Western Security Bank v. Superior Court
15 Cal. 4th 232 (Cal. 1997)
CHIN, J.
This case concerns the extent to which two disparate bodies of
law interact when standby letters of credit are used as additional support for loan
obligations secured by real property. On one side we have California's complex web of
foreclosure and antideficiency laws that circumscribe enforcement of obligations secured
by interests in real property. On the other side is the letter of credit law's
"independence principle," the unique characteristic of letters of credit
essential to their commercial utility.
The antideficiency statute invoked in this case is Code of Civil
Procedure section 580d. That section precludes a judgment for any loan balance left unpaid
after the lender's nonjudicial foreclosure under a power of sale in a deed of trust or
mortgage on real property. [Citation omitted.] The independence principle, in
summary form, makes the letter of credit issuer's obligation to pay a draw conforming to
the letter's terms completely separate from, and not contingent on, any underlying
contract between the issuer's customer and the letter's beneficiary. [Citations omitted.]
The Court of Appeal perceived a conflict between the public
policies behind Code of Civil Procedure section 580d and the independence principle under
the facts of this case. Here, after nonjudicial foreclosure of the real property security
for its loan left a deficiency, the lender attempted to draw on the standby letters of
credit of which it was the beneficiary. Ordinarily, the issuer's payment on a letter of
credit would require the borrower to reimburse the issuer. (See § 5114, subd. (3)).
[References are to Division 5 of the California Commercial Code, which deals with
letters of credit. Division 5 was revised subsequent to the transaction at issue.
The section number references in this opinion will no longer be accurate, but the
rules of law governing letters of credit to which the court refers have not changed.] The
Court of Appeal considered that this result indirectly imposed on the borrower the
equivalent of a prohibited deficiency judgment. The court concluded the situation amounted
to a "fraud in the transaction" under section 5114, subdivision (2)(b), one of
the limited circumstances justifying an issuer's refusal to honor its letter of credit.
The Legislature soon acted to express a clear, contrary intent.
It passed Senate Bill No. 1612 (1993-1994 Reg. Sess.) (hereafter Senate Bill No. 1612) as
an urgency measure specifically meant to abrogate the Court of Appeal's holding. (Stats.
1994, ch. 611, § 5, 6.) In brief, the aspects of Senate Bill No. 1612 we address provided
that an otherwise conforming draw on a letter of credit does not contravene the
antideficiency laws and that those laws afford no basis for refusal to honor a draw. After
the Legislature's action, we returned the case to the Court of Appeal for reconsideration
in light of the statutory changes. On considering the point, the Court of Appeal concluded
the Legislature's action was prospective only and had no impact on the court's earlier
analysis of the parties' rights and obligations. Accordingly, the Court of Appeal
reiterated its former conclusions.
We again granted review and now reverse. The Legislature's
manifest intent was that Senate Bill No. 1612's provisions, with one exception not
involved here, would apply to all existing loans secured by real property and supported by
outstanding letters of credit. We conclude the Legislature's action constituted a
clarification of the state of the law before the Court of Appeal's decision. The
legislation therefore has no impermissible retroactive consequences, and we must give it
the effect the Legislature intended.
I. FACTUAL AND PROCEDURAL BACKGROUND
On October 10, 1984, Beverly Hills Savings and Loan Association,
later known as Beverly Hills Business Bank (the Bank), loaned $ 3,250,000 to Vista
Place Associates (Vista), a limited partnership, to finance the purchase of real property
improved with a shopping center. Vista's general partners, Phillip F. Kennedy, Jr., John
R. Bradley, and Peter M. Hillman (the Vista partners), each signed the promissory note.
The loan transaction created a "purchase money mortgage," as it was secured by a
"Deed of Trust and Assignment of Rents" as well as a letter of credit.
Vista later experienced financial difficulties, and the loan went
into default. Vista asked the Bank to modify the loan's terms so Vista could continue
operating the shopping center and repay the debt. The Bank and Vista agreed to a loan
modification in February 1987, under which the three Vista partners each obtained an
unconditional, irrevocable standby letter of credit in favor of the Bank in the
amount of $ 125,000, for a total of $ 375,000. These were delivered to the Bank as
additional collateral security for repayment of the loan. Under the modification
agreement, the Bank was entitled to draw on the letters of credit if Vista defaulted or
failed to pay the loan in full at maturity.
Western Security Bank, N.A. (Western) issued the letters of
credit at the Vista partners' request. Each partner agreed to reimburse Western if it ever
had to honor the letters. Under the agreement, each Vista partner gave Western a $ 125,000
promissory note. n3
In December 1990, the Bank declared Vista in default on the
modified loan. The Bank recorded a notice of default on February 13, 1991, and began
nonjudicial foreclosure proceedings. (Civ. Code, § 2924.) It then filed an action against
Vista seeking specific performance of the rents and profits provisions in the trust deed
and appointment of a receiver.
On June 11, 1991, attorneys for the Bank and Vista signed a
letter agreement settling the Bank's lawsuit. In that agreement, Vista promised it would
"not take any legal action to prevent [the Bank's] drawing upon [the letters of
credit] after the Trustee's Sale of the Vista Place Shopping Center, . . . provided that
the amount of the draw by [the Bank] does not exceed an amount equal to the difference
between [Vista's] indebtedness and the successful bid of the Trustee's Sale." Vista
promised as well not to take any draw-related legal action against the Bank after the
Bank's draw on the letters of credit.
