ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY (CAMDEN) (D.C. Civil No. 78-0205)
Before Adams and Weis, Circuit Judges, and Kunzig, Judge.*fn*
In order to appeal a judgment against them that had been entered in the Pennsylvania state court system, Horace and Jean Billings were required to post a bond. To induce the Insurance Company of North America (INA) to post such a bond, the Billingses requested Heritage Bank to issue a letter of credit in the amount of $78,673.00 in favor of INA.*fn1 The letter of credit was issued on December 2, 1976, and by its terms was to remain valid until October 21, 1977. In the letter, Heritage committed itself to honor INA's "drafts at sight accompanied by written evidence to the effect that:"
1. "you (INA) have been called upon to make payment of loss, attorney's fees or other expenses by reason of executing an appeal Bond . . .," or that
2. "the premium thereon is unpaid and overdue," or that
3. "you (INA) have not received evidence satisfactory to you of the performance by the Principals of all its (sic) obligations in connection with the aforesaid bond was issued."
As of October 12, 1977, nine days prior to the expiration date of the letter of credit, the Billingses' appeal was still pending. In order to avoid finding itself in the position of having to pay on the appeal bond after the security for that bond, the letter of credit, had expired, INA presented Heritage with a sight draft in the amount of $78,673.00, accompanied by a written demand that Heritage honor the letter of credit. INA's demand, which apparently relied on the third condition of the letter of credit, stated that "under the terms of that letter, dated December 2, 1976, we are enclosing our sight draft in the amount of $78,673.00 and hereby certify that the liability under our bond . . . is still outstanding."*fn2 When Heritage refused to honor INA's demand, allegedly at the Billingses' request, INA filed this diversity suit in the United States District Court for the District of New Jersey. In the meantime, the appeal ran its course, the Billingses did not prevail, and INA paid the judgment holder, as it was obliged to do under the appeal bond.
Two issues were framed for decision in the district court: first, whether the third condition of the letter of credit authorized INA to demand payment from Heritage in the circumstances under which a demand was made, and second, whether INA's written demand complied with the terms of that condition. The district court dismissed INA's complaint for failure to state a claim upon which relief can be granted. It ruled that the third term of the letter of credit did not authorize INA's demand for payment because the Billingses had incurred no obligation to exonerate INA from liability under the appeal bond at any time before the conclusion of the appeal unless they failed to prosecute the appeal with effect. With respect to the second issue, the trial court stated that under the rule of strict compliance, Heritage was not required to honor INA's demand because it did not conform with the terms of the letter of credit. Because we agree with the district court's treatment of the second issue, we affirm.
Originally conceived as a means of facilitating international sales of goods, the letter of credit has recently come to serve a variety of purposes, such as ensuring the payment of construction loans, guaranteeing the performance of obligations, and supporting the issuance of commercial paper. In contrast to its traditional function, the letter of credit in its newer variations frequently serves as a guaranty, and the issuer anticipates that it will not be called upon to honor the credit. Accordingly, this form of the device is known as a standby or guaranty letter of credit,*fn3 an appellation descriptive of the letter given to INA by Heritage.
Whatever the context in which it is being employed, the letter of credit serves the basic purpose of providing an inexpensive means of assuring payment in the course of a transaction to the party that furnishes the goods or services. It does this by creating a primary obligation on the part of the issuer of the letter of credit to pay upon the party's compliance with the terms and conditions enumerated in the letter, which usually calls for the presentation of specified documents. Thus, the letter of credit facilitates the underlying transaction both by substituting the known and secure credit of the issuer, such as a bank, for the unknown and perhaps risky credit of the other party to the underlying transaction, and by ensuring payment "up front," thereby shifting the burden of litigation to the dissatisfied purchaser of the goods or services.*fn4
Ordinarily there are three distinct agreements in a letter of credit transaction: the underlying contract between the customer and the beneficiary which gave rise to their resort to the letter of credit mechanism to arrange payment; the contract between the bank and its customer regarding the issuance of the letter and reimbursement of the bank upon its honoring a demand for payment; and the letter of credit itself, obligating the bank to pay the beneficiary.*fn5 Since the letter of credit is completely independent from the other contracts, it is not surprising that the extent of the bank's undertaking is set forth solely in the letter.*fn6 Generally, the bank obligates itself to purchase specific documents and, unless otherwise stipulated, it need not monitor the underlying contract.*fn7 Rather, it has only to determine whether the documents presented appear on their face to be in accordance with the terms and conditions of the letter of credit, and its responsibility in this regard is entirely ministerial.*fn8 In fact, the issuer of the letter must pay the beneficiary regardless of whether the underlying contract has been performed, except when there has been fraud or some other irregularity, or an undertaking to the contrary.*fn9 Finally, with respect to the documents presented, both the bank and the beneficiary are held to a standard of strict compliance; "in the absence of conformity, the beneficiary cannot force payment and the bank pays at its peril."*fn10
With this perspective, we turn to the case at hand, and note that the parties tender conflicting interpretations of the third condition of the letter of credit, the condition upon which INA relied in demanding payment. That provision required INA to submit "written evidence to the effect that" it had "not received evidence satisfactory to (it) of the performance by the (Billingses) of all (their) obligations in connection with which the aforesaid bond was issued." The parties disagree as to the meaning of that clause, and their dispute centers on whether the Billingses may be said not to have performed all their obligations at the time INA demanded payment from Heritage. Heritage expresses the view adopted by the district court that under the appeal bond the Billingses were under no duty to exonerate INA from liability before the appeal was concluded so long as they prosecuted the appeal with effect, and that consequently it could not be said that the Billingses had not performed all their obligations at the time INA demanded payment from Heritage. INA, on the other hand, contends that one of the Billingses' obligations under the appeal bond, and indeed its primary obligation, was to pay the judgment, thereby discharging the bond, and that when INA demanded payment, the Billingses had not yet performed that obligation.
Of course, if the outcome of this case were to turn on the proper interpretation of the third condition in the letter of credit, we would be required to construe any ambiguous language so as to best effectuate the bargain struck by the parties. Indeed, a possible interpretation one that finds some support in the express terms of the third condition of the letter is that Heritage granted INA a blank check, thereby allowing INA to demand payment at any time by presenting a written statement, prepared by INA, to the effect that it had not received evidence Satisfactory to it of the performance by the Billingses of all their obligations under the appeal bond.*fn11 Thus, Heritage may have committed itself to pay INA upon receipt of that statement, whether or not the Billingses performed all their obligations, and whether or not any evidence in that regard were given to INA, but so long as INA states that whatever evidence it received, if any, was unsatisfactory to it. Under such an interpretation, Heritage could not refuse to honor a demand merely because the ...