Case Illustrates Perils of Drafting LC Draw Caps and Handling Non-Standard LC Transactions

Natixis Funding Corporation, v. GenOn Mid-Atlantic, L.L.C., No. 21-20557 (5th Cir. July 29, 2022),¹ raises important considerations for letter of credit practice including the evaluation of prepaying an LC versus collateralizing it, the merits of structured finance transactions, the limits of indemnities, the limits on imposition of good faith in LC transactions, and consequences of drafting errors. These issues will be taken up here.

Background. GenOn Mid- Atlantic (GenMa) operates several power plants in
Maryland as a subsidiary of GenOn Energy and NRG Energy, one of the largest retail power companies in the US. About 20 years ago, GenMa leased two coal-fired power plants from various Lessors. In those leases, GenMa promised: (i) not to grant any liens on its assets; and (ii) to obtain credit for the Lessors to secure six months’ worth of rent payments, but GenMa could not grant liens on its own assets to collateralize that credit. That restriction ensured that the Lessors drawing that credit would not diminish GenMa’s ability to pay rent. To continue with its promise to provide credit support for its lease obligations, in 2016 GenMa obtained letters of credit for the Lessors from JP Morgan Chase through an NRG parent guarantee of them. Because of GenMa’s deteriorating financial condition, NRG would not back new letters of credit when the existing LCs were to expire.

Payment Agreement. To obtain credit support for six months’ rent under the leases, GenMa entered into a “Payment Agreement” with Natixis Funding Corporation under which GenMa paid NFC USD 130 million plus a USD 1.4 million LC fee. The USD 130 million sum reflected the greatest amount of credit that GenMa had to provide the Lessors in one lease period. In exchange, NFC promised to obtain LCs for the Lessors from its New York affiliate, Natixis. If the LCs went undrawn, NFC would pay up to USD 130 million in rent to the Lessors on GenMa’s behalf. If the LCs were drawn, NFC would reimburse Natixis for those draws.

In structured finance-type wording, the Payment Agreement repeatedly disclaimed GenMa’s interest in the USD 130 million payment to NFC. That payment was stated to be “in full,” upfront, and “irrevocabl[e].” GenMa, the Payment Agreement continued, renounced any “interest, claim, reversionary or residual interest” in the payment. The Agreement also assured that NFC would bear all risk and reward on the payment. NFC would receive “any returns, interest, gains[,] or other earnings” that accrued and would assume all risk of the payment’s loss. And the parties “understood and agreed that … the [USD 130 million] has been indefeasibly paid by [GenMa] to NFC.”

The Payment Agreement protected NFC in three ways:

“First, The Agreement capped NFC’s duty to pay rent or to allow credit draws at each Lessor’s share of $130 million—GenMa’s payment amount. The Agreement called that share the “Excess Capacity of Lessor.” Letter-of-credit draws by, or lease payments to, a Lessor would reduce its “Excess Capacity.” When that capacity reached zero, NFC’s duties to pay rent or to provide letters of credit to that Lessor would cease.

Second, GenMa warranted that the Payment Agreement did not breach its promises to the Lessors, including the promise not to incur liens to secure their credit support. If GenMa breached that warranty, it would indemnify NFC against costs incurred to enforce its rights under the agreement.

Third, GenMa agreed to indemnify NFC against losses from “judicial proceeding[s] … brought or threatened” by third parties. But that indemnity excluded, among other things, “any reimbursement obligation to … any … Person in respect of any” lease payment or letter-of-credit disbursement.”

LCs Issued under Payment Agreement. After NFC and GenMa executed the Payment Agreement, Natixis issued letters of credit to the Lessors. But those LCs covered all lease periods—over USD 2 billion in rent—but according to the Court, did not cap draws as the Payment Agreement allowed.