Morgan Creek Residential v. Kemp

entitled to subrogation under the California Uniform Commercial Code. We shall therefore affirm the judgment.

BACKGROUND

In the operative pleading—the “FIRST AMENDED COMPLAINT FOR UNJUST ENRICHMENT, MONEY PAID, EQUITABLE CONTRIBUTION FROM CO-OBLIGORS, AND SUBROGATION”—plaintiff alleged as follows:

Plaintiff is a land developer formerly entitling and developing real estate in a residential development known as Morgan Creek. Defendants are developers and/or merchant builders engaged in entitling and developing real estate and/or homes for sale to the public in the Morgan Creek Development.

One of the planned amenities of the Morgan Creek Development was a golf course, golf club and clubhouse (the Amenities) to serve the surrounding developments. The ownership of the Amenities was in Morgan Creek Golf Club, LLC (the Golf Club), the members of which were West Placer Golf, LLC, Stonebridge Golf JV, LLC (Stonebridge), and the Stonebridge Group (TSG). Defendant Kemp was a principal of TSG. Defendant Haws was a principal of Stonebridge and TSG. The other individuals named as defendants were principals of defendant Lakemont Homes, which was the managing member of West Placer Golf, LLC. These Lakemont defendants are not parties to this appeal.

During the course of development, the Golf Club applied for a $10 million loan from Citicapital Commercial Corporation (Citicapital) in order to complete the golf course. As a condition of the loan, Citicapital required loan guarantees from all of the named defendants. The guarantees were as follows: Kemp up to the sum of $800,000; Haws up to the sum of $800,000; Lakemont Homes up to the sum of $1.6 million; and the individual Lakemont principals up to the sum of $400,000 each. The written guarantees, totaling $4,800,000 were submitted to Citicapital.

Citicapital subsequently advised the Golf Club, through its members West Placer Golf, LLC, Stonebridge and TSG, that the guarantees were insufficient. The Golf Club, through its members, requested that plaintiff loan or advance additional sums in order to complete the golf course. Plaintiff agreed and advanced and loaned the sum of approximately $2.8 million to West Placer Golf, LLC, the operating member of the Golf Club, to complete the golf course.

Additionally, at the request of the Golf Club and defendants, plaintiff obtained and underwrote an unconditional letter of credit in the sum of $1.4 million for the benefit of Citicapital, as security for the loan. The issuing bank was Northern Trust Bank. The terms of the letter of credit allowed Citicapital to call the letter of credit upon any default in the loan from Citicapital to the Golf Club.

The Golf Club’s $10 million loan application to Citicapital was thereafter reduced to $6.5 million. Citicapital approved the $6.5 million loan (the Loan), and the Golf Club commenced construction of the golf course. The Loan was secured by a note and deed of trust on the real property and personal property comprising the golf course and other Amenities (the Property).

In July 2004, several unpaid contractors filed mechanic’s liens against the real property on which the golf course was being built. As a result of this and other issues, Citicapital gave notice of the Loan default and opportunity to cure. The Golf Club, through its members, failed to take any action to cure the Loan default.

Citicapital then called the letter of credit and was paid the sum of $1.4 million by Northern Trust Bank. As a result of the contractual relationship with Northern Trust Bank, plaintiff was required to and did immediately provide the sum of $1.4 million to Northern Trust Bank to satisfy the draw on the letter of credit.

The $1.4 million drawn down on the letter of credit and obtained by Citicapital was used to reduce the outstanding principal of the Loan from $6,173,738.68 to $4,773,738.68. It was not used to cure the default under the Loan. As a result of the draw on the letter of credit and reduction of the outstanding principal of the Loan, the amount of remaining secured debt on the Property was reduced to an amount substantially equal to the fair market value of the Property.

