Aetna Life and Cas. Co. v. Huntington Nat. Bank

• Decision Date: 20 May 1991
• Docket Number: No. 90-3047,90-3047
• Citation: 934 F.2d 695
• Parties: 14 UCC Rep.Serv.2d 1154 AETNA LIFE AND CASUALTY COMPANY, Plaintiff-Appellant, v. HUNTINGTON NATIONAL BANK, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 695

934 F.2d 695

14 UCC Rep.Serv.2d 1154

AETNA LIFE AND CASUALTY COMPANY, Plaintiff-Appellant, v. HUNTINGTON NATIONAL BANK, Defendant-Appellee.

No. 90-3047.

United States Court of Appeals, Sixth Circuit.

Argued April 9, 1991.

Decided May 20, 1991.

Avrum Levicoff (argued), Anstandig, Levicoff & McDyer, Pittsburgh, Pa., for plaintiff-appellant.

James E. Pohlman (argued), Jennifer T. Mills, Daniel W. Costello, S. Ronald Cook, Porter, Wright, Morris & Arthur, Columbus, Ohio, for defendant-appellee.

Before MARTIN and GUY, Circuit Judges, and LIVELY, Senior Circuit Judge.

LIVELY, Senior Circuit Judge.

This case requires the interpretation and application of a provision of the Uniform Commercial Code (UCC), as adopted by the Ohio legislature in Title XIII of Ohio Revised Code (O.R.C.). More specifically, we are concerned with the provision of UCC Sec. 5-114(2), O.R.C. Sec. 1305.13(B), which permits the issuer of a letter of credit to refuse payment, or to dishonor, a draft presented with the letter of credit because of alleged "fraud in the transaction."

In this case the district court found that there was no fraud in the transaction, and entered summary judgment dismissing a claim for reimbursement made by the assignee of the issuing bank. We affirm.

I.

The plaintiff Aetna Life Insurance and Casualty Company (Aetna) provided fidelity bond coverage to Algemene Bank Nederland, N.V. (ABN) to cover losses to ABN from the misdeeds of its employees. ABN is an international banking institution with its principal office in Amsterdam and a branch office in Pittsburgh, Pennsylvania. The branch manager at ABN's Pittsburgh office was Jan Soels and the assistant manager was Robert Hammar. During the years 1980 and 1981, Soels had authority to lend and extend letters of credit up to $300,000 without approval of ABN's main office.

The defendant Huntington National Bank (HNB) has its principal office in Columbus, Ohio and was the primary lender to Kyova Corporation (Kyova) and its wholly owned subsidiary Tri-State Molded Plastics (Tri-State). Ninety-six percent of the outstanding stock of Kyova was owned by Thomas P. Tyler, who was also its president as well as the president of Tri-State. Tyler was also a principal of Carib Aviation, Inc. (Carib) and Kyova International, Inc. (Kyova Int'l), corporations based in Florida. Both of these latter companies conducted their primary banking business with Royal Trust Bank of Miami.

As a result of their banking relationship, HNB had issued to Kyova and Tri-State a $2.2 million revolving line of credit and held $2 million in notes of these corporations secured by accounts receivable, inventory and other assets. The debt of both corporations was cross-collateralized and was personally secured by Tyler and his wife. By late 1980 HNB had become aware that the financial condition of both these companies had severely deteriorated. Both companies were in default on payments to HNB on the $4.2 million aggregated debt, and HNB assigned a high-risk classification to each company's demand deposit accounts. In 1981 HNB officers discovered that certain of Carib's accounts receivable owned by Kyova were improperly included as collateral under the revolving line of credit. HNB officers also discovered that unregulated cash transfers were being made among several Tyler companies and noted that these accounts needed careful supervision. In order to protect its exposure from loans to Kyova and Tri-State, HNB urged Tyler to acquire financial assistance from another bank. On condition that the cash transfers among the Tyler companies would cease, HNB waived default on its loans to Kyova and Tri-State and renewed the revolving line of credit to prevent possible bankruptcy and forced liquidation of the companies.

In an attempt to manage the seriously deteriorated financial condition of Kyova and Tri-State, Tyler had apparently begun a check kiting scheme between those companies and Carib and Kyova Int'l. To carry out this scheme, Tyler would draw checks on the Miami accounts of Carib and Kyova Int'l payable to the order of Kyova and Tri-State and deposit the checks in the Concerned about paying checks drawn on large uncollected funds balances, HNB advised Tyler in October 1981 that in order for it to continue to pay checks drawn on the Kyova and Tri-State accounts, the amount of uncollected funds in those accounts must decrease. When those balances did not decrease significantly, HNB dishonored $1.7 million in checks payable to Carib and Kyova Int'l drawn on the uncollected balances of the Tyler-controlled accounts at HNB. On October 26, Tyler apparently alerted HNB that the dishonor of checks drawn on the HNB accounts would most likely result in the dishonor of checks in favor of those accounts drawn on the Miami bank.

