Documentary Credit World

Topics: Fraud; Injunction; N.Y. Rev. UCC Section 5-109(a); Standby Letter of Credit

Note: To support potential liquidated damages related to partial construction of Alto Maipo’s (Owner/Beneficiary) hydroelectric power plant, Strabag, SpA (Contractor/Applicant) applied for and caused Credit Agricole CIB (Issuer) to issue an, as amended, USD 90 million standby letter of credit in favor of Owner/Beneficiary. The power plant was located in Chile. In August 2022, Contractor/Applicant claimed achieving substantial completion. By early December 2022, Owner/Beneficiary disputed that substantial completion had been met according the terms of the contract. Critically, 31 December 2022 was the “Critical Milestone Date” where, absent completion, Owner/Beneficiary could assess liquidated damages and in turn demand sums under the standby.

When Owner/Beneficiary discovered that certain tunnels had collapsed allegedly due to the fault of Contractor/Applicant as well as incomplete work, Owner/Beneficiary intended to demand at least USD 16 million on the LC. Disputing any fault and alleging no colorable basis (“no legitimate reason”) to demand payment, Contractor/Applicant applied for an injunction to restrain Issuer from honoring any demand by Owner/Beneficiary. Upon reviewing the available evidence and an International Chamber of Commerce (ICC) arbitration order,₁ the New York Supreme Court, Masley, J., granted a preliminary injunction.

While Owner/Beneficiary disputed substantial completion and claimed Contractor/Applicant caused the collapsed tunnels, Contractor/Applicant essentially claimed the opposite and argued that the collapsed tunnels were discovered long after it relinquished control of the project to Owner/Beneficiary, i.e. during the warranty phase of the contract. In the alternative, insufficient water flows both excused substantial completion and any liquidated damages.

The Judge proceeded to review each element necessary to sustain the requested injunction under N.Y. civil procedure. A movant must: (1) establish a likelihood of success on the merits (here on the claim of fraud); (2) demonstrate irreparable harm absent an injunction; and (3) the balance of equities favor the movant. In noting that the LC was obtained to secure Contractor/Applicant’s performance, the Judge also quoted the choice of law provision of the credit (reprinted below).

Owner/Beneficiary alleged it was entitled to demand payment pursuant to one of the six stated reasons in the credit, i.e. breach of a contract provision related to late milestones and liquidated damages. Contractor/Applicant again disputed any alleged liability. While the parties drew attention to different contract provisions, the Judge highlighted the independence principle of letters of credit. Issuer would look to presented documents and not whether Contractor/Applicant actually met substantial compliance. The exception to the independence principle, however, is fraud. Citing N.Y. Rev. UCC Section 5-109(a) and its Official Comment 1, the Judge noted that, to prevail, Contractor/Applicant would have to establish a likelihood of success on its claim of material fraud: “a contract dispute is not sufficient.”

Contractor/Applicant likened its case to that of Rockwell Intern. Sys., Inc. v Citibank, N.A.₂ “In Rockwell, following the fall of the Shah of Iran, the new government instructed Rockwell to stop working on a project then attempted to drawdown on a letter of credit asserting that Rockwell had defaulted.” Similarly, Contractor/Applicant alleged “a classic bait and switch.” Owner/Beneficiary argued that the N.Y. court could not render a decision on the likelihood of success regarding fraud because the parallel ICC emergency arbitration found to the contrary (i.e. a legal-collateral estoppel argument). The Judge, however, was not persuaded and refused to apply any binding significance from the ICC proceedings.

[T]he Emergency Arbitrator effectively abstained from deciding likelihood of success to avoid prejudging, which could be viewed as a different standard on likelihood of success. While an arbitration award could certainly have preclusive effect, it will not collaterally estop a court when the arbitrator applies a different standard.

What matters to a New York court are “the facts as of the date” of the requested injunction and “what we know at the time.” Turning to the central issue, the Judge noted that the facts of the case were “in dispute.” A provision of the contract, which Owner/Beneficiary ignored, excused Contractor/Applicant for testing delays caused by insufficient water flows. What was undisputed, however, was that Owner/Beneficiary’s “rejection of substantial completion came well before the collapses of the tunnels were discovered.” Critically, in May 2022, the parties executed a contract amendment (Amendment 2) which excused Contractor/Applicant from certain delays (notably including testing delays) so that Owner/Beneficiary could “take over two of the powerplants” to generate “desperately needed revenue.” The project was nearing completion in August 2022, but Owner/Beneficiary faced insolvency. In separate proceedings, Owner/Beneficiary acknowledged that its expected revenues would be diminished due to insufficient water “stemming from climate change”.

According to the General Manager of Owner/Beneficiary, the performance tests originally planned for mid-year 2022 were postponed “toward the end of the year when waterflow was at its highest due to snowmelt. ... This was long before the collapsed tunnels were discovered and renders [Owner/Beneficiary]’s position, that [Contractor/Applicant] and the collapsed tunnels are to blame for [Contractor/Applicant]’s failure to achieve substantial completion, disingenuous at best.”

While the parties have a legitimate dispute about whether [Contractor/Applicant] achieved substantial completion, the [Owner/Beneficiary] has no ‘plausible’ explanation for agreeing to excuse failure to achieve substantial completion due to water shortages in exchange for taking control of the plant earlier than allowed in the Contract, but disavowing [Contractor/Applicant]’s rights in Amendment 2 with two words: ‘collapsed tunnels,’ which had yet to be discovered when the [Owner/Beneficiary] denied substantial completion. ... When a contract provision is crystal clear, as Amendment 2 is here, but a party effectively denies that provision’s applicability based on something that has yet to happen, this basic contract dispute becomes fraud.

Accordingly, Contractor/Applicant succeeded in demonstrating a likelihood of success on its claim of fraud. As to the issue of irreparable harm, Contractor/Applicant noted that Owner/Beneficiary was a “special purpose non-recourse entity” which recently emerged from bankruptcy and was not generating revenue; thus, were Owner/Beneficiary permitted to demand sums under the LC, Contractor/Applicant would be unable to “claw back the letter of credit proceeds.” The Judge agreed, noting that the ICC arbitrator reached a similar conclusion.

As for the final question, whether the balance of equities favored Contractor/Applicant, the Judge concluded that Owner/Beneficiary placed too much emphasis on the collapsed tunnels and inability of the power plant to generate revenue. The contract amendment allowed for an extension of time to perform testing; thus, the potential harm to Owner/Beneficiary would be temporary while the harm to Contractor/Applicant could be permanent. As a preliminary injunction would serve the purpose of maintaining the status quo between the parties, and Judge granted the requested injunction and ordered Contractor/Applicant to post a USD 1.6 million undertaking to secure any damages and costs were it determined later that preliminary relief was unwarranted.

---

---

• ← prev
• next →