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Feb 2006
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February 01, 2006

The Use of Irrevocable Letters of Credit in Lieu of Stay Bonds

The jury has awarded a large judgment against your client, the court has rejected all of your post-trial motions, and the stay of execution is about to expire. Given the amount of the judgment, it is imperative to secure a stay pending appeal to ensure that the plaintiff will not immediately start seizing your client's assets. The knee-jerk reaction is to procure a stay bond, as MCR 7.209(E) contemplates. But there may be a better way.

This article discusses the irrevocable letter of credit as one possible alternative to obtaining a stay bond. Since bond companies will nearly always require collateral (including letters of credit!) before issuing a bond, a letter of credit will ordinarily be less expensive than a stay bond and may offer additional advantages. If the creditor will not stipulate to a letter of credit as the basis for a stay, a simple motion under MCR 7.209(E) is the appropriate vehicle for obtaining the trial court’s permission.

What is an irrevocable letter of credit?

Letters of credit were originally a product of the merchant banking system in Europe and consisted solely of a "letter" from a bank on behalf of its customer to a third party, promising payment in the event the customer defaulted. The modern letter of credit is more formal, but it serves essentially the same purpose. It is a form of guaranteed payment, issued by a bank on behalf of a borrower, that assures full payment of a debt if the borrower defaults on an obligation to a creditor. The creditor can "draw" on the letter by presenting specified documents to the bank for payment before the letter’s expiration.

As its name suggests, an "irrevocable" letter of credit is a letter that cannot be canceled. Thus, just like a bond, an irrevocable letter of credit guarantees that a judgment debtor's payment to a judgment creditor will be made timely and in the full amount of the judgment.

Irrevocable letters of credit as a substitute for bonds

MCR 2.614(A)(1) states that a plaintiff may execute on a judgment 21 days after entry, subject to certain post-judgment motions. While filing a claim of appeal does not, by itself, stay execution, MCR 7.209(A), the judgment debtor may move the trial court for a stay of execution, "with or without a bond as justice requires," MCR 7.209(E). Some alternate forms of security, such as cash or a securities bond under MCL 600.2631, are expressly recognized as permissible bond alternatives under MCR 3.604. But the broad language of MCR 7.209(E) suggests that other alternatives may also be acceptable, assuming the trial court approves.

Courts across the country have routinely exercised their discretion and allowed letters of credit as a basis for a stay pending appeal in lieu of a stay bond. For example, in Bishop v Mid-America Auto Auction, Inc, 1999 WL 169116 (D Kan, Apr 26, 1993), the defendants/appellants moved the court to approve two irrevocable letters of credit as security for payment of judgments entered against them, and to stay the judgments pending appeal. The plaintiff/appellee opposed the motion. The court showed no reservations whatsoever in allowing the defendants/appellants to substitute the letters of credit for the stay bond:

The court believes the letters of credit will provide sufficient security for the judgment and be less costly for the defendants. . . . Further, the court finds that it has inherent equitable authority to allow the acceptance of letters of credit or other forms of security in lieu of a supersedeas bond. Finally, this court would have the same jurisdiction over the issues regarding the letters of credit, as it would have over the supersedeas bond, so enforcement is not an issue. Finding the defendants’ arguments for approval of the letters of credit persuasive, the court will allow such security.

Id. at * 1 (emphasis added, citations omitted). Accord Ligurotis v Whyte, 951 F2d 818, 821 (CA 7, 1992) ("[C]ourts have recognized that the district court has the 'power to provide for a form and amount of security different from the supersedeas bond.' Along with the Second Circuit, we have noted that a letter of credit may serve as the equivalent of a supersedeas bond.") (citations omitted); Gaus v Conair Corp, 2003 WL 542652, at *2 (SD NY, Feb 14, 2003) ("I have decided to stay enforcement of the judgment for a period of ten days, during which time Conair may post either a supersedeas bond or an irrevocable letter of credit . . . .") (emphasis added); Home Mut Fire Ins Co v Jones, 969 SW2d 675, 676-677 (Ark Ct App, 1998) ("[W]e see no reason why a letter of credit cannot constitute an acceptable surety for purposes of a supersedeas bond."); Schatten v Glassman, 628 NW2d 666, 668 (Ill Ct App, 1993) (dismissing cross-appeal "challenging the trial court's refusal to allow [appellant] to raise objections to the amount and quality of the letter of credit filed by respondents during the pendency of the[] appeal.").

