The Attorney's Fee and Jury Trial Provisions
of Revised Article 5 Require Change

UCC Revised Article 5 has now been enacted, with no amendments, in 14 states. As the new letter of credit law wends its way through the local review process in each state, howwever, some groups are starting to take a closer look at certain of its provisions. While most of the revised provisions appear to have general support, there are at least two which have generated lively discussions. The first, Section 5-111(e), which provides for mandatory attorneys' fees to a prevailing party, caused a fair bit of controversy in the final approval stages, and the language was changed from precatory to mandatory in the final draft. The second, Section 5-108(e), which limits the right to a jury trial, produced no controversy until after the final draft was released. Both sections warrant thoughtful consideration by bar committees, law revision commissions, and other groups, as they determine whether or not to recommend adoption of these provisions.

I. MANDATORY ATTORNEY'S FEES

Section 5-111(e) creates a "loser pay rule", providing as follows:

Reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article.

This provision overturns the "American rule" of having each party pay its own legal fees. Since fees and expenses "must be awarded", the provision eliminates a judge's discretion to disallow a fee award in cases of hardship. This "loser pay" rule is even more strict than the English rule, where courts retain some discretion to mitigate excessive hardship caused by a fee shift.

Parties arguing in favor of the rule assert that it will deter both frivolous dishonor on the part of issuers, and frivolous suits on the part of beneficiaries. It has been asserted that "users" as well as issuers favored the rule. However, the users who participated in the Article 5 drafting sessions were representatives of corporations such as Exxon, Occidental Petroleum, and Mobil Oil. Their concern, understandably, was that after having endured the cost and delay of litigating a wrongful dishonor suit, they should be made whole by having their attorneys' fees paid. The possibility of losing and having to pay the banks' attorneys' fees would obviously not deter such companies from bringing a wrongful dishonor suit against a bank.

The problem with the mandatory attorneys' fee provision is in its impact on mid-sized and small companies, where the risk of paying the attorneys' fees of a large bank could be a major deterrent to seeking redress through the courts. These smaller companies had no representatives at the drafting committee sessions. Nonetheless, they make up a substantial portion of letter of credit users and contribute in healthy measure, particularly through exports, to the growth of the economy. These companies have no incentive to bring "frivolous" lawsuits against banks. They simply want to get paid for goods they ship. When such companies sue a bank, the most common framework is a situation where they have shipped goods to a buyer, have not been paid under the letter of credit, and the buyer has become insolvent. The letter of credit, which they believed was their protection against buyer insolvency, has failed to provide such protection.

The loss of payment can have a very major impact on a small company. The mandatory attorney's fee provision of section 5-111(e) will have an additional adverse impact. Having already suffered damage by losing payment for goods shipped, a small company faces difficult prospects in suing on a letter of credit. The substance of letter of credit law effectively protects banks, and makes it hard for a beneficiary to prevail. Moreover, as in all litigation, one-shot players such as beneficiaries tend to do less well in lawsuits against repeat players, such as banks. Added to this, the punitive effect of possibly losing and having to pay the bank's attorneys' fees will certainly deter litigation by these companies. A mandatory shift of attorneys' fees to the losing party will deter not only weak cases, but cases that could reasonably win, thereby reducing access to the courts. The mandatory provision is inescapably and unnecessarily punitive, since it provides no escape for a party undeserving of punishment. Adding a mandatory shift of attorneys' fees to substantive law that is already favorable to banks will come rather close, in some cases, to granting unreviewable discretion in banks to dishonor letters of credit.

The provision may also encourage dilatory tactics by defendants, to drive up costs of litigation in order to encourage faster settlement on the part of plaintiffs, who face the risk that those costs will be shifted to them. This was the experience in Florida, after the legislature in 1980 enacted a two-way mandatory fee-shifting statute applicable to medical malpractice claims. Statistics showed that the provision had a deterrent effect on the willingness of plaintiffs to adjudicate their claims, and that where plaintiffs did sue, defendants drove up the costs of litigation in order to coerce settlements. The Florida legislature repealed the statute in 1985.

