Article

Factual Summary:

To assure that a real estate development was properly constructed, the builder caused bank to issue a standby LC to the beneficiary/ municipal authority. The credit called for a written demand signed by the secretary of the beneficiary. When the municipal authority decided to draw on the standby, its staff made demand on the issuer by telefax. When the developer/applicant contested the demand, the issuer refused to pay and the municipality commenced an action seeking a declaration of its authority to draw on the LC. The trial court ruled that its drawing was authorized.


Legal Analysis:

1. Independence: The applicant argued that its obligation to the municipal authority was not in default. The court noted that "[t]he notion of autonomy has long been accepted as the very basis of the letter of credit system, permitting both assurance and immediacy of payment." After reviewing relevant authorities, the court stated:

enforcement of payment under a standby letter of credit does not require that the beneficiary first prove that the customer has defaulted on its obligations under the underlying commercial contract and, in fact, that issue is irrelevant. The beneficiary must only prove that it has complied with the requirements of the letter of credit to be entitled to payment under the letter. Thus, one must look to the letter of credit and not to the underlying commercial contract to determine whether the beneficiary has met its obligations and is entitled to payment.

In view of the autonomy of the LC, the court concluded that the only question relating to the ability of the authority to recover was whether its drawing complied with the terms and conditions of the credit. Noting that the applicant's arguments were based on an alleged breach of the underlying contract, the court stated that the beneficiary:

will not be entitled to retain any payment that is made under the letter of credit if [it] was in breach of the development agreement in calling the letter. But that issue is not determined in the context of the [its] entitlement to payment under the letter of credit.

2. Standby; Compared to Accessory Guarantee: The court noted that:

While a standby letter of credit is analogous to a guarantee in that it guarantees the performance of obligations under a contract, it is different in the legal relations that it creates among the parties.

It quoted from the Canadian Encyclopedic Digest at 369 to the effect that:

three key features distinguish such credits from guarantees. First, under a standby letter of credit the issuer is liable as a principal rather than as surety. Second, liability is autonomous. Third, standby credits differ from guarantees in that, as in the case of all letters of credit, payment becomes due upon compliance with the terms of the credit, that is, upon presentation of appropriate documentation, rather than because of the act of default itself. The documentation required to bring about payment is set out or specified in the terms of the credit itself; once these documents are presented, the question whether there has actually been default is largely irrelevant to the obligation of the issuer to make payment.

When the applicant cited a case based on an accessory guarantee, the court responded: I find that the law relating to guarantees is of no assistance in determining the rights and obligations of the parties to a transaction involving a letter of credit because a letter of credit is a completely different type of legal arrangement from a guarantee.

Comment:

1. The decision is, of course, correct with regard to the principles of independence. It usefully distinguishes between an accessory guarantee and a standby.

2. One operations question which escaped the notice of the parties was the manner of presentation, namely by telefax. The court sets out the full text of the credit which was silent as to the mode of presentation. Under standard LC practice, it would follow that the presentation must be an original and not a telefax. To be sure, the issuer apparently did not refer to the mode of presentation in its notice of dishonor (if there was one). On the other hand, the standby was not issued subject to the UCP and one is left to imagine to what regime of practice it is subject. This situation highlights the advantages of stated rules of practice and the superiority of the ISP over the UCP in situations such as the present one even though involving a relatively simple standby.

© 2000 INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.