Article

Factual Summary: Issuing Bank maintained an account with Reimbursing Bank's New York branch. Issuing Bank, on the application of Solo Industries, opened a letter of credit in favor of the English Beneficiary, Simetal, Ltd. in the amount of US$1,887,100 payable 180 days after negotiation, to be confirmed by Confirmer's London branch. Confirmer was authorized by Issuing Bank to claim reimbursement from Issuing Bank's US account with Reimbursing Bank.

Several days later, Confirming Bank accepted documents presented to it by the Beneficiary and immediately discounted payment to the Beneficiary in the amount of US$1,821,215.31. On receiving the documents, Issuing Bank informed Confirming Bank that they were in order and authorized it to seek reimbursement from Reimbursing Bank. Issuing Bank also informed Reimbursing Bank that it was authorized to reimburse Confirming Bank on maturity.

A month later, however, and before maturity, Issuing Bank cancelled that authorization and sought and received acknowledgment from Reimbursing Bank that the authorization was cancelled. Issuing Bank informed Confirming Bank that the LC was under investigation and requested Confirming Bank to stop payment until further notice. However, maintaining that it was entitled to claim reimbursement since it had discounted the LC, Confirming Bank sought repayment from Reimbursing Bank. However, due to a procedural error, Reimbursing Bank paid Confirming Bank the requested sum and debited Issuing Bank's account in that amount. When Issuer recognized the error and protested, Reimbursing Bank recredited Issuing Bank's account in the same amount and sought a refund of the sum from Confirming Bank. Confirming Bank refused.

Mediation between the parties was unsuccessful, and Reimbursing Bank brought an action against Issuing Bank and Confirming Bank to recover the amount paid. On motion for summary judgment, the trial court granted summary judgment in favor of Issuer, but denied summary judgment to Reimbursing Bank.

Legal Analysis:

1. Choice of Law: Confirming Bank had argued, and Reimbursing Bank did not dispute, that New York law should be applied to determine how to treat Reimbursing Bank's accidental payment to Confirming Bank, because under English conflicts of laws principles, the governing law is where the claimed enrichment occurs. Therefore, the court analyzed the payment under New York law.

2. Discharge for Value: Noting that New York Law would permit retention of a mistaken payment where there was a discharge for value, both parties presented expert opinion regarding how New York law would treat this payment. Confirming Bank argued that it was entitled to retain the payment because it had no knowledge that the sum had been erroneously paid. Therefore, Confirming Bank argued it had received the funds in good faith in the regular course of business for valuable consideration and without notice of a mistake.

In contrast, Reimbursing Bank argued that if it could prove that it made the payment in mistake, it would have established a prima facie case that the payment should be recovered under the laws of restitution. Confirming Bank must then prove that it received the payment in satisfaction of a valid debt, that it made no misrepresentation regarding the payment, and that it had no knowledge of the mistake.

The court decided that the summary judgment phase of the trial was not appropriate for a discussion between these two interpretations. The court noted that while it was feasible that Confirming Bank could believe it was entitled to the funds, Issuing Bank's revocation of the authorization might have put Confirming Bank on notice that it was not entitled to the payment. Therefore, the court denied summary judgment regarding these claims and left the issue to be decided at trial.

3. Reimbursing Bank had No Real Prospect of Success on Its Claims against Issuing Bank: Reimbursing Bank based its claim for reimbursement from the Issuer on four grounds. Reimbursing Bank first argued that, assuming it could not obtain reimbursement from Confirming Bank, it should be entitled to reimbursement from Issuing Bank. The court ruled that, without more, the mere fact that Confirming Bank would not be liable to Reimbursing Bank was not enough to render Issuing Bank liable.

Reimbursing Bank argued second that by making payment to Confirming Bank, Reimbursing Bank discharged a liability of Issuing Bank to Confirming Bank regarding the LC. To prove this, the court said that Reimbursing Bank would have to show that Issuing Bank owed a liability to Confirming Bank and that Reimbursing Bank's payment discharged that liability. While Issuing Bank could not deny that it was liable to Confirming Bank in relation to the LC, the court held that the liability would only be discharged if Issuing Bank authorized the payment or subsequently ratified the payment. Here, Issuing Bank specifically revoked its authorization before payment was made and refused to reimburse Reimbursing Bank when it sought reimbursement. Thus, the payment would not serve as a discharge of that liability.

Third, Reimbursing Bank had argued that it had a claim for reimbursement from Issuing Bank under New York law or a claim for restitution under English law. However, under English law, Reimbursing Bank would first have to show that the payment had discharged a valid debt, and the court had already found above that the payment had not discharged the valid liability. Further, the court held that Reimbursing Bank's counsel had not presented sufficient reason to consider the claim for reimbursement under New York law merely by saying that New York law would be more beneficial to its client. All of the relevant dealings between the two parties had taken place in London, and therefore the English discharge rules would apply.

Finally, Reimbursing Bank argued that Issuing Bank was liable to make restitution on unjust enrichment principles. However, the court ruled that the mere fact that the Reimbursing Bank's payment had caused a benefit was not sufficient to establish unjust enrichment. Reimbursing Bank could point to no evidence that Issuing Bank was somehow enriched by the payment, nor could it point to any evidence to suggest that whatever benefit it did receive was unjust.

Therefore, Reimbursing Bank had no realistic prospect of success on its claim against Issuing Bank. Summary judgment was, therefore, appropriate in regards to the claims against Issuing Bank and was granted.

