Eastwood Construction Co., Inc. v. Old Towne, LLC et al

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
IN RE:
OLD TOWNE, LLC,
Debtor. 	Case No. 08-07170-8-JRL
EASTWOOD CONSTRUCTION CO., INC., 	Adversary Proceeding No.:
Plaintiff, 	08-00219-8-AP
v.
OLD TOWNE, LLC
LANDCRAFT PROPERTIES, INC. and
LANDCRAFT MANAGEMENT, LLC,
Defendants.
____________________________________________________________________________
ORDER
This case is before the court on the motion for a preliminary injunction filed by Eastwood
Construction Co., Inc. (“Eastwood”). On October 31, 2008, the court conducted a hearing on this
matter in Raleigh, North Carolina.
BACKGROUND
On October 9, 2008, Eastwood filed a complaint in the General Court of Justice, Superior
Court Division, Mecklenburg County, against Old Towne, LLC (“Old Towne”), Landcraft
SO ORDERED.
SIGNED this 13 day of November, 2008.
________________________________________
J. Rich Leonard
United States Bankruptcy Judge
____________________________________________________________
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Properties, Inc., and Landcraft Management, LLC (“Landcraft”) (collectively, the “Defendants”),
seeking an injunction directing Defendants to withdraw their presentment of a letter of credit to
Branch Banking and Trust Co. (“BB&T”) and enjoining Defendants from receiving funds from
BB&T. 	Old Towne filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code
on October 15, 2008. 	On the following day, this action was removed to the United States
Bankruptcy Court for the Western District of North Carolina and subsequently transferred to this
court.
Eastwood is a home builder and real estate development company with its principal place
of business in Mecklenburg County, North Carolina. 	Eastwood contracts with developers to
purchase finished lots in new residential subdivisions, builds homes on these lots, and then sells
them. Eastwood typically contracts to purchase, or “take down,” the lots pursuant to a specified
schedule. Landcraft is a limited liability company that operates out of Mecklenburg County, North
Carolina. Landcraft develops residential real estate subdivisions through various wholly-owned
limited liability companies. 	Old Towne is a limited liability company located in Mecklenburg
County, North Carolina.
On November 18, 2004, Eastwood and Landcraft entered into a contract to develop the Old
Towne subdivision in Forsyth County, North Carolina. 	Landcraft subsequently assigned this
contract to Old Towne. The contract requires Old Towne to transfer lots with good title to Eastwood
on a specific take-down schedule. If Old Towne fails to deliver good title and fails to cure this
defect within 60 days of written notice, the contract allows Eastwood to terminate and cancel its
obligations.
Pursuant to the contract, Eastwood provided Old Towne with good faith cash deposits
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totaling $273,585.00 and a stand-by letter of credit drawn on BB&T also in the amount of
$273,585.00. The letter of credit was subsequently reduced to $136,792.50 after the thirty-first lot
closing. The purpose of the letter of credit is to secure performance by Eastwood. In the event
Eastwood fails to honor its obligations under the contract, Old Towne can present the letter of credit
to BB&T for payment. In addition to cash deposits and a letter of credit from Eastwood, Old Towne
obtained funding from Bank of North Carolina and individual investors. 	To date, Eastwood has
purchased 40 lots in the subdivision.
In April 2008, Investors Title Insurance Company (“Investors Title”), the title insurance
company for Eastwood, received notice of liens and potential liens on the Old Towne subdivision.
As a result, Investors Title began requiring that Landcraft provide accounts payable information as
a condition to issuing title policies for Old Towne lots. Depending on the information provided,
Investors Title also reserved the right to require lien waivers from the contractors to whom accounts
payable were due. Landcraft complied with these disclosure requirements initially but by mid-June
was no longer providing adequate information to Investors Title.
After learning that Landcraft stopped providing required information to Investors Title,
Eastwood delivered a notice of termination to Landcraft, dated June 25, 2008. Subsequent to this
termination notice, Eastwood and Landcraft negotiated a revised take-down schedule and drafted
a term sheet reflecting the parties’ revisions. However, the parties never signed the term sheet.
Following these settlement discussions, Eastwood indicated that it was rescinding its prior
termination notice.
On June 26, 2008, ECS Carolinas, LLP (“ECS Carolinas”), filed liens on all lots in the Old
Towne subdivision in the total amount of $5,308.00. On September 23, 2008, Eastwood informed
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Defendants that they were in default as a result of the June 26, 2008 lien filing and had 60 days to
cure the lien. On October 7, 2008, Defendants presented the letter of credit to BB&T for payment.
