Article

Factual Summary:

To supply 100 armored trucks to the Kuwaiti government following the Gulf War, the applicant caused an LC to be issued. The trucks were to be delivered in time for the first meeting of the Gulf Cooperation Council in December 1991. Under the terms of the LC, the beneficiary was able to draw ten percent of the value of the credit as an advancement upon presentation of an "unconditional performance bond ... on the standard format issued by a recognized insurance company legally operating under U.S. law". The beneficiary obtained a performance bond to guarantee the performance of its subcontractor in the underlying contract. The bond which was obtained and presented by the beneficiary was non-conforming, but nevertheless, the applicant gave its approval and the ten percent amount was released. The beneficiary then, by contract, ordered that the proceeds of the advance be paid to the sub-contractor. Subsequently, the first beneficiary partially transferred rights to draw (up to US$ 2 million) to the subcontractor, making it a second beneficiary under the LC.

The LC was amended when it became apparent the second beneficiary would have to ship via U.S. military air in order to meet the shipping deadline for the goods. The second beneficiary stated that the military required that payment be made through an escrow account earmarked for itself prior to shipment. The parties agreed to use the personal escrow account of the second beneficiary's attorney. The LC was again amended to allow the payment to be placed in this escrow account. Subsequently, the first beneficiary, second beneficiary, and the applicant executed a letter agreement to the confirmer calling for the transfer of the advance into the escrow account in exchange for certain guarantees by the subcontractor's attorney. The funds were then transferred into the escrow account and the balance of the LC was reduced accordingly.

Soon the first beneficiary realized that the subcontractor was not going to deliver the goods as promised and that its attorney "was not an honest man". It then arranged for shipment elsewhere and attempted to execute the performance bond and to transfer the advance proceeds from the escrow account back to the confirmer. The insurance company that issued the bond was never located and never honored its obligations under it. The funds in the escrow account also disappeared. In attempting to recover the amount advanced and the escrow allegedly stolen by the second beneficiary's attorney, the first beneficiary sued numerous parties including the confirmer on the theory that the confirmer improperly transferred funds under the LC and wrongfully disbursed funds to the escrow account. On cross motions for summary judgment, the trial court, applying New York law, granted summary judgment in favor of the confirmer.

Legal Analysis:

1. Payment:The first beneficiary claimed that the confirmer should not have made the original payment of proceeds to the subcontractor because the confirmer knew the performance bond was nonconforming. The court rejected this argument because the funds were paid directly to the beneficiary and only paid to the subcontractor after the beneficiary acknowledged receipt of the funds and authorized the funds transfer. The court noted that the transfer was valid under UCC § 4A-406 (Funds Transfer) and that UCP 400 Art. 55 envisioned an assignment of proceeds.

2. Payment; Confirmer; Duty to Beneficiary:The beneficiary claimed the confirmer had a duty to ensure that the performance bond conformed to the LC. The court rejected this argument on the ground that any breach by the confirmer inured to the beneficiary's benefit, since any breach resulted in thebeneficiary being paid. The court stated that:

Plaintiffs have failed to point to a single case where a beneficiary recovered against an issuing or advising and confirming bank after required payments were made to the beneficiary under the letter of credit. To the contrary, there is authority that a beneficiary's recovery against the bank is limited to the amounts that should have been but were not paid out under the letter of credit.

It also noted that:

[T]he duty of supplying conforming documents lies on the beneficiary. ... In light of this clear allocation of responsibilities, it would be paradoxical to allow the beneficiary to recover because of a non-conforming document. Plaintiffs are not now in a position to challenge a transfer that they approved and that was made for their benefit.

The role of the advising and confirming bank is ministerial, not superintending: to comply with the letter of credit for the benefit of the issuing bank and the applicant. The only reasonable care obligation born by the advising and confirming bank runs in favor of the applicant, not the beneficiary. ... The UCP explicitly says that the advising and confirming bank is not in the position of guarantor of all documents. ... As a result, as advising and confirming bank['s] ... , duty was never to protect [the first beneficiary's] interest. As beneficiary, Insearch is in no position to challenge documents that it had the duty to submit. [It] cannot avoid this duty or seek to pass it off to another party.

The mere fact that the performance bond actually benefitted [the first beneficiary] does not make [it] a de facto applicant under the letter of credit. As the real applicant, ... was entitled to waive the requirements of the letter of credit by accepting nonconforming documents. ... Here, [the applicant] properly waived the failure of the performance bond to conform to the letter of credit.

The first beneficiary also claimed that the confirmer improperly transferred LC funds into the escrow account. It argued that: 1) it agreed to an amendment of the LC, but not the amendment ultimately adopted and; 2) the confirmer was in the position of acting under ambiguous and conflicting instructions, the terms of which should be construed against the confirmer, and that the confirmer breached the terms of the amendment. The court stated that the first beneficiary had no claim against the confirmer regarding the payment to the escrow account, irrespective of whether the LC was effectively amended, because it had consented to the transfer.

The court reasoned that whether made outside the LC or by amendment to it, the payment to the escrow fund gave the first beneficiary no rights against the confirmer.

Nothing prevents the parties to a letter of credit transaction, however, from entering into an arrangement outside the letter of credit to effect payment for the underlying transaction. ... The agreement of all of the parties to follow a different arrangement would be regarded as a waiver of the conditions of the letter of credit, under the law of waiver described above. ... This agreement outside the credit may not, however, create obligations for the bank with respect to the letter of credit.

Moreover, the court noted the absence of any causal link between a failure to advise an amendment properly and absconding with funds from an attorney escrow account. The court indicated that the confirmer was "not the guardian of the success of the transaction" and that it owed "no duty under the letter of credit to protect the interests of the beneficiary."

If the LC were to be treated as amended, the court rejected the first beneficiary's argument that the confirmer violated its duty by transferring the funds into an unrestricted escrow account. The court noted that the confirmer's duty:

is not to protect the beneficiary, who is the party charged with meeting the conditions, or the success of the transaction in general, but to protect ... the applicant. Here, [the applicant] was actively involved in making the transfer and clearly waived any discrepancies between the amendment and the escrow transfer that was ultimately made. Plaintiffs provide no cases where recovery is permitted by the beneficiary against the advising and confirming bank because of a failure to comply with the terms of an amendment when the intended transfer is made with the knowledge and consent of the beneficiary.

Nor did the court, construing the terms of the LC as a matter of law, find any ambiguity in the LC amendment.

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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.