Comments:

1. This decision is troubling. The LC system as it now operates depends heavily on bank to bank reimbursements which provide a quick and inexpensive system for the transfer of hundreds of millions of dollars. For economic and historical reasons, much of that business is centered in New York even though there is no US connection to the transaction. This decision poses a serious threat to that system in that it places the reimbursing bank that has made an innocent mistake in an impossible position.

2. It is a necessary corollary of a commercial fraud such as the Solo Fraud that it will be followed by a scramble among innocent parties seeking to recover. It is another corollary that there are rarely, if ever, sufficient funds to recompense the parties that have been defrauded. In the absence of an international system accepted rule of law, recovery is piece-meal and depends on the vigor and luck of the particular victim. Where the fraud is international, as it often is, the process is even more convoluted.

3. In this particular aspect of the Solo fraud, the confirmer that had discounted its confirmed obligation believed itself entitled to recover from the issuer. The ability of a confirmer to discount its deferred payment obligation is an issue as to which LC bankers and lawyers as well as courts disagree. What is clear, however, is that both the issuer and the confirmer deliberately placed themselves at risk by being involved in the transaction and were presumably compensated accordingly. The issuer was responsible for a credit analysis of the applicant. The confirmer was responsible for a credit analysis of the issuer and a risk assessment of its practice of discounting and was compensated for both confirmation and discounting. It is understood that there are risks inherent in all three activities, issuance, confirmation, and discounting. These banks consciously assumed these risks.

4. The situation of the reimbursing bank differs. Its role is ministerial. It pays in accordance with reimbursement instructions. If it extends credit to the instructing bank, of course it assumes the risk that it will be repaid. It does not assume the risk that there will be a quarrel between the bank giving the instructions and the bank claiming reimbursement. Normally, it is not drawn into any such quarrel because the payment is made in an automatic fashion according to instructions, the account of the instructing bank is debited, and the reimbursing bank is out of the picture.

5. The Gulf International case is an exception to this general rule. It involves a situation where the reimbursing bank became involved because it made an innocent mistake, paying the confirmer despite a revocation of prior authorization to reimburse.

6. In such a situation, several matters should be clear. As between the other two banks, assuming that both remain solvent, the reimbursing bank is the one that should not bear the loss. Its mistaken payment was a supervening event that should not alter the relative rights and obligations between the two parties to the LC, the issuer and confirmer. Whichever of them should be paid should receive the amount paid and whichever is liable should reimburse the reimbursing bank. All three parties should be brought together in one proceeding and all of their relative rights should be determined in one proceeding.

7. The problem is that the courts of different countries are not able to take such a broad view or to align their procedures accordingly. The only foreseeable solution to this type of problem is a binding system of arbitration or an international convention. It is unlikely that judicial doctrines of comity and forum non conveniens will suffice to prevent inequitable results such as the one that has occurred in the Gulf International case. Since there is little or no likelihood of an international convention, it is left to the reimbursing banks to create an adequate system to adjust these problems.

8. Scope of Solo Fraud: The opinion recited some of the actions that resulted from the Solo fraud.

"These investigations ultimately led to a number of actions against Wachovia by a number of banks including Albaraka and Gulf, in which the banks alleged against Wachovia that Wachovia had known or had been reckless about whether or not Solo and Simetal had been participating in fraudulent and fictitious transactions. Proceedings were first brought against Wachovia in October/November 2000 by Arab Banking Corporation, Emirates Bank International and Bank Muscat. Then Albaraka, represented by Allen & Overy, commenced proceedings against Wachovia in May 2001. Lastly Gulf, represented by Reynolds Porter Chamberlain, brought its own action against Wachovia in February 2002. On 20th September 2002 Allen & Overy took over from Reynolds Porter Chamberlain the conduct of Gulf's claim against Wachovia. In all actions (save for the Albaraka action), the claimant banks sought damages for fraud against Wachovia. Additionally, Albaraka, which had made no payment to Wachovia in respect of letter of credit T20/99, sought a declaration that it was not liable to do so. The action brought by Gulf did not include any claim to relief in respect of the payment that it had made to Wachovia in relation to letter of credit T20/99, and Allen & Overy received no instructions from Gulf to advance any such claim. As for Wachovia, it denied any complicity in fraud and, in relation to Albaraka's additional claim to declaratory relief in relation to letter of credit T20/99, asserted that Albaraka was indeed not liable to make payment to it in relation to the letter of credit since, it alleged, Albaraka's debt to it in relation to that letter of credit had already been discharged by Gulf's payment on 27th September 1999."

With respect to the other entities, a settlement had been reached in which the parties agreed that "none of them nor any of their respective current or former employees, officers, directors, or agents acted dishonestly, in bad faith, or with knowledge of or was reckless as to any fraudulent activity committed by any of Madhav Patel, Milton Kounnou, or any employee, officer, director, or agent of Solo Industries Limited, Simetal Limited or Hamco, or of any company related to any of these."

9. Overshadowing this decision is English law regarding discounting of obligations. If the Issuer was obligated to reimburse the Confirmer when the obligation matured, the reimbursing bank satisfied its obligation. Absent an injunction, of which there is no indication, the confirmer was obligated to pay at maturity and entitled to reimbursement. That it discounted the sum should have no impact because a claim of fraud by the issuer is not notice of fraud.

Editors' Note: After admitting his role in the Solo fraud, Milton Kounnou, a metals shipping agent, was reportedly sentenced by a UK court to two years' imprisonment. His companies, Simetal, Ltd. and Fimetco Ltd., were accused of creating false shipping documents.

[JEB/jam]

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.