Rafool v. Evans et al
Filing
9
ORDER & OPINION Entered by Judge Joe Billy McDade on 9/11/13. This Court agrees with the Bankruptcy Court that the letters of credit were not contracts between the Debtor and the issuing institution, that they were not executory in nature, and that t hey were not a financial accommodation to or for the benefit of the Debtor, and thus agrees that § 365(c)(2) did not prevent the bankruptcy estate from drawing upon the letters of credit after the bankruptcy filing. Appellees thus did not proximately cause Appellant's damages and it wasappropriate to grant summary judgment in Appellees' favor. Therefore, the CourtAFFIRMS the Bankruptcy Court's grant of summary judgment in Appellees' favor.IT IS SO ORDERED. (SW, ilcd)
E-FILED
Wednesday, 11 September, 2013 03:58:19 PM
Clerk, U.S. District Court, ILCD
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF ILLINOIS
PEORIA DIVISION
GARY T. RAFOOL, not individually but)
as Trustee for Central Illinois Energy,)
L.L.C.,
)
)
)
Plaintiff/Appellant,
)
v.
)
)
MICHAEL E. EVANS and FROEHLING,)
WEBER & SCHELL, LLP, formerly doing)
business as FROEHLING, WEBER,)
EVANS & SCHELL, LLP,
)
)
)
Defendants/Appellees.
Case No. 12-cv-1352
ORDER & OPINION
This matter is before the Court on Appellant’s appeal from the Bankruptcy
Court for the Central District of Illinois’ determination that the right to draw on a
letter of credit is property of a bankruptcy estate and that Appellees therefore did
not proximately cause Appellant’s damages by failing to cause the Debtor to draw
upon the letters of credit prior to the bankruptcy filing. Both Appellant and
Appellee have filed their briefs on appeal, and the matter is now ready for
disposition. For the reasons stated below, the decision of the Bankruptcy Court is
affirmed.
LEGAL STANDARDS
This Court has jurisdiction to review the decision of the bankruptcy court
pursuant to 28 U.S.C. § 158(a). On an appeal, a “district court or bankruptcy
appellate panel may affirm, modify, or reverse a bankruptcy judge’s judgment,
order, or decree or remand with instructions for further proceedings.” FED. R.
BANKR. P. 8013. District courts are to apply a dual standard of review when
considering a bankruptcy appeal: the bankruptcy court’s findings of fact are
reviewed for clear error, while the conclusions of law are reviewed de novo. Mungo
v. Taylor, 355 F.3d 969, 974 (7th Cir. 2004). The Court reviews mixed questions of
fact and law de novo. Mungo, 355 F.3d at 974.
A legal malpractice claim is made up of four elements: “(1) the existence of an
attorney-client relationship that establishes a duty owed by the attorney; (2) a
negligent act or omission constituting a breach of that duty; (3) proximate cause;
and (4) damages.” 4 ILL. LAW AND PRAC. ATTORNEYS AND COUNSELORS § 85 (citations
omitted). Before the Bankruptcy Court, the parties each cited Illinois law as
governing the legal malpractice claim, and the Bankruptcy Court agreed that
Illinois law probably controlled the claim. In re Central Illinois Energy, L.L.C., 482
B.R. 772, 789 n. 3 (Bkrtcy. C.D. Ill. 2012). On appeal, neither party disputes this
assumption, and the Court agrees that the underlying contract for legal services
appears to have been formed and performed in Illinois by Illinois-licensed attorneys
with an Illinois-based client, and is thus likely governed by Illinois law under both
Illinois and federal choice-of-law rules. Id.; see Auto-Owners Ins. Co. v. Websolv
Computing, Inc., 580 F.3d 543, 547 (7th Cir. 2009) (internal quotation omitted)
(“Courts do not worry about conflict of laws unless the parties disagree on which
state’s law applies.”); In re Jafari, 569 F.3d 644, 648-51 (7th Cir. 2009) (whether
bankruptcy courts are to apply forum state’s or federal choice-of-law rules unsettled
in Seventh Circuit).
2
Finally, as relevant to this appeal, the Bankruptcy Code provides that a
bankruptcy “trustee may not assume or assign any executory contract…if…such
contract is a contract to make a loan, or extend other debt financing or financial
accommodations, to or for the benefit of the debtor, or to issue a security of the
debtor.” 11 U.S.C. § 365(c)(2). The Seventh Circuit has explained that “[§] 365(c)(2)
prevents the assumption of a loan commitment or equivalent promise because the
cost of future credit depends on the probability of repayment, and bankruptcy
reveals that the risk of nonpayment is higher than the would-be creditor likely
assumed.” In re United Airlines, Inc., 368 F.3d 720, 723 (7th Cir. 2004). As
recognized by the Bankruptcy Court, the letters of credit at issue here indicate that
New York state law governs their interpretation. Central Illinois Energy, 482 B.R.
at 789 n. 3. This Court will thus look to New York state law to define the
relationships created by letters of credit, in order to determine whether the one at
issue here falls within § 365(c)(2). See Auto-Owners Ins. Co., 580 F.3d at 547
(internal quotation omitted) (“Courts do not worry about conflict of laws unless the
parties disagree on which state’s law applies.”); Jafari, 569 F.3d at 648-51 (whether
bankruptcy courts are to apply forum state’s or federal choice-of-law rules unsettled
in Seventh Circuit).