On June 13, 1991, the Bank concluded its nonjudicial foreclosure
on the shopping center under the power of sale in its deed of trust. The Bank was the only
bidder, and it purchased the property. The sale left an unpaid deficiency of $
505,890.16.
That same day, the Bank delivered the three letters of credit and
drafts to Western and demanded payment of their full amount, $ 375,000. The Bank never
sought to recover the $505,890.16 deficiency from Vista or the Vista partners. About
the time that Western received the Bank's draw demand, it also received a written notice
from the Vista partners' attorney. The notice asserted that Code of Civil Procedure
section 580d barred Western from seeking reimbursement from the Vista partners for any
payment on the letters of credit, and that if Western paid, it did so at its own risk.
Western did not honor the Bank's demand for payment on the
letters of credit. Instead, on June 24, 1991, Western filed this declaratory relief action
against the Bank, as well as Vista and the Vista partners (collectively, the Vista
defendants). Western's complaint sought: (1) a declaration that Western is not obligated
to accept or honor the Bank's tender of the letters of credit; or, alternatively, (2) a
declaration that, if Western must pay on the letters of credit, the Vista partners must
reimburse Western according to the terms of their promissory notes.
The Vista defendants cross-complained against Western for
cancellation of their promissory notes and for injunctive relief. In July 1991, the Bank
filed a first amended cross-complaint, alleging Western wrongfully dishonored the letters
of credit, and the Vista defendants breached the agreement not to take legal action to
prevent the Bank's drawing on the letters of credit.
* * *
The trial court signed and filed the judgment on March 26, 1992.
The court decreed the Bank was entitled to recover $ 375,000 from Western, plus interest
at 10 percent from June 13, 1991, the date of the Bank's demand, and costs of suit. The
court further decreed Western could seek reimbursement from the Vista partners severally,
and each Vista partner was obligated to reimburse Western, pursuant to the promissory
notes in favor of Western, for its payment to the Bank. Western appealed, and the Vista
defendants cross-appealed.
The Court of Appeal, after granting rehearing and accepting
briefing by several amici curiae, issued an opinion reversing the trial court on December
21, 1993. In that opinion, the court concluded: "We hold that, under section 580d of
the Code of Civil Procedure, an integral part of California's long-established
antideficiency legislation, the issuer of a standby letter of credit, provided to a real
property lender by a debtor as additional security, may decline to honor it after
receiving notice that it is to be used to discharge a deficiency following the
beneficiary-lender's nonjudicial foreclosure on real property. Such a use of
standby letters of credit constitutes a 'defect not apparent on the face of the documents'
within the meaning of California Uniform Commercial Code section 5114, subdivision (2)(b),
and therefore such permissive dishonor does no offense to the 'independence principle.'
" (Original italics, fn. omitted.)
In that first opinion, the Court of Appeal also solicited the
Legislature's attention: "To the extent that this result will present problems for
real estate lenders with respect to the way they now do business (as the Bank and several
amici curiae have strongly suggested), it is a matter which should be addressed to the
Legislature. We have been presented with two important but conflicting statutory policies.
Our reconciliation of them in this case may not prove as satisfactory in another factual
context. It is therefore a matter which should receive early legislative attention."
(Fn. omitted.)
We granted review, and while the matter was pending, the
Legislature passed Senate Bill No. 1612, an urgency statute that the Governor signed on
September 15, 1994. Senate Bill No. 1612 affected four statutes. . . . Section 2 of the
bill added Code of Civil Procedure section 580.5, explicitly excluding letters of credit
from the purview of the antideficiency laws. (Stats. 1994, ch. 611, § 2.) Section 3 of
the bill added Code of Civil Procedure section 580.7, which declares unenforceable letters
of credit issued to avoid defaults on purchase money mortgages for owner-occupied real
property containing one to four residential units. (Stats. 1994, ch. 611, § 3.) . . . .
The Legislature made its purpose explicit: "It is the intent
of the Legislature in enacting Sections 2 and 4 of this act to confirm the independent
nature of the letter of credit engagement and to abrogate the holding [of the Court of
Appeal in this case] . . . . The Legislature also intends to confirm the expectation of
the parties to a contract that underlies a letter of credit, that the beneficiary will
have available the value of the real estate collateral and the benefit of the letter of
credit without regard to the order in which the beneficiary may resort to either."
(Stats. 1994, ch. 611, § 5.) The same purpose was echoed in the bill's statement of the
facts calling for an urgency statute: "In order to confirm and clarify the law
applicable to obligations which are secured by real property or an estate for years
therein and which also are supported by a letter of credit, it is necessary that this act
take effect immediately." (Stats. 1994, ch. 611, § 6.)
After the Legislature enacted Senate Bill No. 1612, we requested
the parties' views on its effect. On February 2, 1995, after considering the parties'
responses, we transferred the case to the Court of Appeal with directions to vacate its
decision and reconsider the cause in light of the Legislature's action.
On reconsideration, the Court of Appeal determined Senate Bill
No. 1612 constituted a substantial change in existing law. Believing there was no clear
evidence that the Legislature intended the statute to operate retrospectively, the Court
of Appeal thought Senate Bill No. 1612 had only prospective application. Therefore, Senate
Bill No. 1612 did not affect the Court of Appeal's prior conclusions on the parties'
rights and obligations. The Court of Appeal filed its second opinion on September 29,
1995, mostly repeating its prior reasoning and conclusions. We granted the Bank's petition
for review.
