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Topics: Agreement Exception; Agreed Use; Breach of Contract; Fraud; Injunction; Irreparable Harm; Standby Letter of Credit
Note: To support a Sales Agreement between North Asia Ltd. (Seller/Applicant) and Jingdong e- Commerce (Trade) Hong Kong Corp. Ltd. (Supplier/Beneficiary), Seller/Applicant applied for and caused HSBC (Issuer) to issue a USD 8 million standby letter of credit in favour of Supplier/ Beneficiary. Standard Chartered Bank (Advising Bank) served as adviser. The Sales Agreement was entered into a year after the parties agreed on a Master Sale and Purchase Agreement (Master Agreement). Previously, Seller/Applicant obtained electronic goods directly from various suppliers on a cash on delivery basis.
Under the Master Agreement, Supplier/Beneficiary allowed Seller/Applicant “to place orders in its name for goods which [Seller/Applicant] would otherwise have sourced directly from its suppliers … [Seller/Applicant] would not be required to pay its suppliers on a [cash on delivery] basis, but only to [Supplier/Beneficiary] 20% of the price marked up by 1.6% as the initial deposits”. Seller/Applicant had additional time to settle the balance.1 Among other advantages, Seller/ Applicant could utilise the purchasing power of Supplier/Beneficiary.
The Sales Agreement was separate from the Master Agreement for unspecified goods (although the Judgment notes that one version of the Sales Agreement was in Chinese and included more terms that were blank or absent in the English version). When the parties entered the Sales Agreement, however, Supplier/Beneficiary “closed down its trading services.” Nevertheless, Seller/Applicant allegedly had 17 outstanding purchase orders with Supplier/Beneficiary for which it had given initial 20% deposits; those orders were said to be made under the Master Agreement. Conversely, Supplier/Beneficiary claimed that Seller/Applicant was indebted to it for several million USD; citing order dates at the time the Sales Agreement was entered, Supplier/Beneficiary claimed that those orders arose therefrom and it could demand sums under the standby. Seller/Applicant rgued the opposite. Apparently, Supplier/Beneficiary had demanded payment under the LC which Seller/Applicant claimed was wrongful. That presentation was allegedly withdrawn, although Seller/Applicant claimed that Supplier/Beneficiary would demand payment again “regardless of whether it would be wrongful to do so.”
Seller/Applicant sued Supplier/Beneficiary for breach of the Sales Agreement and for an injunction to prevent Supplier/Beneficiary from enforcing its rights on the standby. The Hong Kong Court of First Instance, Yeung, J., granted the injunction.
In reviewing the opposing arguments, the Judge accepted as basic that letters of credit are considered equivalent to cash. Further, the party seeking to restrain payment or demands faces a “higher merits threshold.” “The general principle is that the court will not grant an injunction interfering with their presentation or enforcement even though there may be disputes relating to the underlying transactions.” The Judge, however, noted two recognised exceptions under Hong Kong jurisprudence. The fraud exception and the “agreement exception”, i.e. the beneficiary made “an express or implied agreement” to the applicant not to demand payment. This basis of restraining payment may also be referred to as breach of a negative covenant or promise. Taking consideration of both the Sales and Master Agreement, the Judge was of the view that Seller/Applicant had met the high threshold, and “on a proper construction of the express terms, the parties have agreed that the SBLC shall be used as an alternative payment method under the Sales Agreement, so that the SBLC is not available for payment of the Outstanding POs, so that the Agreement Exception is engaged.” On their face, the Agreements are separate, and only the Sales Agreement mentioned the standby. Among other factors, the timing of the orders, when the Sales Agreement was entered, the conduct of the parties, and when the LC was actually issued, all indicated that its “Agreed Use” was for outstanding payments under the Sales Agreement.
Having determined that Seller/Applicant had met the high threshold of establishing a likelihood of success on the merits regarding an LC agreement exception claim, the Judge turned to the issue of irreparable harm. Although the standby would soon expire, the Judge noted that Supplier/Beneficiary was still in possession of goods central to the breach of contract claim; though their value had diminished, it was accepted that such valuations fluctuate and could return to normal. Ultimately, the balance of the equities supported granting the requested injunction.
The Judge concluded by briefly addressing the LC fraud exception. To demand payment, the credit stipulated: “BENEFICIARY’S SIGNED CERTIFICATE CERTIFYING THAT BENEFICIARY HAS MADE SHIPMENT OF THE REQUIRED GOODS AND HAS SUPPLIED THE REQUIRED DOCUMENTS TO BUYER AND HAS NOT BEEN PAID AT SIGHT OF THE INVOICE DATE.”
Seller/Applicant argued that this text required Supplier/Beneficiary to present so-called “Pick Up Notes” regarding the goods to receive LC payment. As no such documents were issued, any demand would be fraudulent. On the available facts, the Judge expressed that “[t]he dispute as to the role of the Pick Up Notes is also a realistic one. Proof of [Issuer]’s knowledge of the fraud is also a concern”. In sum, the Judge was not persuaded that Seller/Applicant demonstrated a likelihood of success regarding LC fraud but nevertheless granted an injunction on the basis of the so-called LC “agreement exception”.
1Master Agreement clause 4: “20% deposit within 7 business days after submission of purchase order, and balance of 80% ‘within 30 calendar days after receiving Products’.”