The background of the mandatory attorney's fees provision shows that despite being touted as a benefit for beneficiaries, it was in fact a major benefit for banks. An initial draft of revised Article 5 included a provision imposing consequential damages upon banks who wrongfully dishonored. This would have permitted seller/beneficiaries to recover not only the face amount of the dishonored draft but also other damages to their business that flowed from the wrongful dishonor. The banks objected, and were supported in their position by the Federal Reserve, which believed such an unquantified exposure would create regulatory problems. A suggested compromise was to eliminate consequential damages, broaden the definition of good faith, and impose mandatory attorney's fees as a way of discouraging frivolous dishonor. The ultimate result of the proposed "compromise" was that consequential damages were eliminated, the definition of the duty of good faith was kept narrow, and mandatory attorneys' fees were provided for the prevailing party. It was a solution that was more than acceptable to the banks.

A two-way mandatory attorneys' fees provision in the U.S. like that proposed in section 5-111(e) is rather unusual. While many statutes shift attorneys' fees, it is usually a one-way provision, that is, attorneys' fees are provided to prevailing plaintiffs, as part of a public policy to deter certain conduct by defendants. Civil rights statutes, as interpreted by the courts, antitrust statutes, and consumer fraud statutes, to name a few, provide that attorneys' fees be paid to a prevailing plaintiff. To discourage frivolous dishonor, Section 5-111(e) could be amended to follow this model and provide a one-way fee award to a prevailing beneficiary, in order to make the company whole after proving wrongful dishonor. It would not punish a beneficiary who brought a reasonable, if unsuccessful suit.

An alternative would be for the provision to be changed from mandatory to precatory, from "must" to "may". Providing the court with some discretion not to shift fees would be more consistent with the goal of discouraging the disfavored conduct of wrongful dishonor. Such judicial discretion would also promote equal access to the justice system by not chilling the right to bring a reasonable lawsuit.

The Committee on Federal Legislation of the Bar Association of the City of New York, in a report in April, 1996, came to this conclusion after examining proposed legislation and other proposals concerning various kinds of fee shifting:

A strict "loser pays" rule...runs the risk of overdeterrence -- it may well discourage meritorious plaintiffs and defendants from litigating.... Frivolous litigation is undoubtedly a problem, but given the substantial risks that a "loser pays" provision will deter meritorious litigation, we believe that frivolous litigation should be regulated by more focused remedies such as Rule 11. We are uncomfortable with a proposal to deter frivolous litigation, where no finding is ever made that the litigation pursued was in fact frivolous.

At least one state Law Revision Commission has decided to recommend to its legislature that it adopt Section 5-111(e) with precatory rather than mandatory language. The New Jersey Law Revision Commission, in its Final Report, recommended changing "must" to "may", based on its finding that the mandatory provision "may have a chilling effect on the beneficiary's exercise of its right to sue on a letter of credit." It also found that while discouraging frivolous litigation may be a worthy goal, New Jersey already has enacted a frivolous claims statute. The Commission concluded that the mandatory language of Section 5-111(e) is thus not needed for that purpose, and is undesirable in light of its chilling effect on potential plaintiffs.

II. JURY TRIAL RIGHT

In Section 5-108(e), the drafters inserted a sentence which impacts upon the right to a jury trial in both federal and state court. Section 5-108(e) provides as follows:

An issuer shall observe standard practice of financial institutions that regularly issue letters of credit. Determination of the issuer's observance of the standard practice is a matter of interpretation for the court. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice.

added. The second sentence removes all discretion from the court to determine in the first instance whether certain issues may be appropriate factual issues for a jury rather than for the court. In mandating that the court determine issuer liability, however, this provision comes into conflict with constitutional guarantees of a right to a jury trial for disputed issues of fact.

In considering the constitutional guarantee, it is important to look both at the Seventh Amendment to the United States Constitution, and at the various state constitutions. Although the Seventh Amendment has never been applied to the states through the due process clause of the Fourteen Amendment, it is nonetheless applicable to letter of credit cases which are tried in federal courts as a result of diversity jurisdiction. Simler v. Conner, 372 U.S. 221, 222 (1962). With respect to the fifty states, all provide some form of right to a civil jury trial, and in forty-eight of the fifty (all but Louisiana and Colorado), the right is constitutionally based.