Although no Michigan Court of Appeals or Supreme Court opinion has specifically recognized that a letter of credit is adequate security to obtain a stay pending appeal, the Michigan Court of Appeals has recognized that a "premium paid by [a] defendant for [a] letter of credit" is a taxable cost in the event of appellate reversal, just like the premium on an appeal bond. Lewis v Grand Rapids Plastics, Inc, 1996 WL 33347806, at *1 (Mich Ct App, Dec 10, 1996). Accord Trans World Airlines v Hughes, 515 F2d 173 (CA 2, 1975); Whittle v Seehusen, 748 P2d 1382, 1388 (Idaho Ct App, 1987) ("We hold that posting the letter of credit was substantially equivalent to posting a supersedeas bond [for purposes of awarding costs]. The . . . cost of the letter of credit is reasonable and probably less than the premium of a surety bond"); cf. MCL 560.182(1)(e) (provision of the Subdivision Control Act, which requires road improvements to be secured by a certified check, surety bond or irrevocable bank letter of credit.).

Given that the premium for a letter of credit will invariably be smaller than the cost of an appeal bond and a letter of credit (serving as collateral for the bond), it is in the best interests of all parties for the court to accept the irrevocable letter of credit as security for an appeal. The real security in that case is not the bond, but the letter of credit itself. And there is no reason why the court should require the judgment debtor to incur the additional expense of obtaining a stay bond when it is willing to provide an irrevocable letter of credit for the full amount of the bond. In a high stakes case, a 1% bond premium (in addition to the letter of credit expense) could amount to hundreds of thousands of dollars.

There are benefits for the judgment creditor as well. All the creditor must do to obtain payment under the letter is to timely present the documents required to effect a draw. In contrast, the creditor might be required to return to court to enforce a bond against the surety company. In addition, a judgment debtor that prevails on appeal is entitled to recover reasonable costs, including stay bond premiums. MCR 7.219(F)(2). So there is a very real chance that a judgment creditor that forces a judgment debtor to incur the extra expense of a bond may end up paying for that heavy-handed negotiating ploy.

Practice Pointers

When negotiating an irrevocable letter of credit in lieu of a stay bond, there are several issues to keep in mind. The judgment creditor will, of course, want to ensure the financial fortitude of the financial institution issuing the letter of credit; a payment amount that is sufficient to cover the judgment plus all post-judgment interest and costs; and an expiration date that post-dates any likely date of final judgment (or alternatively, an evergreen clause that ensures the letter’s automatic renewal unless prior notice is given to the creditor). It should not be difficult to negotiate favorable terms on each of these items. If the judgment debtor refuses, then the judgment creditor can refuse to stipulate to a stay, and a court is likely to order any condition necessary to ensure the judgment creditor’s full protection.

The judgment debtor will want to carefully negotiate the language that triggers the judgment creditor's right to draw on the letter. For example, a negotiated provision might require the creditor to present to the financial institution a certified copy of a final judgment following the expiration of 21 days from the judgment's entry. Many other triggers are possible.

Finally, both parties will want to specify that the court in which the underlying dispute is pending will have jurisdiction over the parties and the issuing bank to resolve any disagreement regarding the letter or a draw. If the financial institution is not a resident of the state in which the suit is pending, it is advisable to secure from the institution a waiver of its objections to personal jurisdiction.

Conclusion

An irrevocable letter of credit is a sensible alternative to obtaining a bond to stay a judgment pending appeal. The parties can play an active role in negotiating the terms of the letter, the creditor can easily enforce its right to payment, and the debtor can save considerable expense. Michigan trial courts should readily grant motions that seek to substitute an irrevocable letter of credit for a stay bond, because the security provided by each is comparable.

* * *

John J. Bursch is a partner at Warner Norcross & Judd LLP, where he chairs the Firm's Appellate Practice Group. A former federal appellate judicial clerk, he is currently an elected member of the Michigan Appellate Practice Section Council and an editor for the American Bar Association’s Appellate Practice Journal. Mr. Bursch routinely assists other practitioners in proceedings before the Michigan Court of Appeals and Michigan Supreme Court. He can be contacted by telephone at 616.752.2474, by e-mail at jbursch@wnj.com, or through the Firm’s Web site at www.wnj.com.

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