In re Valley Vue Joint Venture

• Citation: 123 BR 199
• Decision Date: 29 January 1991
• Docket Number: Bankruptcy No. 90-10499-AB.
• Parties: In re VALLEY VUE JOINT VENTURE, Debtor.
• Court: Bankr. V.I.

123 B.R. 199 (1991)

In re VALLEY VUE JOINT VENTURE, Debtor.

Bankruptcy No. 90-10499-AB.

United States Bankruptcy Court, E.D. Virginia, Alexandria Division.

January 29, 1991.

COPYRIGHT MATERIAL OMITTED

Joseph H. Kasimer, Stephen J. Annino, Kasimer & Ittig, P.C., Falls Church, Va., for S.W. Rodgers Company, Inc.

Ronald L. Walutes, Walutes and Bedford, Annandale, Va., for Valley Vue Joint Venture.

MEMORANDUM OPINION

MARTIN V.B. BOSTETTER, Jr., Chief Judge.

This matter is before the Court upon the objection by Valley Vue Joint Venture, a Virginia general partnership (the "Debtor"), to a proof of claim filed by S.W. Rodgers Co., Inc., a Virginia corporation ("Rodgers"), in the amount of $1,000,000. Rodgers' claim results from its reimbursement of a bank which honored a standby letter of credit issued for the account of Rodgers. The letter of credit was drawn upon by the Bank of Baltimore, a secured creditor of the Debtor, following the Debtor's pre-petition default on a loan made to the Debtor by the Bank of Baltimore. Rodgers asserts that it is entitled to be subrogated to the rights of the Bank of Baltimore pursuant to 11 U.S.C. § 509(a) and general principles of equity. For the reasons stated herein, this Court denies the Debtor's objection and holds that Rodgers is entitled to be subrogated to the rights of the Bank of Baltimore with respect to the bank's lien on certain property owned by the Debtor.

In February 1989, the Debtor, a real estate development partnership comprised of VSE Capital Corporation and John E. Alvey, III, obtained a short term $4,493,000 loan from Ameribanc Savings Bank to enable the Debtor to acquire land in Northern Virginia on which the Debtor intended to build single family homes. Ameribanc required that its loan be guaranteed and that the guaranty be secured by a $1,000,000 standby letter of credit¹. The Debtor asked Rodgers, one of its contractors, to furnish the guaranty and letter of credit to Ameribanc. Rodgers agreed to do so and entered into a Guaranty Agreement² with the Debtor dated February 10, 1989 (the "Original Agreement"). Paragraph 3 of the Original Agreement states that:

Rodgers agrees that it waives subrogation and contribution with respect to its guaranty and acknowledges that it will have no recourse against the Debtor or its partners, VSE Capital Corporation and John E. Alvey, III, or any guarantors including David K. Vitalis or John E. Alvey, III or their respective spouses, if any, or any other indorsers or guarantors of the loans issued by the Mortgagees for the Project in the event that a Mortgagee draws upon the Letter of Credit in the event the Debtor defaults in its obligations to such mortgagee.

(emphasis added).

Rodgers never delivered a guaranty to Ameribanc but did cause a $1,000,000 standby letter of credit to be issued for the benefit of Ameribanc.

In March 1989, the Debtor refinanced the Ameribanc loan with the Bank of Baltimore which required that its loan be secured by a deed of trust on the property that the Debtor acquired with the proceeds of the Ameribanc loan. The Bank of Baltimore required that its loan be guaranteed by VSE Capital Corporation, John E. Alvey, III, David K. Vitalis (the majority shareholder of VSE Capital Corporation) and Vitalis' wife (collectively, the "Guarantors"). The Bank of Baltimore also required the delivery of an additional guaranty to be secured by a $1,000,000 standby letter of credit. Rodgers agreed to furnish such guaranty and letter of credit. In addition, Rodgers, at the request of the Debtor, agreed to lend the Debtor $500,000 to enable the Debtor to satisfy all of the conditions to closing the Bank of Baltimore loan. The $500,000 loan was guaranteed by John E. Alvey, III, David K. Vitalis and Vitalis' wife. To evidence their agreement, Rodgers and the Debtor entered into an Amendment to Guaranty dated March 31, 1989 (the "Amendment"). Paragraph 3 of the Amendment states that "Paragraph 3 of the Guaranty Agreement is replaced by the following language: . . ." (emphasis added)³. The language that followed did not contain the language in Paragraph 3 of the Original Agreement regarding waiver of subrogation and recourse. The Amendment was executed only by the Debtor and Rodgers. No formal consents to the execution of the Amendment were obtained from the Guarantors.

