Don't Require Named Person's Signature to Draw on Letter of Credit

When a powerful tenant gives you a letter of credit (L/C) as a security deposit, the L/C may require you to provide an explanatory certificate or affidavit to the bank that issued the L/C before you can draw on it. This explanatory certificate or affidavit will notify the issuing bank that the tenant violated the lease without curing (that is, fixing) the violation.

But many L/Cs we saw that require a certificate or affidavit contain a loophole: They name a person in your office—say, Joe Smith—and say that the certificate or affidavit must be signed by that person. They don't address what to do if that named person is no longer available to sign the certificate or affidavit. This puts your security deposit in jeopardy—if you try to draw on the L/C with another person's signature on the certificate or affidavit, the issuing bank could refuse to pay you.

Former Owner's Death Prevents Draw on L/C

A Pennsylvania owner discovered this problem the hard way. The tenant's L/C said that the explanatory certificate must be signed by the owner named in the lease. This was an individual. When he died, a new owner bought the space and took over the L/C. Because of an oversight, the new owner didn't amend the L/C's requirement that the former owner must sign the certificate. When the tenant violated the lease, the new owner presented the L/C and a certificate that he had signed. But the issuing bank refused to let the new owner draw on the L/C because the former owner hadn't signed the certificate. The new owner sued the issuing bank for nonpayment.

A Pennsylvania court ruled that the new owner couldn't draw on the L/C because he hadn't met the L/C's requirement that the explanatory certificate be signed by the owner named in the original lease—even though that individual had died. The court refused to make an issuing bank responsible for investigating whether a named signer was alive and then adjusting the L/C if he or she had died. “Such a result would destroy the assurance of prompt payment and lead to uncertainty regarding the requirements necessary to obtain payment,” said the court [Samuel Rappaport Family Partnership v. Meridian Bank].

Use General Description

To plug this loophole, make sure the lease requires that the L/C des-cribe in general terms those who can sign the certificate or affidavit, says Santa Monica attorney Susan Fowler McNally.

For example, the lease should require the L/C to say that any party authorized by the owner (or by the owner's successor) can sign the certificate or affidavit on the owner's behalf, says McNally. By not specifying the required signer by name, you decrease the risk that his or her death will prevent you from drawing on the L/C, McNally explains. And by allowing authorized representatives of an owner's successors to sign, you avoid problems with changes in ownership.

You can add the following language to the lease where you describe what the L/C must say:

Model Lease Language

If the Letter of Credit shall be payable upon presentation by Owner of an affidavit or certificate, then the Letter of Credit shall permit such affidavit or certificate to be signed by an authorized representative of Owner, its heirs, successors, or assigns.

Practical Pointer: Who can be an “authorized representative”? Any person or people designated by you or by your successors if you're no longer the owner, says McNally. The formal designation process should be described in your bylaws, partnership agreement, or operating agreement, depending on how your business is organized. Typically, your directors, partners, or members pass a written resolution designating one or more chosen authorized representatives, she says. Individual owners typically designate an authorized representative through a power of attorney document, she adds.

CLLI Source

Susan Fowler McNally, Esq.: Partner, Gilchrist & Rutter, 1299 Ocean Ave., Ste. 900, Santa Monica, CA 90401; (310) 393-4000.