Federal Deposit Insurance Corporation v. Philadelphia Gear Corporation

PETITIONER: Federal Deposit Insurance Corporation
RESPONDENT: Philadelphia Gear Corporation
LOCATION: United States District Court for the Western District of New York

DOCKET NO.: 84-1972
DECIDED BY: Burger Court (1981-1986)
LOWER COURT: United States Court of Appeals for the Tenth Circuit

CITATION: 476 US 426 (1986)
ARGUED: Mar 04, 1986
DECIDED: May 27, 1986

Charles A. Rothfeld - Argued the cause for the petitioner
Gerald F. Slattery, Jr. - Argued the cause for the respondent

Facts of the case

Orion Manufacturing Corporation (Orion) was a customer of Philadelphia Gear Corporation (PG). To provide a guarantee of payment to PG, Orion obtained a letter of credit for the benefit of PG from Penn Square Bank, N.A. (Bank). If Orion failed to pay an invoice to PG for at least 15 days, PG could draw upon that line of credit, up to $145,200. This type of credit line, meant to guarantee payment to a seller, is referred to as a standby letter of credit. To back up that line of credit, Orion executed an unsecured promissory note in favor of the Bank. This note is referred to as a backup letter of credit. Nothing was due on the backup letter of credit unless PG presented drafts on the standby letter of credit. Thus the backup letter was a contingent promissory note. The Bank did not credit any account of Orion's in exchange for the note, and did not treat its own assets as increased by its acceptance of the note. In 1982, the Bank was declared insolvent and the Federal Deposit Insurance Corporation (FDIC) was appointed its receiver. PG presented drafts on the standby letter of credit for goods delivered before the Bank's insolvency, but the FDIC returned them unpaid. PG sued the FDIC, claiming that the standby letter of credit was an insured deposit under the definition of "deposit" set forth at 12 U.S.C. Section 1813(l)(1), and that PG was therefore entitled to $100,000 in deposit insurance.


Is a standby letter of credit backed by a contingent promissory note insured as a "deposit" under the federal deposit insurance program?

Media for Federal Deposit Insurance Corporation v. Philadelphia Gear Corporation

Audio Transcription for Oral Argument - March 04, 1986 in Federal Deposit Insurance Corporation v. Philadelphia Gear Corporation

Warren E. Burger:

We will hear arguments first this morning in Federal Deposit Insurance Corporation against Philadelphia Gear Corporation.

Mr. Rothfeld, you may proceed whenever you are ready.

Charles A. Rothfeld:

Mr. Chief Justice, and may it please the court.

The issue in this case is a narrow one, whether a standby letter of credit issued by a bank and backed by a contingent note provided by the bank's customer represents a deposit that is insured by the Federal Deposit Insurance Corporation.

While this question obviously is a technical one, reduced to its essentials, the issue here is actually very straightforward, and can be resolved by simply bearing in mind the central purpose of the deposit insurance program, protecting funds that depositors entrust to banks.

This case is typical of commercial transactions that make use of so-called standby letter of credit to guarantee credit by one of the parties, and a look at the facts of the transaction here may help put the issue in focus.

The case began when the Orion Manufacturing Corporation arranged to purchase materials from the respondent.

To guarantee that it would pay for the materials when they were delivered, Orion obtained a standby letter of credit from the Penn Square Bank for the benefit of respondent.

This letter of credit, like all letters of credit, functioned as a guarantee mechanism, and worked very much like a line of credit.

Under the letter, Penn Square was obligated to pay respondent upon the receipt of respondent's signed statement that Orion hadn't paid its bills to respondent when those bills came due.

As security for Penn Square, Orion gave the bank a contingent so-called backup note in the amount of the letter of credit which the bank would draw upon for reimbursement if it was forced to pay out to respondent under the letter of credit.

Although this note was labeled a promissory note and on its face appeared uncontingent, both Orion and Penn Square understood that nothing would be considered due on the note and the note would bear no interest unless and until the bank was forced to pay respondent under the letter of credit.

William H. Rehnquist:

Well, Mr. Rothfeld, are you suggesting in your description of this note that it was not therefore a promissory note within the language of the statute?

Charles A. Rothfeld:

That's correct, Your Honor.

William H. Rehnquist:

You are saying that this particular note was not a promissory note within the language of the statute?

Charles A. Rothfeld:

That is correct, although--

Sandra Day O'Connor:

Is that because there was a side understanding setting forth certain contingencies?

Charles A. Rothfeld:

--Essentially that is correct, Justice O'Connor.

Sandra Day O'Connor:

Does it make any difference at all whether the note bore interest or not, or was in fact easily negotiable because of its lack of interest?

Charles A. Rothfeld:

I think that the note here functioned simply as an elaborate reimbursement agreement, but the note didn't represent any actual liability on the part of the maker of the note.

Sandra Day O'Connor:

Well, on its face, of course, it did.

Theoretically, it would have been negotiable at a discount for money.

Charles A. Rothfeld:

It could have been, arguably could have been negotiated by the holder of the note on its face, although given the contingencies attached to the note, it is difficult... the value of the note would have been practically nil.

Sandra Day O'Connor:

--in due course.

It certainly wouldn't be of no value if the market could just discount it to make up for the lack of interest.

Charles A. Rothfeld:

Well, I think there are two points to make in response to that.

While it could have been negotiated to a holder in due course, as Justice Rehnquist says, anyone who took the note with knowledge of the conditions attached to it between the parties who originally were involved in the transaction would be subject to the defense that--

Sandra Day O'Connor:

Well, you are not a holder in due course if you do that.

Charles A. Rothfeld:

--Well, that is true.

Anyone who took with knowledge of those limitations would not be able to obtain value against Orion based on the note.