HNB accounts. At the same time, Tyler would draw checks on the HNB accounts and deposit them into the Miami accounts of Carib and Kyova Int'l. This technique resulted in large book balances in the Tyler-controlled accounts of all four companies. Because both HNB and the Royal Trust Bank in Miami routinely honored checks drawn against uncollected balances, Tyler was able to generate cash by taking advantage of the "float," or the time between the posting of the credit to the depositor's account and the posting of the corresponding debit to the drawer's account.

In order to deal with the shortfalls of cash in the HNB accounts, Tyler proposed to provide HNB with a letter of credit from another bank that would protect HNB from loss exposure arising out of the continued honoring of checks drawn against the uncollected funds. HNB agreed to this proposal, and on October 28, 1981, Tyler applied for an irrevocable letter of credit from ABN with HNB as beneficiary. On the same date, HNB received a Telex confirmation from ABN's Pittsburgh office that ABN had issued an irrevocable standby letter of credit in the amount of $2 million to cover the net uncollected balance in the Kyova and Tri-State accounts. The confirmation was signed by ABN's branch manager Soels and assistant manager Hammar, both of whom had authority to issue a letter of credit but not in that amount. HNB followed its customary verification procedures to confirm the authenticity of the letter of credit and the signatures, but was unable to detect any irregularities.

Shortly after receiving the letter of credit, HNB determined that the resubmission of the returned checks would result in overdrafts of Kyova's and Tri-State's accounts. Accordingly, HNB concluded that rather than draw upon the letter of credit to cover the uncollected funds balances, it would make loans to Kyova and Tri-State in the amount of the overdrafts and use the letter of credit as security. HNB requested an amendment to the letter of credit to permit the loans, and provided the necessary amending language. ABN amended the letter of credit as proposed by HNB, and by letter dated November 4, 1981, sent the amendment to HNB.

Following confirmation of the amendment to the letter of credit, HNB began extending loans to Kyova and Tri-State to cover overdrafts created by honoring checks drawn on uncollected funds. These loans totalled approximately $2 million by January 1982, at which time ABN informed HNB that there appeared to be irregularities in the issuance of the letter of credit. On January 15 HNB made presentment of a draft and demand for payment on the letter of credit in the amount of $1,987,902.05, which represented the principal and interest on the loans made to Kyova and Tri-State to cover overdrafts. Shortly thereafter, ABN paid the draft to HNB under a reservation of rights and filed a claim in that amount on its fidelity bond with the plaintiff Aetna. Aetna settled the bond claim with ABN and took an assignment of rights. On January 25, 1982, Tyler, Kyova and Tri-State filed for bankruptcy.

II.

A.

In June 1983 Aetna commenced this lawsuit against HNB seeking recovery of its payment to ABN on the fidelity bond. Jurisdiction was based on diversity of citizenship, and the substantive law of Ohio controls Shortly before the scheduled trial date, HNB filed a motion in limine requesting that the court limit Aetna's proof in its case in chief to the question of whether there was fraud in the transaction by HNB, that it preclude the plaintiff from introducing evidence in its case in chief of HNB's failure to disclose to ABN the credit-worthiness of Tyler, and to defer proof until plaintiff's rebuttal case on the issue of whether HNB was a holder in due course. The district court, in considering the motion in limine, noted that under the UCC as adopted by Ohio, the obligation of the issuing bank to honor a letter of credit is generally independent of the underlying contract between the issuer's customer and the beneficiary of the letter of credit. The district court reasoned that while Aetna, as ABN's subrogee, could complain about fraud surrounding the letter of credit contract itself, that contract was independent of underlying agreements between its customer and the beneficiary, and that Aetna, therefore, could not rely on fraud in other transactions. The court noted that this "independence principle" governing letter-of-credit transactions would only be disregarded if the issuer can establish "fraud in the transaction." In order to come under this exception, the court ruled that payment can be refunded or enjoined only if the beneficiary of the letter of credit, rather than the customer, has been guilty of intentional fraud. The court therefore granted HNB's motion in limine to structure the proof, bifurcating the case and ordering that Aetna must initially establish that HNB actively and intentionally misrepresented to ABN that Kyova, Tri-State or Tyler was credit-worthy or that HNB concealed a fact that it had a duty to disclose to ABN. Only if one of these circumstances were established would the court address the question of whether...