San Diego Gas & Electric Co. v. Bank Leumi, D020429

• Decision Date: 15 February 1996
• Docket Number: No. D020429,D020429
• Citation: 50 Cal.Rptr.2d 20,42 Cal.App.4th 928
• Court: California Court of Appeals Court of Appeals
• Parties: , 64 USLW 2563, 29 UCC Rep.Serv.2d 338, 96 Cal. Daily Op. Serv. 1068, 96 Daily Journal D.A.R. 1739 SAN DIEGO GAS & ELECTRIC COMPANY, Plaintiff and Respondent, v. BANK LEUMI, Defendant and Appellant.

Page 20

50 Cal.Rptr.2d 20

42 Cal.App.4th 928, 64 USLW 2563, 29 UCC Rep.Serv.2d 338,

96 Cal. Daily Op. Serv. 1068,

96 Daily Journal D.A.R. 1739

SAN DIEGO GAS & ELECTRIC COMPANY, Plaintiff and Respondent, v. BANK LEUMI, Defendant and Appellant.

No. D020429.

Court of Appeal, Fourth District, Division 1, California.

Feb. 15, 1996.

Buchalter, Nemer, Fields & Younger and Jay R. Ziegler, Los Angeles, for Defendant and Appellant.

William C. Kamenjarin, San Diego, for Plaintiff and Respondent.

KREMER, Presiding Justice.

The instant litigation stems from defendant Bank Leumi's refusal to honor a draft presented San Diego Gas & Electric Company (SDG & E) on a "standby" letter of credit issued by Bank Leumi (the Bank). The Bank appeals from a summary judgment in favor of SDG & E. We are asked to consider whether a beneficiary under a standby letter of credit owes the issuer of the letter of credit a duty to mitigate damages and, irrespective of any duty to mitigate, whether any actual mitigation entitles the issuer to a corresponding reduction of the beneficiary's recovery under the letter of credit. We answer these questions in the negative and affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

The facts surrounding the creation of the subject letter of credit are not in dispute. In May of 1988, SDG & E issued its revised Standard Offer No. 2 Firm Capacity Purchase Agreement, an offer to purchase electricity from small power producers. In June of 1988, SDG & E entered into a Standard Offer No. 2 agreement to purchase power from Luz San Diego Solar Partners, Ltd. I (Luz). Pursuant to that agreement, the Bank issued an irrevocable standby letter of credit in the amount of $400,000, naming SDG & E as beneficiary. The applicant for the letter of credit was Luz International, Ltd. on behalf of Luz San Diego Solar Partners, Ltd. I.

The power purchase agreement between Luz and SDG & E called for the development and construction by Luz of a small power production facility, which was to commence operation by the end of 1993 and produce the electrical power to be purchased by SDG & E. The purpose of the standby letter of credit was to secure Luz's performance under the agreement. The letter of credit provided SDG & E could obtain payment under the letter by drafts drawn on the Bank and accompanied by a statement, signed by an authorized signer for SDG & E, certifying that the drawing was made in accordance with Standard Offer No. 2 and stating the deficiencies in Luz's performance giving rise to the drawing. In October of 1989, the amount of the letter of credit was increased by $25,000, resulting in an aggregate total amount of $425,000.

As a result of Luz's failure to reach certain "project development milestones" specified in the contract, in January of 1992 SDG & E sent the Bank a written demand to draw $425,000 under the letter of credit. The demand stated the drawing was made in accordance with Standard Offer No. 2, and stated Luz's deficiencies in performance of the contract, as required by the letter of credit. The Bank dishonored SDG & E's demand on the ground the letter of credit had expired in June of 1990. SDG & E made a second demand that the Bank honor the letter of credit, disputing the Bank's contention the letter of credit had expired. The Bank again rejected SDG & E's demand.

In November of 1992, SDG & E filed the instant action for wrongful dishonor of demand, breach of contract, and breach of the implied covenant of good faith and fair dealing. The Bank opposed SDG & E's subsequent motion for summary judgment on the grounds the letter of credit had expired, there was a triable issue of fact as to the amount of loss SDG & E could have avoided pursuant to its duty to mitigate damages, and, irrespective of such duty, there was a triable issue of fact as to the amount by The court granted SDG & E's motion for summary judgment, ruling SDG & E was entitled to draw on the letter of credit in the full amount of its demand of $425,000. In its order granting the motion, the court expressly rejected the Bank's argument that the letter of credit had expired and implicitly rejected the Bank's mitigation arguments. The Bank limits its contentions on appeal to the mitigation issues.

which the Bank was entitled to reduce its payment under the letter of credit due to voluntary mitigation efforts by SDG & E. The Bank requested that the motion be denied or continued pursuant to Code of Civil Procedure section 437c, subdivision (h) due to the Bank's incomplete discovery on the issue of mitigation of SDG & E's damages.

