NISSHO IWAI v. KOREA BANK

• Decision Date: 19 November 2002
• Citation: 782 N.E.2d 55,752 N.Y.S.2d 259,99 N.Y.2d 115
• Parties: NISSHO IWAI EUROPE PLC, Respondent, v. KOREA FIRST BANK, Appellant.
• Court: New York Court of Appeals Court of Appeals

99 N.Y.2d 115

782 N.E.2d 55

752 N.Y.S.2d 259

NISSHO IWAI EUROPE PLC, Respondent, v. KOREA FIRST BANK, Appellant.

Court of Appeals of the State of New York.

Argued October 10, 2002.

Decided November 19, 2002.

Paul, Weiss, Rifkind, Wharton & Garrison, New York City (Richard A. Rosen, Walter Rieman, Jeremy Ofseyer, Robyn Sorid and Melanie H. Stein of counsel), and O'Melveny & Myers LLP (Andrew J. Frackman of counsel), for appellant.

Davis Polk & Wardwell, New York City (James L. Kerr, Carmela L. Guerrero, James I. Rim and Mariasole L. Kaine of counsel), for respondent.

Chief Judge KAYE and Judges SMITH, LEVINE, CIPARICK, WESLEY and ROSENBLATT concur.

OPINION OF THE COURT

GRAFFEO, J.

We are asked in this dispute to determine whether the renewal of a revolving standby letter of credit is implicitly contingent on the repayment of funds previously disbursed by the issuing bank.

In September 1994, plaintiff Nissho Iwai Europe PLC agreed to loan $150 million to Daewoo Hong Kong Ltd. in separate installments of $125 million and $25 million. Daewoo was required to pay interest for three years after the first disbursement, to be followed by repayment of principal and accumulated interest in 15 equal quarterly installments of approximately $10.7 million. Daewoo provided two forms of security for the loan, a guarantee by Daewoo's parent corporation and an irrevocable standby letter of credit issued by defendant Korea First Bank (KFB).

The standby letter of credit, drafted by Nissho, states that KFB opened an "irrevocable revolving letter of credit" in favor of Nissho on behalf of Daewoo for "up to USD 11,500,000.00" to cover any principal and interest that was past due under the Nissho-Daewoo loan agreement. The document further provides that the "letter of credit shall be revolved and reinstated every three months within the period of validity." The letter of credit was valid from November 3, 1994 "until November 9, 2001, but bec[a]me drawable up to USD 3,750,000.00 from November 9, 1994 until February 9, 1998 and up to USD 11,500,000 from February 10, 1998 until November 9, 2001." The parties agreed that the instrument would be construed in accordance with New York law and the 1993 version of the International Chamber of Commerce's Uniform Customs and Practice for Documentary Credits (commonly referred to as the UCP 500).

Daewoo timely repaid its loan from Nissho until it missed the scheduled November 9, 1999 payment of principal and interest. The next day, Nissho notified Daewoo of the default and accelerated the outstanding balance of the loan. Nissho then demanded that KFB cover the late payment pursuant to the letter of credit. KFB complied with that request and transferred about $10.7 million to Nissho. Several weeks later, KFB disbursed $761,171.87 to Nissho, the balance of quarterly funds available under the letter of credit. After these two payments were made, Daewoo's unpaid principal loan balance was approximately $74 million.

Around the time of the default, rumors began to circulate of KFB's intention to terminate its operations in the United States, giving rise to concerns about the effect that would have upon the letter of credit. This prompted the Republic of Korea and the Korea Deposit Insurance Corporation (which control KFB) to notify the New York Superintendent of Banks that the KFB letter of credit provided the beneficiary, Nissho, with a maximum aggregate credit limit of $11.5 million, to be reinstated quarterly in proportion to any payments made by Daewoo. Similar notice was sent to Nissho.

Despite KFB's interpretation that repayment by Daewoo was necessary before further draws against the letter of credit would be honored, at the beginning of the next quarter (December 1999), Nissho demanded another draw in the amount of $11.5 million. Upon KFB's refusal to pay, Nissho initiated this action for wrongful dishonor and anticipatory repudiation. Supreme Court granted summary judgment to Nissho, concluding that the letter of credit required that $11.5 million be made available each quarter regardless of Daewoo's failure to reimburse KFB for previously extended credit. The court awarded Nissho the full amount of principal and interest due on the Daewoo-Nissho loan, approximately $82 million. The Appellate Division affirmed, finding that the quarterly reinstatement of the $11.5 million credit was unconditional and automatic. We granted leave to appeal, and now affirm.

