Petition for Writ of Certiorari — First Interstate Credit Alliance, Inc. v. American Bank of Martin County, 109 S. Ct. 557 (1988) (No. 88-646)
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HILED
OCT 19 1988
88 -6 A6
.
In the Supreme Court of the United States
OCTOBER TERM, 1988
FIRST INTERSTATE CREDIT ALLIANCE, INC.
Petitioner
U.
AMERICAN BANK OF MARTIN COUNTY,
DOUGLASS E. WENDEL
Respondents
PETITION FOR A WRIT OF CERTIORARI
TO THE
UNITED STATES COURT OF APPEALS
FOR THE
ELEVENTH CIRCUIT
JAMES E. FOSTER
Foster & Kelly
Post Office Box 3587
Orlando, Florida 32802-3587
(407) 423-0341
Attorneys for Petitioner
QUESTION PRESENTED
Does a beneficiary who draws on a standby letter of credit receive a
preference in bankruptcy under 11 U.S.C. §547 (6) solely because the
issuer required the debtor to provide security?
TABLE OF CONTENTS
Page
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ee eae her Gah ek dnd aed eAwee eee a Oe wR 2
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Reasons For Granting The Petition .............,.........205. 4
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TABLE OF AUTHORITIES
Cases: Page
In re Air Conditioning, Inc. of Stuart,
645 F.2a 203 (iith Cir. 1966) .................. passim
In re Air Conditioning, Inc. of Stuart,
ero RSE og De . ) 1,3
In re Air Conditioning, Inc. of Stuart,
55 B.R. 157 (Bankr. S.D. Fla. 1985) ............ 1,3
American Bell Int'l v. Islamic Republic of Iran,
474 F.Supp. 420 (S.D.N.Y. 1979) .............. 7
Atlantic Richfield Co. v. Good Hope Refineries, Inc.,
604 F.2d 865 (5th Cir. 1979) ................... 10
In re Clothes, Inc., 35 B.R. 487
SR TD oka ccc gabsdcddbecssnase 6
In re Compton Corp., 831 F.2d 586 (5th Cir. 1987) ....passim
Federal Deposit Insurance Corp. v. Philadelphia
Gear Corp., 106 S.Ct. 1931 (1986) (no. 84-1972)
lg, a 4
First National Bank of Danville v. Phalen,
pgs Se eR ener earn es 10
In re Guy C. Long, Inc., 74 B.R. 939
ee ee a edb anes ay 5,9
Harris Corp. v. National Iranian Radio & Television,
GOl F.2d 1344 (11th Cir. 1962) ................. 7
KMW Int'l v. Chase Manhattan Bank, N.A.,
— f e& ff: o> ee ara 7
In re Marine Distributors, Inc., 522 F.2d 791
I ee a a os 6
National Bank of Newport v. National Herkimer County
BN, Se a PP ONEED oe nec ncwceccuecass 10
In re North Shore & Central Illinois Freight Co.,
30 B.R. 377 (Bankr. N.D. Ill. 1983) ............ 6
In re Page, 18 B.R. 713
a OS ene Se gan date oa 6, 9
Pringle-Associated Mortgage Corp. v. Southern National
Bank, 571 F.2d 871 (5th Cir. 1978) ............. 5
Sztejn v. Henry Schroder Banking Corp.,
177 Misc. 719, 31 N.Y.S.2d 631
ee aera een 7
In re Twist Cap, Inc., 1 B.R. 284
Sy Ot es SO Ss soo be ne vo ve eS 8, 9, 10
iv
Cases - Continued: Page
United States v. Sun Bank of Miami,
608 F.2d 832 (Sth Cir. 1960) ................... 5
In re Zaferis Bros. & Co., Ltd., 67 F.2d 140
SORE Ge. I fs Pcs eek ce Wereds ep eoaaeeneus 10
Statutes and Regulations:
28 U.S.C. § 2101(c) 7
Hh Bae eee 3
UO Bit i a eee 5
UDG. Chie ole 7
Miscellaneous:
Baird, Standby Letters of Credit in Bankruptcy,
49 U. Chi. L. Bev. 190 (1962) ... 0.2 cece eee ees 7,9
Baron, Debt Supported by Irrevocable Letters of Credit,
Irrevocable Commitments and Note Purchase
Agreements, Fixed Income Investor 553
a SE SR Na ae ce eee eee aha ween 8
Baron, LOCs and the ‘‘Twist Cap’”’ Problem,
Standard & Poor’s CreditWeek
Pe % eee here er err rere mr 9
Chaitman & Sovern, Enjoining Payment on a Letter of
Credit in Bankruptcy: A Tempest in a Twist Cap,
_ ee SS... rer eee 7,8
B. Clark, The Law of Bank Deposits, Collections
and Credit Cards (rev. ed. 1981 &
ee errr re ee eT err rer ree 5, 8
Federman & Baron, Bankruptcy Cases Impact LOCs,
Standard & Poors CreditWeek (Feb. 1, 1988) .... 9
Hahn & Schwartz, Letters of Credit under the
Bankruptcy Code, 16 U.C.C.L.J. 91 (1983) ..... 9
Kozolchyk, Is Present Letter of Credit Law Up To Its
Task?, 8 Geo. Mason U. L. Rev. 28b (1986) ..... 4
Kozolchyk, The Emerging Law of Standby Letters of
Credit and Bank Guaranties, 24 Ariz. L. Rev. 319
CE oc cndnd ak aaa 9, 10
McLaughlin, Letters of Credit as Preferential Transfers
in Bankruptcy, 50 Fordham L. Rev. 1033 (1982) ... 5
Note, The Independence Ruie in Standby Letters
of Credit, 52 U. Chi. L. Rev. 218 (1985) ......... 4,5,7
126 Cong. Rec. 31,153 (1980)
(statement of Sen. DeConcini) ................ 9
v
No.
Iu the Supreme Court of the United States
OCTOBER TERM, 1988
FIRST INTERSTATE CREDIT ALLIANCE, INC.
Petitioner
Vv.
AMERICAN BANK OF MARTIN COUNTY,
DOUGLASS E. WENDEL
Respondents
PETITION FOR A WRIT OF CERTIORARI
TO THE
UNITED STATES COURT OF APPEALS
FOR THE
ELEVENTH CIRCUIT
First Interstate Credit Alliance, Inc.' petitions for a writ of certiorari
to review the judgment of the United States Court of Appeals for the
Eleventh Circuit in this case.
OPINIONS BELOW
In re Air Conditioning, Inc. of Stuart, 845 F.2d 293 (11th Cir. 1988)
(App. Al).
In re Air Conditioning, Inc. of Stuar* 72 B.R. 657 (S.D. Fla. 1987)
(App. A160).
In re Air Conditioning, Inc. of Stuart, 55 B.R. 157 (Bankr. S.D. Fla.
1985) (App. A18).
' Petitioner First Interstate Credit Alliance, Inc. is a wholly-owned subsidiary of
First Insterstate Bancorp. Petitioner was formerly known as Leasing Service Corpora-
tion and is referred to as such in all the opinions below and throughout this
petition. (1)
a
2
JURISDICTION
The judgment of the court of appeals was entered May 17, 1988
(App. Al). A petition for rehearing was denied on June 20, 1988
(App. A9). The jurisdiction of this court is invoked pursuant to 28
U.S.C. §2101{c).
STATUTE INVOLVED
11 U.S.C. §547(6) provides:
Except as provided in subsection (c) of this section, the
trustee may avoid any transfer of an interest of the debtor
in property-
(1) toor for the benefit of a creditor;
(2) fororon account of an antecedent debt owed by the debtor
before such transfer was made;
(3) made while the debtor was insolvent;
(4) made-
(A) on or within 90 days before the date of the filing of
the petition;
* * *
(5) that enables such creditor to receive more than such creditor
would receive if-
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the
extent provided by the provisions of this title.
STATEMENT
In December, 1982, Petitioner, Leasing Service Corporation (““LSC’’),
leased a computer system to Air Conditioning, Inc. of Stuart (‘ACT’).
To secure ACI’s performance under the lease, ACI granted LSC a
security interest in all of ACI’s assets. ACI defaulted under the lease in
February, 1984. In April of that year, LSC filed suit in Florida state
court seeking to replevy the computer system and ACI’s other assets.
After LSC recovered the computer system, the court ordered the issuance
of a writ of replevin to seize the remainder of ACI’s assets.
In consideration of LSC’s agreement to refrain from seizing ACI’s re-
maining property, ACI agreed to establish a letter of credit to guarantee
3
payment if the pending litigation was ultimately resolved adversely to
ACI. On June 14, 1984, ACI paid Respondent, American Bank of Martin
County (“American Bank”’), a fee of $2,904.35 to issue a standby letter
of credit naming LSC beneficiary. To memorialize ACI’s obligation to
repay American Bank if LSC drew upon the letter of credit, ACI
executed a promissory note in the sum of $20,030.15 payable to the
bank. Six days later at American Bank’s insistence, ACI delivered a
$20,000.00 certificate of deposit to American Bank to secure payment
under the promissory note.?
Approximately six weeks later, on July 25, 1984, ACI filed a petition for
reorganization under Chapter 11 of the United States Bankruptcy Code.
LSC subsequently attempted to draw on the letter of credit. American
Bank refused to honor the letter of credit and filed a complaint in the
bankruptcy court alleging that LSC was violating the automatic stay.
The trustee, Respondent Douglass E. Wendel, intervened. The bank-
ruptcy court, without a trial, found that LSC had received a voidable
preference, nullified the letter of credit, and ordered American Bank to
surrender the certificate of deposit to the trustee. The district court
reversed the bankruptcy court’s nullification of the letter of credit, but
affirmed the finding that LSC had received a preference.
On appeal, the court of appeals affirmed, finding that LSC had
obtained a preference voidable by the bankruptcy trustee. Examining the
provisions of 11 U.S.C. §547(b), the court reasoned that ACI’s pledge of
the certificate of deposit to American Bank as security for ACI’s prom-
issory note was an “indirect transfer” of ACI’s assets “for the benefit of’
LSC. Concluding that a preference had occurred, the court held that
the beneficiary of the letter of credit, LSC, was the recipient of the pre-
ferential transfer. Both the district court and the court of appeals pro-
fessed the independence of the letter of credit but nevertheless held
that the entire letter of credit transaction resulted in a preference be-
cause the debtor gave security to the issuer. The act of furnishing security
at American Bank’s insistence resulted in a preference, thus trans-
fering the risk of insolvency from the issuer to the beneficiary, LSC.
The court of appeals relied heavily on a recent decision of the Fifth
Circuit. See In re Compton Corp., 831 F.2d 586 (5th Cir. 1987) (App.
A21).? The Compton court exhaustively examined several non-letter of
? LSC has no connection whatsover with American Bank and had no involvement in
procuring the letter of credit which was established pursuant to negotiation between
counsel for ACI and LSC. Despite the bankruptcy court’s conclusion that LSC was
“grossly undersecured,” ACI apparently believed that its assets were worth at least
$20,000.
> Judge Brown of the Fifth Circuit sat on the panels of both Compton and the cese
sub judice.
— Ct
4
credit cases where unsecured creditors improved their positions through
circuitous transfers of the debtor’s assets. In each of those cases, the
courts examined the overall impact of the multiple transfers and
reached the conclusion that voidable preferences had occured. The
Compton court then applied this reasoning to letter of credit transactions
where the beneficiary was an unsecured creditor owed an antecedent
debt. Claiming that its ruling preserved the sanctity of letters of credit
while carrying out the purposes of the Bankruptcy Code, the court con-
cluded that the trustee could recover from the beneficiary of the letter
of credit because the beneficiary had “received an indirect preference.”
Without examining the independence rule or the fundamental pur-
pose of letters of credit, the Compton court went to great lengths to
explain why the issuing bank had not received a preference in bank-
ruptcy. That court reasoned that the bank had given “‘new value” by
issuing the letter of credit and had perfected its security interest out-
side the preference period by virtue of a future advances clause in an
earlier security agreement. The court also concluded that the transfer
of the debtor’s assets was not for the benefit of the bank, even though it
was the bank which required that the repayment obligation be secured
with the debtor’s property. The court stated that:
[T]he issuer of the letter of credit, being just the intermediary
through which the preferential transfer was accomplished, com-
pletely falls out of the picture and is not involved in this par-
ticular legal proceding. Jd. at 594.
REASONS FOR GRANTING THE PETITION
With more than 120 billion dollars of standby letters of credit currently
outstanding,‘ the court of appeals has undermined the ability of letters
of credit to perform their most basic and critical economic function:
the absolute guaranty of payment. The court’s holding that payment
under a letter of credit may constitute a preference to the beneficiary
disregards both the commercial expectations of the parties and defeats
the fundamental purpose of letters of credit: the absolute guaranty of
payment. The court of appeals’ decision ignores several basic tenets of
letter of credit law which are critical to the continued economic utility
and efficacy of letters of credit. The crux of this petition is the adverse
“Petition for Certiorari at 7, Federal Deposit Insurance Corp. v. Philadelphia Gear
Corp., 106S.Ct. 1931 (1986) (No. 84-1972). The value of standby letters of credit by the
United States’ 100 largest banks increased to approximately $134 billion by 1984.
Kozolchyk, Js Present Letter of Credit Law Up To Its Task?, 8 Geo. Mason U. L. Rev.
