Documentary Credit World

Topics: Appeal; Autonomy; Beneficial Ownership; Breach of Contract; Burden of Proof; Confirming Bank; Consideration; Contract Interpretation; Damages; Irrevocable Undertaking; Nominated Bank; Risk-Based Approach; Sanctions Clause; UCP600 Articles 2 and 8; Unilateral Offer; Wrongful Dishonour

Note: As part of an underlying trade between PT Borneo Guna Energi (Seller), an Indonesian company, and Oilboy DMCC (Buyer), a Dubai, UAE company, Kuvera Resources Pte Ltd. (Trader), a trader of Indonesian coal based in Singapore, advanced funds to Seller for purchase of 35,000 metric tonnes of coal (± 10%) to resell to Buyer (the Sales Contract). Trader was party to the Sales Contract which required that the coal be delivered in two shipments and payment made by two letters of credit obtained by Buyer from “a major or international bank” and further confirmed by a bank in Singapore. Accordingly, Buyer/Applicant  caused Issuer, based in Dubai, to issue two UCP600 letters of credit of favour of Trader/Beneficiary (hereinafter “Beneficiary”) with terms pursuant to draft LCs attached to the Sales Contract. Issuer also nominated JPMorgan Chase Bank, N.A. (Nominated Bank/Advising  Bank/Confirming Bank, hereinafter “Confirming Bank”) on the credits, and Confirming Bank advised the terms of both LCs to Beneficiary. Confirming Bank also added its confirmation to both LCs from its Singapore branch. Notably, both the advices and confirmations included Confirming Bank’s standard Sanctions Clause (reprinted below). Moreover, as the LCs were amended several times, Confirming Bank advised Beneficiary of each amendment and included its Sanctions Clause.

Late November 2019, Beneficiary, through its Presenting Bank, sent documents to Confirming Bank under both LCs. After Confirming Bank found the presentation discrepant, it gave proper notice. Thereafter, Beneficiary made a second presentation and Confirming Bank reviewed the documents, including the drafts valued at a combined USD 2.42 million. As part of its standard practice, Confirming Bank sent the documents “for its internal sanctions screening procedure.” (para.9). During its review, Confirming Bank learned that the coal was shipped on a vessel known as “the Omnia”. As Confirming Bank discovered, that name was an exact match for a vessel known as “the Lady Mona”, a vessel “likely to be” beneficially owned by a Syrian entity and subject to US sanctions. This information was reflected in Confirming Bank’s internal “Master List”, a list of entities and vessels which the bank determined to have a “sanctions nexus and/or  concern.”₁

Confirming Bank later notified Presenting Bank that it could not “accommodate” the presentation “because the transaction did not comply with applicable US sanctions laws or with policies designed to promote compliance with those laws.” Confirming Bank returned the documents after also notifying Beneficiary that it could not “obtain internal approvals” to honour the otherwise complying documents (satisfying UCP600 Article 16 notice requirements).

After the LCs expired, Beneficiary, Issuer, and Buyer/Applicant  negotiated a Memorandum of Understanding (MOU) whereby Buyer/Applicant  paid Beneficiary USD 2.2 million for the trade documents. Thereafter, Beneficiary sued Confirming Bank for wrongful dishonour (alleging breach of contract) seeking the principal sum of the confirmations, USD 2.42 million or, alternatively, USD 220,000 for breach of contract damages. The trial court ruled in favour of Confirming Bank. Beneficiary appealed. The Singapore Court of Appeal, Sundaresh Menon, Judith Prakash & Steven Chong, JJ., reversed.

The appellate court affirmed the trial court’s analysis and rulings concerning the legal nature of letters of credit and confirmations under Singapore common law. LCs and confirmations are “separate and autonomous [independent] unilateral contracts with one sui generis exception”: banks’ unilateral offers for which no consideration is provided are irrevocable. (para.13).₂  The Sanctions Clause was an incorporated term of the confirmations as it was not “fundamentally inconsistent with [their] commercial purpose”. The Clause was also enforceable as it was narrowly worded so as not to confer on Confirming Bank broad discretion to escape its contractual undertaking thus rendering the confirmations de facto revocable. (para.15).

After reviewing the opposing arguments levelled by the parties, the appellate court turned to the proper interpretation of the Sanctions Clause. In accepting that the Clause was a valid and enforceable term of the confirmations, the court focused its inquiry on the italicised portion of the text which it deemed ought to be construed “objectively” such that Confirming Bank’s refusal of complying documents would have in fact been “contractually justified.” (para.42). It was sufficient for the trial court “that where there was an unresolved possibility that the Omnia may be caught under ‘any applicable restriction’, then the Sanctions Clause would entitle [Confirming Bank] to err on the side of caution to decline payment.” (para.41). The appellate court observed early in its Judgment that the trial court accepted that Confirming Bank proved on the balance of probabilities that it would have been penalised by U.S. OFAC had it honoured the presentation. The appellate court, however, disagreed with that approach which “was not predicated on an objective yardstick but was likely to have been shaped by risk management considerations.” (para.4).