After the draw on the letter of credit and reduction of the outstanding principal of the Loan by $1.4 million, the Lakemont defendants entered into an agreement with Citicapital, pursuant to which the Lakemont defendants sold the assets of the Golf Club, including the Property, to themselves— taking ownership in a new entity known as Step Golf Associates, LLC—and obtained restated and restructured financing from Citicapital in a loan amount already reduced by the $1.4 million draw on the letter of credit, in the sum of approximately $4.7 million (the New Loan).

The first two counts of the complaint, which are not at issue in this appeal, alleged unjust enrichment and money paid as against the Lakemont defendants.

and independent of the underlying transaction between the beneficiary and the issuer’s customer. [Citations.] 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.] The issuer of a letter of credit cannot refuse to pay based on extraneous defenses that might have been available to its customer. [Citation.] 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. [Citation.]” (Western Security Bank, supra, 15 Cal.4th at pp. 246-247.)

“[Commercial Code] section 5114, subdivision (1) provides that ‘[a]n issuer 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.’ The California code comment to section 5114 states, ‘Subdivision (1) reflects the concept that the letter of credit is independent from the underlying sales contract.’ (23B West’s Ann. Cal. U. Com. Code (1964 ed.) § 5114, p. 718.) This unique feature, referred to as the ‘independence principle,’ is the primary characteristic of a letter of credit. Absent fraud, the issuer must pay upon proper presentment regardless of any defenses the applicant for the letter of credit may have against the beneficiary arising from the underlying transaction. (See, e.g., Lumbermans Acceptance Co. v. Security Pacific Nat. Bank (1978) 86 Cal.App.3d 175 , 178 [ 150 Cal.Rptr. 69 ].) Thus, the issuer of a letter of credit is never entitled to defend against payment based on extraneous defenses which might have been available to the primary obligor.” (San Diego Gas & Electric Co. v. Bank Leumi (1996) 42 Cal.App.4th 928 , 933-934 [ 50 Cal.Rptr.2d 20 ] (San Diego v. Leumi).)

Thus, when Citicapital called the unconditional letter of credit furnished by plaintiff, neither plaintiff nor the issuer, Northern Trust Bank, could assert any defenses (except fraud) to stop Citicapital from collecting on the letter of credit. (See San Diego v. Leumi, supra, 42 Cal.App.4th 928 , 933-934.)

“To the extent that resort to analogy is appropriate for such a singular legal creation as the standby letter of credit, its closest relative would seem to be cash collateral.” (Western Security Bank, supra, 15 Cal.4th at p. 251, fn. 8.)

2. The Guarantees

A guarantee is a form of suretyship obligation. (Civ. Code, § 2787, see fn. 6, ante.)

As sureties, Kemp and Haws would have defenses to demands by Citicapital which were not available to plaintiff. Thus, Civil Code section 2845 says, “A

surety may require the creditor, subject to Section 996.440 of the Code of Civil Procedure [motion to enforce liability on bond given in an action or proceeding], to proceed against the principal, or to pursue any other remedy in the creditor’s power which the surety cannot pursue, and which would lighten the surety’s burden; and if the creditor neglects to do so, the surety is exonerated to the extent to which the surety is thereby prejudiced.” (See Cadle Co. v. World Wide Hospitality Furniture, Inc. (2006) 144 Cal.App.4th 504 , 514, fn. 7 [ 50 Cal.Rptr.3d 480 ].) In its reply brief, plaintiff concedes the applicant of a letter of credit is unable to assert suretyship defenses against the creditor.

Because Kemp and Haws had suretyship defenses available to them, and plaintiff, as an applicant of a letter of credit did not, these parties did not share the same level of liability to Citicapital. Consequently, plaintiff has no viable claim for contribution against Kemp and Haws. (Weinberg Co. v. Heller, supra, 73 Cal.App. at p. 779.)

3. Plaintiff’s Arguments

We shall address various arguments advanced by plaintiff in opposition to our conclusion.

Plaintiff concedes there are distinctions between letters of credit and guarantees. Plaintiff’s reply brief acknowledges that “with a letter of credit, the beneficiary bank can count on being able to call the letter of credit without having to worry about suretyship defenses . . . .” Plaintiff’s reply brief further “concedes that if a beneficiary bank calls a letter of credit, the issuing bank has to pay the beneficiary bank without regard to any suretyship defenses.”