II. DISCUSSION
[The court here articulates the principles and precedents
applicable to determining whether a statute shall operate retrospectively or whether, in
the alternative, a statute may be interpreted as simply clarifying existing law.]
* * *
With respect to Senate Bill No. 1612, the Legislature made its
intent plain. Section 5 of the bill states, in part: "It is the intent of the
Legislature in enacting Sections 2 and 4 of this act n5 to confirm the independent nature of the
letter of credit engagement and to abrogate the holding in [the Court of Appeal's earlier
opinion in this case], that presentment of a draft under a letter of credit issued in
connection with a real property secured loan following foreclosure violates Section 580d
of the Code of Civil Procedure and constitutes a 'fraud . . . or other defect not apparent
on the face of the documents' under paragraph (b) of subdivision (2) of Section 5114 of
the Commercial Code. . . . The Legislature also intends to confirm the expectation of the
parties to a contract that underlies a letter of credit, that the beneficiary will have
available the value of the real estate collateral and the benefit of the letter of credit
without regard to the order in which the beneficiary may resort to either." (Stats.
1994, ch. 611, § 5.)
The Legislature's intent also was evident in its statement of the
facts justifying enactment of Senate Bill No. 1612 as an urgency statute: "In order
to confirm and clarify the law applicable to obligations which are secured by real
property or an estate for years therein and which also are supported by a letter of
credit, it is necessary that this act take effect immediately." (Stats. 1994, ch.
611, § 6.) The Legislature's unmistakable focus was the disruptive effect of the Court of
Appeal's decision on the expectations of parties to transactions where a letter of credit
was issued in connection with a loan secured by real property. By abrogating the Court of
Appeal's decision, the Legislature intended to protect those parties' expectations and
restore certainty and stability to those transactions. If the Legislature acts promptly to
correct a perceived problem with a judicial construction of a statute, the courts
generally give the Legislature's action its intended effect. [Citations omitted.] The
plain import of Senate Bill No. 1612 is that the Legislature intended its provisions to
apply immediately to existing loan transactions secured by real property and supported by
outstanding letters of credit, including those in this case.
We next consider whether Senate Bill No. 1612 effected a change
in the law, or instead represented a clarification of the state of the law before the
Court of Appeal's decision. As mentioned earlier, Senate Bill No. 1612 amended two code
sections (§ 5114, Civ. Code, § 2787) and added two sections to the Code of Civil
Procedure (§ 580.5, 580.7). The two code sections Senate Bill No. 1612 amended plainly
made no substantive change in the law. The amendments to section 5114, which concerns the
issuer's duty to honor a draft conforming to the letter of credit's terms, were
"technical, nonsubstantive changes," as the Legislative Counsel's Digest
correctly noted. (See Legis. Counsel's Dig., Sen. Bill No. 1612 (1993-1994 Reg.
Sess.).)
In the other section amended, Civil Code section 2787, Senate
Bill No. 1612 added a statement reflecting an established formal distinction: "A
letter of credit is not a form of suretyship obligation." (Stats. 1994, ch. 611, §
1.) Civil Code section 2787 defines a surety or guarantor as "one who promises to
answer for the debt, default, or miscarriage of another, or hypothecates property as
security therefor." Generally, a surety's liability for an obligation is secondary
to, and derivative of, the liability of the principal for that obligation. (See, e.g.,
Civ. Code, § 2806 et seq.)
By contrast, the liability of the issuer of a letter of credit to
the letter's beneficiary is direct and independent of the underlying transaction between
the beneficiary and the issuer's customer. [Citations omitted.] Thus, as the amendment to
Civil Code section 2787 made clear, existing law viewed a letter of credit as an
independent obligation of the issuing bank rather than as a form of guaranty or a surety
obligation. [Citations omitted.] The issuer of a letter of credit cannot refuse to pay
based on extraneous defenses that might have been available to its customer. (San
Diego Gas & Electric Co. v. Bank Leumi, supra, 42 Cal. App. 4th at p.
934.) Absent fraud, the issuer must pay upon proper presentment regardless of any defenses
the customer may have against the beneficiary based in the underlying transaction. (Ibid.)
Senate Bill No. 1612's remaining statutory addition with which we
are concerned, n6 Code of Civil Procedure
section 580.5, specified that letter of credit transactions do not violate the
antideficiency laws contained in Code of Civil Procedure sections 580a, 580b, 580d, or
726. (Code Civ. Proc., § 580.5, subd. (b)(3).) In particular, the new section specifies
that a lender's resort to a letter of credit, and the issuer's concomitant right to
reimbursement, do not constitute an "action" under Code of Civil Procedure
section 726, or a failure to proceed first against security, regardless of whether they
come before or after a foreclosure. (Code Civ. Proc., § 580.5, subd. (b)(1).) Similarly,
letter of credit draws and reimbursements do not constitute deficiency judgments "or
the functional equivalent of any such judgment." (Code Civ. Proc., § 580.5, subd.
(b)(2).)
