Letter of Credit Forum

Letters of credit in bankruptcy proceedings are only a topic of discussion in the United States. Other countries typically regard the payment of the bank INDEPENDENT (I capitalize in the futile hope to reach the ears of some US judges) of the bankruptcy estate of the applicant. In other words: Bene to Trustee: Move on, there is nothing to see here. 

Not so in the US.

Many courts have repeatedly found that a beneficiary -who receives funds under an LC from the bank- has in fact received a preferential treatment from the applicant, voidable by the trustee. This long-standing misconception of letters of credit has been perpetuated In re ESA Environmental Specialists, Inc., 709 F. 3d 388 - Court of Appeals, 4th Circuit 2013. Even though the lucky beneficiary escaped liability, the escape was narrow and unpredictable. The beneficiary had provided bid bonds to the federal government for the construction to be performed by the applicant. Upon insolvency of the applicant, the beneficiary undertook to perform the contracts himself. 

Was the payment to the beneficiary by the third party bank a preference under bankruptcy law that the trustee of the applicant could void ? The court said no and based its decision on the "new value" defense which is an explicit statutory defense to a § 547(b) preference action. 

The trustee may not avoid under this section a transfer —
(1) to the extent that such transfer was —
(A) 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; and
(B) in fact a substantially contemporaneous exchange.
 

In this case the beneficiary brought new value to the applicant, since the contracts the applicant was able to obtain from the federal government exceeded the value of the LC. Overall a disappointing decision since the new value statute might not protect normal beneficiaries who simply sell goods to the applicant. The court lengthily discusses the calculation of new value (how and when) but focusing on these formalities misses the point that the LC is independent.