However, plaintiff argues the statutory directive—that a letter of credit is not a form of suretyship obligation (Civ. Code, § 2787, see fn. 6, ante)— merely governs the relationship between the parties to the letter of credit transaction, not the relationship between the applicant and others. However, plaintiff fails to persuade, because no such limitation appears in the statute.

In arguing that the statute is limited to the relationship between parties to the letter of credit transaction, plaintiff notes the 1994 amendment (adding to Civ. Code, § 2787 the provision that a letter of credit is not a form of suretyship obligation) was part of a bill enacted to abrogate the holding of a Court of Appeal decision which held an issuing bank could assert defenses under an antideficiency statute (Code Civ. Proc., § 580d) to prevent a beneficiary bank from drawing down on a letter of credit. Western Security Bank, supra, 15 Cal.4th 232 , which reversed the judgment in the abrogated

Court of Appeal case, noted, “The Legislature made its purpose explicit: ‘It is the intent of the Legislature in enacting Sections 2 and 4 of this act [neither of which amended Civil Code section 2787] to confirm the independent nature of the letter of credit engagement and [f] . . . 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.)” (Western Security Bank, supra, 15 Cal.4th at p. 242.) This expression of legislative intent says nothing about the intent of the amendment of Civil Code section 2787. (See Western Security Bank, supra, at p. 242, noting § 2 of the bill added an antideficiency statute excluding letters of credit from the antideficiency laws, and § 4 made nonsubstantive changes to § 5114 [assignment of proceeds of letter of credit].)

In support of its argument that the distinction between letters of credit and suretyship obligations applies only to parties to the letter of credit transaction, plaintiff quotes from Western Security Bank, supra, 15 Cal.4th at page 248, that “the rules applicable to surety relationships do not govern the relationships between the parties to a letter of credit transaction.” However, plaintiff reads too much into this quote. The dispute in Western Security Bank was between the parties to the letter of credit transaction. (Id. at pp. 238-240.)

Plaintiff cites Matthews v. Hinton (1965) 234 Cal.App.2d 736 [ 44 Cal.Rptr. 692 ], for the proposition that “[w]hether one is a surety depends not so much upon his relation with the creditor as upon his relation to the principal debtor.” (Id. at p. 740.) However, in Matthews, which in any case predated the 1994 legislation at issue in this case, this court did not deal with any letter of credit but merely concluded that landowners who, together with their sublessees, signed a trust deed as principals, subjected themselves to primary liability. (Id. at p. 741.)

We conclude plaintiff fails to show that the statutory distinction between letters of credit and suretyship obligations should be limited to parties to the letter of credit transaction. Nothing in the statutory language contains the limitation urged by plaintiff.

Plaintiff contends there is no reason why the distinction between a letter of credit and other types of security should eliminate the right of contribution. However, the reason is that equitable contribution is founded on the premise that the plaintiff and the defendant share the same level of liability. (Jessup Farms v. Baldwin, supra, 33 Cal.3d at p. 650, fn. 7; RLI Ins. Co. v. CNA Casualty of California, supra, 141 Cal.App.4th at p. 84; Weinberg Co. v. Heller, supra, 73 Cal.App. at p. 779.) As we have explained, an applicant of

an unconditional letter of credit does not share the same level of liability with a guarantor. Insofar as plaintiff bemoans this result as harsh formalism elevating form over substance, plaintiff must take his complaint to the Legislature, which codified the distinction between letters of credit and sureties. (See fn. 6, ante.) Since this is a matter of legislative fiat, plaintiff’s reliance on (subrogation) cases from other jurisdictions is misplaced.