BACKGROUND
Appellant does not challenge any of the Bankruptcy Court’s factual findings,
and the issues presented on appeal are ones of pure legal interpretation, so the
Court will briefly summarize the facts from the Bankruptcy Court’s opinion that are
3
relevant to the issues raised before this Court. In re Central Illinois Energy, L.L.C.,
482 B.R. 772 (Bkrtcy. C.D. Ill. 2012).
The Debtor in the bankruptcy proceeding from which this appeal arises is
Central Illinois Energy, L.L.C., which was formed in 2004 for the purpose of
constructing, owning, and operating an ethanol production facility. The Debtor
arranged with Lurgi PSI, Inc. to design and construct the facility, and Lurgi
provided the Debtor with letters of credit as a retainage of the monthly progress
payments. Appellee Michael Evans, an attorney, represented the Debtor in these
negotiations. The Debtor began to encounter financial difficulties, and consulted
with Barry Barash, a bankruptcy attorney, in late fall of 2007. In November 2007,
Lurgi obtained two letters of credit from Calyon Credit Agricole CIB in the Debtor’s
favor, expiring on December 15, 2008.1 The Debtor never drew upon the Calyon
letters of credit.
On December 8, 2007, the Debtor hired Mr. Barash to represent it in a
chapter 11 bankruptcy proceeding. On December 13, 2007, the Debtor filed a
chapter 7 bankruptcy petition. The Trustee brought a complaint against Appellees
for legal malpractice, alleging that they had unreasonably failed to advise or cause
In addition, in July 2006, Lurgi posted a letter of credit from DZ Bank AG,
the amount of which was increased in January 2007. Lurgi also obtained another
letter of credit from Commerzbank in August 2006. These letters of credit expired
on December 15, 2007. These older letters of credit are not relevant to the instant
appeal.
1
4
the Debtor to draw on the letters of credit prior to the bankruptcy filing, and
seeking damages in the amount of the letters of credit.2
BANKRUPTCY COURT’S DECISION
The Bankruptcy Court issued its Opinion on Appellees’ Motion for Summary
Judgment as to the malpractice claim on November 20, 2012. Central Illinois
Energy, 482 B.R. 772. After reviewing the background facts summarized above and
the applicable law, the Bankruptcy Court turned to the issues raised in Appellees’
Motion for Summary Judgment. Appellees’ Motion for Summary Judgment argued,
in part, that they did not proximately cause Appellant’s damages because the
Debtor could have drawn upon the letters of credit after the bankruptcy filing.3
Appellant argued in opposition that § 365(c)(2) applied to the letters of credit,
preventing the Debtor from drawing upon them after the date of the bankruptcy
filing.
The Bankruptcy Court found that § 365(c)(2) was not applicable to the letters
of credit because the letters of credit were not “contracts of the Debtor,” were not
executory contracts, and were not “a contract to make a loan, or extend other debt
financing or financial accommodations, to or for the benefit of the debtor.” Id. at
The Trustee also argued, in the alternative, that Appellees breached their
duty to the Debtor by failing to call or cause the Debtor to call upon the letters of
credit prior to their expiration on December 15, 2007. The Bankruptcy Court
resolved that claim by finding that the Calyon letters extended the termination date
to December 15, 2008, and so there was no malpractice in not causing the Debtor to
call upon them by December 15, 2007. Central Illinois Energy, 482 B.R. at 784. This
finding is not at issue in the instant appeal.
2
As noted above, other issues were raised before the Bankruptcy Court that
are no longer contested on appeal, and so the Court will not review the Bankruptcy
Court’s decisions as to those issues.
3
5
785-789. Because the letters of credit were not within the terms of § 365(c)(2), they
could have been assumed by the Trustee even after the bankruptcy filing. Id. at
789-91. The Bankruptcy Court therefore concluded that the Appellees did not
proximately cause the damages alleged because Mr. Barash, the Debtor’s attorney,
knew of the letters of credit by January 7, 2008, and could have drawn on them
prior to their December 15, 2008 expiration.
DISCUSSION
Appellant challenges the Bankruptcy Court’s determination that § 365(c)(2)
does not apply to the letters of credit, arguing that they were contracts between the
Debtor and the issuing institution, that they were executory in nature, and that
they were a financial accommodation. This finding was essential to the grant of
summary judgment in Defendants’ favor, so if it is reversed, summary judgment
must be overturned and the case remanded to the Bankruptcy Court. Appellant
concedes that if the Court affirms the Bankruptcy Court’s analysis on this question,
it should affirm the Bankruptcy Court’s grant of summary judgment to Appellees.
Under 11 U.S.C. 365(c), “[t]he trustee may not assume or assign any
executory contract or unexpired lease of the debtor, whether or not such contract or
lease prohibits or restricts assignment of rights or delegation of duties” in certain
circumstances. The circumstance relevant to this malpractice action is where “such
contract is a contract to make a loan, or extend other debt financing or financial
accommodations, to or for the benefit of the debtor, or to issue a security of the
debtor.” 11 U.S.C. § 365(c)(2). Appellees argued for summary judgment based, in
part, on the assertion that this subsection was not applicable to the letters of credit,
6
such that the letters of credit could be assumed by or assigned to the bankruptcy
estate. If the letters of credit could be assumed by or assigned to the bankruptcy
estate, then their “failure” to advise the Debtor to draw on the letters of credit prior
to the bankruptcy filing did not proximately cause the damages claimed in
Appellants’ malpractice action.