The essential constitutional requirement is that "questions of fact in common law actions shall be settled by a jury". Walker v. New Mexico & Souther Pacific R. Co., 165 U.S. 593, 596 (1897).

It is well-settled that the jury right also reaches beyond common law forms of action to statutory actions, if those actions are analogous to common law actions existing at the time of the adoption of the jury right provision. Tull v. United States, 481 U.S. 412, 417 (1987). Letter of credit cases, which have ancient origins, and which almost always seek money damages, are legal actions for which a jury trial right is guaranteed.

The second sentence of Section 5-108(e) -- "Determination of the issuer's observance of the standard practice is a matter of interpretation for the court" -- raises three different questions and appears to mandate that the court decide them as questions of law: 1. What is the standard practice of the banking industry? 2. What did the issuer do? 3. Did the issuer's conduct comply with the standard practice? While the plain meaning of the sentence suggests that the judge must decide the second and third questions, the Official Comment to Section 5-108(e) also assigns to the judge the decision as to the first question of what the standard practice is:

Identifying and determining compliance with standard practice are matters of interpretation for the court, not for the jury. As with similar rules in Sections 4A-202(c) and 2-302, it is hoped that there will be more consistency in the outcomes and speedier resolution of disputes if the responsibility for determining the nature and scope of standard practice is granted to the court, not to a jury.

The Official Comment thus interprets Section 5-108(e) to mean that the court, not the jury, should both identify the standard practice and determine its nature and scope. Since the drafters properly considered standard practice to be a usage of trade, this Official Comment directly contradicts UCC 1-205(2), which provides that the existence and scope of a usage of trade are to be proved as facts. While UCC 1-205(2) is a "General Provision", which may be superseded by a specific statutory section in another UCC article, it is not superseded by an Official Comment, which is not law. Thus, the constitutional issue regarding who determines standard practice could be avoided by concluding that the Official Comment is trumped by UCC 1-205(2), and should be disregarded.

If one assumes, however, that the provision itself, upon fair reading, requires the court to determine what is standard practice, then one must consider whether the requirements of UCC 1-205(2) are constitutionally mandated, and therefore cannot be superseded by Section 5-108(e). While a complete analysis of this issue far exceeds the scope of this article, it should be noted that "standard practice" is anything but standard with respect to letters of credit. Paragraph 8 of the Official Comment to Section 5-108(e) makes this point quite clearly:

The standard practice referred to in subsection (e) includes (i) international practice set forth in or referenced by the Uniform Customs and Practice, (ii) other practice rules published by associations of financial institutions, and (iii) local and regional practice. It is possible that standard practice will vary from one place to another. Where there are conflicting practices the parties should indicate which practice governs their rights. A practice may be overridden by agreement or course of dealing. See Section 1-205(4).

Since "standard practice" will "vary from one place to another", and there are "conflicting practices", it is inevitable that there will be factual issues as to whether a practice is "standard", and what the "standard practice" actually is. On the other hand, certain international practices, such as those set forth in writing in the Uniform Customs and Practice for Documentary Credits, ICC Publication 500, 1993 Revision ("UCP"), are, under the general rules of interpretation of written documents, properly to be interpreted by the court, so long as they are clear and undisputed. When extrinsic evidence is necessary, because the terms are not clear, then it presents a question of fact for the jury if a material, disputed fact exists. Banca del Sempione v. Provident Bank of Maryland, 75 F.3d 951, 959 (1996).

Thus, the question of whether judge or jury should determine standard practice and whether determining standard practice in some situations raises issues that are constitutionally mandated for the jury permits no simple answer. The problem with Section 5-108(e), if it is read to require the judge to determine standard practice, is that it is overbroad in denying the judge any discretion to determine that some issues are more appropriately questions for the jury.

With respect to the second question -- what the issuer did -- this seems clearly be a question of fact for the jury, not the judge, at least where the conduct is disputed. In documentary compliance cases, there frequently is no dispute as to what the issuing bank did, so there may be no factual question on the issuer's conduct to go to a jury. If there is a disputed fact, however, its resolution is a jury function.