Plaintiff argues defendants Kemp and Haws provide no authority for their implied premise that the affirmative defenses applicable in an action by the principal to obtain payment from a guarantor would automatically apply to an action for contribution from a co-obligor. In plaintiff’s view, defendants Kemp and Haws are arguing they have affirmative defenses that they should be able to raise to the contribution action. Plaintiffs say the subject of affirmative defenses is premature at the demurrer stage. However, plaintiff misconstrues defendants’ position and misses the point. Kemp and Haws argue the alleged default related to mechanic’s liens rather than a payment default on the Citicapital loan and, while any default might trigger Citicapital’s right to call on the letter of credit, only a payment default by the Golf Club would trigger the right to collect on the guarantees. Certainly, this issue cannot be resolved at this stage, since the guarantees are not part of the record. However, we need not resolve this issue in order to affirm the judgment. The demurrer does not depend on the assertion of affirmative defenses to the contribution claim. Rather, plaintiff has to be able to allege it shared the same level of liability with defendants Kemp and Haws in order to sue them for contribution. Plaintiff cannot do so.

We conclude plaintiff, as a letter of credit applicant, had a different level of liability from Kemp and Haws, as guarantors, and therefore plaintiff has no viable claim for contribution against Kemp and Haws.

Plaintiff’s case is not helped by its allegation that all defendants specifically asked plaintiff to put up the letter of credit. Every party to this transaction was a big boy. Nor does it matter that plaintiff says it would not have obtained the letter of credit had it known the outcome.

We conclude the trial court properly sustained the demurrer without leave to amend as to the contribution count.

HI. Subrogation

Plaintiff contends its complaint states a viable claim for subrogation under section 5117 (see fn. 5, ante), in that plaintiff is subrogated to any rights of Citicapital against defendants Kemp and Haws. Plaintiff claims it can assert Citicapital’s rights under the written guarantees to obtain pro rata contribution from Kemp and Haws. We disagree.

applicant, by subrogation, to circumvent Civil Code section 2787 and step into Citicapital’s separate rights against third parties not in default to the beneficiary and not liable for the portion of the indebtedness paid by the call on the letter of credit.

Plaintiff says that, to understand its conclusion, we must first understand the historical differences between letters of credit and guarantees, and the problem that section 5117 was adopted to address. Plaintiff notes that, before the 1996 enactment of section 5117, an issuing bank’s obligation to pay a beneficiary bank on a letter of credit was independent of any suretyship defenses (pursuant to common law codified in Civ. Code, § 2787, see fn. 6, ante)—a principle known as the “independence principle,” “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.]” (Western Security Bank, supra, 15 Cal.4th at p. 237.) The independence principle deprived the issuing bank of a common law right of equitable subrogation.

Section 5117, a part of the California Uniform Commercial Code, removed that impediment. As explained by the California Uniform Commercial Code comment: “By itself this section does not grant any right of subrogation. It grants only the right that would exist if the person seeking subrogation ‘were a secondary obligor.’ (The term ‘secondary obligor’ refers to a surety, guarantor, or other person against whom or whose property an obligee has recourse with respect to the obligation of a third party. [Citation.] If the secondary obligor would not have a right to subrogation in the circumstances in which one is claimed under this section, none is granted by this section. In effect, the section does no more than to remove an impediment that some courts have found to subrogation because they conclude that the issuer’s or other claimant’s rights are ‘independent’ of the underlying obligation. If, for example, a secondary obligor would not have a subrogation right because its payment did not fully satisfy the underlying obligation, none would be available under this section. The section indorses the position of Judge Becker in [dissent] in Tudor Development Group, Inc. v. United States Fidelity and Guaranty, 968 F.2d 357 (3rd. Cir. 1991).” (Com. on Cal. U. Com. Code, 23B West’s Ann. Cal. Code (2002 ed.) foll. § 5117, p. 255.)

Plaintiff relies heavily on Judge Becker’s dissent in Tudor Dev. Group, Inc. v. U.S. Fid. & Guar. Co., supra, 968 F.2d 357 (Tudor), endorsement of which is reflected in section 5117. However, the dissent does not support plaintiff’s position in this case.

