DATE: 20020627 DOCKET: C36996
COURT OF APPEAL FOR ONTARIO
MCMURTRY C.J.O., O’CONNOR A.C.J.O. AND BORINS J.A.
B E T W E E N :
RICHTER & PARTNERS INC. in its Capacity as Court-Appointed Receiver and Manager of LAVA SYSTEMS INC.
Sharon M. Addison, for the appellant
Applicant (Respondent)
- and -
CLARICA LIFE INSURANCE COMPANY
Michael J. MacNaughton and Carole J. Hunter, for the respondent
Respondent (Appellant)
Heard: June 10, 2002
On appeal from the judgment of Justice Donald R. Cameron dated August 21, 2001.
BORINS J.A.
[1] The issue in this appeal is whether the application judge, in reasons reported in (2001), 2001 28280 (ON SC), 31 C.B.R. (4th) 284, was correct in declaring that Clarica Life Insurance Co. (“Clarica”), the landlord of the bankrupt Lava Systems Inc. (“Lava”), is required to account to Richter & Partners Inc. (“Richter”) as court-appointed receiver and manager of Lava, for $677,979.24 which Clarica drew down on an irrevocable letter of credit issued in its favour by the Bank of Montreal (the “bank”) and which had been provided to it by Lava as security for the performance of its obligations under a lease between itself and Clarica.
[2] In proceedings in which the bank was not a party, Richter applied for advice and direction as to the amount, if any, that Clarica was entitled to draw under the letter of credit and for an order requiring Clarica to pay to Richter all amounts improperly received by Clarica. The application judge conducted an extensive analysis into whether where a trustee in bankruptcy has disclaimed a lease a tenant has any obligations to the landlord under the lease, which are the circumstances in this case. He concluded that the only right of Clarica surviving the disclaimer of the lease was a preferential lien under s. 38 of the Commercial Tenancies Act, R.S.O. 1990, c.L.9 and s. 136(1)(f) of the Bankruptcy and Insolvency Act, R.S.O. 1985, c.B-3 for rent for the periods specified therein. As the amount which Clarica had drawn on the letter of credit substantially exceeded the statutory amounts to which it was entitled, the application judge ordered Clarica to account to Richters for the excess.
[3] Clarica raised two principle grounds of appeal: (1) As the funds drawn on the letter of credit by Clarica were the property of the bank and not of the bankrupt tenant, neither Lava, nor its receiver and manager had a legal right to recover any funds that Clarica may have improperly claimed and been paid under the letter of credit; (2) The application judge erred in holding that Clarica’s draw on the letter of credit was limited to its statutory entitlement. As I would give effect to Clarica’s first ground of appeal, it is unnecessary for the purpose of this appeal to decide whether the application judge erred in limiting Clarica’s draw on the letter of credit to its statutory entitlement.
[4] My decision turns on the law that applies to the autonomy of documentary letters of credit as explained by LeDain J. in Bank of Nova Scotia v. Angelica - Whitewear Ltd., 1987 78 (SCC), [1987] 1 S.C.R. 59 at 70-85. See, also, 885676 Ontario Ltd. (Trustee of) v. Frasmet Holdings Ltd. (1993), 1993 9403 (ON SC), 17 C.B.R. (3d) 64 at 71-73 (Ont. Gen. Div.). Relying on these authorities, the application judge at p. 295 of his reasons, correctly summarized the legal principles governing letters of credit:
A letter of credit is a specialized form of commercial credit. It is an autonomous contract between the issuer, normally a bank, and the beneficiary, normally a supplier, customer with a possible warranty claim, or creditor of the bank’s customer. The issuer’s customer is not a party to the letter of credit. The letter of credit is independent of any agreement or the equities between the beneficiary and the issuer’s customer or the issuer and its customer. Subject to fraud, the letter of credit is payable by the issuer in accordance with its terms, independent of the performance of the underlying contract for which the credit was issued. The funds paid are those of the issuer, not its customer . . .
