Letters of credit

     The letter of credit has traditionally been used as a method of payment for the purchase of goods where the buyer is unwilling to pay in advance of delivery, the seller is unwilling to trust the buyer's promise to pay, and simultaneous exchange of the price for goods is not feasible or practical (such as where the buyer and seller are located in different countries).  A letter of credit is an undertaking, typically but not exclusively made by a financial institution, to pay a designated beneficiary (usually a seller of goods) upon the occurence of stated events (usually the delivery of goods by the seller to a common carrier for transportation to the buyer).  The typical letter of credit is issued by a bank at a buyer's request, usually for a small fee, and is delivered by the buyer to the seller as a condition of delivery.  In the letter of credit, the bank promises to pay the seller the purchase price of goods sold upon presentation to the bank of designated documents (usually including a bill of lading showing loading of the goods with a carrier and a draft drawn upon the buyer by the seller which orders the buyer to pay for the goods).  The bank, in turn, is entitled to reimbursement from the buyer (such as by debiting the buyer's account with the bank) in the amount of the letter of credit.   Legal relationships and practices relating to letters of credit are largely supplied by a set of rules found in the Uniform Customs and Practice for Documentary Credits, a publication of the International Chamber of Commerce, which many letters of credit incorporate by reference.  In transactions governed by the Uniform Commercial Code, UCC Article 5 also supplies some relevant law.  Thorough consideration of the law and practices governing letters of credit is beyond the scope of these materials. 

     A different use of a letter of credit, in connection with real property secured transactions, is a relatively recent innovation.  In such transactions, a debtor (often referred to as the "account party" or "customer") procures a letter of credit, typically referred to as a standby letter of credit, in which a third party issuer (again, often a financial institution) promises to pay the lender (the beneficiary of the letter of credit) under the conditions specified in the letter of credit, usually the debtor's default.  Upon payment of the letter of credit, the issuer is entitled to immediate reimbursement from its customer the debtor.  

     Some advocates and judges characterize this use of the letter of credit as the provision of additional security for the debt.  Others characterize this use of the letter of credit as an indirect mechanism by which the lender can compel the debtor to make payment from available funds upon default, thus in effect circumventing anti-deficiency protections for debtors.  In Western Security Bank v. Superior Court, the California Supreme Court tackled that thorny question of how to characterize a standby letter of credit after a Court of Appeals decision in favor of a debtor had  prompted emergency "corrective legislation" in 1994.   In the case, a creditor called a letter of credit following non-judicial foreclosure on real property.  The issuer of the letter of credit declined to honor the letter after the debtor notified the issuer that payment of the letter of credit (and a subsequent demand by the issuer for reimbursement from the debtor) would amount to a violation of Cal. Code Civ. Pro. 580d, which bars deficiency claims following non-judicial foreclosure.   The majority, concurring and dissenting opinions nicely articulate the debate about how to characterize a standby letter of credit.  Do you see how one part of the corrective legislation (Cal. Code Civ. Pro. 580.5) reflects a characterization of standby letters of credit as additional security and the other part of the legislation (Cal. Code Civ. Pro. 580.7) reflects a characterization of standby letters of credit as an unenforceable waiver of anti-deficiency protections?  Why do you suppose the legislature took these conceptually irreconcilable positions?