286, 304 n. 38 (1986). See Note, The Independence Rule in Standby Letters of Credit,
52, U. Chi. L. Rev. 218, 219 n. 14 (1985) (by 1978 five banks alone had $12.6 billion
worth of outstanding standby letters of credit).
5
economic effect of the court of appeals’ decision on the use of standby
letters of credit as absolute guaranties of prompt payment. Immediate
review by this court of the question presented is appropriate.
The ancient law governing letter of credit transactions is premised
on the independent nature of each of the three discrete undertakings
which are common to all letter of credit transactions: the obligations
between
a. the debtor and the creditor;
b. the debtor and its bank (the “‘issuer’’); and
c. the issuer and the creditor (the ‘‘beneficiary’’).°
The obligations of the parties to any one of these undertakings is com-
pletely separate and independent of the other two undertakings which
together constitute a single letter of credit transaction. This principle
is known as the “independence rule.” This rule is the key to the com-
mercial vitality of the letter of credit.®
Under the court of appeals’ rationale, LSC has received a voidable
preference solely because the issuer, American Bank, required ACI to
secure its repayment obligation. Had American Bank not required
security fromm ACI, no preference would have occurred. According to
the reasoning of the court below, ACI’s pledge of the certificate of
deposit at the issuer’s request is the operative fact which created the
preference as to LSC. Air Conditioning, 845 F.2d at 296 (App. A3).
Whether a beneficiary of a letter of credit receives a preferential transfer
is, therefore, completely beyond the beneficiary’s power or control.
The court of appeals conferred that power on the issuing bank yet
imposed the risk of preference on the beneficiary. This inequitable
allocation is contrary not only to the law governing letters of credit, but
also to fundamental notions of fairness and commercial expectation.
The primary issue then becomes which party to a letter of credit
transaction properly bears the preference risk, if any. The court of
appeals has granted the issuer of a letter of credit the unfettered discre-
tion to place the beneficiary at risk. The issuer may, without risk to
itself, seek additional security placing the beneficiary in jeopardy.
Courts, including the Compton court, have recognized that in a let-
ter of credit transaction, the issuing bank is the best suited to evaluate
SInre Guy C. Long, Inc., 74 B.R. 939, 943 (Bankr. E.D. Pa. 1987); B. Clark, The Law
of Bank Deposits, Collections and Credit Cards $8.2[1] (rev. ed. 1981).
* See McLaughlin, Letters of Credit as Preferential Transfers in Bankruptcy, 50
Fordham L. Rev. 1033, 1039-1040 (1982); Note, The Independence Rule in Standby
Letters of Credit, 52 U. Chi. L. Rev. 218 (1985). See, also, United States v. Sun Bank of
Miami, 609 F.2d 832 (5th Cir. 1980); Pringle-Associated Mortgage Corp. v. Southern
National Bank, 571 F.2d 871 (5th Cir. 1978). The independence rule is codified in U.C.C.
§5-114(1).
6
its customer’s risk of insolvency:’
Under a standby letter of credit, the bank becomes primarily
liable to the beneficiary upon the default of the bank’s cus-
tomer to pay for goods or services. The bank charges a fee to
issue a letter of credit and to undertake this liability. The shift-
ing of liability to the bank rather than to the services or goods
provider is the main purpose of a letter of credit. After all, the
bank is ina much better position to assess the risk of its cus-
tomer’s insolvency than is the service or goods provider (em-
phasis added). Compton, 831 F.2d at 590.®
The issuing bank should not be permitted to utilize its ‘‘better posi-
tion” to unilaterally impose a greater risk on the unsuspecting ben-
eficiary. The decisions of Compton and the court below give a bank the
power not only to determine the risk of insolvency but also, after charging
a fee for assuming the risk, shift this risk to another, the unwary
beneficiary.
An issuing bank pays a letter of credit from its own funds.*® Accord-
ingly, the court of appeals acknowledged that the proceeds from a let-
ter of credit are not property of the debtor’s estate.'° The court also
recognized that the undertaking between the issuing bank and the
beneficiary is independent of the transaction between the bank and its
customer. Yet, from these legal declarations, the court traced the cer-
tificate of deposit from the debtor to the bank and then, in effect,
traced the proceeds from the certificate of deposit to the bank’s funds
which ultimately are paid LSC under the letter of credit. This type of
tracing is exactly what the independence rule prohibits. The finding of
an “indirect transfer” vitiates the essential purpose of the indepen-
dence rule.
Proceeds from a letter of credit are either part of the debtor’s estate
or they are not. The court of appeals in one breath states that the pro-
ceeds are not part of the debtor’s estate but in the next permits the trus-
tee to recover the proceeds from LSC for inclusion in the debtor’s
estate. This type of illogical reasoning takes all meaning from the
words themselves; in essence, the court of appeals has made the pro-
ceeds of a letter of credit property of the debtor’s estate. By its own
’ See In re Page, 18 B.R. 713 (D.D.C. 1982); In re North Shore & Central Illinois
Freight Co., 30 B.R. 377 (Bankr. N.D. Ill. 1983).
* The Compton court then distinguished the “risk of the debtor’s insolvency”’ from
“risk of a preference attack’’. LSC submits that this is an artificial and improper dis-
tinction.
* In re Clothes, Inc., 35 B.R. 487 (Bankr. D.N.D. 1983).
'© Air Conditioning, 845 F.2d at 296; In re Marine Distributors, Inc., 522 F.2d 791
(9th Cir. 1975) (the first decision to examine the relationship between letters of credit
and bankruptcy).
7
terms, 11 U.S.C. §547(6) applies only to a “‘transfer of an interest of the
debtor in property.”
Prior to Compton and the case sub judice, only one exception existed
for defeating the independence rule: fraud.'' Any concern that letters
of credit could be used to intentionally avoid the preference provisions
of the code are unfounded. The rules governing fraud in letter of credit
transactions prevent that result.
If a creditor were to persuade a debtor to obtain a letter of credit in
the creditor’s favor with the intent of avoiding the preference pro-
visions of the code and perpetrate a fraud on the bankruptcy court or
the debtor’s other creditors, that court could properly enjoin the creditor
from drawing on the letter of credit. This remedy is consistent with
well-established letter of credit principles dealing with fraud. The
integrity of the Bankruptcy Code and letters of credit would both be
preserved without venturing beyond the parameters of accepted prece-
dent.'? “In short, the letter of credit is an irrevocable obligation of the
bank which the debtor is powerless to affect except pursuant to the
traditional defenses of fraud.’’'*® The court’s reasoning defeats this
basic premise.
The court of appeals erred in holding that LSC receives a voidable
preference when it draws on the letter of credit from American Bank.
The court misperceived the nature of letters of credit, and failed to con-
sider adequately the commercial expectations of the business world
and the repercussions of a finding that a letter of credit may constitute
a preference as to the beneficiary in the absence of fraud. Under the
court of appeals’ ruling, a letter of credit is no longer an absolute
guaranty of payment. The wall surrounding the sanctity and indepen-
dence of letters of credit has been ruptured by the court, even though it
states otherwise.
Commenting on the district court’s assertion that it was preserving
the sanctity of letters of credit, Professor Clark stated that:
"' Baird, Standby Letters of Credit in Bankruptcy, 49 U. Chi. L. Rev. 130, 144-145
(1982); Note, The Independence Rule in Standby Letters of Credit, 52 U. Chi. L. Rev.
218, 219 (1985). The fraud exception was first applied in the seminal case of Sztejn v.
Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup. Ct. 1941). (The
Sztejn rule is codified in U.C.C. §5-114(2)(6)). The fraud issue has recently been exten-
sively litigated in cases involving post-revolutionary Iran. See, e.g., Harris Corp. v.
National Iranian Radio & Television, 691 F.2d 1344 (11th Cir. 1982); KMW Int'l v.
Chase Manhattan Bank, N.A., 606 F.2d 10 (2d Cir. 1979); American Bell Int'l v.
Islamic Republic of Iran, 474 F.Supp. 420 (S.D.N.Y. 1979).
‘2 In the present case, neither American Bank nor the trustee even hint that LSC’s
agreement with ACI was fraudulent.
'? Chaitman, infra n. 14 at 33.
8
The difficulty with the [district] court’s approach is that it
elevates form over substance. By treating the letter and the
reimbursement agreement as a single composite transaction for
preference purposes, the opinion requires the beneficiary to pay
back the proceeds of the draw. How does this result maintain
the “sanctity” of the letter of credit? A beneficiary cares little
whether it bears the loss by “nullification” or by forced regurgita-
tion under Section 550 (a) of the Bankruptcy Code. In either
case, the issuing bank comes out even and the estate retains the
value of the property pledged to secure the bank’s reimburse-
ment claim. Although the [district] court paid lip service to the
“independence principle”’ of letter of credit law, it violated
that principle by treating the letter and the bank’s right of
reimbursement as part of a two-step composite transaction for
preference purposes. B. Clark, The Law of Bank Deposits,
Collections and Credit Cards 98.11 [2] (cum. supp. 1988).
This criticism is equally applicable to the court of appeals decision
affirming the district court.
Air Conditioning and Compton are not the only recent assaults on
the inviolability of letters of credit. The business and banking com-
munity has only recently recovered from the impact of another Florida
bankruptcy decision: Jn re Twist Cap, Inc..* In Twist Cap, the ban-
kruptcy court first articulated the theory that a beneficiary could
receive an impermissible preference if a beneficiary were permitted to
draw on a letter of credit. This conclusion created what one commentator
characterized as ‘‘a tempest in the world of commercial finance.’’'®
Prior to Twist Cap, letter of credit-backed debt was rated solely on
the basis of the creditworthiness of the issuing bank. This method of
rating letter of credit-backed debt is valuable because a borrower is
able to obtain a credit rating based upon the creditworthiness of its
bank rather than its own. Reliance on the stronger credit of the bank
permits a borrower to secure a lower interest rate for financing.'* As a
result of the Twist Cap preference threat to letters of credit, however,
Standard & Poor’s could no longer rely on such readily and ascertain-
able indicia, stating that “absent the resolutions of the “Twist Cap’
‘* 1 B.R. 284 (Bankr. M.D. Fla. 1979).
's Chaitman & Sovern, Enjoining Payment ona Letter of Credit in Bankruptcy: A
Tempest ina Twist Cap, 38 Bus. Law. 21, 22 (1982).
** Clark, supra n.4 at 4 8.11[1] (cum. supp. 1988); Baron, Debt Supported by Irrevoc-
able Letters of Credit, Irrevocable Commitments and Note Purchase Agreements,
Fixed Income Investor 553 (June 21, 1980).
9
problem...S & P will not rate [letter of credit-backed debt] solely on
the creditworthiness of the bank.’’"’
Courts, commentators and legislators alike have universally criticized
Twist Cap.'* Professor Kozolchyk observed that:
[T]he Twist Cap court’s approach can lead to. . .a finding of
voidability, as a preference. . . These rules have already created
serious national disruption and could also have detrimental
international implications. They reflect a basic misunderstand-
ing of standby and commercial letter of credit transactions, law
and practice.'®
Senator Dennis DeConcini, one of the primary drafters and sponsors of
the Bankruptcy Code, stated in the United States Senate that:
Contrary to language in the case of Twist Cap...payments
...by the letter of credit bank are not preferential. . .since
payments are not being made with property of the estate. 126
Cong. Rec. 31,153 (1980).
The consistent and vehement rejection of Twist Cap prompted Standard
& Poor’s to announce in March 1987 that Twist Cap had become suf-
ficiently remote to be no longer a concern in letter of credit tran-
sactions.
When the furor over Twist Cap subsided, letters of credit were once
again widely believed to be safe from preference attack. Predictably,
the successful preference attack in Air Conditioning and Compton has
prompted a swift response from the business community. Standard &
Poor’s again refuses to rate letter of credit-backed debt unless certain
additional conditions are met.” This increases the cost of obtaining
letters of credit and adversely affects their ability to serve as an absolute
guaranty of payment. Twist Cap disrupted letter of credit transactions
for nearly eight years despite a maelstrom of criticism. Two decisions
of the courts of appeals, however, will undoubtedly have a more lasting
impact on letters of credit.
‘7 Baron, LOCs and the “Twist Cap” Problem, Standard & Poor's Credit Week (Jan.
25, 1982).
'® See, e.g., Inre Page, 18 B.R. 713 (D.D.C. 1982); in re Guy C. Long, Inc., 74 B.R.
939, 944 (Bankr. E.D. Pa. 1987) (exhaustive summary of cases dealing with letters of
credit in bankruptcy); Hahn & Schwartz, Letters of Credit under the Bankruptcy
Code, 16 U.C.C.L.J. 91 (1983); Baird, Standby Letters of Credit in Bankruptcy, 49 U.
Chi. Rev. 130 (1982); Kozolchyk, The Emerging Law of Standby Letters of Credit and
Bank Guaranties, 24 Ariz. L. Rev. 319, 343 (1982); Chaitman & Sovern, Enjoining
Payment ona Letter of Credit in Bankruptcy: A Tempest ina Twist Cap, 38 Bus. Law.
21 (1982).
'® Kozolchyk, supra n. 18 at 343.
2 Federman & Baron, Bankruptcy Cases Impact LOCs, Standard & Poors Credit-
Week (Feb. 1, 1988).