DISCUSSION

On appeal from a ruling on a motion for summary judgment, the appellate court conducts its own independent review of the moving and opposition papers and applies the same standard as the trial court in determining whether the motion was properly granted. (California Aviation, Inc. v. Leeds (1991) 233 Cal.App.3d 724, 730-731, 284 Cal.Rptr. 687.) The mitigation issues raised by the instant appeal are questions of law which must be decided in accordance with principles generally applicable to letters of credit.

Letters of credit are governed by division five of the CALIFORNIA UNIFORM COMMERCIAL CODE. SECTION 5103¹, subdivision (a) defines a letter of credit as "an engagement by a bank or other person made at the request of a customer ... that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit."

An excellent overview of the history and law concerning letters of credit is set forth in Colorado Nat. Bank, etc. v. Bd. of County Com'rs (Colo.1981) 634 P.2d 32. The Colorado Supreme Court explains that

"[t]he letter of credit arose to facilitate international commercial transactions involving the sale of goods. [Citations.] Today the commercial utility of the letter of credit in both international and domestic sale of goods transactions is unquestioned and closely guarded. [Citations.] In recent years, the use of the letter of credit has expanded to include guaranteeing or securing a bank's customer's promised performance to a third party in a variety of situations. [Citations.] This use is referred to as a standby letter of credit. Article five of the Uniform Commercial Code governs both traditional commercial letters of credit and standby letters of credit. [Citation.]

"Three contractual relationships exist in a letter of credit transaction. [Citations.] Underlying the letter of credit transaction is the contract between the bank's customer and the beneficiary of the letter of credit, which consists of the business agreement between these parties. Then there is the contractual arrangement between the bank and its customer whereby the bank agrees to issue the letter of credit, and the customer agrees to repay the bank for the amounts paid under the letter of credit.... Finally, there is the contractual relationship between the bank and the beneficiary of the letter of credit created by the letter of credit itself. The bank agrees to honor the beneficiary's drafts or demands for payment which conform to the terms of the letter of credit. [Citations.]" (Colorado Nat. Bank, etc. v. Bd. of County Com'rs, supra, 634 P.2d at p. 36.)

Although the relationship between the issuer and beneficiary of a letter of credit is often loosely described as "contractual," as in Colorado Nat. Bank, courts and commentators have pointed out that this is an inaccurate characterization. White and Summers state some "characterize the letter of credit as a contract between the beneficiary and the issuer, but it is better to call it an 'undertaking' and so avoid the implication that contract principles might apply to it." (3 White and Summers, Uniform Commercial Code (4th ed., 1995), § 26-2, p. 113; see also Arbest Const. Co. v. First Nat. Bank & Trust Co. (10th Cir.1985) 777 F.2d 581, 583 [relationship between issuer and beneficiary is statutory, not contractual]; accord, Ward Petroleum Corp. v. Federal Deposit Ins. Corp. (10th Cir.1990) 903 F.2d 1297, 1300; Dibrell Bros. v. Banca Nazionale Del Lavoro (11th Cir.1994) 38 F.3d 1571, 1579 [beneficiary "cannot assert a breach of contract claim against the issuer because no contract exists between the two; rather, an engagement runs from the latter to the former."].)

Section 5114, subdivision (1) provides that "[a]n issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying contract for sale or other contract between the customer and the beneficiary." The California code comment to section 5114 states, "Subdivision (1) reflects the concept that the letter of credit is independent from the underlying sales contract." (23B West's Ann.Cal.U.Com.Code, § 5114 (1964 ed.) p. 718.) This unique feature, referred to as the "independence principle," is the primary characteristic of a letter of credit. Absent fraud, the issuer must pay upon proper presentment regardless of any defenses the applicant for the letter of credit may have against the beneficiary arising from the underlying transaction. (See, e.g. Lumbermans Acceptance Co. v. Security Pacific Nat. Bank (1978) 86 Cal.App.3d 175, 178, 150 Cal.Rptr. 69.) Thus, the issuer of a letter of credit is never entitled to defend against payment based on extraneous defenses which might have been available to the primary obligor.

"The rule of the independence of the letter of credit from the underlying transaction is based on two policy considerations. First, the issuing bank can assume no liability for the performance of the underlying contract because it has no control over making the underlying contract or over selection of the beneficiary [citation]. Second, the letter of credit would lose its commercial vitality if, before honoring drafts, the issuing bank were obliged to look beyond the terms of the letter of credit to the underlying contractual...