Article

Prior History: Sirius International Insurance Corp. v. FAI General Insurance Co. Ltd., [2002] All E.R. (Comm.) 745] abstracted at 2003 Annual Survey 271.

Note: To provide Agnew Syndicate of Lloyds security on its reinsurance contract with Applicant, FAI General Insurance Co. Ltd., Beneficiary, Sirius International Insurance Corp. "fronted" the reinsurance coverage and then "retroceded" it to Applicant. In exchange, Applicant caused an LC for US$5 million to be issued to secure its obligation to Beneficiary in the case that Beneficiary was required to pay Agnew's claim. The agreement between Beneficiary and Applicant provided that a claim by Agnew would not be paid without Applicant's prior written approval unless either the Applicant had "agreed that [Beneficiary] should pay the [insurance] claim but [had] not put [Beneficiary] in funds to do so" or Agnew had "obtain[ed] a judgment or binding arbitration award against [Beneficiary] which [Beneficiary was] obligated to pay." The LC itself, however, did not contain this provision.

When Agnew filed a claim against Beneficiary, neither Beneficiary nor Applicant would pay the claim. Agnew, Beneficiary and Applicant then agreed that Agnew would not require Beneficiary to pay the claim until the relative obligations of Applicant were resolved. As a result of the insolvency of Applicant, it was ordered that Beneficiary draw on the LC and place the money in an escrow account until the disagreement concerning the LC was resolved by the court.

The trial court, Jacob, J., ruled that the conditions for drawing on the LC had been met, but rejected Beneficiary's alternative argument that the conditions in an underlying agreement which were not reflected in the LC could not limit its right to draw. Applicant appealed and Beneficiary cross appealed. The UK Court of Appeals, Civil Division, May LJ, granted Applicant's appeal, reversed the decision of the trial court, and dismissed Beneficiary's cross-appeal.

The applicant argued that the court's order requiring the beneficiary to draw on the LC allowed the beneficiary to do so in violation of the letter agreement because applicant had neither provided written permission to draw, nor had a court ordered the beneficiary to pay Agnew's claim. Thus, claimed applicant, the beneficiary was not entitled to the funds from the LC. The beneficiary argued that the LC "was an autonomous contract not affected by the conditions as to its draw down agreed between [beneficiary] and [the applicant]. [Beneficiary was] entitled to draw the [LC] according to its terms."

The court noted that "absent fraud, [the court will not] restrain a beneficiary from drawing on a letter of credit which is payable in accordance with its terms on the application of a buyer who is in dispute with the seller as to whether the underlying sale contract has been broken .... This is the autonomous nature of letters of credit." However, the court noted that the purpose of LC autonomy is to create a situation where "banks are protected and the cash nature of letters of credit is maintained," but stated that "[t]here is no authority extending this autonomy for the benefit of the beneficiary of a letter of credit so as to entitle him as against the seller to draw the LC when he is expressly entitled not to do so."

The appellate court concluded that the trial court misconstrued a stipulated order that permitted the drawing to contain an agreement to the effect that a drawing was justified. The appellate court, however, stated that the order allowed the drawing while preserving all defenses.

Thus, because the letter agreement's restrictions for the draw were not met, "although those restrictions were not terms of the [LC], and although the bank would have been obliged and entitled to honour a request to pay which fulfilled [the LC] terms, that does not mean that, as between themselves and [the applicant], [the beneficiary] was entitled to draw on the letter of credit if the express conditions of this underlying agreement were not fulfilled." Thus, concluded the court, the money drawn from the LC by order of the court and placed in an escrow account did not belong to the beneficiary, but to the issuer because "the conditions of the [letter agreement] have never been fulfilled so as to entitle [beneficiary] to draw the money." The court also noted that the court order requiring the draw and the escrow holding expressly "preserv[ed] each party's position and arguments in relation to [the LC]."

Recognizing the concern for the commercial effectiveness of LCs, the appellate court maintained that the beneficiary was not entitled to draw on the LC at the time the court order required it to do so, noting that there were express terms in the letter agreement which prohibited beneficiary from drawing unless certain conditions obtained.

[JEB/llh]

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