Article

Factual Summary: To pay for the purchase of gas oil, Korean Buyer (Applicant) obtained two LCs from Issuer in favor of Singapore Seller (Beneficiary). Both LCs were issued via SWIFT. Relevant portions of the LCs follow this abstract. Fields 32B and 39A were materially similar for both LCs. Field 32B (Currency code, amount) stated "USD800,000" and Field 39A (Percentage credit amount tolerance) stated "10/10." The goods description under each LC differed. Under the first LC, Field 45A (Description of goods and/or services) indicated "Gas oil 26,000BBL +/- 10 pct." where Field 45A of the second LC stated "27,000BBL +/- 10 pct."

Field 47A (Additional Conditions) included a provision regarding price:

Price: The price in US dollars per barrel based on the quantity as determined under clause 12 of the contract shall be on a ex tank price at Pyongtaek, Korea. Basis shall be equal to the average of the mean quotations published in the Platt's Asia Pacific/Arabian Gulf Marketscan for gasoil reg 0.5 pct quotations under the heading Singapore plus a premium of US dollars 3.38 per US BBL.

Also, both LCs contained a "fluctuation clause" in Field 47A Additional Condition E that stated: "The amount of this letter of credit shall automatically fluctuate to cover any increase/decrease according to the price clause without further amendment to this credit." The LCs required presentation of a sight draft, Seller's commercial invoice, an independent inspector's quantity report at loadport, copy of Seller's authorization for release of product to Applicant, and a photo copy bill of lading. As permitted under the LC terms, a Singapore Bank added its confirmation to both LCs.

Beneficiary presented documents for both LCs to Confirmer. Having determined that the documents complied, Confirmer honored the presentations and forwarded the documents to Issuer for reimbursement under both LCs in the amounts of US$939,789.01 and US$1,021,641.66. Issuer refused, sending a notice of refusal to Confirmer that stated three discrepancies for each presentation. One of the reasons given for refusal of both presentations was "Amount Overdrawn."

In an attempt to cure one claimed discrepancy, Confirmer re-presented the documents and, according to the opinion, "it was made clear to the [Issuer] that the re-presentation by the [Confirming Bank] was without prejudice to [Confirming Bank's] position that the Tendered Documents as [originally] presented complied with the terms and conditions of the LCs." Issuer did not reimburse, send a notice of refusal, or return the documents to Confirming Bank in response to the re-presented documents.

Confirmer sued Issuer for wrongful dishonor in Singapore. On Confirmer's motion, the trial court granted summary judgment in favor of Confirmer for US$1,961,430.67, plus interest and costs. The trial court rejected Issuer's three discrepancies as invalid. Issuer appealed on the sole ground that the refusal was proper because the amount stated in the documents was overdrawn. On appeal, affirmed.

Legal Analysis:

1. Notice of Refusal, Contents; UCP500 Article 14(d): At a preliminary hearing, Confirmer argued that Issuer should be precluded from claiming that the documents did not comply because the stated discrepancy, "Amount Overdrawn", was "inaccurate and lacked particularity". The appellate court noted that an affidavit submitted in the earlier proceedings clarified the basis for the refusal by stating "seller's invoice was overdrawn in the sense that it exceeded the LC limit of US$800,000 +/-10%." Confirmer argued that "it was not open to [Issuer] to embellish belatedly its initial statement of the discrepancy." The court cited Kumagai-Zenecon Construction Pte Ltd v Arab Bank plc, [1997] 2 SLR 805 at [31], abstracted at 1998 Annual Survey 453, for the proposition that later statements may clarify initial notices of refusal.

The appellate court looked at the sources cited by Confirmer in support of its position and concluded that they did not support it. While the court recognized that there is a need to identify all discrepancies in the notice of refusal, it stated that "it seems permissible for a later communication to clarify what was already identified as a discrepancy in the original notice of refusal", citing Kumagai-Zenecon Construction Pte Ltd, at [31]. The appellate judge concluded that "there is a need for sufficient clarity in a notice of refusal so that the beneficiary may know for certain what needs to be rectified. That said, I am of the view that in the present case, the use of the words 'Amount Overdrawn' sufficiently conveyed [Issuer's] objection. Certainly the [Confirmer] was left in no doubt as to its purport."