After learning of Defendants’ presentation to BB&T, Eastwood filed this action seeking a
preliminary injunction.
DISCUSSION
Under Revised Article 5 of the Uniform Commercial Code, as enacted in North Carolina,
if an applicant claims that honoring the presentation of a letter of credit “would facilitate material
fraud by the beneficiary on the issuer or applicant,” a court may enjoin the issuer from honoring the
presentation only if it finds that:
(1) The relief is not prohibited under the law applicable to an accepted draft or deferred
obligation incurred by the issuer;
(2) A beneficiary, issuer, or nominated person who may be adversely affected is adequately
protected against loss that it may suffer because the relief is granted;
(3) All of the conditions to entitle a person to the relief under the law of this State have been
met; and
(4) On the basis of the information submitted to the court, the applicant is more likely than
not to succeed under its claim of forgery or material fraud and the person demanding honor
does not qualify for protection under subdivision (a)(1) of this section.
N.C. GEN . STAT . § 25-5-109(b). Presentment of a letter of credit constitutes material fraud “only
when the beneficiary has no colorable right to expect honor and where there is no basis in fact to
support such right to honor.” Id. at 109(b), Official Comment 1. Thus, the standard for injunctive
relief is high, and the burden falls on the applicant to show that such relief is warranted. Id., Official
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Comment 4.
Eastwood asserts that Defendants are prohibited from presenting the letter of credit to BB&T
because the preconditions to payment have not been satisfied. According to its terms, the letter of
credit may not be presented for payment absent default by Eastwood on its obligations under the
contract, including a failure to purchase lots tendered by Old Towne. 	Eastwood argues that
presentment is improper because it is not in default. Rather, Eastwood alleges that Old Towne has
breached the contract by failing to cure the liens filed by ECS Carolinas.
In addition, Eastwood asserts that a preliminary injunction is necessary because Defendants
acted fraudulently by falsely representing to BB&T that Eastwood failed to perform under the
contract. 	Eastwood claims that its termination letter was ineffective based on subsequent
negotiations between the parties and a term sheet modifying the parties’ obligations. Eastwood
further argues that Old Towne did not consider Eastwood’s termination notice to be effective
because Old Towne lists the contract with Eastwood as executory in its bankruptcy schedules.
Conversely, Defendants argue that they are entitled to present the letter of credit for payment
because Eastwood terminated the contract without justification. Specifically, Defendants contend
that Eastwood’s termination notice resulted in a breach of Eastwood’s obligation to take down lots.
Defendants further argue that presentment of the letter of credit to BB&T is warranted because
Eastwood’s notice of termination extinguished Old Towne’s obligations under the contract.
Defendants contend that discussions held subsequent to Eastwood’s termination did not result in a
mutual agreement to rescind the contract and that the term sheet is ineffective because it was never
signed by the parties. Finally, Defendants claim that although Old Towne listed the contract as
executory in its schedules in the interest of full disclosure, its obligations under the contract ceased
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upon Eastwood’s termination notice.
The issue before the court is whether Eastwood is entitled to a preliminary injunction as to
Defendants’ letter of credit. Letters of credit are powerful commercial instruments that generally
work independently of underlying contracts between the parties. See O’Grady v. First Union Nat’l
Bank, 296 N.C. 212, 232, 250 S.E.2d 587, 600 (1978). Pursuant to North Carolina law, Eastwood
must establish several elements before the court may enjoin the presentment of a letter of credit.
N.C. GEN . STAT . § 25-5-109(b). Of these elements, it is most significant in the case at bar that
Eastwood must show that presentment of the letter of credit would facilitate a material fraud against
Eastwood or BB&T. Id. at 109(b)(4). Eastwood has failed to persuade the court that Defendants’
presentation of the letter of credit to BB&T was materially fraudulent. Rather, both parties have
alleged a breach of contract, with viable theories asserted by each. Defendants assert that they were
in complete compliance with the contract on June 25, 2008, when Eastwood acted to terminate the
contract. In contrast, Eastwood asserts that all parties agreed to a rescission and went ahead as if
the contract was in place, and the debtor subsequently breached it. While either of these theories
may prevail at trial, it is not enough to show that Defendants have no colorable right to an honoring
of the presentment of the letter of credit.
Based on the foregoing, the court DENIES Eastwood’s motion for a preliminary injunction.
Pursuant to Defendants’ request at hearing, proceeds from the letter of credit must be placed in
escrow under terms to be outlined either in a consent order submitted by the parties, or if the parties
fail to submit such consent order, in a separate order of the court.
“END OF DOCUMENT”
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