[5] On the basis of these principles, whether Clarica was entitled to draw on the letter of credit, and, if so, in what amount, is a matter between it and the bank that issued the letter of credit. In making payment pursuant to Clarica’s demand, the bank adhered to its obligations under the letter of credit. The funds which it paid to Clarica were its property, not that of Lava. Had Clarica not drawn on the letter of credit, the balance remaining available to Clarica under the letter of credit would continue to be the property of the bank. In such circumstances, neither Lava’s receiver and manager, nor its trustee in bankruptcy, would have any claim on the undrawn portion of the security represented by the letter of credit. In my view, the fact that Clarica had obtained these funds as a result of its demand under the letter of credit places Richter in no better position than it would have been in had Clarica not issued its demand. This is because the funds available as security under the letter of credit at all times were the property of the bank.
[6] As I have noted, the bank was not a party to the proceedings. No doubt the bank received some form of consideration from Lava for issuing the letter of credit. However, the record is silent on the nature of the consideration. Nor is there any evidence that the receiver and manager had received an assignment of the bank’s rights against Lava sufficient to give it the legal right to recover the funds advanced under the letter of credit. The receiver does not stand in the shoes of the bank. Applying the principles that pertain to the autonomy of letters of credit, there is no reason why Clarica is required to account to the receiver, Richter, for the $677,979.24, which it drew on the letter of credit.
[7] In fairness to the application judge, he was alert to the problem faced by Richter. Clarica took the same position respecting Richter’s legal rights before him as it did before this court. The application judge considered this issue at pp. 296-297 of his reasons for judgment. He recognized that the funds paid by the bank under the letter of credit were its property, not Lava’s property, and that they did not “vest” in the receiver. He speculated that the bank’s payment to Clarica “might” give it a claim against Lava, but acknowledged that there was no evidence of any payment by Lava to the bank pursuant to such a claim. However, in his view any claim that the bank might have against Lava was limited to the amount drawn by Clarica in excess of its statutory entitlement. This analysis led to the application judge’s conclusion at pp. 296-97:
Assuming the Bank was entitled to recover full reimbursement from Lava, the Landlord, having drawn more than was secured by the Letter of Credit and knowing from the Letter of Credit that it was for the account of Lava, must account to the Trustee and Receiver for any realization under the Letter of Credit in excess of the obligations under the Lease secured by the Letter of Credit arising prior to termination.
[8] I am unable to accept this conclusion. It is based on an assumption that is unsupported by the record. It also implicitly assumes that the bank had assigned to Richter its claim to recover full reimbursement from Lava for the amount it paid to Clarica in excess of Clarica’s statutory entitlement.
[9] In summary, on the basis of the findings of the application judge, the record and the autonomy of letters of credit, it appears that there are at least two situations in which the trustee and manager of Lava may have a legal right to obtain redress from Clarica. The first would be if the bank had assigned to the receiver any claim that it had against Clarica. To succeed, the bank or the receiver as assignee of the bank’s interest, would have to prove that Clarica acted fraudulently as that is the only basis on which an issuer of a letter of credit can obtain redress from the beneficiary. The second situation is if Lava had reimbursed the bank for the amount drawn by Clarica on the letter of credit, Lava, or its receiver, may have a claim against Clarica for breach of clause 26.01(b)of the lease for the amount of the improper draw by Clarica. As the record contains no evidence of either situation, and as the application judge made no finding of fraud against Clarica, the receiver had no legal right to the relief that it requested in its application. Whether or not the bank has a claim against Clarica is not for this court to decide.
[10] For all of the above reasons the appeal is allowed, the judgment of the application judge is set aside and there will be an order dismissing the application. Clarica is to have its costs of the application and the appeal on a partial indemnity scale. We would fix the costs of the appeal in the amount of $10,000.
RELEASED: June 27, 2002
“S. Borins J. A.” “I agree R. Roy McMurtry C.J.O.” “I agree Dennis O’Connor A.C.J.O.”