The Court of Appeal saw Code of Civil Procedure section 580.5 as
a change in the law, in large part, because of the analogy it employed to examine the use
of standby letters of credit as additional support for loans also secured by real
property. The Bank argued a standby letter of credit was the functional equivalent of cash
collateral. The Court of Appeal disagreed, instead analogizing standby letters of credit
to guaranties and emphasizing the similarities of purpose and function: "No matter
how it may be regarded by the beneficiary, a standby letter is certainly not cash or
its equivalent from the perspective of the debtor; in reality, it represents his promise
to provide additional funds in the event of his future default
or deficiency, thus confirming its use not as a means of payment but rather as an
instrument of guarantee." (Original italics.) The Court of Appeal relied on Union
Bank v. Gradsky (1968) 265 Cal. App. 2d 40 [71 Cal. Rptr. 64] (Gradsky) and Commonwealth
Mortgage Assurance Co. v. Superior Court (1989) 211 Cal. App. 3d 508 [259 Cal. Rptr.
425] (Commonwealth Mortgage).
Gradsky held that a creditor, after nonjudicial
foreclosure of the real property security for a note, could not recover the note's unpaid
balance from a guarantor. (Gradsky, supra, 265 Cal. App. 2d at p. 41.)
Significantly, the court did not find Code of Civil Procedure section 580d's prohibition
of deficiency judgments barred the creditor's claim on the guarantor: "It is barred
by applying the principles of estoppel. The estoppel is raised as a matter of law to
prevent the creditor from recovering from the guarantor after the creditor has exercised
an election of remedies which destroys the guarantor's subrogation rights against the
principal debtor." (Gradsky, supra, 265 Cal. App. 2d at p. 41.)
The court noted that the guarantor, after payment, ordinarily
would be equitably subrogated to the rights and security formerly held by the creditor. (Gradsky,
supra, 265 Cal. App. 2d at pp. 44-45; cf. Civ. Code, § 2848, 2849.) However,
where the creditor first resorts to nonjudicial foreclosure, the guarantor could not
acquire any subrogation rights from the creditor because under Code of Civil Procedure
section 580d, the nonjudicial sale eliminated both the security and the possibility of a
deficiency judgment against the debtor. (Gradsky, supra, 265 Cal. App.
2d at p. 45.) Because the creditor has a duty not to impair the guarantor's remedies
against the debtor, the court held the creditor is estopped from pursuing the guarantor
after electing a remedy--nonjudicial foreclosure--that eliminated the security for the
debt and curtailed the possibility of the guarantor's reimbursement from the debtor. (Id.
at pp. 46-47.)
However, the rules applicable to surety relationships do not
govern the relationships between the parties to a letter of credit transaction. [Citation
omitted.] At the time of this case's transactions, a majority of courts did not
grant subrogation rights to an issuer that honored a draw on a credit; the issuer
satisfied its own primary obligation, not the debt of another. [Citations omitted.]
Nor does the beneficiary of a letter of credit owe any obligations to the issuer; literal
compliance with the letter of credit's terms for payment is all that is required.
[Citations omitted.]
Gradsky contains additional language
suggesting a much broader rule than its holding and analysis warranted. Going beyond the
subrogation theory underlying its holding, the court observed: "If . . . the
guarantor . . . can successfully assert an action in assumpsit against [the debtor] for
reimbursement, the obvious result is to permit the recovery of a 'deficiency' judgment
against the debtor following a nonjudicial sale of the security under a different label.
It makes no difference to [the debtor's] purse whether the recovery is by the original
creditor in a direct action following nonjudicial sale of the security, or whether the
recovery is in an action by the guarantor for reimbursement of the same sum." (Gradsky,
supra, 265 Cal. App. 2d at pp. 45-46.) The court also said: "The Legislature
clearly intended to protect the debtor from personal liability following a
nonjudicial sale of the security. No liability, direct or indirect, should be imposed upon
the debtor following a nonjudicial sale of the security. To permit a guarantor to recover
reimbursement from the debtor would permit circumvention of the legislative purpose in
enacting section 580d." (Id. at p. 46.) In view of the reasoning of the
court's holding, these additional observations were unnecessary to the case's
determination.
Commonwealth Mortgage followed Gradsky to hold
a mortgage guaranty insurer could not enforce indemnity agreements to obtain reimbursement
from the debtors for the insurer's payment to the lender after the lender's nonjudicial
sale of its real property security. (Commonwealth Mortgage, supra, 211
Cal. App. 3d at p. 517.) The court said the mortgage guaranty insurance policy served the
same purpose as the guaranty in Gradsky, and thus Gradsky would bar the
insurer from being reimbursed under subrogation principles. (Commonwealth Mortgage,
supra, 211 Cal. App. 3d at p. 517.) The court found the substitution of indemnity
agreements for subrogation rights did not distinguish the case from Gradsky.
Relying on the rule that a principal obligor incurs no additional liability on a note by
also being a guarantor of it, the court said the agreements added nothing to the debtors'
existing liability. (Commonwealth Mortgage, supra, 211 Cal. App. 3d at
p. 517.) Thus, the court said the indemnity agreements could not be viewed as independent
obligations. (Ibid.) Instead, the court concluded they were invalid attempts to
have the debtors waive in advance the statutory prohibition against deficiency judgments.
(Ibid.)
As did Gradsky, Commonwealth Mortgage also
inveighed against subterfuges that thwart the purposes of Code of Civil Procedure section
580d. (Commonwealth Mortgage, supra, 211 Cal. App. 3d at pp. 515, 517.)