10
Other legal bases exist for questioning the propriety of the court of
appeals’ conclusion. Standby letters of credit are occasionally referred
to as ‘‘guaranty letters of credit,’’ more accurately descriptive of
their function." The beneficiary of a letter of credit can easily be
analogized to the beneficiary of a guaranty. A beneficiary of a guaranty
does not receive a preference in bankruptcy when paid by the guaran-
tor even though the primary obligor is bankrupt.** No preference is
created because the payment depletes the assets of the guarantor not
the debtor. Due to the functional similarities between letters of credit
and guaranties, beneficiaries of letters of credit should receive no worse
treatment than beneficiaries of a simple guaranty; the unique and
necessarily inviolable nature of letters of credit dictate this result. The
payment tothe beneficiary of a letter of credit should not be recaptured
by the debtor or trustee as a preference.
CONCLUSION
The decision of the court of appeals sub judice as well as that of
Compton unnecessarily deviate from well-established letter of credit
and bankruptcy preference principles even though an adequate remedy
already existed. Financial markets which only recently recovered from
the effects of Twist Cap are again disrupted.” The petition for cer-
tiorari should be granted so that this Court may more fully review the
adverse impact of the court’s decision on letters of credit.
Reaper ee
Vee
JAMES E. FOSTER
Foster & Kelly
Post Office Box 3587
Orlando, Florida 32802-3587
(407) 423-0341
Attorneys for Petitioner
September 16, 1988
2" Kozolchyk, The Emerging Law of Standby Letters of Credit and Bank Guaran-
ties, 24 Ariz. L. Rev. 319 (1982).
22 Atlantic Richfield Co. v. Good Hope Refineries, Inc., 604 F.2d 865 (5th Cir. 1979);
Inre Zaferis Bros. & Co., Ltd., 67 F.2d 140 (9th Cir. 1933); First National Bank of Danuille
uv. Phalen, 62 F.2d 21 (7th Cir. 1932). Accord National Bank of Newport v. National
Herkimer County Bank, 225 U.S. 178 (1912).
23 Because of the impact of the court of appeals decision on letters of credit and com-
mercial finance, we believe that review by this court is warranted despite the absence
of an existing conflict in the circuits on the precise question presented.
Al
In re AIR CONDITIONING, INC. OF
STUART, Debtor.
AMERICAN BANK OF MARTIN COUNTY,
Douglass E. Wendel, Trustee,
Plaintiffs-Appellees,
Vv
LEASING SERVICE CORPORATION,
Defendant-Appellant.
No. 87-5223.
United States Court of Appeals,
Eleventh Circuit.
May 17, 1988.
Before VANCE and ANDERSON, Circuit Judges, and BROWN*,
Senior Circuit Judge.
VANCE, Circuit Judge:
This bankruptcy appeal involves an undersecured creditor’s attempt
to obtain the proceeds of a $20,000 certificate of deposit used tosecure a
letter of credit issued in favor of the creditor. Both the bankruptcy
court and the district court held that there had been a preference, and
the district court ordered the creditor to deliver the payment made
pursuant to the letter of credit to the trustee. Except as to an award of
attorneys’ fees, we affirm.
I.
In December 1982 Leasing Service Corporation (LSC) leased a com-
puter system to Air Conditioning, Incorporated of Stuart (ACI). To
secure its performance under the lease, ACI granted LSC a security
interest in everything ACI owned.' ACI defaulted in February 1984,
and in April LSC instituted replevin actions against ACI in Florida
state court.
During June the parties negotiated a solution to the problem so that
ACI could remain in business. They reached an agreement whereby
LSC agreed not to exercise its right to seize ACI’s property. On June 11
ACI agreed in a joint stipulation to furnish a $20,000 bond within four
days. If it failed to furnish the bond, LSC would seize all of ACI’s assets
* Honorable John R. Brown, Senior U.S. Circuit Judge for the Fifth Circuit, sitting
by designation.
' A supplemental writ of replevin LSC later obtained pursuant to this security
interest ordered ACI to deliver to LSC: “All goods, chattels, fixtures, furniture, equip-
ment, assets and property of any kind whatever located now and hereafter belonging to
Air Conditioning, Inc. of Stuart and in which Air Conditioning, Inc. of Stuart has any
interest.”
A2
as provided in the supplemental writ of replevin LSC had previously
obtained. In either event, the agreement provided that LSC would
replevin the computer equipment. On June 19, the parties agreed to a
new joint stipulation which stated that ACI’s obligation to furnish the
bond had been met by the terms and provisions of a June 15, 1984 letter
of credit issued by American Bank in LSC’s favor. In return for the let-
ter of credit ACI had executed a promissory note payable to American
Bank in the amount of $20,030.15. ACI had secured the note with a
security interest in a $20,000 certificate of deposit.
As a result of these transactions, LSC allowed ACI to stay open for
business. ACI’s reprieve, however, only lasted a month. On July 25,
1984 ACI filed a petition under Chapter 11. On September 14 ihe bank-
ruptcy court granted LSC’s motion for relief from the stay to allow LSC
to obtain a judgment for possession and judicial sale of the computer
equipment. On October 4 the bankruptcy court lifted the automatic
stay further to permit LSC to proceed against ACI’s other assets as des-
cribed in the supplemental writ of replevin. LSC claims it never located
any assets of ACI other than the computer system. In November 1984
the case was converted to a Chapter 7 liquidation proceeding.
On May 23, 1985 LSC demanded that American Bank honor the let-
ter of credit. American Bank responded by filing a complaint in the
bankruptcy court, alleging that LSC was violating the automatic stay.
The trustee filed an intervention complaint. The bankruptcy court,
without a trial, nullified the letter of credit, ordered American Bank to
surrender the certificate of deposit to the trustee, and awarded American
Bank attorneys’ fees and costs associated with the original complaint.?
The district court reversed the bankruptcy court’s nullification of the
letter of credit, but affirmed the bankruptcy court’s finding of a pre-
ference in favor of LSC. 72 B.R. 657. The district court ruled that the
trustee could attack the preference under 11 U.S.C. § 550(a). LSC now
appeals the district court’s order.
II.
A.
LSC’s primary argument on appeal is that the district court and the
bankruptcy court erred by ruling that the trustee had proved all five
7A merican Bank had filed an interpleader action previously in Florida state court.
This action apparently was dismissed voluntarily because an interpleader action is
improper in letter of credit situations like this one. See Dallas Bank & Trust Co. v.
Community Dev. Corp., 686 S.W.2d 226, 230-31 (Tex.Ct.App.1985). American Bank
recovered the fees and expenses associated with this aborted state court interpleader
action. We reverse this award.
A3
elements of a preferential transfer under 11 U.S.C. § 547(b). That sub-
section allows the trustee to avoid any transfer of property of the
debtor:
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor
before such transfer was made;
(3) made while the debtor was insolvent;
(4) made -
(A) on or within 90 days before the date of the filing of the
petition;
(5) that enables such creditor to receive more than such creditor
would receive if -
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt tothe extent
provided by the provisions of this title.
11 U.S.C. § 547(b). The trustee may recover any property transferred
in violation of section 547(b) from “‘the initial transferee of such transfer
or the entity for whose benefit such transfer was made...”’ Jd.
§ 550(a)(1). LSC argues that the trustee failed to prove elements (1)
and (5) under section 547(b), and that the district court erroneously
granted relief under section 550(a).
Initially LSC argues that there has been no preferential transfer
because the letter of credit issued by American Bank is not “‘an interest
of the debtor in property,” as required by the first sentence of section
547(b). Waving a banner acclaiming the inviolability of letters of
credit, LSC argues that section 547(b) cannot apply in this case.
We agree with LSC that neither a letter of credit nor its proceeds are
property of the debtor’s estate. See Jn re AOV Indus., Inc., 64 B.R. 933,
941 (Bankr.D.D.C.1986); In re Clothes, Inc., 35 B.R. 487, 489
(Bankr.D.N.D.1983). As the district court correctly noted, a letter of
credit is an undertaking between the issuing bank and the beneficiary,
and is independent of the relationship between the bank and the
account party. Jn re Air Conditioning, Inc. of Stuart, 72 B.R. 657, 660
(S.D.Fla.1987); see Pro-Fab, Inc. v. Vipa, Inc, 772 F.2d 847, 852-53
(1ith Cir.1985).
Collateral which has been pledged by the debtor as security for a let-
ter of credit, however, is property of the debtor’s estate. Jn re Compton
Corp., 831 F.2d 586,590 (5th Cir.1987). It was the transfer of the
$20,000 by the debtor ACI to American Bank as collateral for the letter
of credit that constituted the preferential transfer under section 547(b).
As the Fifth Circuit recently held: ““When a debtor pledges its assets to
A4
secure a letter of credit, a transfer of debtor’s property has occurred
under the provisions of 11 U.S.C. § 547.”” Compton, 831 F.2d at 590.
Thus there was a transfer of ACI’s property, and section 547(b) applies
in this case.
Turning to the disputed elements of section 547(b), LSC contends
first that the transfer of the $20,000 was not “‘to or for the benefit”’ of
LSC. See 11 U.S.C. § 547(b)(1). Instead, LSC maintains that the
transfer of the $20,000 to purchase the certificate of deposit was solely
and exclusively for the benefit of the bank.
The Fifth Circuit’s recent Compton opinion contains an excellent,
scholarly discussion of this issue. It held that a creditor can receive an
indirect benefit in the letter of credit context sufficient to meet the
requirement of section 547(b)(1). See 831 F.2d at 591-95. We agree that
an indirect transfer arising from a debtor’s pledge of security to a third
party bank “may constitute a voidable preference as to the creditor
who indirectly benefitted from the direct transfer to the third party.”’
Id. at 591-92. The district court in this case correctly held that “although
the transfer of the certificate of deposit (the debtor’s property) was
made to American Bank it was clearly ‘for the benefit’ of LSC because
it indirectly secured payment of an undersecured antecedent debt
owed by ACI.” 72 B.R. at 661. In addition the promised transfer of the
certificate of deposit induced American Bank to issue the letter of
credit in the first place. We hold therefore that LSC did receive a
benefit under section 547(b)(1).°
LSC contends next that the transfer did not enable LSC io receive
more than it would have received in a Chapter 7 liquidation had the
transfer not been made. See 11 U.S.C. §547(b)(5). LSC argues that the
trustee failed to present any evidence that ACI’s assets were insuffi-
cient tosatisfy fully LSC’s claims. LSC complains that the bankruptcy
court did not allow LSC the opportunity to show that ACI may have
had assets in which LSC had a valid security interest.
The Fifth Circuit eloquently and forcefully articulated this principle in Compton:
We hold that a creditor cannot secure payment of an unsecured antecedent debt
through a letter of credit transaction when it could not do so through any other type
of transaction. The purpose of the letter of credit transaction iu this case was to
secure payment of an unsecured antecedent debt for the benefit of an unsecured
creditor. This is the only proper way to look at such letters of credit in the bank-
ruptcy context. The promised transfer of pledged collateral induced the bank to
issue the letter of credit in favor of the creditor. The increased security interest held
by the bank clearly benefitted the creditor because the bank would not have issued
the letter of credit without this security. A secured creditor was substituted for an
unsecured creditor to the detriment of the other unsecured creditors.
831 F.2d at 594-95.
A5
The trustee responds that the bankruptcy court determined that
section 547(b)(5) was satisfied on the basis of the bankruptcy schedules
which showed LSC was grossly undersecured.* The trustee correctly
points out that he asked the bankruptcy court to take judicial notice of
the schedules, and that LSC did not object.$ In its memorandum deci-
sion, the bankruptcy court stated that “the essential facts appear from
undisputed documents or are otherwise admitted....’’ LSC again
made no motion or objection to this statement in the bankruptcy court.
LSC did not protest the bankruptcy court’s reliance on the schedules
until LSC was before the district court on appeal, where LSC com-
plained in its brief that although the bankruptcy court “did take judi-
cial notice of the Bankruptcy schedules. . . that is not evidence nor is it
binding on LSC.” This protest, however, was too late, and because
LSC failed to object to the schedules at the trial level in the bankruptcy
court, the schedules are indeed binding on LSC. Cf. In re Shults, 28
B.R. 395, 396 (Bankr. 9th Cir. 1983) (debtors impliedly consented to
trial of creditor’s claims for relief as presented through failure to
object).
On the basis of these schedules, the bankruptcy court found that
because the unsecured claims on the debtor’s estate could not be satis-
fied in full, the transfer at issue gave LSC more than it would have
received in a Chapter 7 liquidation without the transfer. The trustee
therefore met his burden under section 547(b)(5).
LSC makes much of the fact that there was no hearing in the bank-
ruptcy court. LSC argues that it is impossible to determine whether
the certificate of deposit was purchased with the debtor’s own funds,
and now asks this court to remand the case for a hearing on the origin of
the $20,000.
When a third party makes a loan toa debtor which enables the debtor to
satisfy a creditor’s claim, the proceeds of the loan do not become part of
the debtor’s estate. See Jn re Price Chopper Supermarkets, Inc., 40
B.R. 816, 820 (Bankr.S.D.Cal.1984); Jn re Castillo, 39 B.R. 45, 46
(Bankr.D.Colo.1984); Jn re Sun Railings, Inc., 5 B.R. 538, 539
(Bankr.S.D.Fla.1980). There are several possible sources from which
“The bankruptcy court found that ACI’s total debts exceeded its assets by at least
$50,000. ACI’s personal preperty, valued by ACI at $21,711, was subject to liens of
$173,470. The trustee had sold all of ACI’s tangible personal property for $1,000. The
court concluded that LSC was “grossly undersecured.”
