Unpublished Disposition, 844 F.2d 792 (9th Cir. 1979)

MEMORANDUM^* 

Lincoln Liberty Life Insurance Company ("Lincoln") appeals the district court's order permanently enjoining Lincoln from collecting on a $22,000 letter of credit issued by Nevada National Bank on the account of Hubbard Business Plaza ("Hubbard"). We affirm.

FACTS AND PROCEEDING BELOW

On June 1, 1979, the parties executed a loan commitment agreement. Lincoln agreed to loan Hubbard $1,100,000 at 10 3/8% interest, provided Hubbard complied with certain loan conditions. Hubbard did not satisfy the loan conditions and thereby breached the loan commitment agreement. By the time of Hubbard's breach, however, the applicable interest rate had risen sharply. Because Lincoln no longer had to loan Hubbard the $1,100,000 at 10 3/8% interest, Lincoln was free to reinvest the amount of the loan with another company at the higher interest rate.

The agreement contained a liquidated damages clause in the amount of $22,000. Hubbard agreed to pay Lincoln $22,000 if Hubbard breached the loan commitment agreement. Hubbard secured its obligation to pay Lincoln $22,000 in the event of breach with a letter of credit arranged through Nevada National Bank.

In January 1982, Hubbard filed suit in the district court to enjoin Lincoln from collecting on the letter of credit. Hubbard argued that Nevada law transforms otherwise valid liquidated damages clauses into unenforceable penalties when the party seeking to enforce them has suffered no actual damages. Hubbard asserted that Lincoln suffered no actual damages as a result of Hubbard's breach. Hubbard pointed out that Lincoln was able to recover expenses it incurred in connection with the loan commitment agreement by reinvesting the $1,100,000, initially committed to Hubbard, at the higher interest rate.

Applying Nevada law, the district court agreed with Hubbard and ruled that the liquidated damages clause was a penalty under the circumstances of Hubbard's breach. To prevent damage to Hubbard's business reputation, the court enjoined Lincoln from collecting on the letter of credit Hubbard used to secure payment of the liquidated damages.

STANDARD OF REVIEW

This court reviews de novo district court interpretations of state law. In re McLinn, 739 F.2d 1395, 1403 (9th Cir. 1984) (en banc). When the state's highest court has adjudicated an issue, this court's task is to apply existing state law, not to predict that the state may change its law and then apply our view of what the change might be. Klingebiel v. Lockheed Aircraft Corp., 494 F.2d 345, 346 (9th Cir. 1974).

DISCUSSION

I. Enforceability of the Liquidated Damages Provision

Lincoln presents two arguments on why the liquidated damages clause should not be considered a penalty. First, Lincoln argues that it did in fact incur damages as a result of Hubbard's breach. Accordingly, Lincoln argues that the liquidated damages clause is enforceable under existing Nevada case law.

Nevada law states that liquidated damages clauses will be considered unenforceable penalties when the agreed upon damages are disproportionate to the actual damages suffered. See Haromy v. Sawyer, 654 P.2d 1022, 1023 (Nev.1982) (per curiam); Silver Dollar Club v. Cosgriff Neon Co., 389 P.2d 923, 925 (Nev.1964).

Lincoln contends it incurred investigating, processing, and liquidity loan costs in connection with the Lincoln-Hubbard loan commitment agreement. Lincoln asserts that these out-of-pocket costs should be counted as "damages" for the purpose of applying Nevada's liquidated damages law regardless of any profits Lincoln made from reinvesting the amount of the loan at the post-breach higher interest rate. In depositions and during oral argument, however, Lincoln conceded that it incurred no net actual damages as a result of Hubbard's breach; in practical terms, Lincoln was in a financially better position after Hubbard's breach than Lincoln would have been had Hubbard gone through with the loan commitment agreement at the lower interest rate.

Given Lincoln's admission that it suffered no net actual damages as a result of Hubbard's breach, we agree with the district court that this case requires only a straightforward application of Nevada law. Liquidated damages clauses will be construed as penalties when the agreed upon damages are disproportionate to the actual damages suffered. Haromy, 654 P.2d at 1023; Silver Dollar Club, 389 P.2d at 925. Because Lincoln suffered no damages, Lincoln's actual damages are disproportionate to the agreed upon amount of liquidated damages ($22,000). Therefore, the liquidated damages clause of the loan commitment agreement should be considered an unenforceable penalty.