As agreed by the parties and Bankruptcy Court, in this case, § 365(c)(2)
provides that the letters of credit were not assumable if they (1) were contracts of
the Debtor, (2) were executory in nature, and (3) were “financial accommodations”
to the Debtor or for the Debtor’s benefit. If any one of these elements is missing, the
estate could have drawn on the letters of credit, even after the date of the
bankruptcy filing. The Bankruptcy Court found that none of these elements
described the letters of credit in question, and so § 365(c)(2) did not apply and the
letters of credit were assumable after the bankruptcy filing; because the estate
could have drawn on the letters of credit even after the bankruptcy filing, Appellees’
failure to advise the Debtor to draw on them prior to the filing did not proximately
cause Appellant’s damages. Appellant argues that the letters were contracts
between the Debtor and the issuing institution, were executory, and were a
financial accommodation, and were thus not assumable by the bankruptcy estate
after the bankruptcy filing. If any one of these elements is missing, the decision of
the Bankruptcy Court must be affirmed.
A letter of credit substitutes for payment from the applicant to the
beneficiary, or, as in this case, the beneficiary holds the letter of credit and may
draw upon it in lieu of retaining part of a payment to the applicant. Nissho Iwai
7
Europe PLC v. Korea First Bank, 782 N.E.2d 55, 58 (N.Y. 2002) (citations omitted).
The applicant for the letter of credit contracts with the issuer of the letter of credit,
in order to have the issuer pay out to the beneficiary upon the presentation of
appropriate documentation. 3Com Corp. v. Banco do Brasil, S.A., 171 F.3d 739, 741
(2d Cir. 1999) (citing Voest-Alpine Int’l Corp. v. Chase Manhattan Bank, N.A., 707
F.2d 680, 682 (2d Cir.1983); First Commercial Bank v. Gotham Originals, Inc., 475
N.E.2d 1255 (N.Y. 1985)). The arrangement is thus made up of three relationships,
between the applicant, issuer, and beneficiary, and each relationship is independent
of the others; they can be thought of as a triangle. Id. Between the applicant and
beneficiary is an underlying contract; in this case, Lurgi and the Debtor contracted
for Lurgi to design and construct an ethanol production facility for the Debtor. Id.
The applicant, here Lurgi, then contracts with the issuer, here Calyon, for the
issuance of a letter of credit. Id. Finally, the issuer has an obligation under that
contract with the applicant to pay out to the beneficiary upon the presentation of
proper documentation; the beneficiary owes no duties to the issuer and confers no
benefit upon the issuer, though it must strictly comply with the form of
documentation for payment required by the letter of credit’s terms. Id.; 4A
N.Y.PRAC., COM. LITIG. IN NEW YORK STATE COURTS § 69:28 (3d ed.).
The hallmark of letter of credit law is the “independence principle,” which
provides that each of these three relationships is independent of the others. 3Com
Corp., 171 F.3d at 741 (quoting First Commercial Bank, 475 N.E.2d 1255); 4A
N.Y.PRAC., COM. LITIG.
IN
NEW YORK STATE COURTS § 69:24 (3d ed.). The issuer’s
duty to pay out to the beneficiary is not predicated on either the applicant’s or the
8
beneficiary’s performance of their underlying contract, or upon the applicant’s
performance of its obligation to the issuer; the issuer’s good credit is substituted for
the credit of the applicant and the parties are spared the expense and uncertainty of
determining whether the obligations have been met. 3Com Corp., 171 F.3d at 741
(quoting First Commercial Bank, 475 N.E.2d 1255); Nissho Iwai Europe PLC, 782
N.E.2d at 58.
I.
Letters of credit are not “contracts of the Debtor”
Appellant’s argument that the letters were contracts of the Debtor is based
on the premise that “there are three separate and distinct contracts involved in a
letter of credit transaction,” including a contract between the issuer of the letter and
its beneficiary, and he cites a number of cases to this effect. The Bankruptcy Court
considered the fact that “the beneficiary passes no value to the issuer, makes no
promise to the issuer, and incurs no duty of performance to the issuer,” and
concluded that because the relationship lacked mutuality, it did not constitute a
contract of the Debtor. Central Illinois Energy, 482 B.R. at 786 (citing Jarka Corp.
v. Hellenic Lines, Ltd., 182 F.2d 916, 918 (2nd Cir. 1950); Consolidated
Laboratories, Inc. v. Shandon Scientific Co., 413 F.2d 208, 212-13 (7th Cir. 1969)).
As Appellee points out, the cases cited by Appellant do not undertake any
substantive analysis of whether a letter of credit constitutes a contract between the
issuer and the beneficiary, but merely explain the independence principle or state
without elaboration that a letter of credit is made up of three contracts. See 3Com
Corp., 171 F.3d at 741 (reviewing general letter of credit principles, described as
“three separate and independent relationships”); Marino Industries Corp. v. Chase
9
Manhattan Bank, N.A., 686 F.2d 112, 115 (2d Cir. 1982) (calling letter of credit a
“contract” between issuer and beneficiary in context of explaining independence
principle and rule of strict compliance); Venizelos, S. A. v. Chase Manhattan Bank,
425 F.2d 461, 464-65 (2d Cir. 1970) (stating that three separate contracts exist in
letter of credit in context of explaining independence principle and rule of strict
compliance); CVD Equipment Corp. v. Taiwan Glass Indus. Corp., No. 10 Civ.
