In re Carley Capital Group

• Decision Date: 25 May 1990
• Docket Number: Adv. No. 89-0223-11.,Bankruptcy No. MM11-89-00587
• Citation: 118 BR 982
• Parties: In re CARLEY CAPITAL GROUP, Debtor. Thomas G. BEACH, Charles A. Carpenter, Charles R. Carpenter, Charles I. Trainer, Baker G. Clay, and Daniel J. McCarty, Plaintiffs, v. FIRST UNION NATIONAL BANK OF NORTH CAROLINA, Defendant.
• Court: U.S. Bankruptcy Court — Western District of Wisconsin

118 B.R. 982 (1990)

In re CARLEY CAPITAL GROUP, Debtor Thomas G. BEACH, Charles A. Carpenter, Charles R. Carpenter, Charles I. Trainer, Baker G. Clay, and Daniel J. McCarty, Plaintiffs, v. FIRST UNION NATIONAL BANK OF NORTH CAROLINA, Defendant.

Bankruptcy No. MM11-89-00587, Adv. No. 89-0223-11.

United States Bankruptcy Court, W.D. Wisconsin.

May 25, 1990.

Kenneth B. Axe, Lathrop & Clark, Madison, Wis., J. Michael Booe, Petree, Stockton & Robinson, Charlotte, N.C., for defendant.

Michael B. Van Sicklen, Foley & Lardner, Madison, Wis., Daniel W. Stolper, Stafford, Rosenbaum, Rieser & Hansen, Madison, Wis., for plaintiffs (except Daniel J. McCarty).

Anne W. Reed, Reinhart, Boerner, Van Deuren, Norris & Rieselbach, Milwaukee, Wis., for Daniel J. McCarty.

MEMORANDUM DECISION

ROBERT D. MARTIN, Chief Judge.

Plaintiffs, Thomas G. Beach, Charles A. Carpenter, Charles R. Carpenter, Charles I. Trainer, Baker G. Clay, and Daniel J. McCarty ("Plaintiffs"), have sued First Union National Bank of North Carolina ("First Union"), seeking release from obligations related to a letter of credit, money damages, subrogation rights, and recovery of litigation expenses. First Union has moved to dismiss Plaintiffs' amended complaint pursuant to Bankruptcy Rule 7012(b) and FRCP 12(b)(6).

Taking the well-pleaded allegations of Plaintiffs' amended complaint as true,¹ it appears that on or about August 29, 1985, the debtor in the principal case, Carley Capital Group ("CCG"), executed a Deed of Trust Note (the "Note"), pursuant to which it agreed to pay First Union $6,800,000.00; the Note was secured by, inter alia, a duly-recorded Deed of Trust. First Union subsequently requested or required additional protection against defaults by CCG.

On or about June 15, 1987 Plaintiffs agreed with CCG to secure for a limited term up to $1,000,000.00 of the amount owing under the Note by purchasing a letter of credit which would provide First Union the requested additional security. (Plaintiffs allege that they agreed with CCG to "guarantee" the Note to the extent of $1,000,000.00, but no written guaranty is in existence.) Accordingly, Plaintiffs arranged for First Wisconsin National Bank of Milwaukee ("First Wisconsin"), to issue an irrevocable letter of credit to First Union. On June 11, 1987 First Wisconsin issued a irrevocable standby letter of credit to First Union (the "Letter of Credit"). The Letter of Credit provided that an amount not exceeding $1,000,000.00 would be available to First Union upon its presentation to First Wisconsin of a sight draft stating either:

Carley Capital Group, its successors or assigns, is not in compliance with all the terms and conditions of the agreements pertaining to the USD 6.8 Million credit facility for development of the One University Place Office Building at University Place in Charlotte

or:

Carley Capital Group, its successors or assigns, has not provided a satisfactory Standby Letter of Credit more than sixty (60) days prior to the expiration date of this Letter of Credit from an issuer acceptable to First Union and with a maturity date and other provisions which are acceptable to First Union.

The Letter of Credit was stated to expire on July 1, 1988.

On July 1, 1987 CCG and First Union entered into an agreement pursuant to which First Union extended an additional $2,500,000.00 credit facility to CCG, ("Refinancing Agreement"), and consolidated and cross-collateralized all outstanding obligations from CCG to First Union, ("Consolidated Obligations"), including the Note. Total outstanding obligations as of July 1, 1987 were approximately $17,000,000.00 plus accrued interest. The Refinancing Agreement was subsequently amended five times. The amendments provided for, inter alia, the release of collateral, with portions of the proceeds from sales applied to the Consolidated Obligations; the extension of maturity dates of overdue Consolidated Obligations; and the advancement of additional funds to be included among the Consolidated Obligations. First Union and CCG did not obtain Plaintiffs' consent to the Refinancing Agreement or any of the amendments.

On June 29, 1988 the Letter of Credit was amended by replacing the words "sixty (60) days" with "thirty (30) days," and its term was extended until October 1, 1988. By amendment dated September 14, 1988 the term of the Letter of Credit was again extended, with a new expiration date of July 1, 1989.

