The LoC & Insurance: An Important Tip From A Cautionary Case
For main street agents, a letter of credit (LoC) is not something they deal with in the ordinary course of their business. However, LoCs have substantial importance in various commercial transactions, including certain insurance operations, making their understanding vital for industry professionals.
Use of LoCs in Insurance Transactions
In property and casualty insurance, LoCs are commonly employed as a mechanism for risk financing, acting as collateral for amounts owed by an insured party in various cash flow programs. These can include scenarios involving incurred but unpaid losses within paid loss retrospective rating programs, the provision for capitalization requirements in captive insurance entities, or the satisfaction of security prerequisites set by excess insurers in “fronted” deductible or retention initiatives.
A recent decision of the Appeals Court involving a dispute over a bank dishonoring a $300,000 LoC underscores a risk in physically securing and handling LoC documents that professionals, particularly those who are beneficiaries of an LoC, should heed.
The Appeals Court Decision and Its Implications
In ProQuip Limited v. Northmark Bank, the Appeals Court ruled that a LoC can only be paid on the presentation of original documents. ProQuip, the beneficiary of a LoC that was renewed annually for ten years, sought payment from the issuing bank. The bank refused to honor the LoC because ProQuip had produced the original LoC but not an original amendment. The Superior Court ruled in favor of ProQuip. On appeal, however, the Appeals Court ruled that ProQuip’s failure to produce the original amendment barred its recovery under its LoC.
Today, copies of business and legal documents are accepted for almost any purpose. A requirement of an original document in most situations is almost an anomaly. However, for LoCs, the financial security they provide can be a “trap for the unwary” if a beneficiary does not safeguard the original LoC and its amendments.
Facts of the ProQuip Case
ProQuip Limited (ProQuip), a Scottish company specializing in golf apparel, entered into an agreement with Marblehead Weather Garments, LLC (Marblehead) for the resale of ProQuip’s products in North America, Bermuda, and the Caribbean. This agreement had a 15-year term extending into 2025. As part of the agreement, Marblehead procured a Standby Letter of Credit (LoC) from Northmark Bank (Northmark), with ProQuip as the beneficiary, in the amount of $300,000.
The LoC stipulated certain requirements for payment, including the original Letter of Credit and any amendments, and it explicitly stated it was subject to both the Uniform Customs and Practices for Documentary Credits (UCP 600) and the laws of Massachusetts. The LoC was set to expire one year after its date of issue.
Two days before the original expiration date, an amendment was made to the LoC (Amendment 1), which extended it by one year, added an automatic extension provision, and reaffirmed the other original terms. The automatic renewal process allowed the LoC to be renewed annually with a requirement for a 45-day written notice to ProQuip if Northmark intended not to renew the LoC.
In 2020, Northmark notified ProQuip that the LoC, as amended, would not be renewed, and it expired later that year. Six days before the expiration date, ProQuip demanded payment under the LoC, presenting the original LoC but only a copy of Amendment 1. An affidavit from ProQuip’s company secretary was also provided, declaring that a diligent search failed to locate the original Amendment 1 and promising to hold Northmark harmless from potential liabilities relevant to Amendment 1.
The bank refused to honor the demand, citing that the original of Amendment 1 was required by the terms of the amended LoC.
In a subsequent communication before the expiration date, Northmark reaffirmed that the original documents of both the LoC and Amendment 1 were required. In response, ProQuip’s U.K. counsel sent various documents to Northmark, including a Sight Draft and an Original Document Affidavit and Indemnity.
ProQuip’s indemnity provided it “would defend, indemnify, and hold harmless Northmark “from any and all demands, claims, causes of action, liabilities, losses, cost, or damage, including, but not limited to, reasonable attorney’s fees, arising out of, pertaining to, or in any manner connected with or related to [Amendment 1].”
ProQuip offered the indemnity because they were unable to locate the original Amendment 1, but only the copy.
Based on ProQuip’s inability to present the original Amendment 1, Northmark again declined to honor the presentment, and the LoC and Amendment 1 expired without any payment made.
Superior Court rules in favor of ProQuip and Northmark appeals
On November 3, 2021, ProQuip filed a complaint in the Superior Court against Northmark, asserting two counts:(1) Breach of the Letter of Credit and (2) Declaratory Judgment. As there was no dispute as to the facts, both Northmark and ProQuip moved for judgment in their favor.