With respect to the third question -- whether the issuer's conduct complied with the standard practice -- it is not a simple matter to determine if such a question is constitutionally mandated to be determined by a jury rather than by a judge. There may well be times, however, when constitutional requirements would seem to mandate that a jury resolve this question. Knowing what the issuing bank did, and knowing what the standard practice was, may, for example, require a drawing of inferences in order to conclude whether the conduct of the bank met the standard. The drawing of such inferences is a factual finding, appropriately made by the jury.

Contrary to the assertion in the Official Comment that Sections 4A-202(c) and 2-302 provide support for mandating that factual issues be decided by the court, there is little, if any, support to be found there. Section 2-302 pertains to unconscionability, which has always been a question of equity. Assigning to a judge the power to determine if a contract is unconscionable is consistent with the fact that in matters of equity, there is no jury trial right. Since letters of credit have always been considered legal, not equitable matters, Section 2-302 provides no basis for restricting a jury trial right for letter of credit cases.

Section 4A-202(c) deals with the commercial reasonableness of a security procedure. The Official Comment to that section (which is combined with the Comment for 4A-203 and found following 4A-203), supports having a jury, rather than a judge determine whether a bank's conduct meets a particular standard.

The issue of whether a particular security procedure is commercially reasonable is a question of law. Whether the receiving bank complied with the procedure is a question of fact. (Emphasis added).

While one might disagree that "commercial reasonableness" can be legislated to be a question of law, it cannot be disputed, and the Comment clearly states, that the bank's compliance with the procedure is a question of fact. Comparing Section 5-108(e) to this provision, the interpretation of a written practice may well be a matter for the court, but the bank's compliance with that practice is a question of fact. Thus, a comparison with 4A-202(c) not only does not support having a judge determine an issuer's compliance with a standard, but makes clear that this is a fact question for the jury.

The New Jersey Law Revision Commission has recommended an interesting approach to Section 5-108(e). The Commission found the second sentence of the provision to be ambiguous. The Final Report of the Commission stated that if read to mean that the court "must determine the ordinary fact question of whether the issuer complied with standard practice", the provision might abridge the state constitutional right of a jury trial. The Report also stated that representatives of the National Conference of Commissioners on Uniform State Laws had testified that the sentence did not mean that the court was required to resolve factual disputes surrounding the conduct of the issuer, but rather that the court was merely required to determine the standard practice of financial institutions that regularly issue letters of credit. The Commission considered trying to resolve the ambiguity by a Comment, but determined that since Comments are not law, the better way was to recommend a non-conforming amendment to Section 5-108(e). It thus recommended deletion of the phrase "issuer's observance of", so that the second sentence of Section 5-108(e) would read, "Determination of the standard practice is a matter of interpretation for the court."

While this is clearly an improvement, since the judge is no longer mandated to determine what the issuer did and whether the issuer's conduct complied with the standard, it does not completely resolve the problem. Having the judge determine the standard practice is not a problem when the standard practice is clearly set forth in the UCP, and no extrinsic evidence is required. It is a problem, however, when the standard is not in writing, or when extrinsic evidence is required to establish what the written standard practice in fact means. A better solution, which would completely eliminate the problem, would be simply to delete the second sentence of Section 5-108(e), so the provision would read:

An issuer shall observe standard practice of financial institutions that regularly issue letters of credit. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice.

Deletion of the controversial second sentence would permit trial judges to continue to do in letter of credit cases what they do in so many other kinds of cases -- determine in the first instance what issues, if any, are disputed issues of fact, and send these issues to the jury. It is in denying a judge this function that the second sentence of Section 5-108(e) abridges the constitutional right to a jury trial.

Revised Article 5 is the culmination of years of effort to improve and clarify the provisions governing letter of credit law, and to harmonize them with international practice. While the effort has succeeded in large measure, Sections 5-111(e) and 5-108(e), as drafted, are flawed, and should be modified prior to enactment.

For further advice about revised Article 5, please contact Margaret L. Moses.