The issue in Tudor, supra, 968 F.2d 357 , was whether a bank that issued a standby letter of credit could qualify for equitable subrogation to the rights of

its defaulting customer in the underlying commercial transaction. (Tudor, supra, 968 F.2d at p. 364 (dis. opn. of Becker, J.).) The Tudor majority defined the issue as “whether a bank which has honored a letter of credit may be equitably subrogated to the rights of its customer vis-a-vis funds paid to the customer by a party unrelated to the original letter of credit.” (Id. at p. 358.) In Tudor, after a default by a general manager on a real estate project, the issuer of the letter of credit (Dauphin Deposit) paid the beneficiary (Township) but was not reimbursed by the owner/developer (Associates) which applied for the letter of credit. (Ibid.) In addition to being the applicant on the letter of credit, Associates was also the primary obligor on the underlying obligation to the Township. (Ibid.) Dauphin Deposit and Associates’ assignee made competing claims to funds paid into court by a surety which had issued performance bonds (USF&G). USF&G paid the money into court pursuant to a settlement with Associates, in which Associates kept part of the money, and the rest was paid into court to be held pending resolution of the various parties’ claims to the fund. (Id. at p. 359.)

Tudor, supra, 968 F.2d 357 , held the bank, which was satisfying its own primary liability rather than liability of another when it made payment under the letter of credit, could not avail itself of the common law remedy of equitable subrogation. (Id. at p. 358.)

Plaintiff quotes from the Tudor dissent (endorsed by § 5117), that subrogation should not be foreclosed (though the dissent would have left it to the trial court to balance the equities in the particular case). (Tudor, supra, 968 F.2d at pp. 368, 371.) The dissent reasoned, “Guarantors and sureties pay their own legal obligations, yet they are still entitled to seek equitable subrogation as well as contractual subrogation. That is because in meeting their own ‘primary’ obligations, guarantors and sureties are also ‘secondarily’ liable to pay others’ debts. So far as the common law is concerned, the same logic should apply to issuers of letters of credit . . . .” (Id. at p. 366.) The dissent also said, “The independence principle ensures the beneficiary of prompt payment and basically determines that the beneficiary will have the dollars in its pocket if there is a dispute between it and the customer over the underlying transaction. [Citation.] . . . [T]his distinguishes a letter of credit from an ordinary guaranty: a guaranty is not independent in this sense, and guarantors may generally assert defenses available to the party whose obligation is guaranteed, [f] . . . The independence principle undoubtedly requires the issuer to pay first, without looking through to the underlying transaction. Subrogation should therefore be unavailable before the issuer has paid the beneficiary. Once the issuer has done so, however, ... the purpose of the independence principle has been served: the beneficiary has the money. [|] Insistence on perpetual separation is thus pointless formalism. [Fn. omitted.] On a more pragmatic level, I would agree that if the possibility of subsequent subrogation would discourage issuers from honoring already-issued letters of

credit [fn. omitted], then subrogation should not be permitted, because that would undercut the purposes of Article 5 [of the Uniform Commercial Code]. But I cannot see why that would be so. If anything, the ««availability of subsequent subrogation might discourage issuers from honoring the letters because they would have one less means of obtaining reimbursement.” (Id. at p. 368.)

The factual scenario in Tudor, supra, 968 F.2d 357 , did not require a judicial determination whether to order a surety to pay a party to a letter of credit. Although the money at issue in Tudor came from a surety rather than the party primarily liable on the underlying obligation, the money was already made available—through the settlement efforts of Associates, not through a court order for equitable subrogation from a surety to a letter-of-credit applicant. Moreover, Associates was not a mere letter-of-credit applicant but also the primary obligor on the underlying obligation.

Thus, we do not believe the Tudor dissent goes so far as to support plaintiff’s position that a party to a letter of credit can seek equitable subrogation from a surety which is not primarily liable on the underlying obligation. We note this is not a case, about which the Tudor dissent expressed concern, where one party to a letter of credit may receive an undeserved windfall. (Tudor, supra, 968 F.2d at p. 369.)

