Philipp Bros., Inc. v. Oil Country Specialists, Ltd.

• Decision Date: 13 March 1986
• Docket Number: No. 01-85-01006-CV,01-85-01006-CV
• Citation: 709 S.W.2d 262
• Parties: 42 UCC Rep.Serv. 1731 PHILIPP BROTHERS, INC., Appellant, v. OIL COUNTRY SPECIALISTS, LTD., Appellee. (1st Dist.)
• Court: Texas Court of Appeals

Page 262

709 S.W.2d 262

42 UCC Rep.Serv. 1731

PHILIPP BROTHERS, INC., Appellant, v. OIL COUNTRY SPECIALISTS, LTD., Appellee.

No. 01-85-01006-CV.

Court of Appeals of Texas,

Houston (1st Dist.).

March 13, 1986.

Rehearing Denied April 24, 1986.

Carol Vance, Illeana M. Blanco, Bracewell & Patterson, Houston, for appellant.

William E. Junell, Jr., Kay J. Hazelwood, Reynolds, Allen & Cook, Houston, for appellee.

Before DUGGAN, DUNN and LEVY, JJ.

OPINION

LEVY, Justice.

This is an accelerated appeal from the granting of a temporary injunction in which the trial court enjoined Philipp Brothers, Inc. ("Phibro") from presenting, and Texas Commerce Bank ("TCB") from paying, a $1,516,000 letter of credit until disposition of a suit on a contract.

Oil Country Specialists, Ltd. ("OCS"), has sued Phibro claiming breach of contract, fraudulent inducement of a contract, negligent misrepresentation, and fraudulent presentation against a letter of credit. The claims arose out of a May 29, 1985, consignment contract, in which Phibro agreed to place on consignment with OCS both threaded and unthreaded oil field casing pipe worth approximately $15 million. The proposed inventory consisted of approximately 35,000 tons of pipe. Due to the quantity of pipe and diverse locations, OCS did not inspect the pipe prior to execution of the contract; rather, Phibro's representations about the quality of the pipe were incorporated into the contract. The contract provided that each item in inventory would meet American Petroleum Institute specifications, would be of merchantable quality, and would pass without objection in the trade under descriptions set forth in the contract. OCS was obligated to purchase the pipe only as it made sales to customers. In return, the contract required OCS to pay a "restocking" fee at a rate of 10% per year on that portion of the pipe that remained in inventory and on consignment in the event OCS terminated the consignment agreement or otherwise defaulted on the contract. To secure OCS's payment of the restocking fee, OCS caused TCB to issue the standby letter of credit.

By a June 19, 1985, amendment to the original consignment agreement, which was executed one day before the original contract became effective, Phibro released OCS from any requirement to pay a consignment fee on the threaded pipe in inventory, and Phibro was given the right to sell from the threaded inventory without obtaining OCS's prior approval. Under the amendment, OCS was no longer required to purchase the threaded pipe from the Phibro inventory unless OCS had first determined the threaded pipe to be "merchantable." If OCS determined the threaded pipe to be merchantable, it was to buy the threaded inventory prior to threading and selling any other similar grade and size plain-end material then in the inventory, and to pay Phibro an "interest payment" in addition to the purchase price of the threaded pipe.

On August 15, 1985, OCS sent Phibro a letter stating its intention to cancel the contract, claiming that Phibro's pipes did not conform to the contract specifications. Phibro responded that it intended to take delivery of the remaining inventory and demanded from OCS $1,659,722.08 (10% of the worth of the remaining inventory) as the restocking fee under the contract. When OCS failed to pay Phibro the restocking fee, Phibro attempted to draw on the letter of credit. OCS filed suit to enjoin Phibro from presenting, and TCB from honoring, the draft. The trial court granted the injunction. Phibro appeals. The letter of credit, originally set to expire on January 31, 1986, has been extended to April 30, 1986.

Essentially, OCS claims that such a substantial portion of the pipe was defective as to amount to fraud in the underlying transaction, and that the legitimate purpose of the contract and letter of credit was destroyed. Phibro claims that the percentage of pipe not accepted is within recognized industry standards, that there is no fraud involved, and that the injunction frustrates the purpose of letters of credit.

In its first point of error, Phibro argues that the trial court abused its discretion in granting a temporary injunction, because there was no showing of fraud as is required under the Texas Uniform Commercial Code for the issuance of a temporary injunction enjoining the presentment and payment of a letter of credit.

A "letter of credit" is essentially a promise by the issuing bank to honor upon presentment a draft or demand for payment in order to facilitate a commercial transaction. The Texas Supreme Court has defined a letter of credit as follows:

The engagement is a letter of credit if the issuer has a primary obligation that is dependent solely upon presentation of conforming documents and not upon the factual performance or nonperformance by the parties of the underlying transaction.

Republic National Bank v. Northwest National Bank, 578 S.W.2d 109, 115 (Tex.1978) (emphasis in original). Thus, the contractual disputes between the customer and the beneficiary usually are not the concern of the issuer. When a draft or demand for payment, which complies with the terms of the relevant letter, is presented, payment should be made. Tex.Bus. & Com.Code Ann. sec. 5.114(a) (Tex. UCC) (Vernon 1968). The UCC does recognize fraud as an exception that allows the issuer to dishonor, or a court to enjoin the honoring of, an otherwise conforming letter of credit. Sec. 5.114(b) (Vernon Supp.1986).

Fraud occurs when a false representation of material fact is made with intent to induce the listener to act upon it and the listener acts in reliance upon the misrepresentation and suffers injury as a consequence. Gulf Interstate Engineering Co. v. Pecos Pipeline & Producing Co., 680 S.W.2d 879 (Tex.App.--Houston [1st Dist.] 1984, writ dism'd); Hicks v. Wright, 564 S.W.2d 785, 791 (Tex.Civ.App.--Tyler 1978, writ ref'd n.r.e.). The standard for enjoining a letter of credit is such fraud that destroys the legitimate purposes of the letter of credit's independence from the underlying obligation. GATX Leasing Corp. v. DBM Drilling Corp., 657 S.W.2d 178 (Tex.App.--San Antonio 1983, no writ). In GATX Leasing Corp., the court adopted the standards set out by a New York case as correctly effectuating the purpose of sec. 5-114(b). Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Supreme Court 1941). In Sztejn, the beneficiary had contracted to supply the customer bristles but intended to deliver cowhair, other worthless material, and rubbish. The customer gave advance notice to the bank of the beneficiary's intended...