*The transcript of the October 24, 1985 hearing reads:
The Court: You would ask me to take judicial notice of the schedules?
[Counsel for the Trustee]: Yes, your Honor.
The Court: The schedules will tell me what the debts are.
Counsel for LSC responded to this exchange by renewing his argument that a letter
of credit cannot be property of the debtor’s estate. At no time did LSC object to the
introduction or use of the bankruptcy schedules.
A6
the $20,000 could have come such that the transfer to the bank would
not have created a preference. Once again, LSC did not initiate an
inquiry into this possibly important issue.
In its brief to the district court, LSC argued that “‘[n]o discovery ever
took place on that issue as the Bankruptcy Judge deemed it to be irrele-
vant.” This is not, however, an accurate account of what occurred in
the bankruptcy court. At the October 24, 1985 hearing, LSC raised the
issue of the source of the funds used to purchase the certificate of
deposit. The bankruptcy judge responded:
I wili. . . allow you, for the purposes of protecting your record, to pur-
sue discovery on that point, and I will require any person that you
want answers from to give you answers that would give the entire
genesis and the history of that money within-reason, if that is your
wish...
Thus the bankruptcy court practically encouraged LSC to pursue dis-
covery on this issue. LSC simply failed to foliow up.®
LSC raises some potentially meritorious contentions with respect to
the source of the $20,000. LSC did not pursue these avenues, however,
in the bankruptcy court. Although we will consider an issue not raised
below if it involves a pure question of law and if refusal to consider it
would result in a miscarriage of justice, Roofing & Sheet Metal Serus.,
Inc. v. La Quinta Motor Inns, Inc., 689 F.2d 982, 990 (11th Cir.1982),
the issue in this case of the source of the $20,000 is a pure question of
fact. Bankruptcy cases are to be tried in bankruptcy court. We therefore
affirm the district court and the bankruptcy court and held that the
trustee proved all elements of a preferential transfer under 11 U.S.C.
§ 547(b).
B.
Despite the existence of a transfer which satisfies the five elements
of section 547(b), the trustee may not avoid a transfer as a preference if
the transfer was “intended by the debtor and the creditor to or for
whose benefit such transfer was made to be a contemporaneous exchange
for new value given to the debtor....”’ Jd. at § 547(c)(1)(A).? LSC
argues that its acceptance of the letter of credit and its release of its
right to seize ACI’s inventory and property pursuant to the supplemental
*LSC similarly argued to the district court that it had never waived its right to pre-
sent evidence. This is true. It is also true, however, and more determinative of this
appeal, that LSC did not pursue the opportunities it had to discover and present
evidence.
"The Bankruptcy Code defines ‘“‘new value” as money or money’s worth in goods,
services, or new credit, or release by a transferee of property previously transferred to
such transferee in a transaction that is neither void nor voidable by the debtor or the
trustee under any applicable law, including proceeds of such property, but does not
include an obligation substituted for an existing obligation. 11 U.S.C. § 547(a)(2).
A7
writ of replevin constitute “new value” under section 547(c)(1)(A).
This argument overlooks the fact that whatever value LSC created
by these actions was not new. As in Compton, the bank in this case
issued the letter of credit “‘to secure an antecedent unsecured debt due
the beneficiary of the letter of credit. The unsecured creditor beneficiary
gave no new value upon the issuance of the letter of credit.’” Compton,
831 F.2d at 594. An agreement by an undersecured creditor to forego its
right to foreclose on collateral cannot be treated as a new value under
section 547. Drabkin v. A.I. Credit Corp., 800 F.2d 1158, 1159 (D.C.
Cir.1986). Forbearance from exercising pre-existing rights does not
consititute new value under section 547(a)(2). See Charisma Inv. Co.,
N.V. v. Air Florida Sys., Inc., 68 B.R. 596, 600-03 (S.D.Fla. 1986);
Matter of Lario, 36 B.R. 582, 584 (Bankr.S.D.Ohio 1983); cf. Matter of
Duffy, 3 B.R. 263, 266 (Bankr.S.D.N.Y.1980) (forbearance by lessor
from repossession of rented vehicle did not enhance the value of debtor’s
estate and therefore did not constitute new value within § 547(c)(1) as
defined by § 547(a)(2)). The letter of credit transaction therefore did
not give ACI new value, and LSC cannot use section 547(c)(1) as a
defense to the trustee’s avoidance of the preferential transfer under
section 547(b).
C.
Finally LSC argues that the district court erred by allowing the trustee
to recover the proceeds of the letter of credit from LSC pursuant to 11
U.S.C. § 550(a)(1) because the trustee sought relief from the bank and
not LSC. LSC complains that the trustee’s complaint failed to give
LSC notice of the nature of the claim against it, and the remedy reques-
ted, thus depriving LSC of procedural due process.
LSC doth protest too much. Although the parties’ initial pleadings
were perhaps misguided, see supra note 2, it has been clear from the
outset what this dispute is about: The $20,000 certificate of deposit. The
district court, in fact, did not allow the trustee to recover the proceeds
of the letter of credit (as LSC characterizes the district court’s judg-
ment). Instead, the district court correctly allowed the trustee to
recover from LSC the property transferred: the certificate of deposit.
The Bankruptcy Code explicitly provides for this by allowing the trustee
to recover a preferential transfer from ‘‘the initial transferee of such
transfer or the entity for whose benefit such transfer was made... .”’
11 U.S.C. § 550(a)(1) (emphasis added). The district court did this
primarily to uphold the sanctity of letters of credit as vital instruments
of commerce, the virtues of which LSC so vigorously extols. The record
thoroughly presented the preference issue, and the district court did
not abuse its discretion in resolving it. See In re Pizza of Hawaii, Inc.,
761 F.2d 1374, 1380 (9th Cir.1985); cf. Inre Espino, 806 F.2d 1001, 1002
A8&
(11th Cir.1986) (where the record reflects an issue was presented in a
cursory manner and never properly presented to the bankruptcy court,
the issue is not preserved for appeal).* We therefore affirm the district
court’s ruling that the trustee can recover the transfer under section
590(a).
III.
The district court’s order affirming the bankruptcy court’s award of
attorneys’ fees associated with American Bank’s initial interpleader
action is REVERSED. In all other repsects, the district court’s judg-
ment is AFFIRMED.
*LSC attempts to distinguish Pizza of Hawaii on the grounds that the bankruptcy
court denied LSC the opportunity to develop a complete factual record on the pre-
ference issue. The bankruptcy court, however, did not deny LSC this opportunity. See
supra Part II.A.
A9
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
No. 87-5223 FLED
U.S. COURT OF APPEALS
IN RE: ELEVENTH CIRCUIT
AIR CONDITIONING, INC. OF STUART,
JUN 2 0 1988
Debtor,
AMERICAN BANK OF MARTIN COUNTY, MIGUEL J. CORTEZ
DOUGLASS W. WENDEL, trustee, CLERK
Plaintiffs-Appellees,
versus
LEASING SERVICE CORPORATION,
Defendant-Appellant.
Appeal from the United State District Court for the
Southern District of Florida
ON PETITION(S) FOR REHEARING
(June 20, 1988)
BEFORE: VANCE and ANDERSON, Circuit Judges, and
BROWN’, Senior Circuit Judge.
PER CURIAM:
The petition (s) for rehearing filed by appellant,
LEASING SERVICE CORPORTATION, is Denied.
ENTERED FOR THE COURT:
/s/ Robert S. Vance
United States Circuit Judge
*Honorable John R. Brown, Senior U.S. Circuit Judge for the Fifth Circuit,
sitting by designation.
Al10
In re AIR CONDITIONING, INC. OF
STUART, Debtor.
LEASING SERVICE,
CORPORATION, Appellant,
v
Douglas E. WENDEL, as trustee for Air
Conditioning, Inc. of Stuart, and American
Bank of Martin County, Appellees.
Bankruptcy Nos. 86-8006-CIV-NES-
BITT, 84-01395-BKC-TCB and
85-0965-BKC-TCB-A.
United States District Court,
S.D. Florida.
May 10, 1987.
CORRECTED MEMORANDUM
OPINION AND ORDER
NESBITT, District Judge.
I. NATURE OF THE APPEAL
This is an appeal from a memorandum decision and judgment by the
United States Bankruptcy Court entered in an adversary proceeding
involving a pre-bankruptcy transaction by the debtor. The Bank-
ruptcy Court nullified the debtor’s promissory note, an assignment of
its certificate of deposit and a Bank’s letter of credit and ordered return
of the certificate of deposit to the bankrupt’s estate. Upon review of the
decision and judgment of the Bankruptcy Court the Bankruptcy Court’s
“[flindings of fact should not be set aside unless clearly erroneous.”
Bankruptcy Rule 8013, Jn re All American of Ashburn, Inc., 805 F.2d
1515 (11th Cir.1986); Matter of Hammons, 614 F.2d 399 (5th Cir.1980).
However, the conclusions of law made by the Bankruptcy Court are
subject to de novo review by this Court. Jn Re All American, supra;
Hammons, supra. For the reasons hereinafter given upon a de novo
review, the Bankruptcy Court’s conclusion of law by which it “nullified” a
letter of credit is contrary to controlling principles of law and shall be
reversed. In all other respects the opinion and judgment appealed from
is affirmed.
Il. PROCEDURAL HISTORY
On or about April 24, 1984 Leasing Service Corporation (LSC)
obtained a writ of replevin directed toward the recovery of computer
equipment which was leased by it to Air Conditioning, Inc. of Stuart,
(ACI). LSC sought the writ as a result of ACI’s failure to make payments
on account of debt admittedly owing and past due under the lease of
All
the computer equipment owned by LSC. A supplemental writ of replevin
was issued on May 9, 1984 to recover all of ACI’s ‘‘goods and assets”’ in
which LSC had a security interest pursuant to the term of the lease.
Apparently to avoid being put out of business completely, ACI arranged
for a $20,000 letter of credit to be issued on June 15, 1984 by AMERICAN
BANK OF MARTIN COUNTY (AMERICAN BANK) for the account
and benefit of LSC in return for LSC’s promise not to enforce the
second writ of replevin. As consideration for AMERICAN BANK’s
issuance of the letter of credit ACI executed an unsecured promissory
note dated June 15, 1984 and payable to AMERICAN BANK, which
was to be secured by a $20,000 certificate of deposit owned by the debtor
ACI' The assignment and delivery of the certificate of deposit took
place some six days later, on or about June 21, 1984.
On July 25, 1984, just over one month later, ACI filed a voluntary
petition in bankruptcy under Chapter 11. Thereafter LSC sought and
obtained relief from the automatic stay to liquidate the computer system
previously replevied by it from ACI. The liquidation of the computer
equipment was not sufficient to discharge the amount due and owing
LSC. On November 8, 1984 the Chapter 11 case was converted to a
Chapter 7 liquidation proceeding and Douglass E. Wendel was appointed
as trustee (Trustee). On May 10, 1985 LSC obtained a state court judg-
ment in the amount of $40,447 against ACI.
Thereafter, on or about May 23, 1985, LSC made a timely demand
upon AMERICAN BANK to honor its letter of credit. Instead of honoring
the draft, AMERICAN BANK filed an adversary proceeding against
LSC in the Bankruptcy Court seeking inter alia a judgment determining
the validity of any lien or interest by LSC in the letter of credit. The
trustee filed an intervention complaint seeking the return of the certifi-
cate of deposit on the theory that its transfer constituted a voidable
preference under 11 U.S.C. § 547(b). LSC took the position that there
had been no transfer of property to or for the benefit of a creditor, an
essential element of a preference under 11 U.S.C. § 547(b)(1). After
some threshold issues being raised as to whether the Bankruptcy Court
should dismiss or decline to exercise jurisdiction, the Bankruptcy
Judge conducted two hearings and after considering stipulated facts
and memorandums of law entered the decision and judgment ap-
pealed from.
The creditor LSC urges several procedural and substantive grounds for
reversal or for remand with instructions to enter judgment for LSC and
against the AMERICAN BANK in accordance with the terms of
‘The promissory note provided that the $20,000 certificate of deposit was to be
deposited with the bank no later than fifteen (15) days from the date of the note.
Al2
the letter of credit. LSC claims error by the Bankruptcy Judge’s
“enjoining”’ the drafting of the letter of credit and cites a legion of legal
authority for the proposition that it is “improper’’ for a Bankruptcy
Court to enjoin the drafting upon a letter of credit on the theory that
preference has occurred or may occur by reason of the honoring of the
letter of credit. Jn re Clothes, Inc., 35 B.R. 489 (Bankr.D.N.D.1983), Jn
re Price Chopper Supermarkets Inc., 40 B.R. 816 (Bankr.S.D.
Calif.1984). However, the Bankruptcy Court did not “enjoin” the let-
ter of credit, but agreed with AMERICAN BANK’s position that the
letter of credit should be canceled and the bank released from its
obligations thereunder. The net effect, however, was to nullify the let-
ter of credit which could threaten the disruption of commerce and
banking as they are dependent upon the traditional integrity of the letter
of credit.