On June 19, 1989 First Union drafted against the Letter of Credit the full amount of $1,000,000.00. On or about June 21, 1989 First Wisconsin paid the draft to First Union. Plaintiffs do not contend that the Letter of Credit was improperly drafted upon.

The sole issues to be decided on this motion are: 1) whether Plaintiffs are entitled to assert a guarantor's defenses to payment of the Letter of Credit, and 2) whether Plaintiffs are entitled to be subrogated to First Union's rights against CCG. For the reasons elaborated upon below the Plaintiffs are not entitled to assert a guarantor's defenses to payment of the Letter of Credit, nor are they entitled to be subrogated to First Union's rights against CCG.

Plaintiffs contend that they should be characterized as guarantors or sureties so as to allow them to assert a guarantor's defenses to payment. Some review of the background for letters of credit and the structure of letter of credit transactions is essential to proper evaluation of Plaintiffs' contention.

Two types of letters of credit exist, the "commercial" or "sale" letter of credit and the "standby" letter of credit. The difference between the two has been described as follows:

"The standby letter of credit, unlike the commercial letter of credit, has been developed to assist in loan transactions by assuring payment in the event of a default. In a commercial letter of credit, the letter supports the sale contract. In the case of a standby letter of credit the letter supports, essentially, an underlying debt contract. It is used, primarily, to upgrade the credit of the borrower."

Baldwin B. Tuttle, Letters of Credit, in THIRD PARTY GUARANTIES: ENHANCING YOUR BORROWING OPTIONS 1, 5-6 (Law Journal Seminars-Press, Inc., 1981).

"Letters of credit are governed by ch. 405, Stats., art. 5 of the Uniform Commercial Code." Werner v. A.L. Grootemaat & Sons, Inc., 80 Wis.2d 513, 522, 259 N.W.2d 310 (1977). Wis.Stat. § 405.103(1)(d) (1984) defines "letter of credit":

"Credit" or "letter of credit" means an engagement by a bank or other person made at the request of a customer and of a kind within the scope of this chapter (s. 405.102) that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit. A credit may be either revocable or irrevocable. The engagement may be either an agreement to honor or a statement that the bank or other person is authorized to honor.

The irrevocable Letter of Credit in our case meets the description contained in Wis.Stat. § 405.103(1)(d) (1984).

Wis.Stat. § 405.103(1)(e) (1984) defines "customer" (also known as "account party") as "a buyer or other person who causes an issuer to issue a credit. The term also includes a bank which procures issuance or confirmation on behalf of that bank's customer." An "issuer" is "a bank or other person issuing a credit." Wis. Stat. § 405.103(1)(g) (1984). A "beneficiary" of a letter of credit is "a person who is entitled under its terms to draw or demand payment." Wis.Stat. § 405.103(1)(b) (1984). Thus, in our case, Plaintiffs are the "customers," First Wisconsin is the "issuer," and First Union is the "beneficiary."

A letter of credit transaction normally consists of "an underlying contract for goods or services between the beneficiary and the customer, a contract for the letter of credit between the customer and the bank, and a letter of credit. . . . While a letter of credit transaction consists of three or more parties and three or more independent legal relationships, a mere letter of credit consists only of two parties—the issuer and the beneficiary—and one legal relationship." In re Taggatz, 106 B.R. 983, 987 n. 1 (Bankr.W.D.Wis.1989). Unlike the normal letter of credit transaction, in our case there was no underlying contract for goods or services between the beneficiary (First Union) and the customers (Plaintiffs); the contract for goods or services was between First Union and CCG. In addition, a fourth legal relationship existed between CCG and Plaintiffs pursuant to which Plaintiffs obligated themselves to purchase a letter of credit which could be drawn down in the event of CCG's default on its contract with First Union.

Wis.Stat. § 405.103 Official UCC Comment 3 indicates that "the legal relations between the customer and the beneficiary turn on the underlying transaction between them. . . ." Furthermore, Wis.Stat. § 405.109 Official UCC Comment 1 provides that "the customer by entering the underlying transaction has assumed the risks inherent in it. . . . The allocation of such risks between the parties to the underlying transaction is a proper subject for agreement between them. . . ." Thus, the Official UCC Comments indicate that in the usual letter of credit transaction there exists an underlying transaction between the customer and the beneficiary, pursuant to which each party assumes risks inherent in the transaction. In our case, Plaintiffs and First Union did not contract with each other. Instead, each contracted with a third-party, CCG. The Letter of Credit in and of itself creates no legal relations between them.

This conclusion is reinforced by Wis.Stat. § 405.114 Official UCC Comment 1, which states that "The letter of credit is essentially a contract between the issuer and the beneficiary and is recognized by this Article as independent of the underlying contract between the customer and the beneficiary (See Section 5-109 and Comment thereto)."² If, as is stated in Wis.Stat. § 405.114 Official...