2. Interpretation; Construction: In addressing the interpretation of the credit, the appellate court relied on two rules of construction. First, it stated that "in construing a contract all parts of it must be given effect where possible, and no part of it should be treated as inoperative or surplus", quoting from K. Lewison, The Intepretation of Contracts (3rd Ed. 2004).

Second, the court noted that "a clause must not be considered in isolation but rather in the context of the document as a whole." In explaining the application of this norm, the court cited cases involving interpretation of a deed and a lease.

3. Oil Fluctuation Clauses; Automatic Fluctuation Clauses; Price Escalation Clauses; Amount; Overdrawing; Discrepancies, Overdrawn; Alleged Discrepancies; UCP500 Article 13(a); UCP500 Article 14(a): Issuer argued that Fields 32B and 39A, when read together as US$800,000 +/- 10% limited the LC drawable amount to a range of US$720,000 to US$880,000. Accordingly, Issuer reasoned that by making demands in the presentations for US$939,789.01 and US$1,021,641.66, amounts in excess of these tolerances, the credits were overdrawn. Issuer further argued that Additional Condition E "allowed for fluctuation in the price of gas oil without the need to amend the LC provided the price payable for the gas oil shipped was within the '+/- 10 pct.' tolerance for the LC amount stipulated for under Field 39A" but was subordinate to the amount tolerances in Fields 32B and 39A which were "paramount".

Confirmer, on the other hand, argued that Field 47A Additional Condition E "prevailed". It argued that the scope of Field 47A was price fluctuations whereas "the '+/- 10 pct' tolerance in the credit limit was meant to cater to a similar percentage tolerance for the volume of gas oil shipped, as provided for in Field 45A." Since only Additional Condition E applied to price fluctuations, Confirmer further argued the reimbursement claims were proper given that Additional Condition E stated "[t]he amount of the LC shall automatically fluctuate to cover any increase/decrease according to the price clause without further amendment to this credit." Confirmer argued that the phrase "according to the price clause" from Additional Condition E simply referred to Field 32B (USD800,000) as a starting point from which automatic fluctuation is allowed.

Resorting to applicable rules of construction (see paragraph 2 above), the appellate judge concluded that the construction proposed by Issuer would render Additional Condition E "superfluous" and "if the tolerance in the credit limit was completely taken up by a maximum increase of 10% in the volume of gas oil, Additional Condition E would have to be disregarded and given absolutely no effect even if there was a price increase." Accordingly, the court characterized Issuer's proposed construction to be "untenable", drawing support from decisions regarding the drafting of a deed and a lease.

The appellate court stated that:

Fields 32B and 39A limiting the credit limit to US$800,000 '+/- 10 pct' should not be read in isolation but should be considered in the context of the LCs as a whole. When that is done, it will be seen that there is an apparent conflict between those provisions and the automatic fluctuation clause in Additional Condition E. I use the word 'apparent' advisedly for, in my view, the conflict can be resolved so that Additional Conditional E prevails over Fields 32B and 39A. The key to this resolution is found in the wording of Additional Condition E itself; as noted earlier, the second part of Additional Condition E provides that any fluctuation in the LC amount shall take effect without further amendment to the credit. In my view, that is as good as saying 'Notwithstanding the credit tolerance limit provided under Fields 32B and 39A'.

The appellate court indicated that it was "unmoved" by Issuer's argument that Confirmer's interpretation would leave its liability "unlimited". The court stated that "[i]t is untrue that such a construction would render the LC similar to a 'blank cheque' as the [Issuer's] counsel described it. Under Additional Condition E, the increase in the credit is limited by the increase in the price of oil." The court also noted that "[i]f there is any ambiguous or unclear term in a letter of credit, a confirming bank is entitled to take a reasonable construction thereof even if, upon closer consideration in an action in a court of law, it is possible that some other interpretation is to be preferred", citing Credit Agricole Indosuez v Muslim Commercial Bank Ltd [2000] 1 Lloyd's Rep 275, abstracted in 2001 Annual Survey 213.

4. Non Documentary Condition; Automatic Fluctuation Clauses; Price Escalation Clauses; UCP500 Article 13(c): Issuer also argued that the price clause in Field 47A was a non-documentary condition "which, by reason of Art 13(c) of UCP 500, was to be treated as not stated and therefore disregarded; Additional Condition E, being inseparably linked to the price clause, had to suffer the same fate."