The trustee, having prevailed, urges affirmance of the Bankruptcy
Court ruling as being ‘“‘well within the jurisdiction of the Bankruptcy
Court” to set aside a preferential transfer under § 547 of the Bank-
ruptcy Code.
The New York Clearing House Association (the “Clearing House’’)
has filed an amicus curiae brief before this Court. The Clearing House
urges that the Bankruptcy Court decision nullifying the letter of credit
is contrary to well established legal precedent and “‘threatens to create
uncertainty and confusion which would undermine the function of letters
of credit generally as an essential element of commerce.”
III. LEGAL DISCUSSION
The primary issue which governs disposition of this appeal is whether
under the stipulated facts of this case the Bankruptcy Court exceeded
its authority when it nullified the letter of credit. This, in turn, depends
on whether the letter of credit transaction was a transfer of property of
the debtor (ACI) for the benefit of the creditor (LSC) so as to be con-
sidered a preferential transfer under 11 U.S.C. § 547(b).
In order to put this case in perspective an important fact should be
kept in mind. The debt owed by ACI to LSC existed prior to the
issuance of the letter of credit. In other words, there is no question that
the debt owed by ACI was an “antecedent” debt. Thus, if ACI had
given LSC an additional security interest of any kind to secure repay-
ment of the debt, rather than providing for the issuance of the letter of
credit, the transfer clearly would have been subject to being avoided as
a preference by the trustee under 11 U.S.C. § 547(b)? The question
211 U.S.C. § 547(b) provides that “the trustee may avoid any transfer of an interest
of the debtor in property. . . (2) for or on account of an antecedent debt owed by the debtor
before such transfer was made.”
Al3
that then arises is whether a debtor should be able, through the
recognized sanctity of a letter of credit, tosecure payment of an antece-
dent debt when he could not do so through any other type of security
interest.
One can understand how in the interest of efficiency, and looking to
substance rather than form, the Bankruptcy Court found that the letter of
credit was part of a “single contemporaneous transaction’’(i.e., the
promissory note, the letter of credit and the assignment of collateral)
which transferred property of the bankrupt debtor. Additionally, the
transfer of the certificate of deposit depleted the estate of the bankrupt
debtor ACI and conferred a benefit on the creditor LSC to the detri-
ment of other creditors which is the essence of a preferential transfer.
However, there is an equally compelling factor to be considered in
that a letter of credit is traditionally an instrument of commerce that
travels with no baggage except that which is acquired by its terms. The
independence of the letter of credit is well established. It is a fun-
damental principle of commercial transactions that a letter of credit is
an undertaking solely of the issuing bank to the beneficiary; it is
independent of the obligations of the issuing bank and the account
party. See Fla.Stat. § 675.109. Pringle-Associated Mortgage Corp. v.
Southern National Bank, 571 F.2d 871 (5th Cir.1978); Pro-Fab, Inc. v.
Vipa Inc., 772 F.2d 847 (11th Cir.1985). Thus under the facts of this
case, an apparent conflict exists between the preference provisions of
the Bankruptcy Code and established principles governing the unique-
ness of a letter of credit.
Putting aside the propriety of the Bankruptcy Court “nullifying a
letter of credit’ as a remedy, it is necessary first to determine whether
the composite transaction completed between ACI and the AMERICAN
BANK during the six day period between June 15, and June 21, 1984
constituted a “‘preference.” The creditor LSC conceded three of the
five elements of a preference as specified in 11 U.S.C. § 547, contesting
only elements (1) and (5). The pertinent parts of § 547(b) are as
follows:
«the trustee may avoid any transfer of an interest of the debtor in
property—
(1) to or for the benefit of a creditor. . . (and)
(5) that enables such creditor to receive more than such creditor
would receive (in Chapter 7 liquidation proceedings).”
Once a preference is established under § 547(b) the trustee may recover, if
the Court so orders, the ‘“‘value of such property, from. . .the initial
transferee of such transfer or the entity for whose benefit such transfer
was made...” § 550(a)(1).
a. Transfer of Property of the Debtor to or for Benefit of a Creditor
Al4
LSC takes the position that there was no transfer of property by ACI
for the benefit of LSC because the only transfer of the debtor’s property
occurred six days after the issuance of the letter of credit when ACI
delivered the $20,000 certificate of deposit to AMERICAN BANK. It
follows therefore, according to LSC, that at the time the letter of credit
was issued for the benefit of LSC, there was no transfer of the debtor’s
property for LSC’s benefit, and that since LSC was not a party to the
transaction between AMERICAN BANK and ACI, it did not receive a
preference by receiving the letter of credit. LSC further reasons that at
the time the certificate of deposit was pledged it was for the benefit of
the Bank and became the Bank’s collateral, not LSC’s, and therefore
the issuance of the letter of credit was not a transfer of property of the
debtor’s estate for the benefit of a creditor. LSC concludes that if any-
one, it was AMERICAN BANK that received a preferential transfer
because it transformed an unsecured obligation of ACI into a secured
obligation within ninety (90) days of the filing of the chapter 11 peti-
tion, and as it did not receive the certificate of deposit until six days
after the letter of credit was issued.
LSC’s analysis seems reasonable at first blush, particularly as there
is no evidence of any urging by LSC for ACI to obtain the letter of credit
to the disadvantage of other creditors, and for the further reason that
LSC “gave up” pursuing its second writ of replevin in exchange for the
letter of credit. However, LSC’s analysis is lacking in some important
respects.
First, although the transfer of the certificate of deposit (the debtor’s
property) was made to AMERICAN BANK it was clearly “for the
benefit” of LSC because it indirectly secured payment of an under-
secured antecedent debt owed by ACI. Secondly, it is not disputed that
the promised transfer of the certificate of deposit to AMERICAN
BANK induced the Bank to issue the letter of credit in favor of LSC.
Consequently, by the so-called ““contemporaneous transaction’”’ there
was a transfer of property of the debtor (ACI) for the benefit of the
creditor (LSC).
b.Creditor LSC Would Receive More Than in Chapter 7 Liquida-
tion Proceeding.
The next element the trustee must prove is that LSC would have
received more from the letter of credit transaction than they would
have received if the letter of credit transaction had not been made and
LSC received distribution under a Chapter 7 proceeding. § 547(b)(5).
The creditor asserts that there was no evidence before the Bankruptcy
Court as to the value of the debtor’s estate and therefore no such deter-
mination could have been properly made.
Upon a review of the transcript of October 24, 1985 it appears the
a
———————————
Ald
Bankruptcy Court conducted a hearing and elicited a narrowing of the
issues and stipulations by the parties and reflects that the Bankruptcy
schedules would be reviewed and relied on by the Bankruptcy Court to
determine whether LSC was an undersecured creditor. The Bank-
ruptcy Court in its opinion concluded the Bankrupt’s total debts
exceeded the total assets by approximately $50,000. Thus, the Bank-
ruptcy Court’s finding that the letter of credit would have enabled LSC
to recover more than they would under a Chapter 7 liquidation is sup-
ported by the record.
In summary, the Bankruptcy Court was correct in finding all the
elements of a preferential transfer to LSC. There was clearly a transfer
of property of the debtor for the benefit of a creditor when ACI obtained
the letter of credit secured by the certificate of deposit which was
timely delivered to AMERICAN BANK. Further, there is no question
that the transfer of the certificate of deposit depleted the estate of the
debtor. Since LSC was a vastly undersecured creditor prior to the date
the ____ letter of credit secured by the certificate of deposit was issued,
the letter of credit enabled it to receive more than it would have ina
Chapter 7 proceeding at the expense of other creditors. Also, as con-
ceded by LSC, the transfer of the certificate of deposit on June 21, 1984
was only one month before the bankruptcy petition was filed on July
25, 1984, well within the ninety day provision of § 547(b)(4). Additionally,
the debtor ACI was concededly insolvent at the time of the transfer
and, the transfer was made on account of antecedent debt.‘ Therefore,
all the elements of a preference have been met.
Having properly found a preference the Bankruptcy Court then
recited that the letter of credit was part of a “‘single contemporaneous
transaction” and concluded that the appropriate remedy was to nullify
the letter of credit issued by AMERICAN BANK. This is where the
Bankruptcy Court erred.
Even though a letter of credit may be ‘“‘contemporaneous”’ with
other agreements between debtors and creditors, it still includes by its
very nature and purpose an independent agreement between the
customer and the Bank which is to be treated separately from the
3[t apparently is undisputed that the debtor’s tangible personal property was subse-
quently sold by the trustee for only $1,000.00. Consequently, in light of the fact that
ACI was indebted to LSC in an amount exceeding $47 ,000.000, the Bankruptcy Court’s
finding that LSC was undersecured has been borne out by the facts and cannot be said
to be clearly erroneous.
“LSC also asserts that the transaction fits within the contemporaneous exchange
exception of § 547(c)(1) because it allegedly gave new value when it agreed not to
enforce the writ of replevin. However, simple forbearance from repossessing goods does
not constitute new value. Matter of Lario, 36 B.R. 582 (Bankr.S.D.Ohio1983); Matter
of Duffy, 3 B.R. 263 (Bankr.S.D.N.Y.1980).
Al6
agreement existing betweea the customer and the beneficiary. /n re
Clothes, supra.
In fact, the usefulness of a letter of credit as a recognize instrument
in commerce rests on the premise that timely payment under the letter
of credit will be forthcoming so long as the beneficiary complies with
the terms and conditions of the letter of credit, regardless of any dis-
pute between the account party and beneficiary or issuing bank. East
Girard Savings Assn. v. Citizens Nat'l Bank & Trust Co. of Baytown,
593 F.2d 598 (5th Cir.1979). As was said in Pringle-Assoc. Mortg. Corp.
v. Southern Nat. Bank, 571 F.2d 871, 874 (5th Cir.1978):
The essence of a letter of credit is the promise by a bank, or other
issuer, to pay money. The key to the uniqueness of a letter of credit
and to its commercial vitality is that the promise by the issuer is
independent of any underlying contracts.
The trustee, having established a preferential transfer to LSC, is not
without a remedy even though the sanctity of the letter of credit is reaf-
firmed by this opinion. Section 550(a) provides that the trustee may
recover either the debtor’s property that was transferred or the value of
such property from “the entity for whose benefit the transfer was made.”
In this case the property transferred was the certificate of deposit and
the entity for whose benefit the transfer was made was LSC.
Since the creditor LSC received the benefit of a letter of credit as a
preferential transfer, the trustee should be able to recapture from LSC
the payment made pursuant to the letter of credit to the extent of the
value of the certificate of deposit transferred to AMERICAN BANK
without nullifying the letter of credit or the certificate of deposit itself.
While this procedure may appear to be revering form over substance,
as LSC will still “‘be out” the $20,000 under the facts of this case, LSC
was at least assured that they would receive payment under the letter
of credit. It is only the preference risk which may not be eliminated
under the facts and circumstances of this case. Thus, this procedure
only places the burden of repayment of the monies paid pursuant tothe
letter of credit where it belongs, upon LSC who received the preferen-
tial transfer to the detriment of other creditors of ACI, not upon
AMERICAN BANK who issued the letter of credit.
A discussion of the sanctity of the letter of credit, particulariy in
Florida, would not be complete without an acknowledgment of Matter
of Twist Cap, Inc., 1 B.R. 284 (Bankr.M.D.Fla.1979). Although not
referred to or mentioned by the Bankruptcy Court, it is relied on by the
trustee as authority for affirming the Judgment appealed from.
In Twist Cap, a Bank issued three letters of credit for the account of the
debtor Twist Cap in favor of two of Twist Cap’s creditors. The issuance
of the letters of credit took place more than four months before Twist
Al7
Cap filed a bankruptcy petition. The Bankruptcy Court issued a
temporary restraining order prohibiting payment on the letters of
credit in order to preserve the status quo pending a determination of
the rights of the parties.
The beneficiaries of the letters of credit challenged the jurisdiction
of the Bankruptcy Court to enjoin payment of the letter of credit as
they were not properties of the debtor Twist Cap. The Bankruptcy
Court rejected the beneficiary’s argument and granted a preliminary
injunction. The underlying basis for the Court’s decision was the view
that a letter of credit can constitute property of the bankrupt’s estate
and therefore is within the jurisdiction of the Bankruptcy Court.
The Twist Cap case did not invalidate or nullify the letter of credit as
was done by the Bankruptcy Court in this case. Further, the Twist Cap
decision has not been followed in subsequent decisions. See, e.g., Jn re
M.J. Sales & Distributing Co., Inc., 25 B.R. 608 (Bankr.S.D.N.Y.1982);
In re North Shore & Central Illinois Freight Co., 30 B.R. 377
(Bankr.N.D.IIl.1983); Matter of St. Petersburg Hotel Associates, Ltd.,
37 B.R. 380 (M.D.Fla.1984). Thus, Twist Cap is not determinative of
this proceeding.
IV. CONCLUSION
After due consideration the Court concludes that that portion of the
Bankruptcy Court’s Opinion and Judgment finding a preference in
favor of LSC is affirmed, and that portion of the opinion which nullifies
the letter of credit, promissory note and assignment of certificate of
deposit is reversed and this matter is remanded for further proceedings
not inconsistent with this opinion.
Al8
In re AIR CONDITIONING, INC. OF
STUART, Debtor(s).
AMERICAN BANK OF MARTIN COUNTY,
Plaintiff,
Vv.