"Although section 580d applies by its specific terms only to actions for 'any
deficiency upon a note secured by a deed of trust' and not to actions based upon other
obligations, the proscriptions of section 580d cannot be avoided through artifice
[citation] . . . . In determining whether a particular recovery is precluded, we must
consider whether the policy behind section 580d would be violated by such a recovery.
[Citation.]" (Commonwealth Mortgage, supra, 211 Cal. App. 3d
at p. 515.) Thus, as did the Gradsky court, the Commonwealth Mortgage
court augmented its opinion with concepts unnecessary to its determination of the case.
The Court of Appeal in this case extrapolated from the Gradsky
and Commonwealth Mortgage precedents a rule that swept far beyond their origins
in guaranty and suretyship relationships: "Not only is a creditor prevented
from obtaining a deficiency judgment against the debtor, but no other person is permitted
to obtain what would, in effect, amount to a deficiency judgment." (Original
italics.) The Court of Appeal apparently concluded a transaction has such an effect if it
"has the practical consequence of requiring the debtor to pay additional money
on the debt after default or foreclosure." (Original italics.) "Thus,
we preserve the principle, clearly established by Gradsky and Commonwealth
[Mortgage], that a lender should not be able to utilize a device of any kind to
avoid the limitations of section 580d; and we apply that principle here to standby letters
of credit." However, as we have seen, neither Gradsky nor Commonwealth
Mortgage established such a principle as a rule of law. Instead, their statements
accentuated the courts' vigilance regarding attempted evasions of the antideficiency and
foreclosure laws.
The Court of Appeal mistook standby letters of credit for such an
attempt by seeing them only as a form of guaranty. The court analogized the standby
letter of credit to a guaranty because of the perceived functional similarities. One
consequence of that analogy was that the court applied to standby letters of credit a rule
whose legal justifications originated in the subrogation rights owed to sureties. However,
as discussed before, letters of credit--standby or otherwise--are not a form of
suretyship, and the rights of the parties to these transactions are not governed by
suretyship principles. Further, suretyship involves no counterpart to the
independence principle essential to letters of credit.
While analogies can improve our understanding of how and why
letters of credit are useful, analogies cannot substitute for recognizing the letters'
unique qualities. The authors of one leading treatise aptly summarized the point: "In
short, a letter of credit is a letter of credit. As Bishop Butler once said, 'Everything
is what it is and not another thing.' " (3 White & Summers, Uniform Commercial
Code, supra, Letters of Credit, § 26-2, p. 117, fn. omitted.)
By focusing on analogies to guaranties, the Court of Appeal also
overlooked that the parties in this case specifically intended the standby letters of
credit to be additional security. n8 The
parties' stipulated facts include that the original loan agreement was secured by a letter
of credit, and that "Vista caused [the subsequent letters of credit] to be issued by
Western as additional collateral security . . . ." The Court of Appeal found the
letters of credit were not security interests in personal property under California
Uniform Commercial Code section 9501, subdivision (4), as the Bank had argued. However, we
need not determine whether a standby letter of credit comes within the scope of division 9
of the California Uniform Commercial Code. A letter of credit is sui generis as a means of
securing or supporting performance of an obligation incurred in a separate transaction.
Regardless of whether this idiosyncratic undertaking meets the qualifications for a
security interest under the California Uniform Commercial Code, it nevertheless is a form
of security for assuring another's performance.
When viewed as additional security for a note also secured by
real property, a standby letter of credit does not conflict with the
statutory prohibition of deficiency judgments. Code of Civil Procedure section 580d
does not limit the security for notes given for the purchase of real property only to
trust deeds; other security may be given as well. (Freedland v. Greco (1955) 45
Cal. 2d 462, 466 [289 P.2d 463].) Creditors may resort to such other security in addition
to nonjudicial foreclosure of the real property security. (Ibid.; Hatch v.
Security-First Nat. Bank (1942) 19 Cal. 2d 254, 260 [120 P.2d 869].) A standby letter
of credit is a security device created at the request of the customer/debtor that is an
obligation owed independently by the issuing bank to the beneficiary/creditor. [Citations
omitted.] A creditor that draws on a letter of credit does no more than call on all the
security pledged for the debt. When it does so, it does not violate the prohibition of
deficiency judgments.
The Legislature plainly intended that the sections of Senate Bill
No. 1612 we have addressed would apply to existing loan transactions supported by
outstanding letters of credit. We conclude the Legislature's action did not effect a
change in the law. Before the Legislature passed Senate Bill No. 1612, an issuer could not
refuse to honor a conforming draw on a standby letter of credit--given as additional
security for a real property loan--on the basis that the draw followed a nonjudicial sale
of the real property security. The Court of Appeal created such a basis, but produced an
unprecedented rule without solid legal underpinnings or any real connection to the actual
language of the statutes involved.
Therefore, the aspects of Senate Bill No. 1612 we have discussed
did not effect any change in the law, but simply clarified and confirmed the state of the
law prior to the Court of Appeal's first opinion. Because the legislative action did not
change the legal effect of past actions, Senate Bill No. 1612 does not act
retrospectively; it governs this case. The Legislature concluded that Senate Bill No. 1612
should be given immediate effect to confirm and clarify the law applicable to loans
secured by real property and supported by letters of credit. This conclusion was
reasonable, particularly in view of the uncertainties the financial community evidently
faced after the Court of Appeal's decision. (See, e.g., Murray, What Should I Do With
This Letter of Credit? (Cont.Ed.Bar 1994) 17 Real Prop. L. Rptr. 133, 138-140.)