Confirmer responded that the provisions of the price clause were "requirements stipulated in a letter of credit, the satisfaction of which could only be achieved by reference to extraneous factual matters rather than the documents presented" and that even if it were disregarded, "one should just ignore the reference therein to the price clause. [Confirmer] reasoned that to do so would be to give a purposive interpretation to the clause so as not to frustrate the intention behind the inclusion of the automatic fluctuation clause in the LCs, viz, to facilitate the trade in gas oil where contract prices, rather than being fixed, are usually linked to a benchmark."

Rather than follow the line of reasoning suggested by Confirmer, the court chose to "look into the purpose behind the introduction of Art 13(c) in UCP 500." Relying on ICC Position Paper No. 3, reprinted in LC Rules & Laws: Critical Texts (3rd Ed.), the court indicated that "the specific purpose of this sub-Article was to eradicate the totally wrong practice of incorporating non-documentary conditions into documentary credits", a practice that the court noted created "serious difficulties" and contravened the principle of independence. The court noted that this solution was accepted over the "alternative which was to allow banks to exercise their discretion to accept any document which they deemed sufficient in purported compliance with a non-documentary condition."

Identifying the basis of this choice, the court quoted from Documentary Credits: UCP500 & 400 Compared written by Charles del Busto, the then Chair of the UCP500 Drafting Group and of the ICC Banking Commission:

The onus must be placed on the Applicant and the Issuing Bank to issue the Credit properly. They cannot be allowed to shift this responsibility to other parties. The Applicant and the Issuing Bank must be the ones who must determine the document required to satisfy a non-documentary condition.

Drawing on this perspective, the appellate court concluded that the non documentary condition rule of UCP500 Article 13(c) "avails the negotiating bank or confirming bank against the issuing bank and, arguably, the issuing bank against the applicant." The court concluded that use of the non documentary condition rule by the Issuer against a Confirmer would turn the rule "on its head. Besides in invoking Art 13(c) and thereby contending that Additional Condition E was to be disregarded, [Issuer] was seeking to renege on its obligations under Additional Condition E. This leads us to another reason why the [Issuer] should fail in its attempt to invoke Art 13(c)."

5. Modification of UCP; Variation of UCP; UCP500 Article 1; Express Terms; Non Documentary Conditions; UCP500 Article 13(c): The appellate court noted that even if that Issuer were correct regarding the non documentary character of the price fluctuation clause, a conflict would arise between an express term of an LC and the non documentary condition provision implied from UCP500 Article 13(c). The court noted that UCP500 Article 1 provides that when a credit is subject to the UCP, its provisions shall apply "unless otherwise expressly stipulated in the Credit." Considering whether these credits otherwise expressly stipulated, the court noted that "[t]he quoted words have not been interpreted so stringently as to mean that only an express exclusion of any particular provision of UCP 500 will have effect. It is enough if an express provision in the LC stipulates a requirement which is clearly at odds with a provision in UCP 500 in circumstances where an implication may be drawn that the intention was to exclude the operation of the UCP provision in question. In such an event, the express provision will override the provision of the UCP incorporated by reference only."

In support of its conclusion, the appellate court quoted at length from Jack, et al., Documentary Credits (Butterworths, 3rd Ed., 2001) to the effect that the parties to a credit are free to make their own bargain and that this principle applies to the UCP provisions on non documentary conditions.

The appellate court noted that "the importance of the price clause and the automatic fluctuation clause to the working of the credit is obvious. Without it, the credit would be unworkable as the price for the gas oil is not fixed but fluctuates with a benchmark" the court concluded "even if they were non-documentary conditions, effect should be given to the two express clauses rather than to Art 13(c)."

Concluding that Issuer's argument that the price fluctuation clauses should be disregarded had failed, the appellate court stated that "the amount of payment sought by the respondent did not exceed the credit limit of the LCs."