LEASING SERVICE CORPORATION,
Defendant
Bankruptcy No. 84-01395-BKC-TCB
Adv. No.85-0965-BKC-TCB-A.
United States Bankruptcy Court,
S.D. Florida.
Nov. 12, 1985.
MEMORANDUM DECISION
THOMAS C. BRITTON, Bankruptcy Judge.
The plaintiff bank has sued a creditor of the debtor asking this court
to determine whether it owes $20,000 to the defendant/creditor or to
the debtor’s chapter 7 trustee. The creditor moved for abstention or
dismissal. (C.P. No. 3). The trustee moved to intervene and tendered a
complaint seeking recovery of the $20,000 upon the ground that it con-
stituted a voidable preference under 11 U.S.C. § 547(b). (C.P. No. 6).
The trustee has since abandoned a second count contained in the com-
plaint. The matter was heard on September 17 and October 24.
At the first hearing this court agreed with the defendant/creditor
that only the trustee has standing to maintain a preference action;
however, since the trustee has intervened and asserted the preference
claim, the creditor’s motion to abstain or dismiss was denied.
Though not framed as such, the complaint is in effect an inter-
pleader action under 28 U.S.C. §§ 1335, 1397, and 2361. B.R. 7022
incorporates Rule 22(1), Fed.R.Civ.P. See Wright & Miller, Federal
Practice and Procedure: Civil, § 1701 ff. The $20,000 which is in dis-
pute is held by the plaintiff bank in the form of a certificate of deposit
drawing interest. Under these circumstances, plaintiff is excused from
depositing the sum into this court’s registry.
At the second hearing, the parties agreed that the essential facts
appear from undisputed documents or are otherwise admitted and the
parties stated their respective contentions. Further pleadings are,
therefore, unnecessary. The parties have since submitted their
arguments by memoranda.
The trustee claims that the following actions constituted a $20,000
preferential transfer of the debtor’s property to or for the benefit of the
creditor under 11 U.S.C. § 547(b).
Alg
On May 10, 1984 the creditor, Leasing Services, got a judgment
against the debtor for $40,447 on account of an antecedent debt admit-
tedly owing and past due. On April 24 and May 9 the creditor had
obtained two writs of replevin on account of the same claim. The first
was for the computer equipment leased to the debtor. The writ was
executed before bankruptcy.
By stipulations dated June 11 and June 19 the parties agreed that
the unexecuted second writ of replevin be replaced by a $20,000 letter
of credit issued June 15, 1984 by the plaintiff bank.
The consideration for issuance of the letter of credit was the debtor’s
note dated June 15 in the amount of $20,000 which was secured by the
assignment and delivery on June 21 to the bank of a $20,000 certificate
of deposit owned by the debtor.
The debtor’s bankruptcy petition was filed a month later on July 25.
The sum still due the creditor was $37,067 with 18% interest as of
November 6, 1984, after applying the proceeds ($5,000) from the execu-
tion of the first writ of replevin.
The creditor concedes three of the five elements specified in § 547(b),
contesting only the first and fifth. The first element is that there
was a:
“transfer of property of the debtor (1) to or for the benefit of a
creditor’.
The creditor argues that it received only the letter of credit which
was the bank’s property, not the debtor’s, and that there is no proof
where the money came from to purchase the letter of credit.
I agree with the trustee that the letter of credit was but a part of a
single contemporaneous transaction which included (a) the debtor’s
note to the bank (which bore the notation that its purpose was to
establish the letter of credit) and (b) the assignment of the debtor’s cer-
tificate of deposit. The assignment of the C.D. as security was an
express condition stated on the note for the issuance of the letter of
credit. By these documents both parties intended that $20,000 additional
collateral for the antecedent debt be furnished to the creditor by the
debtor through the bank as an intermediary. The transaction was con-
cluded within seven days. This composite transaction was a transfer of
the debtor’s property for the creditor’s benefit.
I also agree with the trustee that it is irrelevant where the money
came from to purchase the C.D. The certificate was unquestionably
property of the debtor and it was transferred by the debtor to the
bank.
The creditor also argues that it would be against public policy to permit
the nullification of a letter of credit under § 547. On the contrary, to
permit a debtor and creditor to evade the preference statute by this
A20
device would defeat the purpose of §547.
The trustee has proved the first element.
The fifth element requires proof that the transfer gave the creditor
more than it would receive under a chapter 7 liquidation of this debtor’s
estate had the transfer not occurred.
This creditor had a duly perfected security interest in the debtor’s:
“goods, chattels, fixtures, furniture and equipment’’. (C.P. No. 30).
This personal property was valued by the debtor at $21,711, but the
inventory ($17,241) was subject to a $169,000 lien of another party and
the remaining personalty ($4,470) was subject to purchase money liens
of $4,250. All of the debtor’s interest in its tangible personal property
was sold by the trustee on February 21, 1985 for $1,000. (C.P. No. 57).
The creditor is, therefore, grossly undersecured. The debtor’s total
debts exceeded its total assets by at least $50,000. Unsecured claims
cannot be satisfied in full from this estate. I find, therefore, that the
transfer at issue here gave the creditor far more than it would receive in
liquidation. Of course, if I am mistaken this creditor will suffer no
harm because this state is being liquidated now under chapter 7.
The creditor has also argued under § 547(c)(1) that the transfer was:
‘“‘a contemporaneous exchange for new value given to the debtor”.
The new value claimed is the creditor’s forbearance in executing its
second writ of replevin of May 9, 1984. That writ was aimed at the same
personal property just discussed which has been sold by the trustee
for $1,000.
Forbearance is not ‘“‘new value” as defined in § 547(a)(2). An obliga-
tion substituted for an existing obligation is expressly excluded from
the definition of ‘“‘new value’. Bavely v. Merchants National Bank
(Matter of Lario), 36 B.R. 582, 584 (Bankr.S.D.Ohio 1983); Matter of
Duffy, 3 B.R. 263, 266 (Bankr.S.D.N.Y.1980).
As required by B.R. 9021(a), a separate judgment will be entered
avoiding under § 547 and, therefore, nullifying the debtor’s note, the
debtor’s assignment of its certificate of deposit and the bank’s letter of
credit in favor of Leasing Services Corp. (each of which is in the
amount of $20,000). The bank will be ordered to deliver the debtor’s
certificate of deposit to the trustee. The creditor may continue enforce-
ment of its security interest as previously authorized by this court’s
order of October 4, 1984. (C.P. No. 30).
Upon its compliance with the foregoing requirements, the bank is
discharged of further liability to Leasing Services and, except under
the terms of the C.D., to the trustee.
Costs in the amount of $560 are assessed in favor of the plaintiff bank
against the disputed fund. Therefore this amount may be setoff against
the certificate of deposit. Wright & Miller, supra § 1719. Each party
shall bear anv other costs incurred by it.
A21
In the Matter of COMPTON CORP.,
Debtor.
Walter KELLOGG, Trustee,
Plaintiffs-Appellant,
Vv.
BLUE QUAIL ENERGY, INC.,
Defendant-Appellee,
and
MBank Abilene, N.A., Appellee.
No. 87-1135.
United States Court of Appeals,
Fifth Circuit.
Nov. 12, 1987.
Rehearing Granted Jan. 12, 1988.*
Appeal from the United States District Court for the Northern
District of Texas.
Before BROWN, JOHNSON and WILLIAMS, Circuit Judges.
JERRE S. WILLIAMS, Circuit Judge:
This is a bankruptcy preference case in which a bankruptcy trustee
seeks to recover a transfer made via a letter of credit for the benefit of
one of the debtor’s unsecured creditors on the eve of bankruptcy. The
bankruptcy court and the district court found there to be no voidable
preference. We reverse.
I. Factual Background
~ In March 1982, Blue Quail Energy, Inc., delivered a shipment of oil
to debtor Compton Corporation. Payment of $585,443.85 for this ship-
ment of oil was due on or about April 20, 1982. Compton failed to make
timely payment. Compton induced Abilene National Bank (now
MBank-Abilene) to issue an irrevocable standby letter of credit in Blue
Quail’s favor on May 6, 1982. Under the terms of the letter of credit,
payment of up to $585,443.85 was due Blue Quail if Compton failed to
pay Blue Quail this amount by June 22, 1982. Compton paid MBank
$1,463.61 to issue the letter of credit. MBank also received a promissory
note payable on demand for $585,443.85. MBank did not need a
security agreement to cover the letter of credit transaction because a
prior 1980 security agreement between the bank and Compton had a
future advances provision.' This 1980 security agreement had been
perfected as to a variety of Compton’s assets through the filing of
several financing statements. The most recent financing statement
*Opinion on rehearing, 835 F.2d 584.
‘A future advances clause ina security agreement subjects the specified collateral to
any future loan made by the creditor in addition to the current loans.
A22
had been filed a year before, May 7, 1981. The letter of credit on its face
noted that it was for an antecedent debt due Blue Quail.
On May 7, 1982, the day after MBank issued the letter of credit in
Blue Quail’s favor, several of Compton's creditors filed an involuntary
bankruptcy petition against Compton. On June 22, 1982, MBank paid
Blue Quail $569,932.03 on the letter of credit after Compton failed to
pay Blue Quail.
In the ensuing bankruptcy procceding, MBank’s aggregate secured
claims against Compton, including the letter of credit payment to Blue
Quail, were paid in full from the liquidation of Compton’s assets which
served as the bank’s collateral. Walter Kellogg, bankruptcy trustee for
Compton, did not contest the validity of MBank’s secured claim against
Compton’s assets for the amount drawn under the letter of credit by
Blue Quail. Instead, on June 14, 1983, trustee Kellogg filed a complaint
in the bankruptcy court against Blue Quail asserting that Blue Quail
had received a preferential transfer under 11 U.S.C. § 547 through the
letter of credit transaction. The trustee sought to recover $585,443.85
from Blue Quail pursuant to 11 U.S.C. § 550.
Blue Quail answered and filed a third party complaint against
MBank. On June 16, 1986, Blue Quail filed a motion for summary
judgment asserting that the trustee could not recover any preference
from Blue Quail because Blue Quail had been paid from MBank’s
funds under the letter of credit and therefore had not received any of
Compton’s property. On August 27, 1986, the bankruptcy court granted
Blue Quail’s motion, agreeing that the payment under the letter of
credit did not consitute a transfer of debtor Compton’s property but
rather was a transfer of the bank’s property. The bankruptcy court
entered juagment on the motion on September 10, 1986. Trustee
Kellogg appealed this decision to the district court. On December 11,
1986, the district court affirmed the bankruptcy court ruling, holding
that the trustee did not establish two necessary elements of a voidable
transfer under 11 U.S.C. § 547. The district court agreed with Blue
Quail and the bankruptcy court that the trustee could not establish
that the funds transferred to Blue Quail were ever property of Compton.
Furthermore, the district court held that the transfer of the increased
security interest to MBank was a transfer of the debtor’s property for
the sole benefit of the bank and in no way benefitted Blue Quail. The
district court therefore found no voidable preference as to Blue Quail.
The trustee is appealing the decision to this Court.
II. The Letter of Credit
It is well established that a letter of credit and the proceeds therefrom
are not property of the debtor’s estate under 11 U.S.C. §541./n re W.L.
A23
Mead, Inc., 42 B.R. 57 (Bankr.N.D.Ohio, W.D.1984); Jn re Leisure
Dynamics, Inc., 33 B.R. 171 (Bankr.Minn.1983); In re North Shore &
Central Illinois Freight Co., 30 B.R. 377 (Bankr.N.D.Ill., E.D.1983);
In re M.J. Sales & Distributing Co., 25 B.R. 608 (Bankr.S.D.N.Y.1982).
When the issuer honors a proper draft under a letter of credit, it does so
from its own assets and not from the assets of its customer who caused
the letter of credit to be issued. Jn re W.L. Mead; Inre M.J. Sales. Asa
result, a bankruptcy trustee is not entitled to enjoin a post petition
payment of funds under a letter of credit from the issuer to the
beneficiary, because such a payment is not a transfer of debtor’s pro-
perty (a threshold requirement under 11 U.S.C. § 547(b). A case
apparently holding otherwise, Jn re Twist Cap., Inc., 1 B.R. 284
(Bankr.Fla.1979), has been roundly criticized and otherwise ignored
by courts and commentators alike.
Recognizing these characteristics of a letter of credit ina bankruptcy
case is necessary in order to maintain the independence principle, the
cornerstone of letter of credit law. Under the independence principle,
an issuer’s obligation to the letter of credit’s beneficiary is independent
from any obligation between the beneficiary and the issuer’s cus-
tomer. All a beneficiary has to do to receive payment under a letter of
credit is to show that it has performed all the duties required by the letter
of credit. Any disputes between the beneficiary and the customer do
not affect the issuer’s obligation to the beneficiary to pay under the letter
of credit.
Letters of credit are most commonly arranged by a party who benefits
from the provision of goods or services. The party wil! request a bank to
issue a letter of credit which names the provider of the goods or services
as the beneficiary. Under a standby letter of credit, the bank becomes
primarily liable to the beneficiary upon the default of the bank’s cus-
tomer to pay for the goods or services. The bank charges a fee to issue a
letter of credit and to undertake this liability. The shifting of liability
to the bank rather than to the services or goods provider is the main
purpose of the letter of credit. After all, the bank is in a much better
position to assess the risk of its customer’s insolvency than is the ser-
vice or goods provider. It should be noted, however, that it is the risk of
the debtor’s insolvency and not the risk of a preference attack that a
bank assumes under a letter of credit transaction. Overall, the
independence principle is necessary to insure “the certainty of payments
for services or goods rendered regardless of any intervening misfortune
which may befall the other contracting party.” Jn re North Shore, 30
B.R. at 378.