Lincoln's second argument is that a straightforward application of Nevada law is inappropriate in this case because the Nevada Supreme Court has not yet addressed the validity of a liquidated damages clause in a loan commitment agreement. Therefore, Lincoln contends that this court should look to the law of other states to see if they enforce liquidated damages clauses in loan commitment agreements. Lincoln then points out that many states do enforce liquidated damages clauses in loan commitment agreements. See Annotation, Enforceability of Provision in Loan Commitment Agreement Authorizing Lender to Charge Standby Fee, Commitment Fee, or Similar Deposit, 93 A.L.R.3d 1156 (1979). Lincoln therefore asks us to reverse the district court because Lincoln believes that if the Nevada Supreme Court were presented with this case it would follow those states that have decided to enforce liquidated damages clauses in loan commitment agreements.

We decline Lincoln's invitation to make new Nevada law. " [T]he proper function of the ... federal court is to ascertain what the state law is, not what it ought to be." Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 497 (1941). We therefore will apply Nevada liquidated damages law as it now exists and leave further developments in this area to the Nevada courts. The Nevada Supreme Court has stated that failure to present persuasive evidence which suggests that actual damages exist will support a district court's finding that a liquidated damages clause acts as a penalty. Haromy, 654 P.2d at 1024. Lincoln concedes that it suffered no net actual damages. Accordingly, we affirm the district court's finding that the liquidated damages clause in this case acted as a penalty.

Nevada courts may eventually agree with appellant's position and decide to carve out an exception to the state's general rule by enforcing liquidated damages clauses in loan commitment agreements as a general matter. On the other hand, Nevada courts may decide to adhere to their current rule and refuse to enforce these clauses in those cases where the lender has suffered no actual damages.

Lincoln also argues that letters of credit have a special status under Nevada law. Specifically, they contend that courts may not enjoin the collection of a letter of credit. Lincoln relies heavily on the language of Nev.Rev.Stat. Sec. 104.5114(1) (1985), which provides that " [a]n issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conformed to the underlying contract for sale or other contract between the customer and the beneficiary." Lincoln also cites non-Nevada case law to support the proposition that this statute precludes courts from enjoining an issuer's payment of a letter of credit.

When we addressed the liquidated damages issue, we did not consider holdings of other state courts because the Nevada Supreme Court had previously ruled on that issue. In contrast, the Nevada Supreme Court has not yet interpreted Nev.Rev.Stat. Sec. 104.511(1) on the question whether the beneficiary of a letter of credit may be enjoined from enforcing it. Therefore, we find it useful to look to California decisions, which Nevada courts often follow, in our attempt to interpret Nev.Rev.Stat. Sec. 104.511(1).

California courts interpreting a California statute similar to Nev.Rev.Stat. Sec. 104.511(1) have enjoined a beneficiary from collecting on a letter of credit. See Mitsui Mfrs. Bank v. Texas Commerce Bank-Fort Worth, 159 Cal. App. 3d 1051, 1057-59, 206 Cal. Rptr. 218, 222 (1984); Steinmeyer v. Warner Consol. Corp., 42 Cal. App. 3d 515, 519, 116 Cal. Rptr. 57, 60 (1974).

In Steinmeyer, the buyer of some capital stock presented several promissory notes to the seller, including one reserving the right to offset losses suffered in connection with their underlying agreement. A letter of credit was used to guarantee payment of the promissory notes. The buyer later contended that the seller had failed to disclose several substantial liabilities, which adversely affected the value of the stock. The buyer then sought injunctive relief to prevent the seller from demanding payment on the letter of credit and to prevent the bank from making payment thereon. The court granted the injunction against the seller-beneficiary because " [i]t would be anomalous to empower Warner to circumvent Steinmeyer's rights of offset simply by seeking payment of the letter of credit." Steinmeyer, 42 Cal. App. 3d at 519, 116 Cal. Rptr. at 60.

Likewise, in this case, enjoining Lincoln from collecting on the letter of credit is necessary to prevent Lincoln from circumventing the court's decision to invalidate the liquidated damages clause as a penalty. Otherwise, Hubbard would be forced to relitigate to recover the penalty after payment on the letter of credit was made. Lincoln was not entitled to the $22,000 because it was a penalty. Consequently, there was no harm in enjoining Lincoln, as the beneficiary, from collecting on the letter of credit.

CONCLUSION

We hold that the liquidated damages clause was a penalty under Nevada law. We also hold that enjoining a beneficiary from collecting on a letter of credit is consistent with Nev.Rev.Stat. Sec. 104.511(1) under the circumstances of this case. We therefore affirm the district court's permanent injunction.

AFFIRMED.