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Recon/Optical Inc. v. Government of Israel

decided: April 17, 1987.


Appeal from an order of the United States District Court for the Southern District of New York (Thomas P. Griesa, Judge) denying an application for a preliminary injunction to prevent a drawdown under a letter of credit. Affirmed.

Author: Winter

Before: FEINBERG, Chief Judge, MANSFIELD,*fn* and WINTER, Circuit Judges.

WINTER, Circuit Judge:

Recon/Optical, Inc. ("Recon") appeals from Judge Griesa's denial of its application for a preliminary injunction. Recon sought to prevent the Government of Israel ("Israel") from drawing $21.5 million against a letter of credit pending arbitration of the parties' contractual disputes. Because we conclude that Recon has no chance of success on the merits, we affirm.


The dispute concerns a contract entered into by Recon and the Israeli Ministry of Defense, Mission to the United States (the "Mission"), in October 1984 for the development and production of a unique aerial reconnaissance system for the Israeli Air Force ("IAF"). The parties' differences arose over the contract's specifications for the "flight envelope," the range of aircraft speeds and altitudes at which the aerial reconnaissance camera would operate, aeronautical technology that need only be mentioned and not understood for purposes of this opinion. By mid-1985, it was clear that the system could not be completed in accordance with the contract specifications. The exact source of this problem is a subject of dispute between the parties. According to Recon, it is the result of Israel's insistence on specifications that are unrealistic and unreasonable. Israel maintains, however, that it had allowed potential contractors to provide their own specifications if they believed them necessary and that Recon's own mistaken estimations are at fault.

In October 1985, Recon proposed various specification modifications to enable it to perform under the contract. This proposal apparently was made to, and orally approved by, the IAF. Whether the IAF had authority under the contract to bind Israel to this proposal is in dispute. Thus, while Recon and made millions of dollars in changes by April 1986, Israel denied having ordered them and refused payment.

To ensure completion of the project, Israel urged Recon to submit its claims to arbitration under Article 18, which required that all disputes relating to the contract be resolved by arbitration. Recon did submit the claims to arbitration on May 9, 1986, but announced simultaneously that it was "terminating" the contract under Article 17.1, which allowed an aggrieved party to terminate in the event of a material breach. Recon justified its termination on the grounds that, inter alia, Israel had refused to pay for the changes and had been late in paying certain invoices. Israel filed an answer and a counterclaim in the arbitration proceeding, reiterating that it had not agreed to pay the cost of the contract changes.

Pursuant to its "termination" of the contract, Recon refused to continue work on the project. Asserting this work stoppage as grounds, Israel on June 2, 1986, gave Recon a 30-day notice of its intent to draw under a letter of credit that Recon had furnished under Article 4.3. Article 4.3 required Recon to obtain the letter of credit in order to receive advance payments under the contract. Accordingly, Recon obtained an irrevocable standby letter of credit in favor of Israel from the Security Pacific National Bank of California in the principal amount of $33,292,000.*fn1 The letter of credit was guaranteed by Recon's parent corporation, Bourns, Inc. The contract allowed Israel to draw against the letter of credit in any amount not exceeding its advance payments if it certified to the bank that it was "entitled" to such amount because of: "(i) non-delivery by Seller of a deliverable item hereunder in accordance herewith or (ii) other material breach by Seller of its obligations hereunder."*fn2

Requiring military contractors to furnish a letter of credit was a long-standing practice of the Mission. Prior to the instant case, the Mission had attempted to draw under such a letter of credit only once, in connection with a contract with Sperry International Trade, Inc. ("Sperry") for the design and construction of a ground-to-ground communication system for the IAF. After a dispute arose over contract performance, Sperry initiated arbitration proceedings, ceased all work on the project, and instituted suit in the Southern District of New York to enjoin Israel from drawing on the letter of credit pending a decision by the arbitrators. The district court issued an injunction, but we reversed on the ground that Sperry had made no showing of irreparable injury. Sperry Int'l Trade, Inc. v. Government of Israel, 670 F.2d 8 (2d Cir. 1982). At an expedited arbitration proceeding, the arbitration panel, ordered that the proceeds of the letter of credit be held in an escrow account in the joint names of Sperry and Israel pending a decision on the merits. See Sperry Int'l Trade, Inc. v. Government of Israel, 689 F.2d 301 (2d Cir. 1982) (affirming order confirming preliminary arbitration award). The arbitrators determined that Sperry had to pay Israel $16.4 million, return to Israel or destroy certain "protected material," and bear various bank charges. This award was upheld in Sperry Int'l Trade, Inc. v. Government of Israel, 602 F. Supp. 1440 (S.D.N.Y. 1985). Israel was thus prevented from recovering any of its payments to Sperry for the 39 months from the time work ceased on the contract to the time the $16.4 million was paid.

In an attempt to strengthen its hand in the event of a similar future dispute, Israel added certain provisions to its standard form contract. To discourage future contractors from stopping work in the event of arbitration, as Sperry had done, Israel added the following language at Article 18.6 of the Recon contract:

Unless otherwise directed by Buyer, pending the final disposition of any dispute hereunder, Seller agrees to proceed diligently with the performance of this Contract, or any change thereto in accordance with the decision and instructions of the Buyer, provided that Buyer shall pay Seller the amount due in accordance with this Contract, subject to adjustment based on the final disposition of the dispute.

Further, to avoid again being forced to litigate its right to draw under a letter of credit pending an arbitration decision, Israel added clauses at Article 4.3, providing that the contractor would not institute any action seeking to enjoin a drawdown, and at Article 18.1, providing that the arbitrators have no authority over an attempted drawdown.

Israel deemed Recon's work stoppage a material breach in violation of Article 18.6, entitling it to draw down the letter of credit by as much as $21.5 million, the total payments made to Recon by Israel. Recon then commenced the instant suit to enjoin the drawdown. At a hearing on September 3, 1986, Judge Griesa denied Recon's preliminary injunction request. He found that Recon had terminated its performance under the contract because of a financial dispute with Israel. Further, he found that the financial dispute and the right to terminate were to be resolved through arbitration. Reasoning that Recon was bound under Article 18.6 to continue work pending arbitration and ...

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