In sum, the Court of Appeal erred in concluding the Legislature's
enactment of Senate Bill No. 1612 had no effect on this case. The Legislature explicitly
intended to abrogate the Court of Appeal's prior decision and make certain the parties'
obligations when letters of credit supported loans also secured by real property. The
Legislature manifestly intended the respective obligations of the parties to a
letter of credit transaction should remain unaffected by the antideficiency laws, whether
those obligations arose before or after enactment of Senate Bill No. 1612. Accordingly, we
conclude the judgment of the Court of Appeal should be reversed.
DISPOSITION
The judgment of the Court of Appeal is reversed, and the cause
remanded for further proceedings consistent with this opinion.
George, C. J., Baxter, J., and Brown, J., concurred.
WERDEGAR, J.,
Concurring and Dissenting.--I concur in the majority's conclusion that California Uniform
Commercial Code section 5114, subdivision (2)(b), does not excuse Western Security Bank,
N.A. (Western), the issuer, from honoring its letter of credit upon demand for payment by
Beverly Hills Business Bank (the Bank), the beneficiary. I would not, however, reach this
conclusion under the majority's reasoning that Senate Bill No. 1612 (Stats. 1994, ch. 611)
merely declared existing law and that, prior to the bill's enactment, the antideficiency
law had no effect on letters of credit. Instead, I agree with Justice Mosk that section
5114 simply does not bear the interpretation that the use of a letter of credit to support
an obligation secured by a mortgage or deed of trust constitutes "fraud in the
transaction." (Cal. U. Com. Code, § 5114, subd. (2); see conc. & dis. opn.
of Mosk, J., post, at pp. 262-263, 933 P.2d 526-527.) Thus, Western was obliged
to honor the Bank's demand for payment.
The conclusion that the Bank may properly draw upon the letter of
credit does not compel the further conclusion that the antideficiency law ultimately
offers no protection to Vista Place Asssociates. This is illustrated by a comparison of
the majority opinion and the separate opinion of Justice Mosk, which agree on the former
point but disagree on the latter. In my view, the Bank's petition for review of a decision
rejecting its claim (as beneficiary) against Western (as issuer) under superseded law does
not present an appropriate vehicle for broader pronouncements on the antideficiency law's
effect on other claims and other parties. Because the Legislature in Senate Bill No. 1612
has articulated rules that will govern all future letters of credit, and because letters
of credit typically expire after a finite period, the status of residual letters of credit
issued before the bill's effective date will soon become an academic question. In
contrast, whether the antideficiency law should as a general matter be expansively or
narrowly construed remains of vital importance, as demonstrated by the interest in this
case shown by amici curiae involved in the purchase and sale of real estate. Under these
circumstances, the principle of judicial restraint counsels against the majority's
sweeping declaration that the reach of the antideficiency law prior to Senate Bill No.
1612 was too narrow to affect the respective obligations of the parties to a letter of
credit transaction.
Underlying the broad declaration just mentioned is the majority's
erroneous conclusion that Senate Bill No. 1612 merely clarified existing law and, thus,
may be applied to transactions entered into before the bill's operative date. Before that
date, the antideficiency law did not distinguish between residential and nonresidential
real estate transactions. Now, however, as amended by Senate Bill No. 1612, the
antideficiency law does distinguish between residential and nonresidential real estate
transactions. New Code of Civil Procedure section 580.7, which the bill added, makes a
letter of credit unenforceable when issued to avoid the default of an existing loan and
"[t]he existing loan is secured by a purchase money deed of trust or purchase money
mortgage on real property containing one to four residential units, at least one of which
is owned and occupied, or was intended at the time the existing loan was made, to be
occupied by the customer." (Id., subd. (b)(3).)
In light of this provision, we may conclude that letters of
credit before Senate Bill No. 1612 either were enforceable in the specified residential
real estate transactions but now are not, or were not enforceable in all other real estate
transactions but now are. This case does not require us to choose between these
possibilities. Either way, Senate Bill No. 1612 went beyond mere clarification to change
the effective scope of the antideficiency law. To apply it retroactively would change the
legal consequences of past acts. Under these circumstances, it is appropriate to apply the
ordinary presumption that a legislative act operates prospectively, and inappropriate to
apply to this case the new set of rules articulated in Senate Bill No. 1612.
MOSK, J.,
Concurring and Dissenting.--I agree with the majority that the issue before us is not
whether Senate Bill No. 1612 (1993-1994 Reg. Sess.) (hereafter Senate Bill No. 1612) has
retrospective application. It does not. Rather, we must determine what the law was before
Senate Bill No. 1612 was enacted to provide, in effect, a "standby letter of credit
exception" to the antideficiency statutes.
I disagree with the majority that Senate Bill No. 1612 did not
change prior law. In my view, far from merely "clarifying" the "true"
meaning of prior law--as the majority implausibly assert--its numerous amendments and
additions to the statutes reversed what the Court of Appeal aptly referred to as "the
fifty years of consistent solicitude which California courts have given to the foreclosed
purchase money mortgagee."
