as amended, was $172,026. It was transferrable and contained an expiration date of September 5, 1981. On September 10, 1981, R. Bore International, Inc., a transferee beneficiary of Teng Shih Industries, negotiated to petitioner two drafts in the amount of $70,978.50, payable on sight 60 days from date, together with the other documents required by the letter of credit. Petitioner paid for the drafts in Taiwanese currency and credited the amounts to R. Bore's checking account although it did so "under reserve" because the letter of credit had expired on September 5, 1981. On September 21st, Bank Leumi received from petitioner the two drafts, the required documentation and transmittal letters and a request for payment of the drafts on Gotham's letter of credit. Petitioner disclosed the discrepancy in the expiration date, noted that it had negotiated the drafts "under reserve" and requested advice as to when it could lift the reserve and make final payment to R. Bore. Bank Leumi subsequently obtained a waiver of the discrepancy in the expiration date from Gotham and on September 24th it notified petitioner by letter that the drafts had been accepted and that payment would be made on November 23, 1981.

After Bank Leumi had accepted the drafts, but before it had paid them, Gotham instituted an action against Teng Shih, R. Bore and the other shoe manufacturers-sellers in Supreme Court, New York County, claiming they had sold it worthless merchandise and charging them with fraud and breach of contract. It simultaneously obtained a temporary restraining order enjoining Bank Leumi from transferring the letter of credit or any moneys or assets of the sellers and sought orders attaching the proceeds of the drafts. After the restraining order was served on Bank Leumi and the attachment was perfected, Bank Leumi refused to pay petitioner.

Petitioner first attempted to recover the funds by a plenary action against Bank Leumi and the bank, in turn, impleaded Gotham. Petitioner then moved for summary judgment and when its motion was denied it commenced this proceeding. In it petitioner seeks to vacate and discharge the restraining order and the orders of attachment, to void the Sheriff's levy and to obtain a determination that section 4-303 of the Code controls this transaction and requires Bank Leumi to pay the accepted drafts. Before answering, Gotham moved to dismiss the petition contending that it failed to state a cause of action and that granting the relief sought would violate a prior order of the same court (i.e., the order denying petitioner summary judgment in the plenary action). It requested leave to answer if its motion was denied. Bank Leumi appeared and answered the petition.

On November 15, 1983 Special Term granted Gotham's motion and dismissed the petition holding that (1) petitioner's plenary action involved the same parties and issues and was still pending, (2) no judgment had been obtained in it, which it viewed as a necessary predicate to a CPLR 6221 petition, and, (3) petitioner failed to name as necessary parties the defendants in the Gotham action and the Sheriff of New York City.

The Appellate Division, First Department, unanimously reversed and granted the petition (101 A.D.2d 790, 476 N.Y.S.2d 835). It held that there were no procedural bars to reaching the merits and, on the merits, it held that the attachment order was untimely under Uniform Commercial Code § 4-303 and was therefore ineffective to terminate or suspend Bank Leumi's duty to pay the accepted drafts.

II

The purpose of a letter of credit is to substitute for, and therefore support, an engagement to pay money. Letters of credit are used in various ways in modern business practice, but when used in the traditional manner to finance a sale of goods, the credit subsumes a separate agreement by a buyer to pay money to a seller (for illustrations of other uses see J. White & R. Summers, Handbook on Uniform Commercial Code § 18-1, at 708-09 [2d ed.] ). By issuing a letter of credit, the issuer undertakes an obligation to pay the beneficiary, or his transferee if the letter is negotiable, from the account of its customer. Thus, a commercial letter of credit transaction involves three separate contractual relationships and undertakings: first, the underlying contract for the purchase and sale of goods between the customer (the buyer, Gotham in this case) and the beneficiary (the seller Shih): second, the agreement between the issuer (Bank Leumi), customarily a bank but frequently some other institution or person, and its customer (Gotham) in which the issuer typically agrees to issue the letter of credit in return for its customer's promise to reimburse it for any payments made under the credit plus a commission; and third, the letter of credit itself which is an engagement by the bank or other issuer that it will honor drafts or other demands for payment presented by the beneficiary or a transferee beneficiary upon compliance with the terms and conditions specified in the credit (see United Bank v. Cambridge Sporting Goods Corp., 41 N.Y.2d 254, 258-259, 392 N.Y.S.2d 265, 360 N.E.2d 943; Uniform Commercial Code § 5-103[1][a]; see also, Voest-Alpine Intl. Corp. v. Chase Manhattan Bank, 707 F.2d 680, 682 [2d Cir.]; PLI, Letters of Credit and Bankers' Acceptances 13-14 [1984]; J. White & R. Summers, Handbook on Uniform Commercial Code § 18-1, at 704, 708-10 [2d ed.] ).

The fundamental principle governing these transactions is the doctrine of independent contracts. It provides that the issuing bank's obligation to honor drafts drawn on a letter of credit by the beneficiary is separate and independent from any obligation of its customer to the beneficiary under the sale of goods contract and separate as well from any obligation of the issuer to its customer under their agreement (see, Uniform Commercial Code § 5-114[1]; J. White & R. Summers, Handbook on Uniform Commercial Code § 18-2, at 711-13 [2d ed.] ). Stated another way, this principle stands for "the fundamental proposition * * * that all parties [to a letter of credit transaction] deal in documents rather than with the facts the documents purport to reflect" (H. Harfield, Letters of Credit 76 [ALI-ABA Uniform Commercial Code Practice Handbook 1979]; see, United Bank v. Cambridge Sporting Goods Corp., 41 N.Y.2d 254, 259, 392 N.Y.S.2d 265, 360 N.E.2d 943, supra; Uniform Commercial Code § 5-114[1]; Uniform Customs and Practice for Commercial Documentary Credits [UCP], promulgated by the International Chamber of Commerce, General Provisions and Definitions [c] and art. 9). Thus, the issuer's obligation to pay is fixed upon presentation of the drafts and the documents specified in the letter of credit. It is not required to resolve disputes or questions of fact concerning the underlying transaction.

A limited exception to this rule of independence is provided in section 5-114 of the Code ⁴ (see also, Sztejn v. Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631). Under the general rule the issuer must honor the draft when the documents presented comply with the terms of the letter of credit (Uniform Commercial Code § 5-114[1] ). But when a required document does not conform to the necessary warranties or is forged or fraudulent or there is fraud in the transaction, an issuer acting in good faith may, but is not required to, refuse to honor a draft under a letter of credit when the documents presented appear on their face to comply with the terms of...