Plaintiff also cites a federal case from New York, but without any discussion other than to say it discussed the Uniform Commercial Code and found an issuer was subrogated to the rights of the beneficiary. We have no need to consider the New York case or the additional cases from other jurisdictions cited for the first time in plaintiff’s reply brief.

Plaintiff argues the Legislature intended that Civil Code section 2787 (see fn. 6, ante), which says letters of credit are not sureties, should not prevent a party such as plaintiff from asserting a claim of equitable subrogation under section 5117. Plaintiff cites no authority supporting its assertion of legislative intent.

No California court has discussed the relationship between section 5117 (see fn. 5, ante) and Civil Code section 2787 (fn. 6, ante). (See Western Security Bank, supra, 15 Cal.4th at pp. 237-238, fn. 2, & p. 248 [addressing letter of credit which issued before enactment of § 5117].)

We do not see a conflict between the statutes. Civil Code section 2787 prevents plaintiff from seeking contribution against guarantors who signed on for lesser liability than plaintiff. Section 5117 might allow plaintiff to go after the debtors on the underlying obligation, but it does not allow plaintiff to go after Kemp and Haws as mere guarantors.

Plaintiff’s attempt to use a subrogation theory to obtain apportionment from others who were not primarily liable is inconsistent with the aim of subrogation. (Caito, supra, 20 Cal.3d at p. 704 [doctrine of equitable subrogation includes every instance in which one person pays a debt “ ‘for which another is primarily liable, and which in equity and good conscience should have been discharged by the latter’ ”].) “The different equitable principles on which contribution and subrogation are based are reflective of different underlying public policies. The aim of equitable subrogation is to place the burden for a loss on the party ultimately liable or responsible for it and by whom it should have been discharged, and to relieve entirely the insurer or surety who indemnified the loss and who in equity was not primarily liable therefor. [Citations.] On the other hand, the aim of equitable contribution is to apportion a loss between two or more [parties] who cover the same risk, so that each pays its fair share and one does not profit at the expense of the others. [Citations.] Although these underlying policy aims may be similar, they are nonetheless distinct. Confusing the doctrines with each other necessarily blurs the corresponding policies behind them, with the unintended result in some cases of defeating those very policy goals.” (Fireman’s Fund, supra, 65 Cal.App.4th at p. 1296, italics added [concluding that California law recognizes a direct right of action for equitable contribution between coinsurers on the same risk, entirely independent of any of the requirements for bringing a cause of action based on equitable subrogation to the rights of the insured].)

Plaintiff argues its interpretation of section 5117 does not conflict with Civil Code section 2787, because the Civil Code applies in the context of a dispute between an issuing bank and a beneficiary bank, while the California Uniform Commercial Code applies in the context where a party to the letter of credit tries to obtain equitable contribution from a stranger to the letter of credit transaction. The distinction is not persuasive.

Plaintiff argues that, even if its interpretation creates a conflict between the two statutes, section 5117 would control as the later-enacted statute. We reject plaintiff’s interpretation.

Though not argued by plaintiff, we note that, if the doctrine of equitable subrogation applies, the trial court should be given the opportunity to balance the equities and exercise its discretion. (Dieden v. Schmidt (2002) 104 Cal.App.4th 645 , 654 [ 128 Cal.Rptr.2d 365 ].) We conclude plaintiff’s complaint fails to allege a viable claim for application of the doctrine of equitable subrogation, and therefore plaintiff is not entitled to have the trial court balance the equities.

We conclude the trial court properly sustained the demurrer without leave to amend. On appeal, plaintiff offers no possible amendment that could cure the complaint’s defects.

DISPOSITION

The judgment is affirmed. Defendants Kemp and Haws shall recover their costs on appeal. (Cal. Rules of Court, rule 8.276(a)(1)-(2).)

Blease, Acting P. J., and Cantil-Sakauye, J., concurred.

Appellant’s petition for review by the Supreme Court was denied October 31, 2007, S155893.