As the majority concede, a legislative declaration of an existing
statute's meaning is neither binding nor conclusive. "The Legislature has no
authority to interpret a statute. That is a judicial task." [Citations omitted.] As
the majority also concede, the legislative interpretation of prior law in this case is
particularly unworthy of deference: Nothing in the previous legislative history of letter
of credit statutes suggests an intent to create an exception to the antideficiency
statutes. Indeed, it is apparently only recently that standby letters of credit have been
used in real estate transactions.
Accordingly, unlike the majority, I conclude that before Senate
Bill No. 1612, standby letters of credit were not exempt from the antideficiency statutes
precluding creditors from obtaining a deficiency judgment from a creditor following
nonjudicial foreclosure on a real property loan.
I.
As the Court of Appeal emphasized, before Senate Bill No. 1612,
the potential conflict between the letters of credit statutes and the antideficiency
statutes posed a question of first impression, arising from the relatively recent
innovation of the use of standby letters of credit as additional security for real estate
loans. Does the so-called "independence principle"--under which letters of
credit stand separate and apart from the underlying transaction--constitute an exception
to the antideficiency statutes that bar deficiency judgments after a nonjudicial
foreclosure on real property?
The majority conclude that even before Senate Bill No. 1612,
there was no restriction on the right of a creditor to demand payment on a standby letter
of credit after a nonjudicial foreclosure on real property. They are wrong.
Under the so-called "independence principle," the
issuer of a standby letter of credit "must honor a draft or demand for payment which
complies with the terms of the relevant credit regardless of whether the goods or
documents conform to the underlying contract for sale or other contract between the
customer and the beneficiary." (Cal. U. Com. Code, former § 5114, subd. (1), as
amended by Stats. 1994, ch. 611, § 4.) In turn, the issuer of a standby letter of credit
"is entitled to immediate reimbursement of any payment made under the credit and to
be put in effectively available funds not later than the day before maturity of any
acceptance made under the credit." (Id., subd. (3).) n2
A standby letter of credit specifically operates as a means of
guaranteeing payment in the event of a future default. "A letter of credit is an
engagement by an issuer (usually a bank) to a beneficiary, made at the request of a
customer, which binds the bank to honor drafts up to the amount of the credit upon the
beneficiary's compliance with certain conditions specified in the letter of credit. The
customer is ultimately liable to reimburse the bank. The traditional function of the
letter of credit is to finance an underlying customer's beneficiary contract for the sale
of goods, directing the bank to pay the beneficiary for shipment. A different function is
served by the 'standby' letter of credit, which directs the bank to pay the beneficiary
not for his own performance but upon the customer's default, thereby serving as a
guarantee device." (Note, "Fraud in the Transaction": Enjoining Letters
of Credit During the Iranian Revolution (1980) 93 Harv. L.Rev. 992, 992-993, fns.
omitted.)
Thus, in practical effect, a standby letter of credit constitutes
a promise to provide additional funds in the event of a future default or deficiency. As
such, prior to passage of Senate Bill No. 1612, it potentially came up against the
restrictions of the antideficiency statutes barring a creditor from obtaining additional
funds from a debtor after a nonjudicial foreclosure. Indeed, as the parties concede,
nothing in the applicable statutes or legislative history prior to the amendments and
additions enacted by Senate Bill No. 1612 created any specific exception to the
antideficiency statutes for standby letters of credit. Nor did anything in the applicable
statutes or legislative history "imply" that the antideficiency statutes must
yield to the so-called "independence principle," based on public policy or
otherwise.
[Discussion of the history and purpose of the antideficiency
statutes omitted.]
* * *
Over the several decades since their enactment, our courts have
construed the antideficiency statutes liberally, rejecting attempts to circumvent the
proscriptions against deficiency judgments after nonjudicial foreclosure. "It is well
settled that the proscriptions of section 580d cannot be avoided through artifice . . .
." [Citations omitted.]
Nor can the antideficiency protections be waived by the borrower
at the time the loan was made. [Citations omitted.]
In this regard, as the Court of Appeal observed, two decisions
are of particular relevance here: Union Bank v. Gradsky (1968) 265 Cal. App. 2d
40 [71 Cal. Rptr. 64] (hereafter Gradsky), and Commonwealth Mortgage
Assurance Co. v. Superior Court (1989) 211 Cal. App. 3d 508 [259 Cal. Rptr. 425]
(hereafter Commonwealth).
In Gradsky, the Court of Appeal held that Code of Civil
Procedure section 580d operated to preclude a lender from collecting the unpaid balance of
a promissory note from the guarantor after a nonjudicial foreclosure on the real property
securing the debt. It concluded that if the guarantor could successfully assert an action
against the borrower for reimbursement, "the obvious result is to permit the
recovery of a 'deficiency' judgment against the [borrower] following a nonjudicial sale of
the security under a different label." (Gradsky, supra, 265 Cal.
App. 2d at pp. 45-46.) "The Legislature clearly intended to protect the [borrower]
from personal liability following a nonjudicial sale of the security. No liability, direct
or indirect, should be imposed upon the [borrower] following a nonjudicial sale of the
security. To permit a guarantor to recover reimbursement from the debtor would permit
circumvention of the legislative purpose in enacting section 580d." (Id. at
p. 46.)
In Commonwealth, borrowers purchased real property with
a loan secured by promissory notes provided by a bank. At the bank's request, they
obtained policies of mortgage guarantee insurance to secure payment on the promissory
notes. They also signed indemnity agreements promising to reimburse the mortgage insurer
for any funds it paid out under the policy. When the borrowers defaulted on the promissory
notes, the bank foreclosed nonjudicially on the real property. It then collected on the
mortgage insurance; the mortgage insurer then brought an action for reimbursement on the
indemnity agreements.