Letters of credit are commercial instruments that provide a seller or lender (the beneficiary) with a guaranteed means of payment from a creditworthy third party (the issuer) in lieu of relying solely on the financial status of a buyer or borrower (the applicant) (see Centrifugal Casting Mach. Co., Inc. v American Bank & Trust Co., 966 F2d 1348, 1352

[10th Cir 1992]). Historically, letters of credit have been used to assure predictability and stability in mercantile transactions by diminishing a seller's risk of nonpayment and a buyer's risk of nondelivery due to insufficient funds (see Voest-Alpine Intl. Corp. v Chase Manhattan Bank, N.A., 707 F2d 680, 682 [2d Cir 1983]). These "commercial" or "documentary" letters of credit are used as a substitute for money in a sales contract; the issuing bank pays the beneficiary upon certification of satisfactory performance in the underlying agreement (see Centrifugal Casting, 966 F2d at 1350 n 1; Dolan, The Law of Letters of Credit: Commercial and Standby Credits ¶ 1.04, at 1-22 [update 2002 no. 1]).

Letters of credit have evolved to serve an additional purpose—to provide security in the event of a default in payment owed under a separate agreement, such as a loan (see 6B Hawkland UCC Series Rev § 5-101:2, at Rev Art 5-7-5-8). A letter of credit serving this objective is referred to as a "standby" letter of credit because it is payable only upon proof of the applicant's nonperformance or default (see Brenntag Intl. Chems., Inc. v Bank of India, 175 F3d 245, 251

[2d Cir 1999]; Dolan, The Law of Letters of Credit ¶ 1.04, at 1-22). Stated another way, a commercial letter of credit substitutes as the primary means of payment, while a standby letter of credit is used secondarily after the beneficiary fails to obtain payment from the applicant (see Federal Deposit Ins. Corp. v Philadelphia Gear Corp., 476 US 426, 428 [1986]).¹

Both types of instruments are similar in one significant respect—they can "revolve" by periodically replenishing credit lines upon the occurrence of a specified condition or event, thereby allowing the beneficiary to make additional draws in satisfaction of sums still owed by the applicant (see Siviglia, Letters of Credit § 14:6, at 14-25; Dolan, The Law of Letters of Credit ¶ 1.09, at 1-62). Additionally, because letters of credit depend upon the certainty of payment to the beneficiary, the issuer's obligation is independent of the rights and liabilities of the parties to the underlying contract; payment must be made irrespective of any allegations of breach of warranty or nonconformity (see Mennen v J.P. Morgan & Co., 91 NY2d 13, 20 [1997]

; Matter of Supreme Mdse. Co. v Chemical Bank, 70 NY2d 344, 352 [1987]).

Three distinct contractual relationships are usually present when a letter of credit is issued (see First Commercial Bank v Gotham Originals, 64 NY2d 287, 294 [1985]

). There is the underlying agreement between the applicant (here, Daewoo) and the beneficiary (Nissho). The second contractual obligation arises between the issuer (KFB) and its applicant (Daewoo) regarding the terms of the letter of credit and the extent of funds to be made available. Finally, there is the issuance of the letter of credit, the agreement embodying the issuer's commitment to "honor drafts or other demands for payment presented by the beneficiary or a transfer beneficiary upon compliance with the terms and conditions specified in the credit" (id.; see e.g. Mennen, 91 NY2d at 20; Wood v R.R. Donnelley & Sons Co., 888 F2d 313, 317-318 [3d Cir 1989]).

Here, there is no disagreement that KFB issued a revolving standby letter of credit or that Nissho has complied with the requirements of the letter. The focus of the dispute is whether the letter of credit revolves automatically or conditionally. More specifically, do the terms of the letter of credit require that subsequent draws be honored by KFB without regard to repayment by Daewoo, or are future draws contingent on Daewoo's repayment of funds disbursed during the prior quarter? KFB's position is that the instrument is unclear as to whether an additional $11.5 million was automatically available at the beginning of each three-month interval or was conditioned upon Daewoo's repayment of previously utilized credit. It notes that the document does not set forth the total amount of the Nissho-Daewoo loan ($150 million), but refers only to $11.5 million. As a result, KFB maintains that its exposure was limited to the latter amount. Furthermore, although KFB concedes that a repayment condition does not appear in the letter of credit, it nevertheless asserts that the use of the term "revolved" in a standby letter of credit implicitly imposes a duty upon the applicant to reimburse the issuing financial institution for utilized credit before further credit can be renewed and reused by the beneficiary. Consequently, KFB claims that the document is ambiguous because it is susceptible of both interpretations. We disagree.

We have long adhered to the principle that letters of credit must be strictly construed and performed in compliance with their stated terms (see e.g. United Commodities-Greece v Fidelity Intl. Bank, 64 NY2d 449, 455,

rearg denied 65 NY2d 923 [1985]; Maurice O'Meara Co. v National Park Bank of N.Y., 239 NY 386, 396-397, rearg denied 240 NY 607 [1925]). The reason for this rule is rooted in the very purpose of a letter of credit: "[b]y conditioning payment solely upon the terms set forth in the letter of credit, the...