On certification to the Superior Court, Appellate Division, whose opinion is reported at 146 N.J. Super. 6 (1977).
For modification and reinstatement -- Chief Justice Hughes and Justices Pashman, Schreiber and Handler. For affirmance -- Justice Clifford and Judge Conford. The opinion of the court was delivered by Schreiber, J. Conford, P.J.A.D. (temporarily assigned), dissenting. Justice Clifford joins in this opinion.
This case involves the effect of a written assurance given by defendant First State Bank of Hudson County to plaintiff New Jersey Bank to induce it to loan Joseph P. Palladino $50,000. The document stated that if Palladino did not repay the $50,000 debt, which was evidenced by a note, defendant bank would honor that commitment. The crucial question is whether that paper was an illegal guaranty or a valid letter of credit.
The facts are essentially undisputed. In July 1972, Joseph P. Palladino sought a $100,000 loan from plaintiff New Jersey Bank. Plaintiff's Senior Vice-President and Senior Lending Officer, Everett B. Muh, after reviewing Palladino's financial statement, indicated a willingness to advance the money for 90 days but wanted "some sort of collateral or support for the note." In response Palladino obtained a letter from defendant bank signed by its President, Edward Dooley, which read as follows:
This letter will serve as a commitment to you that the First State Bank of Hudson County will assume the obligation arising from a note signed by Mr. Joseph P. Palladino on July 6, 1972, in the amount of $100,000.
We will honor this commitment, 90 days after the date of the note, upon notice to us that the loan has not been paid by Mr. Joseph P. Palladino.
Thereupon Palladino executed a 90-day note and plaintiff bank advanced $100,000.
Palladino deposited the $100,000 proceeds together with an additional $25,000 in his checking account with defendant
bank. Of these funds $5,790 were used to satisfy an overdraft on the account and $28,000 were applied to a reduction of Palladino's personal loan of $60,000 from defendant bank. At the time, Palladino was an officer or party in interest of Surf Realty Company, which was also indebted to defendant bank. The sum of $23,850 was transferred from Palladino's account to that of Surf Realty Company.
When Palladino did not repay the $100,000 loan, Mr. Muh in a letter dated October 6, 1972, called upon defendant bank to pay the $100,000 loan plus accrued interest of $2,020.80. President Dooley of defendant bank telephoned Mr. Muh and asked if plaintiff would accept a $50,000 reduction in the indebtedness and renew the note for the $50,000 balance. Mr. Muh accepted "with the understanding that Mr. Dooley would send me another letter covering the $50,000, and he agreed to do this."
Defendant delivered a letter to plaintiff reading:
This letter will serve as a commitment to you that the First State Bank of Hudson County will assume the obligations arising from a note signed by Mr. Joseph P. Palladino on October 12, 1972 in the amount of $50,000.
We will honor this commitment six (6) months after the date of the note upon notice to us that the loan has not been paid by Mr. Joseph P. Palladino.
Relying upon the letter and the $50,000 reduction in the principal indebtedness, plaintiff renewed the loan upon Palladino's executing a new note for $50,000. The note contained provisions requiring the maker, in the event of default, to pay all costs and expenses of collection including attorney's fees of 15% of the amount due.
When the loan was renewed in October 1972, defendant bank's capital funds were $1,776,540. At that time, Palladino and Surf Realty Company owed defendant $32,000 and $125,000, respectively. Palbro Realty Co., in which Palladino had a substantial interest, was also indebted then to defendant in the amount of $130,162.
Palladino paid the interest due plaintiff each quarter on the $50,000 note until February 15, 1974, when the loan fell into default. None of the principal had been repaid. At the time of the trial on November 6, 1975, $7,762 of interest had accumulated.
Plaintiff New Jersey Bank sued both Palladino and defendant, First State Bank of Hudson County, which cross-claimed against Palladino. Palladino defaulted.
The trial court found it difficult to accept defendant bank's disclaimer of any liability when it gained the benefit from these loans "by the reduction of the outstanding loans shown on * * * [its] own records of Palladino and of Surf Realty Company * * *. The purpose in getting that loan was to assist in the reduction of a problem line" of defendant bank. The trial court concluded that the $100,000 loaned by plaintiff in July 1972 had been deposited in Palladino's account in defendant bank and that these funds had been used to cure an overdraft of $5,790, to reduce Palladino's personal liability to the bank from $60,000 to $32,000, and to amortize the Surf Realty Company's indebtedness (an entity in which Palladino was an officer in interest) to defendant bank by $23,850. The trial court held that defendant's letter dated October 11, 1972 was a letter of guaranty, that the guaranty was a binding contract, and that any violation of banking statutes or regulations could not shield the bank from its obligations to plaintiff, which had relied upon defendant's affirmative contractual offer. Judgments were entered against defendant bank for $65,595 and on behalf of defendant bank against Palladino in the same amount.
The Appellate Division's reversal was grounded on the finding that the letter was a guaranty and was therefore illegal under N.J.S.A. 17:9A-213.1, which prohibits banks from guaranteeing obligations of others. 146 N.J. Super. 6, 13 (App. Div. 1976). The Appellate Division also held that the defendant bank's letters were not letters of credit within the contemplation of the Uniform Commercial Code, N.J.S.A.
12A:5-101 et seq., or of the Banking Act, N.J.S.A. 17:9A-25(3). 146 N.J. Super. at 12. It also reasoned that even if the letter of October 11, 1972 were a letter of credit, it would have violated the requirement in N.J.S.A. 17:9A-25(3) that the duration of such guaranties be limited to one year. However, it found that defendant had obtained a benefit to the extent of $8,790 (that part of the proceeds loaned by plaintiff bank which was used to reduce Palladino's personal indebtedness to defendant) and modified the judgment accordingly. 146 N.J. Super. at 13-14. We granted plaintiff's petition for certification. 74 N.J. 286 (1977).
Although state banks*fn1 generally do not have the power to guarantee the obligations of others, the prohibition is not an absolute one.*fn2 Section 213.1 of the Banking Act of 1948 reads:
Except as in this act or otherwise by law provided, no bank or savings bank shall have power to guarantee the obligations of others; * * *. [ N.J.S.A. 17:9A-213.1 (emphasis supplied)]
An exception is found in that provision of the Banking Act which expressly endows banks with the power, whether or not specifically set forth in their certificates of incorporation,
to issue letters of credit authorizing holders thereof to draw drafts upon it or upon its correspondents at sight or on time not exceeding one year; to guarantee, for a period not exceeding one year from the date of such guarantee, the payment by its customers of amounts due or to become due upon the purchase by such customers of real or personal property. [ N.J.S.A. 17:9A-25(3)]
Chapter 5 of the Uniform Commercial Code is devoted to letters of credit. N.J.S.A. 12A:5-101 et seq. As stated therein, the chapter applies "to a credit issued by a bank if the credit requires a documentary draft or a documentary demand for payment." N.J.S.A. 12A:5-102(1) (a). A letter of credit is defined as "an engagement by a bank or other person made at the request of a customer * * * that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit. A credit may be either revocable or irrevocable. The engagement may be either an agreement to honor or a statement that the bank or other person is authorized to honor." N.J.S.A. 12A:5-103(1) (a). A documentary demand for payment is ...