The Court of Appeal in Commonwealth held that
reimbursement was barred by Code of Civil Procedure section 580d. It rejected the argument
that the indemnity agreements constituted separate and independent obligations: "The
instant indemnity agreements add nothing to the liability [the borrowers] already incurred
as principal obligors on the notes . . . . To splinter the transaction and view the
indemnity agreements as separate and independent obligations . . . is to thwart the
purpose of section 580d by a subterfuge [citation], a result we cannot permit." (Commonwealth,
supra, 211 Cal. App. 3d at p. 517.)
The majority's attempt to distinguish Gradsky and Commonwealth,
by characterizing them as grounded in subrogation law, is unpersuasive. Indeed, in Commonwealth,
subrogation law was not directly in issue; the indemnity obligation provided a contract
upon which to base collection. n3
The majority miss the point. As the Court of Appeal in
this matter explained: "Gradsky and Commonwealth reflect the strong
judicial concern about the efforts of secured real property lenders to circumvent section
580d by the use of financial transactions between debtors and third parties which involve
post-nonjudicial foreclosure debt obligations for the borrowers. Their common and primary
focus is on the lender's requirement that the debtor make arrangements with a third party
to pay a portion or all of the mortgage debt remaining after a foreclosure, i.e., to pay
the debtor's deficiency."
The Legislature, in enacting Senate Bill No. 1612, expressly
abrogated the Court of Appeal decision in this matter and gave primacy to the so-called
"independence principle" as against the antideficiency protections. Its
additions and amendments to the statutes--lobbied for, and drafted by, the California
Bankers Association--significantly altered prior law. Senate Bill No. 1612, therefore,
should have prospective application only.
In their strained attempt to reach the conclusion that Senate
Bill No. 1612 governs this case, the majority adopt the fiction that a standby letter of
credit is an "idiosyncratic" form of "security" or the
"functional equivalent" of cash collateral. They offer no sound support for such
an approach. There is none. n4
As the Court of Appeal observed, from the perspective
of the debtor, a standby letter of credit is not cash or its equivalent. It is, instead, a
promise to provide additional funds in the event of future default or deficiency
and has the practical consequence of requiring the debtor to pay additional money
on the debt after default or foreclosure. n5 Moreover, unlike cash, which can be pledged
as collateral security only once, a standby letter of credit does not require a debtor to
part with its own funds until payment is made and thus permits a borrower to use standby
letters of credit in a large number of transactions separately. Cash collateral, by
contrast, does not impose personal liability on the borrower following a trustee's sale
and does not encourage speculative lending practices.
As the Court of Appeal observed: "For us to conclude that
such use of a standby letter of credit is the same as an increased cash investment
(whether or not from borrowed funds) is to deny reality and to invite the very
overvaluation and potential aggravation of an economic downturn which the antideficiency
legislation was originally enacted to prevent."
II.
The Court of Appeal correctly concluded that, before Senate Bill
No. 1612, there was no implied exception to the antideficiency statutes for letters of
credit. It erred, however, in holding that Western Security Bank, N.A. (Western) could
have refused to honor the letter of credit on the ground that the Beverly Hills Business
Bank (Bank), in presenting the letters of credit after a nonjudicial foreclosure, worked
an "implied" fraud on Vista Place Associates (Vista).
The Court of Appeal cited former California Uniform Commercial
Code former section 5114, subdivision (2)(b), which provides that when there has been a
notification from the customer of "fraud, forgery or other defect not apparent on the
face of the documents," the issuer "may"--but is not obligated
to--"honor the draft or demand for payment."(Cal. U. Com. Code, § 5114, subd.
(2)(b) as amended by Stats. 1994, ch. 611, § 4.) n6 The statute is inapplicable under the
present facts.
Western, presented with a demand for payment on a letter of
credit, was limited to determining whether the documents presented by the beneficiary
complied with the letter of credit--a purely ministerial task of comparing the documents
presented against the description of the documents in the letter of credit. If the
documents comply on their face, the issuer must honor the draw, regardless of disputes
concerning the underlying transaction. [Citations omitted] Thus, in this case, Western was
not entitled to look beyond the documents presented by the Bank and refuse to honor the
standby letter of credit based on a potential violation of the antideficiency statutes in
the underlying transaction.
In my view, the concurring and dissenting opinion by Justice
Kitching in the Court of Appeal correctly reconciled the policies behind standby letter of
credit law and the antideficiency provisions of Code of Civil Procedure section 580d, as
they existed before Senate Bill No. 1612. Thus, I would conclude that Western was
obligated, under the so-called "independence principle," to honor the standby
letter of credit presented by the Bank. None of the limited exceptions to that rule
applied. Western was not, however, without recourse. It was entitled to seek reimbursement
from Vista, pursuant to former California Uniform Commercial Code former section
5114, subdivision (3) and its promissory notes. Vista, in turn, could seek disgorgement
from the Bank, if it has not legally waived its protection under Code of Civil Procedure
section 580d--an issue that is not before us and should be remanded to the trial court. As
Justice Kitching's concurrence and dissent concluded, "[t]his procedure would retain
certainty in the California letter of credit market while implementing the policies
supporting section 580d."
Kennard, J., concurred.