The Superior Court judge hearing the parties’ cross-motions ruled in favor of ProQuip holding:
In sum, because the LOC does not clearly require presentment of the original of Amendment 1 for payment, and because equity supports judgment in favor of ProQuip since there is no risk that Northmark will be harmed, the court concludes that Northmark’s refusal to make payment to ProQuip pursuant to the LOC was unlawful. Accordingly, ProQuip is entitled to judgment as a matter of law on its claim for breach of contract (Count I) and its request for declaratory relief (Count II)
Northmark appealed the judge’s decision to the Appeals Court
The Appeals Court’s decision in favor of Northmark
Although the lower court had ruled in favor of ProQuip based on its hold harmless agreement and the equity of the situation, the Appeals Court found that strict compliance with the terms of the LoC was required. The presentation of a copy instead of the original Amendment 1 did not meet the legal standard applicable to payment under a LoC.
The Court’s reasoning was straightforward.
According to Massachusetts law, a letter of credit (LoC) serves as a definite commitment by an issuer to the beneficiary to honor a documentary presentation, either by payment or the delivery of an item of value. As per the statute, the issuer must honor a presentation that strictly complies with the LoC’s terms and conditions. Conversely, the issuer must dishonor a presentation that fails to comply.
The LoC in question stipulated that credit would be available through payment against the presentation of the original letter and all amendments for endorsement by the issuer. Additionally, it indicated that the LoC was subject to the Uniform Customs and Practices for Documentary Credits (2007 Revision) (UCP 600) and Massachusetts law.
Under Article 17(a) of UCP 600, the presentment of an original of “each document stipulated in the credit” is required for payment under an LoC. ProQuip’s presentment included the original LoC but only a copy of Amendment 1.
Certainty, without inquiry, required for payment
In deciding this case, the Court explained that letters of credit are unique commercial instruments, serving the primary purpose of assuring payment to the party providing goods or services. Their attractiveness lies in the certainty they offer. However, deviating from strict compliance could undermine this certainty, making banks reluctant to assume the risks of litigation.
The Court also noted that ProQuip and Northmark had different versions of Amendment 1. Northmark’s version included three handwritten signatures at the bottom of each page of the document, while the photocopy presented by ProQuip included just one. Since Northmark’s role was ministerial, requiring it to determine the substantiality of discrepancies in the documents presented to it, the Court found, was inconsistent with its function.
The Court emphasized the importance of originals, stating that even under the strict compliance standard, some variances might be allowable if they do not compel inquiry into the underlying commercial transaction.
In this case, however, the variance in the copies of Amendment 1 presented, the Court determined “was not minor, and [Northmark] rightfully dishonored payment.”
The final order of the Court
The final order of the Court was:
“Accordingly, we reverse the judgment in favor of ProQuip and remand the case for entry of judgment in favor of [Northmark].”
Conclusion
The ruling in ProQuip Limited v. Northmark Bank serves as a reminder of the significance of original documents in securing and handling LoC transactions in the insurance industry. It highlights the vital need for beneficiaries to safeguard the original LoC and its amendments, emphasizing that even legal indemnities might not be sufficient to overcome the strict requirements of LoC provisions. Professionals dealing with Letters of Credit should heed this warning and ensure their measures to protect the integrity and enforceability of these vital financial instruments are adequate.
ProQuip has twenty days to apply for further appellate review to the Supreme Judicial Court
The Massachusetts Appeals Court is an intermediate appellate court. The ultimate judicial authority resides with the Supreme Judicial Court. Parties dissatisfied with an Appeal Court’s decision may apply for further appellate review. However, the allowance of any further appeal is discretionary with the Supreme Judicial Court.
Under the Massachusetts Rules of Appellate Procedure, ProQuip will have until September 7, 2023, to apply for further appellate review.
Based upon the decision of the Appeals Court to take away the judgment in favor of the ProQuip, there is a likelihood it will make an application for further appellate review to the Supreme Judicial Court.
Owen Gallagher
Insurance Coverage Legal Expert/Co-Founder & Publisher of Agency Checklists
Over the course of my legal career, I have argued a number of cases in the Massachusetts Supreme Judicial Court as well as helped agents, insurance companies, and lawmakers alike with the complexities and idiosyncrasies of insurance law in the Commonwealth.
Connect with me directly, by calling me at 617-598-3801.