0573(JPO), 2012 WL 5506120, *4 (S.D. N.Y. Nov. 7, 2012) (referring to three
“relationships,” including “underlying contract,” “application” between applicant
and issuer, and “actual letter of credit which is the bank’s irrevocable promise to
pay,” in explaining independence principle’s application to all segments of letter of
credit triangle); ACE American Ins. Co. v. Bank of the Ozarks, No. 11 Civ.
3146(PGG), 2012 WL 3240239, *4 (S.D. N.Y. Aug. 3, 2012) (calling letter of credit a
“contractual relationship” while finding issuer’s failure to pay out to beneficiary
because of applicant’s bankruptcy to be violation of independence principle);4 Gilday
v. Suffolk County Nat. Bank, 954 N.Y.S.2d 109, 113 (N.Y. App. Div. 2012) (calling
letter of credit a “distinct contractual relationship” between beneficiaries and
issuer,
obligating
issuer
to
pay
out
upon
presentation
of
appropriate
This case does quote the statement that “[t]t is well settled that a letter of
credit and the proceeds therefrom are not property of the debtor’s bankruptcy
estate.” ACE American Ins. Co. v. Bank of the Ozarks, No. 11 Civ. 3146(PGG), 2012
WL 3240239, *6 (quoting In re Papio Keno Club. Inc., 247 B.R. 453, 459 (8th
Cir.BAP2000)). Both ACE American Ins. Co. and the case it cites, though, concerned
situations in which the applicant was the debtor, which comports with the analysis
of this Court and the Bankruptcy Court, and is a function of the independence
principle. Id.; In re Papio Keno Club. Inc., 247 B.R. at 459.
4
10
documentation).5 They do not examine the relationship between the issuer and
beneficiary to determine if it is truly a contract under the principles of contract law,
and fail to discuss the concept of mutuality, because their decisions do not turn on
whether the relationship is truly a contract. Though some of them call letters of
credit “contracts” or “contractual” as between the issuer and beneficiary, the cases
do not actually hold, as a result of a considered analysis, that they are contracts.
The Court agrees with the Bankruptcy Court’s analysis. Under well-settled
principles of contract law, a letter of credit cannot constitute a contract between the
beneficiary and the issuer, because the beneficiary owes no obligation of payment or
performance to the issuer – there is no “mutuality” between the beneficiary and the
issuer. 28 N.Y. PRAC., CONTRACT LAW § 2:3 (“Unless both parties to a contract are
bound, so that either can sue the other for breach, neither party is bound and there
is no enforceable contract.”).6 Another way of putting this is to say that there is no
Appellant also cites to two cases applying Illinois letter of credit law. As
discussed above, the letters of credit’s selection of New York law appears to be
controlling, as Appellant recognizes in its brief. (Doc. 2 at 8 n. 2). Moreover, neither
of the cited cases contradicts the New York authorities discussed above, and they do
not actually analyze letters of credit in terms of whether the relationship between
an issuer and a beneficiary is itself a contract. Bank of North Carolina, N.A. v. Rock
Island Bank, 570 F.2d 202, 206 (7th Cir. 1978) (discussing whether letters of credit
are prohibited by Illinois Banking Act; no mention of whether a letter of credit is a
contract between issuer and beneficiary); Stringer Const. Co. v. La Grange State
Bank, 499 N.E.2d 948, 951 (Ill. App. Ct. 1984) (calling letter of credit a “contract”
between issuer and beneficiary, in context of ruling upon claim for breach of
contract between issuer and applicant).
5
New York cases draw a subtle distinction between mutual “consideration”
and “mutuality of obligation,” but also say that the promisor must receive
consideration in exchange for its performance in order to constitute a valid contract.
28 N.Y. PRAC., CONTRACT LAW § 2:33. Consideration is defined as “a benefit to the
promisor or a detriment to the promisee.” Weiner v. McGraw-Hill, Inc., 443 N.E.2d
441, 444 (N.Y. 1982) (citing Holt v. Feigenbaum, 419 N.E.2d 332 (N.Y. 1981)).
6
11
consideration, which is “a benefit to the promisor or a detriment to the promisee,”
and “[a] contract that does not require performance by each party is unenforceable
for lack of consideration.” Weiner v. McGraw-Hill, Inc., 443 N.E.2d 441, 444 (N.Y.
1982); 28 N.Y. PRAC., CONTRACT LAW § 2:27.
Appellant cites no cases standing for the proposition that the independence
principle or § 365(c)(2) conflict with ordinary contract law, and so the Bankruptcy
Code’s use of the term “contract” should be read as having its ordinary legal
meaning. The cases calling a letter of credit a “contract” between the issuer and the
beneficiary are not using that term precisely, but are instead pointing out that the
relationship between the beneficiary and the issuer is “independent” of the contract
between the issuer and the applicant and of the contract between the applicant and
beneficiary, such that the issuer owes payment to the beneficiary upon presentation
of proper documents, regardless of whether the applicant or beneficiary have
performed their obligations. That relationship is not itself a contract, because it
lacks the mutuality essential to a contract, but is instead the issuer’s performance
Because the basic concept is still that each party must be bound to do or give
something in exchange for the other’s performance or consideration, the Court will
refer to it as “mutuality.”