The Bank of Baltimore never received a guaranty from Rodgers but did receive an irrevocable standby letter of credit in the amount of $1,000,000 (the "Letter of Credit") issued by Security Bank Corporation and confirmed by Sovran Bank, N.A. (the "Confirming Bank")⁴ for the account of Rodgers. The Letter of Credit provided that it could be drawn by a written instrument stating that "a default or Event of Default has occurred as defined under the terms of a certain deed of trust from Valley Vue Joint Venture, as grantor, in favor of The Bank of Baltimore as beneficiary. . . ."

The loan agreement between the Debtor and the Bank of Baltimore provided that "in the event the Bank of Baltimore draws down the Letter of Credit, such proceeds will be applied to the outstanding principal balance under the Note" evidencing the Bank of Baltimore's loan to the Debtor.

On February 13, 1990, following a default by the Debtor on its loan from the Bank of Baltimore, the Bank of Baltimore drew the full amount of the Letter of Credit. Pursuant to its obligations to the Confirming Bank, Rodgers promptly reimbursed the Confirming Bank for the $1,000,000 that the Confirming Bank had paid to the Bank of Baltimore. On March 9, 1990, the Debtor filed its voluntary petition under Chapter 11 of the Bankruptcy Code⁵. Thereafter, Rodgers filed its proof of claim asserting that it is entitled to be subrogated to the rights of the Bank of Baltimore because it caused the Debtor's loan to be reduced by $1,000,000 pursuant to the Letter of Credit.

In objecting to Rodgers' proof of claim, the Debtor first contends that Rodgers, as the account party who arranged for the issuance of the Letter of Credit, is not entitled under either 11 U.S.C. § 509(a)⁶ or general principles of equity to be subrogated to the rights of the Bank of Baltimore. The Debtor argues that the Confirming Bank's obligation to pay the Bank of Baltimore pursuant to the Letter of Credit was a primary obligation and not in the nature of a guaranty or suretyship agreement. Therefore, according to the Debtor, the Confirming Bank was not "liable with the debtor on, . . . a claim of a creditor against the debtor" and Rodgers could not acquire any rights greater than those that the Confirming Bank possessed. The Debtor relies principally on Bank of America Nat'l Trust & Sav. Assoc. v. Kaiser Steel Corp. (In re Kaiser Steel Corp.), 89 B.R. 150 (Bankr.D.Colo. 1988), which held that an issuer who pays a standby letter of credit is not entitled under 11 U.S.C. § 509(a) to be subrogated to the rights of the beneficiary.

The Kaiser court stated that because subrogation is an equitable principle, an entity seeking to be subrogated to the rights of a creditor under 11 U.S.C. § 509(a) must satisfy a five-part test derived from general equitable principles of subrogation. Kaiser, 89 B.R. at 152. The opinion of the court indicated that one element of such test is that any payment made by such entity to such creditor must have satisfied a debt for which the entity was "not primarily liable." Id. The court held that the issuer of a standby letter of credit "assumes an independent obligation to pay the creditor upon presentation of demand. When the issuer pays its own debt it cannot then step into the shoes of the creditor to seek subrogation, reimbursement or contribution from the debtor." Kaiser, 89 B.R. at 153.⁷

In Kaiser, the debtor obtained a standby letter of credit from a bank for the benefit of a leasing company that extended credit to the debtor through a sale/leaseback transaction. The debtor's obligations to the leasing company under their lease agreement were secured by a lien on all of the debtor's assets. After the debtor defaulted on its obligations to the leasing company, the leasing company drew against its letter of credit. The debtor failed to reimburse the issuer after the issuer honored the letter of credit. The issuer claimed that it was entitled, after the leasing company's claim was paid in full, to be subrogated to the leasing company's security interest in the debtor's assets. The court found that the payment under the letter of credit satisfied a debt for which the issuer was primarily liable and therefore rejected the issuer's claim. Kaiser, 89 B.R. at 152.

The Kaiser court correctly observed that an issuer's obligation to honor a standby letter of credit is considered a "primary" obligation. See, e.g., Republic Nat'l Bank v. Northwest Nat'l Bank, 578 S.W.2d 109, 114 (Tex.1978) ("The issuer assumes a primary obligation independent of the underlying contract and engages that it will pay upon the presentation of documents required by the instrument."). However, the Kaiser court failed to distinguish between the primary liability of a debtor to its creditor to repay a loan and the primary obligation of the issuer to its beneficiary to honor a letter of credit. When a standby credit supporting a loan is honored, the issuer⁸ admittedly is satisfying its obligation as a primary obligor to honor the standby credit, but at the same time it is in fact satisfying a debt for which a person other than the issuer is primary liable. This distinction, although not recognized by the Debtor or the Kaiser court, is critical.⁹ An issuer is not primarily liable on the debt supported by its standby credit.

We reject the Kaiser analysis and hold that where a standby letter of credit is used to support a loan from the beneficiary to the debtor, a confirming bank, by honoring the credit and thereby reducing the debtor's obligation to the beneficiary, is "an entity that is liable with the debtor on, . . . a claim...