6. Notice of Refusal, Re-Presentation; ICC Banking Commission Opinion R328; Re- Presentation; Refusal, Re-Presentation; Preclusion; UCP500 Article 14(d), 14(e); Cure; Good Faith: Confirmer argued that even if documents are discrepant, Issuer was precluded from asserting that the documents are not in compliance based on its failure to respond to the re-presentation. Although he noted that stating "it is not strictly necessary that I consider" the issue, the appellate judge stated that UCP500 Articles 13 and 14 "do not distinguish between the first and subsequent presentations. Neither is such a distinction drawn in any of the standard texts on documentary credit to which I have referred." He noted that Confirmer had called his attention to ICC Opinion R328 which indicated that the provisions of UCP500 Article 14(d) apply regardless of whether an initial or subsequent presentation was at issue. The judge also indicated that "[s]upport for the [Confirmer's] position may also be found in the judgment of Evans J in Floating Dock Ltd v The Hongkong & Shanghai Banking Corporation [1986] 1 Lloyd's Rep 65 at 80. In what appears to be obiter dicta, the learned judge opined that the failure of an issuing bank, in its second notice of refusal, to cite a valid discrepancy which it had properly cited in its first notice of refusal precluded the bank from relying on such discrepancy. A fortiori in the present case where even if there was a valid discrepancy, the [Issuer] simply gave no second notice of refusal."

7. Good Faith; Re-presentation; UCP500 Article 15: Issuer had argued that no notice of refusal was necessary where the presenting bank was aware that the documents re-presented did not comply due to the previous notification and that such "re-presentation was in bad faith". The appellate judge stated that "I do not see how the re-presentation of the Tendered Documents (with amendment to the seller's authorisation) could be criticised as lacking in good faith. The [Confirmer] was convinced that the Tendered Documents were compliant and were well entitled to re-present them for payment. It was surely no hardship for the [Issuer] to respond a second time even if it was only to reject the Tendered Documents once again."

The appellate judge noted that "I agree with the [Confirmer] that to read into the UCP 500 an overriding requirement of good faith may require banks to go beyond documentary examination. This would be contrary to the fundamental principle in documentary credit that banks deal only with documents. In similar vein, albeit not entirely apropos, Art 15 of UCP 500 provides, inter alia, that '[b]anks assume no liability or responsibility ... for the good faith ... of the consignors, the carriers, the forwarders, the consignees or the insurers of the goods, or any other person whomsoever'".

Comments by SOH Chee Seng:

As a letter of credit practitioner, I fully agree with the above judgment made by the learned judge in the High Court of Singapore.

1. Price Escalation Clause: It has been a practice in an oil letter of credit that the amount of the credit shall automatically fluctuate to cover any increase/ decrease according to the price clause without further amendment to the credit. South Korean banks have incorporated this price clause in their oil credits in the past and have never disputed with it.

I agree with the position taken by the Confirming Bank that Additional Condition E prevailed over the provisions of Fields 32B and 39A. In its view, the "+/- 10 pct" tolerance in the credit limit was meant to cater to a similar percentage tolerance for the volume of gas oil shipped. Additional Condition E was to cater to fluctuations in the price of the gas oil and that the credit limit provided for in Fields 32B and 39A could be exceeded without the need for amendment of the credits.

It is quite obvious that the refusal to take up documents by the Issuer was mainly due to the insolvency of the Applicant in late 2003. The Issuer would have been unable to obtain reimbursement from Applicant if it had paid under the two credits. Issuer was trying to take a chance by finding fault on the documents. Due to the recent oil crisis, it seems that this has been the practice in South Korean banks to find fault on documents by raising baseless discrepancies to refuse payment if the oil credit applicant has financial difficulty to reimburse the banks. In a recent case which I was requested by a bank in Singapore to provide my opinion on the discrepancies raised by a South Korean bank, none of the discrepancies were valid. One of the discrepancies was "bill of exchange" not marked on the draft and the South Korean bank claimed that the wording "bill of exchange" was mandatory in according to the agreement of "International Draft Law". This is nonsense as the credit did not provide such requirement.

2. Notice of Refusal on Re-Presented Documents: Issuer sought to argue that a party presenting documents for payment had to act in good faith; where, as in this case, Confirming Bank already was aware of the discrepancy (having been previously notified under the notice of refusal) its re-presentation was in bad faith and could not be considered a presentation for purposes of UCP500 Articles 13 and 14.