In a unilateral contract, the promisor becomes bound to perform or give
consideration upon performance by the promisee, thus again resulting in each
party’s having performed or given consideration. Flemington Nat. Bank & Trust Co.
v. Domler Leasing Corp., 410 N.Y.S.2d 75, 79-80 (N.Y. App. Div. 1978) (citations
omitted). In the letter of credit context, the beneficiary does not become obligated to
do anything for the benefit of the issuer or to its own detriment upon payment by
the issuer, so the letter of credit is also not a valid unilateral contract between the
issuer and the beneficiary.
12
of its obligation under its contract with the applicant.7 See also Moog World Trade
Corp. v. Bancomer, S.A., 90 F.3d 1382, 1386 (8th Cir. 1996) (letter of credit not a
contract between issuer and beneficiary; issuer is merely performing on its
contractual obligation to applicant); In re Montgomery Ward, LLC, 292 B.R. 49, 54
(Bkrtcy. D. Del. 2003) (letter of credit not a contract between issuer and beneficiary
because issuer has no cause of action against beneficiary for failure to present
documents drawing upon letter of credit).8
In its Reply, Appellant claims that this reading of the term “contract” is
“esoteric” and should not be applied to § 365(c)(2). The Court does not deny that a
letter of credit arrangement between the applicant and the issuer is a contract, and
that there is typically an underlying contract between the applicant and the
beneficiary, under either an “esoteric” or an ordinary definition – in this sense,
The independence principle prevents the beneficiary’s obligation to the
applicant from serving as consideration for the relationship between the beneficiary
and the issuer, though in some cases a benefit to a third party can constitute
consideration. 28 N.Y. PRAC., CONTRACT LAW § 2:29. Under contract law, “there
must be a connection between the consideration a party receives and the party’s
promise for the consideration; the promise must purport to be the motive each for
the other, in whole or at least in part.” Id. Because an issuer may not look to
whether the beneficiary has performed its obligation to the applicant in determining
whether to pay out under a letter of credit, the beneficiary’s performance benefitting
the applicant cannot constitute consideration for the relationship between the
beneficiary and the issuer.
7
Appellant objects to the Bankruptcy Court’s citation of these two cases, but it
misunderstands their import. (Doc. 2 at 14-16). In each of these opinions, unlike the
cases cited by Appellant, the courts are analyzing the qualities of letters of credit in
terms of contract law, to specifically determine if there exists a contract between the
issuer and the beneficiary. This Court recognizes that they are not controlling
authority, but it cites them as examples of the kind of analysis that must be
undertaken in order to answer the question posed by the instant appeal; that
question cannot be answered by citations to cases that merely refer to that
relationship as a contract, without any analysis of the issue.
8
13
Appellant is correct that a letter of credit is “contractual in nature,” and if an issuer
fails to pay the beneficiary upon a proper demand for payment, the issuer has
breached its contract with the applicant. However, as between the beneficiary and
the issuer, the most basic requirement of contract, mutuality of obligation, is
absent. It is not “esoteric” or inappropriate to apply the ordinary legal meaning to
terms used in statutes.
The Court therefore concludes that the Bankruptcy Court did not err in
finding that the letters of credit were not “contracts of the Debtor.” This conclusion
is alone enough to affirm the Bankruptcy Court’s grant of summary judgment to
Appellees, as it puts the letters of credit outside of § 365(c)(2).
II.
Letters of credit were not “executory contracts”
As the Court has determined that the letters of credit were not “contracts of
the Debtor” as required for them to be within the terms of § 365(c)(2), it is not
strictly necessary to review the other two requirements of that section; § 365(c)(2)
only prohibits the assumption of “contracts of the Debtor,” so if the letters of credit
were not such contracts, Appellees did not proximately cause the damages claimed
by Appellant. However, it is a simple matter for the Court to also affirm that the
Bankruptcy Court was correct in its determination that the letters of credit, as
between Calyon and the Debtor, were also not executory contracts.
The Bankruptcy Court observed that the Seventh Circuit uses Professor Vern
Countryman’s definition of “executory” when applying § 365(c)(2), a federal statute.
Central Illinois Energy, 482 B.R. at 786 (citing In re Streets & Beard Farm
Partnership, 882 F.2d 233, 235 (7th Cir. 1989). Professor Countryman defined an
14
executory contract “as an agreement where ‘the obligation of both the bankrupt and
the other party are so far unperformed that the failure of either to complete
performance would constitute a material breach excusing performance of the
other.’” In re Streets & Beard Farm Partnership, 882 F.2d at 235 (quoting Vern
Countryman, Executory Contracts in Bankruptcy: Part I, 57 MINN.L.REV. 439, 460
(1974)). This definition was drawn from the legislative history of the statute, but
also conforms to the general common law meaning of the term “executory contract.”
17 C.J.S. CONTRACTS § 8 (“A contract is executory when substantial performance
remains due by both parties, such that failure of either to complete performance
would constitute a material breach excusing performance of the other”). The
Seventh Circuit also explained that ‘[i]n determining the significance of the
remaining obligations under a contract we look to relevant state law.” Id. (citing
Butner v. United States, 440 U.S. 48, 54 (1979)).