Confirming Bank continued to rely on its correspondence with OFAC (and related expert testimony), reviewed in the trial judgment, that the U.S. regulator would have held Confirming Bank in breach of U.S. sanctions had it paid Beneficiary. It would, in the court’s view, be unacceptable to adopt an approach that permitted Confirming Bank to withhold payment based on “extrapolat[ing] what finding OFAC might [have arrived at] based on largely circumstantial evidence”; a “certain element of speculation and arbitrariness” in such an evidentiary approach “would practically render it impossible for a beneficiary of a letter of credit … to know with certainty whether it would be paid notwithstanding its full compliance with the documentary requirements.” (para.44). This approach, which the appellate court rejected, was “borne out” by the trial court’s review of OFAC’s investigative and penalty processes for suspected breaches of U.S. sanctions. The appellate court also reviewed and quoted communications between Confirming Bank and OFAC which the court viewed as the bank “actively seeking support from OFAC to justify its decision in refusing payment” (para.47). In fact, Confirming Bank, upon request, shared with OFAC its detailed due diligence results in attempting to determine the precise ownership of the vessel.

The appellate court accepted that Confirming Bank had objectively determined a Syrian-based beneficial ownership as early as 2015 (when the vessel was known as ‘the Lady Mona’). (paras.54-55). It was at that time Confirming Bank placed the vessel on its Master List. The central issue turned on “whether ’ ‘the Omnia’ under her new registered ownership remained under Syrian beneficial ownership in 2019.” (para.55). Despite its efforts, Confirming Bank ultimately found no “conclusive evidence” that the vessel’s ownership had changed from being Syrian-based. The appellate court, however, was unsatisfied with that argument as it effectively placed “the burden on [Beneficiary] to prove a negative when the burden of proof that the beneficial ownership had remained unchanged squarely rest[ed] with [Confirming Bank].”

By analogy, the court explored in rem maritime case law regarding determination of beneficial ownership of vessels since that body of law addressed the “same inquiry, ie, the evidential process by which a change of ownership of a vessel is established.” (paras.57-61). While not “entirely applicable” to the case at issue, “what is clear from the case law is that the ownership of a vessel and any change thereof is an issue capable of proof.” Consequently, a similar inquiry would meet what the appellate court viewed as required for a bank to dishonour otherwise complying documents presented under a letter of credit as being objectively in violation of the terms of a valid sanctions clause. To wit: “The imposition of the burden of proof on [Confirming Bank] is a function of [Confirming Bank]’s reliance on the Sanctions Clause to deny payment under the Confirmations. (para.61).

Industry-defined “red flags” cited by Confirming Bank which suggested the vessel continued to be beneficially owned by a Syrian entity were unpersuasive. What the appellate court could gather from public sources after the vessel was renamed in early 2019 indicated that the registered owner was a Barbados entity and the vessel’s technical manager was a UAE entity named Serenity Ship Management; the owner thereof was a Cypriot national which Confirming Bank had previously been aware of but did not consider relevant to any sanctions nexus. As Confirming Bank failed to demonstrate a beneficial ownership of the vessel that was the subject of “any applicable restriction” under the Sanctions Clause, the appeal was allowed. (para.68).

Before concluding with an assessment of damages, the appellate court analysed further the issue of whether the Sanctions Clause was compatible with the commercial purpose of an LC confirmation. These observations, however, were “provisional” as the court ruled that Confirming Bank was not entitled to rely on its Clause in the way the trial court accepted. The appellate court’s views were specific to the context of this action “where the sanctioned entity is the owner of a vessel. This is because a beneficiary under a letter of credit is typically not involved in the nomination of the vessel and the beneficial ownership of the vessel might not be apparent from the publicly available records.” (para.69). In reviewing case law and secondary sources which discuss the tension of inclusion of sanctions clauses in irrevocable independent undertakings, i.e. introducing uncertainty within what should be definite payment instruments, the appellate court expressed that:

The point of relevance to this appeal is simply that the construction of sanctions clauses and therefore the legal effect to be accorded to them remains a fact-specific and context-specific exercise in contractual interpretation. … At this point, it suffices for us to observe that a balance must be struck between preserving the autonomy of individual contracts within a documentary credit transaction (such that it is open to parties to insert conditions in each autonomous contract) and upholding the commercial viability of a documentary credit transaction, whereby each autonomous contract is intended to correspond to and/or  provide a safety net for the other contracts in the transaction. [paras.75-77].

In closing, the appellate court awarded Beneficiary damages totalling USD 98,786.87 and SGD 11,429.32. These damages represented the confirmation charges, the “discount” (difference in sum paid via the MOU mentioned previously and “the actual sum paid out by” Buyer to Beneficiary), as well as travel expenses incurred by Beneficiary, respectively.

[MJK]

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