OGC Opinion No. 04-01-15: Letters of Credit / Regulation 133

OGC Op. No. 04-01-15

The Office of General Counsel issued the following opinion on January 13, 2004, representing the position of the New York State Insurance Department.

Re: Letters of Credit / Regulation 133

Questions:

1. Where several of an insurers subsidiaries require security from an insured in connection with a number of separate insurance contracts, can the insurer require the insured to name several of the insurers subsidiaries as beneficiaries on each of the letters of credit provided by the insured?

2. May a letter of credit make reference to a specific underlying agreement by listing a policy number, endorsement, or other specific reference associated with the beneficiary thereof?

Conclusions:

1. An insurer may not properly require the insured to name several of the insurers subsidiaries as beneficiaries on each of the letters of credit provided by the insured.

2. Yes, a letter of credit may make reference to a specific underlying agreement by listing a policy number, endorsement, or other specific reference associated with the beneficiary thereof.

Facts:

A large commercial insured ("Insured") has several insurance coverage programs with a large insurer ("Company"). These programs involve policies for more than one kind of insurance, and the different kinds of coverage are obtained from different corporate subsidiaries of the Company. The Insured, in the course of its several insurance programs with the Company, is obtaining coverage from several different subsidiaries of the Company.

Certain of the insurance programs forming the basis for this inquiry have high deductible limits. The Companys subsidiaries will generally pay out on claims and will recoup the deductible from the Insured. Given this arrangement, the Company has required that the Insured provide it with letters of credit ("LOCs") as security for payment of the deductibles. In connection with the several LOCs that will be required in the course of all of the programs, the Company wants each LOC to list 16 of its subsidiaries, including several from whom the Insured is not securing coverage. The Insured prefers that each LOC name as beneficiary only the subsidiary or subsidiaries to whom it is providing security under each respective program of insurance coverage.

Analysis:

N.Y. Comp. Codes R. & Regs. tit. 11, § 79.1 (2003) sets forth the definitions of terms used in Regulation 133, which governs LOCs, and provides, in pertinent part, as follows:

(a) Applicant means the party who applies for and causes the bank or trust company to issue the letter of credit.

(b) Beneficiary means the insurer in favor of which the letter of credit or its confirmation is established and shall include any successor by operation of law of any named beneficiary including, without limitation, any liquidator, rehabilitator, receiver or conservator.

(c) Clean and unconditional letter of credit or clean and unconditional confirmation means a letter of credit or confirmation which:

(1) makes no reference to any other agreement, document or entity; and

(2) provides that a beneficiary need only draw a sight draft under the letter of credit or confirmation and present it to promptly obtain funds and that no other document need be presented.

N.Y. Comp. Codes R. & Regs. tit. 11, § 79.1 (2003).

As indicated by the above definition, the practice insisted upon by the insurer, i.e., requiring the names of many of its subsidiaries as beneficiaries on all of the LOCs provided by the insured, represents an illogical application of the definition of beneficiary. Where no contractual privity exists between an insurer and an insured, the insured cannot reasonably be required to include such an insurer as a beneficiary on an LOC secured in connection with a policy obtained from a different entity.

In addition to being inconsistent with the Regulation, the practice at issue herein can lead to unnecessary confusion. An LOC is often utilized to protect the financial interests of an insurer in connection with a specific policy. The naming of several insurers on several different LOCs, with the result that many entities are denoted as "beneficiaries" of LOCs issued in connection with policies wholly unrelated to such insurers, creates a tangled web of interrelationships, rife with the potential for the making of erroneous payments and the disputes that will inevitably ensue. Accordingly, in the situation described above, it is our view that where an LOC is required in connection with a given insurance policy, it should only name as beneficiary the insurer or insurers from whom the insured has purchased such policy.

With regard to the second inquiry, although Regulation 133 requires that an LOC be "clean and unconditional," N.Y. Comp. Codes R. & Regs. tit. 11, § 79.2(b) (2003), and that it state that is not "subject to any agreement, condition or qualification outside the letter of credit," N.Y. Comp. Codes R. & Regs. tit. 11, § 79.2(f) (2003), the inclusion of the information suggested would not run afoul of the Regulation, provided that such information is only included in a "For Internal Identification Purposes Only" section such as those set forth in the Exhibits contained in Regulation 133 at N.Y. Comp. Codes R. & Regs. tit. 11, § 79.9 (2003), and not included in the body of the LOC itself.