The Court agrees with the Bankruptcy Court that the term “executory,” as
used in § 365(c)(2), does not include the letter of credit relationship between the
Debtor and Calyon. This is so because the Debtor did not owe an obligation to
Calyon that excused Calyon from its obligation to perform. As discussed above, New
York does not treat the presentation of conforming documents by the beneficiary of
a letter of credit as an obligation of the beneficiary, and does not treat the failure to
present conforming documents that excuses the issuer from its future obligation to
pay upon the presentation of conforming documents. While the Debtor, in order to
draw upon the letters of credit, had to submit conforming documents to Calyon in
order to receive payment upon the letters, this was not an obligation to Calyon, but
15
merely a procedural component of making the demand for payment. If the Debtor
did not submit conforming documents, either by not attempting to draw on the
letters at a particular time, or by submitting non-conforming documents, this would
not constitute a “breach” that would then release Calyon from its obligation; Calyon
would still be obliged, under its contract with Lurgi, to pay out upon the later
presentation of conforming documents (up to the letters’ expiration date).
Appellant bases his argument that the letters of credit were “executory in
nature” on two courts’ use of the term “executory” in describing the fact that a
beneficiary must present properly conforming documents to the issuer in order to
receive payment. Appellant’s argument is without merit. It is true that in Union
Planters Nat. Bank v. World Energy Systems Associates and Diakan Love, S.A. v. AlHaddad Bros. Enterprises, Inc., courts used the courts used the term “executory” to
describe letters of credit. Union Planters, 816 F.2d 1092, 1098 (6th Cir. 1987)
(citing, inter alia, Diakon Love) (applying Tennessee law and federal maritime law);
Diakan Love, 584 F.Supp. 782, 784 (D.C. N.Y. 1984) (applying New York law and
maritime garnishment law). It is plain that the term was used in these cases in an
effort to explain that the issuer of the letters need not make payment to the
beneficiary until the beneficiary presents conforming documents. In that sense, they
are “executory,” in that the issuer’s performance depends on presentation of
conforming documents, but they are not “executory” as that term is used in contract
law or in § 365(c)(2), because the beneficiary is not obligated to the issuer; the issuer
is not released from its obligation to remain ready to pay out by the beneficiary’s
failure to present conforming documents.
16
The letters of credit at issue here are not “executory contracts” within the
meaning of § 365(c)(2) because they are not “executory” and are not “contracts,” and
so the Court affirms the Bankruptcy Court’s decision.
III.
Letters of credit were not “financial accommodations to or for
the benefit of the Debtor”
Finally, Appellant argues that the Bankruptcy Court erred in determining
that the letters of credit were not “financial accommodations to or for the benefit of
the debtor” because the Bankruptcy Court rejected Appellant’s reliance on In re
Swift Aire Lines, Inc., 30 B.R. 490, 496 (9th Cir. 1983). Again, as the Court has
determined that the letters of credit were clearly not executory contracts of the
Debtor, they are not within § 365(c)(2), and the Bankruptcy Court’s decision must
be affirmed. In order to be thorough, though, the Court will also address this issue.
The Bankruptcy Court cited to In re Thomas B. Hamilton Co., Inc., in which
the Eleventh Circuit, interpreting § 365(c)(2), explained that courts have been
consistent in defining “financial accommodation:”
Citing the legislative history quoted above and this passage from
Collier on Bankruptcy, these courts uniformly conclude that § 365(c)(2)
does not apply to all contracts that involve the extension of credit;
rather, it applies to “contracts to make loans and other traditional
kinds of debt financing arrangements.” Thus, courts define the term
“financial accommodations” narrowly, as “the extension of money or
credit to accommodate another.” Courts also distinguish between
contracts for which the extension of credit is the primary purpose, that
is, a primary contractual obligation, and contracts in which the
extension of credit is only incidental to or a part of a larger
arrangement involving the debtor; the former constitute contracts to
extend financial accommodations while the latter do not.
969 F.2d 1013, 1018-19 (11th Cir. 1992) (citations omitted). The Seventh Circuit
indicated its approval of most of the Eleventh Circuit’s analysis in In re United
17
Airlines, Inc., 368 F.3d 720, 723-24 (7th Cir. 2004) (citing Thomas B. Hamilton, 969
F.2d at 1019-20). The United Airlines court held that the courts should look to
whether the purported “financial accommodation” is a material part of the overall
transaction between the parties, rather than attempting to discern the parties’
subjective “purpose.” Id. at 724-25.
Under this controlling definition of “financial accommodation,” the Court
finds that the Bankruptcy Court was correct in determining that the letter of credit
relationship between the Debtor and Calyon was not a “financial accommodation” to
the Debtor within the meaning of § 365(c)(2). It was not a contract to a make loan to
the Debtor, or another traditional kind of debt financing arrangement, such as a
guarantee of the Debtor’s financial obligations. Thomas B. Hamilton, 969 F.2d at
1018-19. The letter of credit here was a form of payment to the Debtor from Lurgi,
held in lieu of the Debtor’s retention of a portion of its payments to Lurgi as
assurance of Lurgi’s performance. As observed by the bankruptcy court, the letter of
credit is more properly considered a financial accommodation to Lurgi, substituting
Calyon’s credit for Lurgi’s, not to the Debtor. Central Illinois Energy, 482 B.R. at
789. Moreover, the letter of credit was only an incidental part of the underlying
contract between Lurgi and the Debtor – it was merely the exercise of “an option to
post an irrevocable standby letter of credit in lieu of 10% retainage.” Id. at 782.