The learned judge disagreed. The Confirming Bank was convinced that the documents were compliant and was well entitled to re-present them for payment. He said that it was surely no hardship for Issuer to respond a second time even if it was only to reject the documents once again.

This is a sound judgment. The ICC Banking Commission has stated in its opinion R328 that UCP500 Article 14(d)(i) applied "whether the documents are a first presentation or a presentation on the basis of corrected documents". An issuing bank is required to examine the re-presented documents and determine whether to take up or refuse the documents and to inform the party from which it received the documents accordingly within reasonable time. If an issuing bank fails to do so, it is precluded by UCP500 Art. 14(e) from claiming that the said documents were not in compliance with the terms and conditions of the credit.

[JEB/ejh]

TEXT APPENDIX

The terms of the two credits are materially similar and are set out below:

Credit No. M06M8310NS00032

50: Applicant Petaco Petroleum Inc.

59: Beneficiary Trafigura Beheer BV Amsterdam.

32B: Currency code, amount USD800000

39A: Percentage credit amount tolerance 10/10

41D: Available with By any bank by negotiation

42C: Drafts at Sight

42D: Drawee Korea Exchange Bank" World Trade Center Branch

45A: Description of goods and/or services Origin: Japan Gas oil 26,000 BBL +/- 10 pct. Price term: CFR any port(s) in South Korea

47A: Additional conditions Late presentation B/L acceptable.

Price: The price in US dollars per barrel based on the quantity as determined under clause 12 of the contract shall be on a ex tank price at Pyongtaek, Korea Basis shall be equal to the average of the mean quotations published in the Platt's Asia Pacific/Arabian Gulf Marketscan for gasoil reg 0.5 pct quotations under the heading Singapore plus a premium of US dollars 3.38 per US BBL.

A. Availability by negotiation at sight against following documents.

Seller's commercial invoice (telex/telefax acceptable)

Independant [sic] inspector's quantity report at loadport (telex/fax acceptable)

Copy of seller's authorization for release of product to Petaco (telex/fax copy acceptable)

Photo copy B/L (telex/telefax acceptable)

...3

E. The amount of this letter of credit shall automatically fluctuate to cover any increase/ decrease according to the price clause without further amendment to this credit.

...

J. Documents showing alterations without approval stamp or initials are acceptable.

49. Confirmation instructions May add

Credit No. M06M8310NS00064

The material terms and conditions of Letter of Credit M06M8310NS00064 are similar to those enumerated above with the exception that under "Description of Goods", the quantity of gas oil shows as "27000 BBL +/- 10 pct".

(a) M06M8310NS00032 [as amended]

50: Applicant Petaco Petroleum Inc.

59: Beneficiary Trafigura Beheer BV Amsterdam.

32B: Currency code, amount USD800000

39A: Percentage credit amount tolerance 10/10

41D: Available with By any bank by negotiation

42C: Drafts at Sight

42D: Drawee Korea Exchange Bank World Trade Center Branch

45A: Description of goods and/or services Origin: Japan Gas oil 26,000 BBL +/- 10 pct. Price term: CFR any port(s) in South Korea

47A: Additional conditions Late presentation B/L acceptable. Price: The price in US dollars per barrel based on the quantity as determined under clause 12 of the contract shall be on a ex tank price at Pyongtaek, Korea Basis shall be equal to the average of the mean quotations published in the Platt's Asia Pacific/ Arabian Gulf Marketscan for gasoil reg 0.5 pct quotations under the heading Singapore plus a premium of US dollars 3.38 per US BBL.A. Availability by negotiation at sight against following documents.Seller's commercial invoice (telex/telefax acceptable) Independant [sic] inspector's quantity report at loadport (telex/fax acceptable)Copy of seller's authorization for release of product to Petaco (telex/fax copy acceptable)Photo copy B/L (telex/ telefax acceptable)...3E. The amount of this letter of credit shall automatically fluctuate to cover any increase/decrease according to the price clause without further amendment to this credit....J. Documents showing alterations without approval stamp or initials are acceptable.

49. Confirmation instructions May add

(b) M06M8310NS00064

SOH Chee Seng is Technical Consultant on Trade Finance Issues for the Association of Banks in Singapore, a member of the Editorial Advisory Board of Documentary Credit World, and regular panelist participant in the Annual Survey of Letter of Credit Law & Practice conference series.

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