Letters of Credit Under Revised UCC Article 9

Many in the letter of credit community follow the progress of the revisions to Article 9 of the Uniform Commercial Code ("UCC'') as those revisions pertain to letters of credit. Article 9 of the UCC was substantially revised in 1998 by the Uniform Law Commission. The 1998 amendments have now been adopted in all states and in the District of Columbia.

In 2010, Article 9 was amended again. This time the amendment were to provide greater guidance for providing information on financing statements. The 2010 amendments have also been adopted by all of the states and the District of Columbia.

UCC Article 9 deals generally with security interests in assets other than real property and with the assignment of accounts (which includes accounts receivable) and general intangibles. One area of potential conflict between the letter of credit community and the secured lending industry is with regard to priority disputes between secured parties of a letter-of-credit beneficiary, on the one hand, and those claiming the proceeds of a letter of credit as confirmer, nominated person, transferee beneficiary or other assignee, on the other hand.

Letter-of-Credit Rights

To help structure the general framework for dealing with letters of credit, the 1998 amendment uses a new defined term, "letter-of-credit right.'' This term is defined as "a right to payment and performance under a letter of credit.'' The definition specifically states that the term "does not include the right of a beneficiary to demand payment or performance under a letter of credit.'' Thus, letter-of-credit rights would include the right to receive payment from the issuer, confirmer or other nominated person when, as and if the beneficiary makes a complying draw. It does not include the right to actually draw under the letter of credit. The distinction parallels the distinction (both under UCC Article 5 and the UCP) between an assignment of the proceeds of a letter of credit and a transfer of the letter of credit. However, the new terminology focuses, primarily for bankruptcy reasons, on the fact that the right to receive proceeds in the future is nevertheless a current asset in which a security interest can be granted and perfected.

Support Obligations

Letters of credit by their very nature are almost always issued in connection with an underlying transaction. Although the independence principle precludes the issuer from considering the underlying transaction in determining whether documents under the letter of credit are complying, as between the beneficiary and the applicant (and as between the beneficiary and the beneficiary's creditors) the underlying transaction is normally of primary importance.

One of the concepts introduced in revised Article 9 is that of a "support obligation.'' This is defined in the 1998 amendment as "a secondary obligation or letter-of-credit right that supports the payment or performance of an account, chattel paper, general intangible, document, healthcare insurance receivable, instrument, or investment property.''

The general principle under revised Article 9 is that a security interest in an account, chattel paper, general intangible, etc., should automatically attach to any "support obligation'' in connection therewith. Similarly, if the security interest in the underlying obligation is perfected, the security interest in the support obligation is automatically perfected.

Thus, if a secured party has a perfected security interest in the borrower's accounts, the secured party will also automatically have a perfected security interest in any guaranties, letter-of-credit rights or other support obligations supporting those accounts. The secured party does not need to do anything further than what was required to perfect the security interest in the accounts (usually just the filing of a UCC financing statement).


In addition to being able to perfect a security interest in letter-of-credit rights as a support obligation, Sections 9-203 and 9-312 allow the attachment and perfection of a security interest in letter-of-credit rights by obtaining "control.'' "Control'' of letter-of-credit rights is defined under Section 9-110 as meaning that the issuer or nominated person has consented to an assignment of proceeds of the letter of credit under recently promulgated UCC Section 5-114(c) or otherwise applicable law or practice.

Thus, if a secured party or other assignee of the beneficiary obtains the issuer's consent to the assignment of the letter-of-credit proceeds by signing the necessary forms required by the issuer, the secured party or assignee will have "control'' over the letter-of-credit rights. The concept of "control'' is limited to the specific person giving the consent to the assignment. For instance, if only the confirmer has given its consent to an assignment of proceeds, the secured party or assignee would have "control'' with respect to any proceeds coming from the confirmer but would not have "control'' over any proceeds if the beneficiary bypassed the confirmer and drew directly against the issuer.

Similarly, if the issuer has consented to the assignment but the confirmer has not, the secured party would have "control'' as to any proceeds received directly from the issuer but not from the confirmer. Thus, to be sure that it has "control'' in all circumstances, a secured party should obtain the consent of each of the issuer, any confirmer and any other nominated person.

Other methods of perfection of a security interest in letter-of-credit rights (such as taking possession of a letter of credit) will no longer be available. Perfection can be only by perfection in the underlying obligation (and hence in the letter-of-credit rights as support obligations) or by "control.''

Issuer Need Not Deal with Secured Parties

These new provisions on support obligations highlight the potential conflict between the beneficiary's secured creditors and other people who may be claiming letter-of-credit proceeds through traditional letter-of-credit avenues. Recognizing that issuers, confirmers and nominated persons need to be protected from having to deal, without their consent, with the creditor's beneficiaries, Section 9-406A reaches a Solomonic splitting of the baby.

The Section first provides that, notwithstanding any prohibition in the letter of credit itself to the creation of a security interest in or assignment of letter-of-credit rights, such a security interest or assignment is effective generally. However, the Section further provides that, to the extent that such a prohibition on assignments or security interests would be effective under UCC Article 5 or other law or a custom or practice (such as the UCP), an assignment or security interest would not be enforceable against the applicant, issuer, nominated person or transferee beneficiary and imposes no duties or obligations on the applicant, issuer, nominated person, transferee beneficiary.