Finally, the Seventh Circuit has explained that the purpose of § 365(c)(2) is to
protect lenders from being forced to persist in offering credit to newly bankrupt
parties on the same favorable terms negotiated before the bankruptcy filing
revealed the credit-unworthiness of the borrower. United Airlines, Inc., 368 F.3d at
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723. With this purpose in mind, it is plain that Calyon does not need such
protection, as in the letter of credit situation Calyon does not look to the Debtor for
repayment. A letter of credit, as discussed above, is triangular, and the issuer looks
to the applicant for repayment of the funds paid out to the beneficiary, not to the
beneficiary. The creditworthiness of the beneficiary is irrelevant to the letter of
credit transaction and to the issuer, and so the issuer does not need the protection
afforded by § 365(c)(2).9
Appellant’s argument, both here and before the Bankruptcy Court, relies
primarily on In re Swift Aire Lines, Inc., in which the Ninth Circuit held that letters
of credit are within the terms of § 365(c)(2), and are thus not assumable by the
bankruptcy estate. 30 B.R. 490, 496 (9th Cir. 1983). In coming to this conclusion,
the Ninth Circuit looked only to the legislative history of § 365(c)(2); the drafters of
that subsection stated that “under the provision, contracts such as…letters of credit
are non-assignable, and may not be assumed by the trustee.” Id. (quoting H.R. REP.
No. 95-595 (1977); reprinted in 1978 U.S.C.C.A.N. 5787, 6304). The Swift Aire court
did not consider the several elements of § 365(c)(2), but simply seized upon the
mention of “letters of credit” in finding that they were always within the statute.
Appellants argue that Swift Aire’s reading of § 365(c)(2) as always including all
three of the letter of credit relationships should control, notwithstanding the
meaning of “contract” and “executory.” The Bankruptcy Court addressed Swift Aire
It is also worth noting that § 365(e)(2)(B) permits contracts that are within §
365(c)(2) to be terminated upon a bankruptcy filing, lending further support to the
conclusion that the purpose of § 365(c)(2) is to protect lenders from uncreditworthy
borrowers by permitting them to escape from previous contracts to extend credit to
newly-bankrupt parties.
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in its Opinion, rejecting the argument that Swift Aire’s apparent conclusion that all
letters of credit are always within the terms of § 365(c)(2) should determine the
outcome in this case. Central Illinois Energy, 482 B.R. at 788-89. This Court agrees
with the Bankruptcy Court’s conclusion that Swift Aire was too broad, and that the
legislative history’s mention of letters of credit does not control the outcome in this
case.
First, there is no need to resort to legislative history to determine if §
365(c)(2) applies in this case, as it is obvious that the letter of credit is not a
“contract of the Debtor.” Under the ordinary meaning of the term “contract,” the
relationship between the Debtor and Calyon does not fall within the terms of §
365(c)(2). Therefore, it is improper to resort to legislative history to define “contract”
or to contradict its use in the statute. Five Points Road Joint Venture v. Johanns,
542 F.3d 1121, 1128 (7th Cir. 2008) (citing United States v. Shriver, 989 F.2d 898,
901 (7th Cir. 1992) (“Resort to the legislative history…is only necessary if the
language of the statute is ambiguous.”). While courts have looked to legislative
history in order to illuminate the statute’s use of the term “executory,” that term is
not unknown in contract law, and, as mentioned above, its ordinary common law
meaning comports with the meaning found by courts looking to legislative history.
The clear definition of those terms puts the letter of credit relationship at
issue in this case outside of § 365(c)(2); even though “financial accommodation” may
be ambiguous enough to justify a resort to legislative history, the letter of credit
relationship at issue here was neither a “contract of the debtor” nor “executory in
nature,” so it is outside of § 365(c)(2) no matter what “financial accommodation”
20
means. In Swift Aire, the Ninth Circuit did not find that the statute’s terms were
ambiguous before turning to the legislative history, as required by the ordinary
canons of statutory interpretation, but merely noted that “the legislative history…is
pertinent,” and thus held that a letter of credit relationship is always within §
365(c)(2). Under the governing law of this Circuit, it is inappropriate to resort to
legislative history where a statute’s terms are clear. See, e.g., United States v. Rand,
482 F.3d 943, 947 (7th Cir. 2007) (citing Holder v. Hall, 512 U.S. 874, 932 n. 28
(1994); United States v. Hayward, 6 F.3d 1241, 1245 (7th Cir. 1993)) (“When a
statute is clear, any consideration of legislative history is improper.”). Because the
other operative terms of the statute put the letter of credit relationship here outside
of § 365(c)(2), there is no need to resort to the legislative history in order to
interpret the statue.
