Article

Factual Summary: A standby letter of credit was issued to cover the cost of potential warranty repairs in connection with the design and construct a commercial refrigeration unit for use by the beneficiary. The standby provided that issuer would pay against a written declaration that the applicant had failed or refused to perform warranty work on the unit.

The applicant delivered the unit but the unit would not function despite repeated efforts to repair and replace non-working parts. The applicant "took the position that the defects occurred in the 'delivery and installation phase' and that the warranty covered only defects occurring in the 'operational phase.' [The applicant] sent repair personnel to Thailand only on condition that [the beneficiary/buyer] pay in advance for their services."

The beneficiary then made a demand on the standby letter of credit stating the applicant "had failed or refused to perform warranty work on the unit." The applicant responded with a suit seeking temporary injunction and permanent injunction preventing the issuer from honoring the letter of credit. The trial court denied the applicant's application for temporary injunction. On appeal, the appellate court affirmed.

Legal Analysis:

1. LC Fraud: The applicant claimed the presentment was fraudulent because the beneficiary knew or should have known: 1) that the problems for which it sought repairs and replacement were not, in fact, warranty obligations because they occurred in the "installation phase of the project and not in normal use and service as required by the warranty;" and 2) that the beneficiary's material modifications to the unit voided the warranty obligations altogether and therefore, vitiated the entire transaction, entitling the applicant to injunctive relief.

The court ruled that the facts of the underlying transaction are generally not relevant to the obligation of an issuer of a letter of credit under the independence principle and that the general rule is that an injunction will not issue to block payment of a letter of credit where the beneficiary has presented complying documents. One exception to this rule is recognized when there is fraud in the transaction, established by evidence of "trickery, dishonesty, deception or other wrongdoing that rises to the level of fraud".

In this case, the court ruled that injunction should not issue.

"In fact, the evidence shows that [the beneficiary/ buyer] was using the letter of credit exactly as the parties had contemplated at the time it was issued. [The applicant's] steadfast contention that it has no liability on the warranty, even if true, is insufficient to justify enjoining payment on the letter of credit under [prior] section 5.114(b). A dispute over the existence or scope of warranty obligations does not provide grounds to enjoin payment of a letter of credit issued to secure performance of those obligations. To allow an account party to obtain an injunction based on a mere contractual dispute with the beneficiary would destroy the commercial viability of letters of credit and, in this case, would undermine the rationale for utilizing a letter of credit - to shift leverage back to the purchaser in demanding performance by the seller of the warranty obligations."

2. Fraud Elements:The court also noted that the applicant also failed to show that there was no adequate legal remedy or that irreparable injury would result whereas the beneficiary proved that it was financially secure and capable of paying the full amount of the LC.

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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.