The trustee in this case accepts this analysis and does not ask us to
upset it. The trustee is not attempting to set aside the post petition
A24
payments by MBank to Blue Quail under the letter of credit as a pref-
erence; nor does the trustee claim the letter of credit itself constitutes
debtor’s property. The trustee is instead challenging the earlier transfer
in which Compton granted MBank an increased security interest in its
assets to obtain the letter of credit for the benefit of Blue Quail.
Collateral which has been pledged by a debtor as security for a letter of
credit is property of the debtor’s estate. Jn re W.L. Mead, 42B.R. at 59.
The trustee claims that the direct transfer to MBank of the increased
security interest on May 6, 1982, also constituted an indirect transfer
to Blue Quail which occurred one day prior to the filing of the involun-
tary bankruptcy petition and is voidable as a preference under 11
U.S.C. § 547. This assertion of a preferential transfer is evaluated in
Parts III and IV of this opinion.
It is important to note that the irrevocable standby letter of credit in
the case at bar was not arranged in connection with Blue Quail’s initial
decision to sell oil to Compton on credit. Compton arranged for the letter
of credit after Blue Quail had shipped the oil and after Compton had
defaulted in payment. The letter of credit in this case did not serve its
usual function of backing up a contemporaneous credit decision,? but
instead served as a back up payment guarantee on an extension of
credit already in jeopardy. The letter of credit was issued to pay off an
antecedent unsecured debt. This fact was clearly noted on the face of
the letter of credit.* Blue Quail, the beneficiary of the letter of credit,
did not give new value for the issuance of the letter of credit by MBank
on May 6, 1982, or for the resulting increased security interest held by
MBank. MBank, however, did give new value for the increased security
interest it obtained in Compton’s collateral: the bank issued the letter
of credit.
When a debtor pledges its assets to secure a letter of credit, a transfer
of debtor’s property has occurred under the provisions of 11 U.S.C.
§ 547. By subjecting its assets to MBank’s reimbursement claim in the
event MBank had to pay on the letter of credit, Compton made a
transfer of its property. The broad definition of “transfer” under 11
U.S.C. § 101(50) is clearly designed to cover such a transfer. Overall,
the letter of credit itself and the payments thereunder may not be pro-
perty of debtor, but the collateral pledged as a security interest for the
letter of credit is.
Furthermore, in a secured letter of credit transaction, the transfer of
debtor’s property takes place at the time the letter of credit is issued
(when the security interest is granted) and received by the beneficiary,
?As was thecasein/nre W.L. Mead, Inc., Inre Leisure Dynamics, In re North Shore
& Central Illinois Freight Co., and In re M.J. Sales, all supra.
2The letter of credit was dated May 6, 1982, and noted that it covered delivery of
Oklahoma Sweet crude oil during March 1982.
A25
not at the time the issuer pays on the letter of credit. Jn re Briggs
Transportation Co., 37 B.R. 76, 79 (Bankr.Minn.1984). In re M.d.
Sales, supra (transfer of pledged collateral occurs not when bank
forecloses on it, but when it is pledged.)
The transfer toMBank of the increased security interest was a direct
transfer which occurred on May 6, 1982, when the bank issued the letter of
credit. Under 11 U.S.C. § 547(e)(2)(A), however, such a transfer is
deemed to have taken place for purposes of 11 U.S.C. § 547 at the time
such transfer ‘“‘takes effect’’ between the transferor and transferee if
such transfer is perfected within 10 days. The phrase “‘takes effect” is
undefined in the Bankruptcy Code, but under Uniform Commercial
Code Article 9 law, a transfer of a security interest ‘“‘takes effect” when
the security interest attaches. Because of the future advances clause in
MBank’s 1980 security agreement with Compton, the attachment of
the MBank’s security interest relates back to May 9, 1980, the date the
security agreement went into effect. The bottom line is that the direct
transfer of the increased security interest to MBank is artifically deemed
to have occurred at least by May 7, 1981, the date MBank filed its final
financing statement, for purposes of a preference attack against the
bank.* This date is well before the 90 day window of 11 U.S.C.
§ 547(b)(4)(A). This would protect the bank from a preference attack
by the trustee even if the bank had not given new value at the time it
received the increased security interest. MBank is therefore protected
from a preference attack by the trustee for the increased security
interest transfer under either of two theories: under 11 U.S.C. § 547(c)(1)
because it gave new value and under the operation of the relation back
provision of 11 U.S.C. § 547(e)(2)(A). The bank is also protected from
any claims of reimbursement by Blue Quail because the bank received
no voidable preference.
The relation back provision of 11 U.S.C. § 547(e)(2)(A), however,
applies only to the direct transfer of the increased security interest to
MBank. The indirect transfer to Blue Quail that allegedly resulted
from the direct transfer to MBank occurred on May 6, 1982, the date of
issuance of the letter of credit. The relation back principle of 11 U.S.C. -
§ 547(e)(2)(A) does not apply to this indirect transfer to Blue Quail.
Blue Quail was not a party to the security agreement between MBank
and Compton. So it will not be able to utilize the relation back provi-
sion if it is deemed to have received an indirect transfer resulting from
the direct transfer of the increased security interest to MBank. Blue
“Tex. Bus. & Com.Code Ann. § 9.312(g) specifies that for purposes of priority among
competing secured parties, the security interest for a future advance has the same
priorty as the security interest for the first advance. Conflicting security interests rank
according to priority in time of filing or perfection. Tex.Bus. & Com.Code Ann.
§ 9.312(e)(1)
A26
Quail, therefore, cannot assert either of the two defenses to a preference
attack which MBank can claim. Blue Quail did not give new value
under § 547(c)(1), and it received a transfer within 90 days of the filing
of Compton’s bankruptcy petition.’
III. Direct/Indirect Transfer Doctrine
The federal courts have long recognized that “[t]o constitute a pref-
erence, it is not necessary that the transfer be made directly to the
creditor.” National Bank of Newport v. National Herkimer County
Bank, 225 U.S. 178, 184, 32 S.Ct. 663, 635¢G, 56 L.Ed. 1042¢G (1912).
“If the bankrupt has made a transfer of his property, the effect of which
is toenable one of his creditors to obtain a greater percentage of his debt
than another creditor of the same class, circuity of arrangement wiil
not avail to save it.’’ Jd. (Emphasis added). To combat such circuity,
the courts have broken down certain transfers into two transfers, one
direct and one indirect. The direct transfer to the third party may be
valid and not subject toa preference attack. The indirect transfer, aris-
ing from the same action by the debtor, however, may constitute a void-
able preference as to the creditor who indirectly benefitted from the
direct transfer to the third party.
This is the situation presented in the case before us. The term
“transfer” as used in the various bankruptcy statutes through the
years has always been broad enough to cover such indirect transfers
and to catch various circuitous arrangements. Katz v. First National
Bank of Glen Head, 568 F.2d 964, 969 n. 4, (2nd Cir.), cert, denied, 434
U.S. 1069, 98 S.Ct. 1250¢G, 55 L.Ed.2d 771¢G (1978). The new Bank-
ruptcy Code implicitly adopts this doctrine through its broad defini-
tion of ‘‘transfer.”* Examining the case law that has developed since
the National Bank of Newport case yields an understanding of what
types of transfers the direct/indirect doctrine is meant to cover.
In Palmer v. Radio Corporation of America, 453 F.2d 1133 (5th
Cir.1971), athird party purchased from the debtor a television station
for $40,000 cash and the assumption of certain liabilities of the debtor,
including unsecured claims by creditor RCA. This Court found the
direct transfer from the debtor to the third party purchaser constituted
an indirect preferential transfer to creditor RCA. We found that the
assumption by the third party purchaser of the debt owed by the debtor
to RCA and the subsequent payments made thereunder constituted a
voidable transfer as to RCA. The court noted that such indirect transfers
as this had long been held to constitute voidable preferences under
bankruptcy laws. 458 F.2d at 1136.
‘Nor does Blue Quail have the protection of the 11 U.S.C. § 547(c)(2) “ordinary
course of business” preference exception. Getting a standby letter of credit issued to
cover a debt several] weeks past due does not constitute ordinary course of business.
A27
Although the Palmer court did not elaborate its reasoning behind
this holding, such reasoning is self evident. A secured creditor was
essentially substituted for an unsecured creditor through the transfer
of the television station to the third party purchaser and the assump-
tion of the unsecured debt by the purchaser. The third party purchaser
was in effect secured because it had the television station. Creditor
RCA would receive payments directly from the solvent third party
without having to worry about its original debtor’s financial condition.
The original debtor’s other unsecured creditors were harmed because a
valuable asset of the debtor, the television station, was removed from
the debtor’s estate. The end result of the Palmer case was that the third
party’s payments on the RCA debt were to be made to the debtor’s
estate instead of to RCA. RCA would then recover the same percentage
of its unsecured claim from the estate as the other unsecured creditors.
In Jn re Conrad Corp., 806 F.2d 610 (5th Cir.1986), we found a void-
able indirect transfer on facts similar to those of Palmer v. Radio
Corporation of America. In the Conrad case, the debtors bought several
restaurants from the Burtons in exchange for an unsecured promissory
note. A third party in turn purchased the restaurants from the debtors
and assumed the payments to the Burtons on the promissory note.
Relying on the analysis of the Palmer case, we held that the transfer of
the restaurants by the debtors in exchange for a simultaneous assump-
tion of the Burton debt by the third party benefitted the Burtons and
constituted a voidable indirect transfer as to the Burtons.
We observed that as a result of executing the assumption of debt
agreement, the debtors transfered to the Burtons the debtors’ right to
receive from the third party so much of the sales price for the res-
taurants as was needed to reimburse the Burtons on their unsecured
note. Once again a secured creditor, in effect, was substituted for an
unsecured creditor by the transfer, and a depletion of the debtor’s
estate occurred. We held that the trustee of the debtor could recover
from the Burtons the payments made by the third party to the Burtons
and that the Burtons’ would recover only their proportionate share of
the value of the unencumbered assets of the debtor along with the other
unsecured creditors.
There are a number of federal cases in the other circuits supporting
the holdings and reasoning in our direct/indirect doctrine cases. In
Aulick v. Largent, 295 F.2d 41 (4th Cir.1961), a third party endorsed
the debtor’s antecedent obligation to one of the debtor’s unsecured
creditors in exchange for the transfer of some stock within the pre-
ference time period. The creditor eventually received payment from
the third party who in turn retained the pledged stock. The Fourth Cir-
cuit held that while the direct transfer of the stock to the third party to
A28
secure the contingent liability of the endorsement was not voidable
because it was a transfer for consideration presently furnished, the
indirect transfer to the unsecured creditor via the third party endorser
was a voidable preference. The creditor in Aulick made the same argu-
ment that Blue Quail makes in the case at bar. The creditor claimed
that the payment to it by the third party endorser came from the en-
dorser’s personal funds and thus the payment did not deplete the debtor’s
estate. Therefore one of the essential elements of a voidable preference
was lacking.
The court rejected this argument relying on National Bank of New-
port. The Aulick court found there to be two transfers arising from the
pledge of stock to the third party, one direct and one indirect, and then
collapsed them, in effect, into a single one for a preference attack
against the indirect transferee creditor. The court noted that if the
debtor had delivered the shares of stock directly to the unsecured
creditor as security for the antecedent debt, the creditor would have
clearly received a voidable preference. The court held that such a
result could not be avoided by indirect arrangement.’ “[P]references
obtained by indirect or circuitous arrangements are to be struck down
just as quickly as those obtained by direct arrangements.”295 F.2d
at 52.
In Virginia National Bank v. Woodson, 329 F.2d 836 (4th Cir.1964),
the debtor had several overdrawn accounts with his bank.* The debtor
talked his sister into paying off $8,000 of the overdrafts in exchange for
an $8,000 promissory note and an assignment of some collateral as
security. The debtor’s sister made the $8,000 payment directly to the
bank. The $8,000 technically was never part of the debtor’s estate. The
court, however, held that the payment of the $8,000 by the sister to the
bank was a preference as to the bank to the extent of the value of the
collateral held by the sister. The court noted that the measure of the
value of a voidable preference is dimunition of the debtor’s estate and
not the value of the transfer to the creditor.
In the Woodson case the sister was secured only to the extent the
pledged collateral had value; the remainder of her loan to her brother
’Apparently the bottom line in the Aulick case was that the creditor and not the
third party endorser was ultimately liable for the preferential transfer. This is the way
the preference provisions are supposed to work; it was the creditor, after all, and not
the endorser who was preferred. It should also be noted that there would have been no
preference attack against the creditor had not the endorser received the assignment of
stock from the debtor to secure its contingent liability on the endorsement. It is the
substitution of a secured creditor for a general unsecured creditor that constitutes the
voidable transfer as to the unsecured creditor. This is acommon theme underlying the
direct/indirect cases and applies with equal force to the case at bar.
*Unsecured antecedent debts.