Even if the legislative history is considered, though, it must be considered in
light of the structure of the statute and its purpose, as did the courts in United
Airlines and Thomas B. Hamilton. As the Court explained above, the issuerbeneficiary relationship in a letter of credit transaction cannot be considered a
financial accommodation to the beneficiary under the legislative history-based
definition stated by United Airlines and Thomas B. Hamilton, and is thus outside of
§ 365(c)(2). Moreover, the letter of credit is only an incidental component of the
underlying contract, and it does not serve § 365(c)(2)’s purpose to permit lenders to
escape from uncreditworthy borrowers because the beneficiary of a letter of credit
will never owe repayment to the issuer. The Bankruptcy Court noted that the
legislative history quoted by the Swift Aire court does not distinguish between
21
situations where the debtor is the party applying for the letter of credit, and those
where the debtor is the beneficiary of the letter of credit. Central Illinois Energy,
482 B.R. at 789. The Bankruptcy Court explained that in the former case, the letter
of credit might be considered an accommodation for the benefit of the debtor, but it
is certainly not such an accommodation in the latter case. It thus held that Swift
Aire’s conclusion was too broad. Id. In light of the foregoing analysis, this Court
agrees with the Bankruptcy Court.10
Appellant counters the Bankruptcy Court’s analysis with the argument that
if this letter of credit is not within § 365(c)(2) in regards to a debtor-beneficiary,
then a letter of credit is never within the meaning of § 365(c)(2), and that the abovequoted language from the legislative history expressing Congress’ intent would be
meaningless – if debtor-beneficiaries’ letters of credit are not subject to § 365(c)(2),
then no letters of credit are ever within the terms of § 365(c)(2), and there would be
no reason for the legislative history to refer to the non-assumability of letters of
credit. Appellant points to caselaw holding that the proceeds of a debtor-applicant’s
letter of credit are not assumable by the bankruptcy estate, and to provisions of the
bankruptcy code prohibiting financial institutions from becoming Chapter 7 debtors
such that a letter of credit cannot be assumed by the bankruptcy estate of the issuer
of the letter if the issuer is a financial institution. 11 U.S.C. § 109(b); In re Keene
Corp., 162 B.R. 935, 942 (Bkrtcy. S.D. N.Y. 1994 (letters of credit applied for by
debtor are not property of debtor-applicant’s estate).
Simply put, Appellant’s argument is that the only member of the letter of
credit triangle subject to § 365(c)(2) is the beneficiary, and so, since Congress meant
for § 365(c)(2) to cover at least some letters of credit (as shown by the legislative
history), Congress’ intent must have been for § 365(c)(2) to prevent the assumption
of letters of credit by the bankruptcy estates of beneficiaries. While the Court
maintains that it is improper to resort to legislative history here, where the
statute’s terms are not ambiguous, the Court also notes that Appellant’s argument,
while somewhat persuasive, is not airtight. As Appellant point out, it is the case
that, “typically,” letters of credit are issued by financial institutions. (Doc. 2 at 20).
However, Appellant points to no prohibition on entities other than financial
institutions, as that term is used in § 109(b), issuing letters of credit. Thus, even
under the terms of Appellant’s argument, there could be some issuers of letters of
credit that become bankruptcy debtors subject to § 365(c)(2). It is thus unnecessary
to contradict the clear terms of the statute in order to comply with the supposed
intention of the statute’s drafters.
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Finally, Appellant claims that Congress’ failure to amend § 365(c)(2) to
overturn Swift Aire’s interpretation of it is evidence of Congress’ agreement with
that interpretation. The Court does not agree that this inaction by Congress carries
the weight Appellant ascribes to it. First, this is merely another form of legislative
history, in that it looks to the implied meaning of Congress’ inaction, rather than to
the actual terms of the statute; thus, it should not be considered where the statute
is clear. Moreover, Appellant points to no other courts following Swift Aire’s
interpretation of § 365(c)(2) in the context of a debtor-beneficiary, which undercuts
the contention that the case is so notable or influential that Congress would find it
necessary to correct it.11 Most importantly, the statute as written and interpreted
by the courts effectively conveys the meaning given to it by the Bankruptcy Court
here – the fact that one court, thirty years ago, may have ignored the clear terms of
the statute in favor of the legislative history should not compel Congress to change
those clear terms.
The Court thus finds that the Bankruptcy Court was correct in determining
that the letter of credit was not a financial accommodation to the Debtor.
CONCLUSION
This Court agrees with the Bankruptcy Court that the letters of credit were
not contracts between the Debtor and the issuing institution, that they were not
The Court has found only a few cases citing Swift Aire in reference to this
portion of the decision, and none follow it or are directly supportive of it. In In re
Taggatz, the Bankruptcy Court for the Western District of Wisconsin observed that
“[w]hether a letter of credit is property of the estate is an unsettled issue” in terms
of § 365(c)(2) and other law, and declined to “add its own dicta to the cacophony of
opinions in this area.” 106 B.R. 983, 988 n. 4 (Bkrtcy. W.D. Wis. 1989) (citations
omitted).
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executory in nature, and that they were not a financial accommodation to or for the
benefit of the Debtor, and thus agrees that § 365(c)(2) did not prevent the
bankruptcy estate from drawing upon the letters of credit after the bankruptcy
filing. Appellees thus did not proximately cause Appellant’s damages and it was
appropriate to grant summary judgment in Appellees’ favor. Therefore, the Court
AFFIRMS the Bankruptcy Court’s grant of summary judgment in Appellees’ favor.
IT IS SO ORDERED.
Entered this 11th day of September, 2013.
s/ Joe B. McDade
JOE BILLY McDADE
United States Senior District Judge
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