In short, the assignment or security interest in letter-of-credit rights would be good as between the beneficiary, the beneficiary's secured party and the beneficiary's other creditors, but the issuer, nominated person or transferee beneficiary can ignore any such assignment or security interest unless the issuer, nominated person or transferee beneficiary consents otherwise. This parallels the structure recently adopted in UCC Article 5 that an issuer need only deal with a assignee to which the issuer has consented.


The 1998 amended Section 9-326 deals with the question of priority of interests in letter-of-credit rights. It specifically provides that the rights of a transferee beneficiary or nominated person are independent and superior to the extent provided by new Section 5-114 (which generally favors the transferee beneficiary or nominated person). Thus, transferee beneficiaries and nominated persons will trump the beneficiary's secured creditors with regard to the proceeds of a letter of credit. Section 9-326 also provides that any person with "control'' over letter-of-credit rights will have priority over someone who does not have control, for instance, someone who has a perfected security interest in the letter-of-credit rights solely as a support obligation. If there are more than two parties with control, they will rank according to priority in time in obtaining control.

This rule that "control trumps'' had been the subject of much debate. There was a quick consensus among the 1998 amendment drafters, that the issuer or confirmer must deal only with an assignee as to whom the issuer or confirmer had consented. The debate was instead over whether the assignee with "control'' might need to disgorge the proceeds of the letter of credit to a prior perfected secured party who had perfected solely by reason of the letter-of-credit rights being a support obligation. Put another way, could a secured party who had a first priority perfected security interest in accounts but who did not have "control'' be primed by someone who came in later and obtained "control'' of the letter-of-credit rights supporting the accounts?

After prolonged discussions by the drafters of the 1998 amendment, segments of the secured lending community concluded that, given the significant benefits obtained by having automatic perfection in support obligations, they were willing to take the risk of occasionally being trumped by a subsequent party who took "control'' of letter-of-credit rights. This issue was of primary concern in the letter-of-credit community, not as to issuers generally (who would be unaffected by whether the assignee could keep the money or had to disgorge it) but as to those issuers who took assignments of other letters of credit in the back-to-back letter of credit scenario.

Duties of Transferee Beneficiaries

Because it is clear under revised Article 9 that a transferee beneficiary will trump both assignees with "control'' and secured parties claiming letter-of-credit rights as support obligations, there is a significant probability that many secured parties will seek to become transferee beneficiaries, particularly with regard to large dollar letters of credit.

One of the issues raised in the comments to Section 9-326 of the October 1997, but left unresolved in the text of the 1998 amendment is what duties are owed by the transferee beneficiary to the original beneficiary if the transferee beneficiary is in fact a secured party vis-`-vis the original beneficiary.

For instance, if a transferee beneficiary/secured party receives more under the letter of credit than is owed by the beneficiary/borrower to the transferee beneficiary/secured party, is the transferee beneficiary/secured party obligated to return the surplus to the original beneficiary?

Would the transferee beneficiary/secured party be obliged to collect under the letter of credit in a commercially reasonable manner?

The Uniform Law Commission recognized, particularly with regard to commercial letters of credit, that many transferee beneficiaries do not consider themselves as having a security interest in any of the beneficiary's assets. The Uniform Law Commission considered various approaches as to how to deal with transferee beneficiaries who are secured parties and those who are not.

Automatic Perfected Security Interest in Documents

Most reimbursement agreements grant the issuer a security interest, vis-`-vis the applicant, in documents which are presented under a letter of credit if the issuer honors the letter of credit. In addition, under current law as to certificated securities, negotiable instruments or negotiable documents, the issuer arguably has a security interest by possession in such items even if the reimbursement agreement does not so provide. However, confirmers and other nominated persons cannot rely upon any security interest grant in a reimbursement agreement. In addition, there are many documents which are not certificated securities, negotiable instruments or negotiable documents.

As an adjunct to revised Article 9, a new Section 5-118 was added to Article 5. Now, Section 5-118 provides that an issuer or nominated person has an automatic perfected security interest in documents presented under a letter of credit and in any identifiable proceeds of the collateral to the extent that the issuer or nominated person honors or gives value for the presentation of the document. That security interest continues so long as the issuer or nominated person has not been reimbursed or has not otherwise recovered the value given.

No security agreement is necessary to make the security interest enforceable, and the security interest has priority over conflicting security interests in the collateral or its proceeds. However, because perfection is not dependent upon possession of the documents (that is, the documents can be turned over for the applicant to collect the goods), the security interest is subject to the rights of any subsequent purchaser of either the documents or of the underlying goods or any transferee of funds which constitute proceeds, in each case if the purchaser or transferee meets certain requirements, including those of good faith and lack of collusion.

These provisions will add a significant amount of certainty with regard to the rights of issuers and nominated persons.

Other Provisions

Finally, the 1998 amendment clarified a number of provisions to assure that issuers, confirmers and nominated persons do not need to deal with the beneficiary's secured creditors unless a secured creditor has obtained "control'' by obtaining the consent of the issuer or nominated persons. The 1998 amendment also included provisions dealing with choice of law, the release of security interests in letter-of-credit rights, and other matters which will lend more certainty to various aspects of the intersection between Article 5 and Article 9.

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