A29
was unsecured. Swapping one unsecured creditor for another unsecured
creditor does not create any kind of preference. The court held that a pref-
erence in such a transaction arises only when a secured creditor is
swapped for an unsecured creditor. Only then is the pool of assets
available for distribution to the general unsecured creditors depleted
because the secured creditor has priorty over the unsecured creditors.
Furthermore, the court held that the bank and not the sister had
received the voidable preference and had to pay back to the trustee an
amount equal to the value of the collateral.
A slightly different indirect transfer was involved in Jn re Mercon
Industries, Inc., 87 B.R. 549 (Bankr.E.D.Penn.1984). In that case a
debtor paid off a non-insider unsecured creditor within one year of the
filing of the bankruptcy petition on a debt guaranteed by insiders of the
debtor. The payment to the creditor had the effect of releasing the
insider guarantors from contingent liability on the debt, thereby
benefitting the insiders. The court held that releasing an insider
guarantor from contingent liability is a beneficial transfer to the
guarantor for purposes of 11 U.S.C. § 547.
The court in Mercon viewed the payment to the non-insider creditor
as effecting two transfers under the Bankruptcy Code because of the
secondary liability of the guarantors on the debt. The court held that
while the direct transfer from the debtor to the non-insider creditor in
satisfaction of the primary debt may not be a voidable preference (if it
was made over 90 days of filing), the court found that the indirect
transfer to the insider guarantors extinguishing their contingent
liability (and their contingent unsecured claim for reimbursement)
was a separate voidable transfer under 11 U.S.C. § 547. Such an
indirect transfer is voidable if it occurred within one year of filing pur-
suant to § 547(b)(4)(B). Furthermore, the court held that because the
Bankruptcy Code “dictates that there are two transfers rather than
one, liability of the guarantors under § 547(b) need not be predicated
on a finding of an avoidable transfer to [the non-insider creditor], since
a finding of liability on one transfer is independent of the other, rather
than derivative.” 37 B.R. at 552. The court held that the insider
guarantors, and not the non-insider creditor, were ultimately liable for
this preference.®
*See also In re Deprizio Construction Co., 58 B.R. 478 (N.D.IIl.E.D.1986) (case with
similar facts and a similar holding). This case also described the bankruptcy courts’
equitable powers under 11 U.S.C. § 550 to preclude a trustee from recovering from
innocent creditors who were the initial direct transferees of a voidable indirect
preference.
A30
IV. The Direct/Indirect Doctrine in the Context
of a Letter of Credit Transaction
The case at bar differs from the cases discussed in Part III supra only
by the presence of the letter of credit as the mechanism for paying off
the unsecured creditor. Blue Quail’s attempt to otherwise distinguish
the case from the direct/indirect transfer cases does not withstand
scrutiny.
In the letter of credit cases discussed in Part II supra, the letters of
credit were issued contemporaneously with the initiai extension of
credit by the beneficiaries of the letters. In those cases the letters of
credit effectively served as security devices for the benefit of the creditor
beneficiaries and took the place of formal security interests. The courts
in those cases properly found there had been no voidable tranfers,
direct or indirect, in the letter of credit transactions involved. New
value was given contemporaneously with the issuance of the letters of
credit in the form of the extensions of credit by the beneficiaries of the
letters. As a result, the 11 U.S.C. § 547(c)(1) preference exception
was applicable.
The case at bar differs from these other letter of credit cases by one
very important fact: the letter of credit in this case was issued to secure
an antecedent unsecured debt due the beneficiary of the letter of
credit. The unsecured creditor beneficiary gave no new value upon the
issuance of the letter of credit. When the issuer paid off the letter of
credit and foreclosed on the collateral securing the letter of credit, a
preferential transfer had occurred. An unsecured creditor was paid in
full and a secured creditor was substituted in its place.
The district court upheld the bankruptcy court in maintaining the
validity of the letter of credit issued to cover the antecedent debt. The
district court held that MBank, the issuer of the letter of credit, could
pay off the letter of credit and foreclose on the collateral securing it. We
are in full agreement. But we also look to the impact of the transaction
as it affects the situation of Blue Quail in the bankrupt estate. We hold
that the bankruptcy trustee can recover from Blue Quail, the beneficiary
of the letter of credit, because Blue Quail received an indirect pre-
ference. This result preserves the sanctity of letter of credit and carries
out the purposes of the Bankruptcy Code by avoiding a preferential
transfer. MBank, the issuer of the letter of credit, being just the inter-
mediary through which the preferential transfer was accomplished,
completely falls out of the picture and is not involved in this particular
legal proceeding.
MBank did not receive any preferential transfer — it gave new value
for the security interest. Furthermore, because the direct and indirect
a
A31
transfers are separate and independent, the trustee does not even need
to challenge the direct transfer of the increased security interest to
MBank, or seek any relief at all from MBank, in order to attack the
indirect transfer and recover under 11 U.S.C. § 550 from the indirect
transferee Blue Quail.
We hold that a creditor cannot secure payment of an unsecured
antecedent debt through a letter of credit transaction when it could not
doso through any other type of transaction. The purpose of the letter of
credit transaction in this case was to secure payment of an unsecured
antecedent debt for the benefit of an unsecured creditor. This is the
only proper way to look at such letters of credit in the bankruptcy con-
text. The promised transfer of pledged collateral induced the bank to
issue the letter of credit in favor of the creditor. The increased security
interest held by the bank clearly benefitted the creditor because the
bank would not have issued the letter of credit without this security. A
secured creditor was substituted for an unsecured creditor to the detri-
ment of the other unsecured creditors.
We also hold, therefore, that the trustee can recover under 11 U.S.C.
§ 550(a)(1) the value of the transferred property from “‘the entity for
whose benefit such transfer was made.” In the case at bar, this entity
was the creditor beneficiary, not the issuer, of the letter of credit even
though the issuer received the direct transfer from the debtor. The
entire purpose of the direct/indirect doctrine is to look through the
form of a transaction and determine which entity actually benefitted
from the transfer.'®
The fact that there was a prior security agreement between the issu-
ing bank and the debtor containing the future advances clause does not
alter this conclusion. As we pointed out in Part il supra, this prior
security agreement gave MBank an additional shield from preferential
attack because of the relation back mechanism of 11 U.S.C. § 547(e)(2)(A).
1i U.S.C. § 547(e)(2)(A), however, does not avail Blue Quail te shield
it from a preferential attack for the indirect transfer. The indirect
transfer to Blue Quail occured on May 6, 1982, when the letter of credit
was issued and the increased security interest was pledged. This was
the day before the involuntary bankruptcy petition was filed. For pur-
poses of 11 U.S.C. § 547, a transfer of Compton’s property for the
benefit of Blue Quail did occur within 90 days of the bankruptcy filing.
'°We have found only one prior case that has fully addressed the application of the
direct/indirect doctrine in the context of a letter of credit transaction. Jn re Air Con-
ditioning, Inc. of Stuart, 55 B.R. 157 (Bankr.S.D.Fla.1985), affirmed in part, reversed
in part 72 B.R. 657 (S.D.Fla.1987) (currently on appeal to the Eleventh Circuit). In a
carefully and thoroughly reasoned opinion, the court reached the same conclueion we
reach in this case.
A32
The bankruptcy and district courts erred in failing to analyze properly
the transfer of debtor's property that occurred when Compton pledged
its assets to obtain the letter of credit. This transfer consisted of two
aspects: the direct transfer to MBank which is not a voidable pre-
ference for various reasons and the indirect transfer to Blue Quail
which is a voidable preference.
All of the requirements of 11 U.S.C. § 547(b) have been satisfied in
the trustee’s preferential attack against Blue Quail. There was (1) a
transfer of Compton’s property for the benefit of Blue Quail (2) for an
antecedent debt owed by Compton (3) made while Compton was insol-
vent" (4) within 90 days before the date of the filing of the petition (5)
that enabled Blue Quail to receive more than it would receive under a
Chapter 7 liquidation.'? The net effect of the indirect transfer to Blue
Quail was to remove $585,443.85 from the pool of assets available to
Compton’s unsecured creditors and substitute in its place a secured
claim for the same amount.
The precise holding in this case needs to be emphasized. We do not
hold that payment under a letter of credit, or even a letter of credit
itself, constitute preferential transfers under 11 U.S.C. § 547(b) or
property of a debtor under 11 U.S.C. § 541. The holding of this case
fully allows the letter of credit to function. We preserve its sanctity and
the underlying independence doctrine. We do not, however, allow an
unsecured creditor to avoid a preference attack by utilizing a letter of
credit to secure payment of an antecedent debt. Otherwise the unsecured
creditor would receive an indirect preferential transfer from the grant-
ing of the security for the letter of credit to the extent of the value of
that security. Our holding does not affect the strength of or the proper
use of letters of credit. When a letter of credit is issued contem-
poraneously with a new extension of credit, the creditor beneficiary
will not be subject to a preferential attack under the direct/indirect doc-
trine elaborated in this case because the creditor will have given new
value in exchange for the indirect benefit of the secured letter of credit.
Only when a creditor receives a secured letter of credit to cover an
unsecured antecedent debt will it be subject to a preferential attack
under 11 U.S.C. § 547(b).
"There is a presumption that a debtor is insolvent at least 90 days prior to its bank-
ruptcy filing. 11 U.S.C. § 547(f).
'?There was undisputed evidence below that the other unsecured creditors of
Compton would receive less than fifty cents on the dollar for their unsecured claims.
A33
V. Liability of MBank for the Preferential Transfer
Blue Quail has no valid claim against MBank for reimbursement for
any amounts Blue Quail has to pay the trustee under the trustee’s pref-
erence claim, just as the trustee has no preference challenge against
MBank. Blue Quail received the preferential transfer, not MBank.
MBank gave new value in exchange for the increased security interest
in its favor. Thus, it is insulated from any assertion of a voidable pref-
erence. The bank in no way assumed the risk of a preference attack by
issuing the letter of credit. For these reasons, we affirm the district
court’s dismissal of Blue Quail’s request to proceed against MBank
for reimbursement."*
In addition, the trustee may not set aside the $1,463.61 fee Compton
paid MBank to issue the !xtter of credit. This payment is not a pref-
erential transfer. MBank has fully performed its duties under the
terms of the letter of credit and has earned this fee. The services
MBank rendered in issuing and executing the letter of credit constitute
new value under the 11 U.S.C. § 547(c)(1) preference exception.
VI. Conclusion
Blue Quail Energy received an indirect preferential transfer from
Compton Corporation on May 6, 1982, one day prior to the filing of
Compton’s bankruptcy petition. We reversethe district court and render
judgment in favor of Trustee Kellogg against Blue Quail Energy, Inc.
in the amount of $585,443.85 plus interest to be fixed by the district
court pursuant to 11 U.S.C. §§ 547, 550. The district court’s dismissal
of Blue Quail’s claim against MBank for reimbursement is affirmed.
REVERSED IN PART, AFFIRMED IN PART, AND REMANDED.
'2The liability of MBank to Blue Quail in the event of this Court's finding a preferen-
tial transfer to Blue Quail is interrelated with the Trustee’s preference challenge
against Blue Quail. The briefs of Blue Quail and Trustee Kellogg both addressed
this issue.
A34
In the Matter of COMPTON CORPORATION,
Debtor.
Walter KELLOGG, Trustee,
Plaintiff-Appellant,
Vv.
BLUE QUAIL ENERGY, INC.,
Defendant-Appellee,
and
MBank Abilene, N.A., Appellee,
No. 87-1135.
United States Court of Appeals,
Fifth Circuit.
Jan. 12, 1988.
Rehearing Denied Feb. 29, 1988
ON PETITION FOR REHEARING .
(Opinion November 12, 1987, 5th Cir.1987, 831 F.2d 586)
Before BROWN, JOHNSON and WILLIAMS, Circuit Judges.
PER CURIAM:
We grant the petition for rehearing for the narrow purpose of
remanding one additional matter to the district court.
Our previous decision, Matter of Compton Corp., 831 F.2d 586 (5th
Cir.1987), remanded this case in order for the district court to deter-
mine the amount of interest due on the preference claim. We now hold
that on remand the district court needs to make factual findings
regarding the amount MBank actually foreclosed on and received
from Compton Corp.’s trustee to cover the letter of credit transaction.
In addition, the district court needs to determine the amount Blue
Quail received from MBank under the letter of credit. The trustee
states the amount paid to Blue Quail on June 22 , 1982, by MBank
totaled $569,932.03, rather than $585,448.85, the face amount of the
letter of credit and the amount Compton owed Blue Quail. This is a
difference of $15,511.82. Whether this amount was paid to Blue Quail
on another occasion by MBank under the letter of credit, whether Blue
Quail and MBank reached some kind of compromise on the amount,
or whether Blue Quail received this amount directly from Compton
Corp. are all factual issues that need to be resolved by the district
court on remand.
Overall, the amount of the preference which Blue Quail! has to pay
over to the trustee, prior to interest adjustments, is limited to the
value of the collateral MBank actually foreclosed on to cover the letter
A35
of credit transaction. This amount represents the dimunition of the
assets in Compton’s estate available to the unsecured creditors. This
amount in turn is to be limited by the actual amount Blue Quail
received from MBank under the letter of credit transaction.
REHEARING GRANTED.
ADDITIONAL REMAND TO DISTRICT COURT.
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