Article

Factual Summary: To enable Applicant, a demolition company, to obtain a permit to demolish buildings in accordance with an agreement between the building's Owner, the City where they were located, and Applicant, Bank issued a standby LC in favor of City for US$200,000. The standby was expressly subject to ISP98 and required presentation of a draft, the original LC, and a statement containing the terms stated in the LC, including references to the "Tri-Party Agreement".

When the state environmental agency ordered that demolition work be stopped as a result of the discovery of asbestos in the buildings, the Owner notified Applicant of its intent to terminate the demolition contract. Subsequently, City issued a notice that it would draw on the LC. When Applicant sought to enjoin the drawing, the court ordered that the LC be extended 90 days. Two days later, the LC expired. Subsequently, Bank issued a second LC on order of the court which was said in the opinion to be "substantially identical" to the first one.

On the day prior to expiration of the second LC, Applicant informed Issuer that no prior notice of intent to draw had been received as required by the contract and instructed Issuer to dishonor any presentation since the notice was required to be given five days before the drawing.

When the City drew on the LC later that day, the Issuer dishonored. The documents presented included a draft which, as required by the terms of the LC, specifically referenced to the second LC, and correctly stated its issuance date. The signed certification contained all the terms required by the LC, but also contained an extensive heading that referred to the transaction, the parties, the Applicant, the credit amount, and an "Issuance Date" giving the issuance date of the first LC, instead of the second.

Issuer then filed an action seeking declaratory judgment regarding its obligations under the LC and moved for an injunction pending the decision. When the court denied its motion, Issuer honored the LC. Applicant counter sued Issuer for wrongful honor and moved for partial summary judgment. The court denied the motion.

Legal Analysis:

1. Local Law, applicability; Practice Rules; ISP98, Interpretation; ISP98, Relationship to Local Law: Although acknowledging that the standby was "governed" by ISP98, Applicant argued that "ISP98 requires the application of Massachusetts law for the ultimate decision of whether the Bank acted appropriately in honoring the draft." Disagreeing, Issuer contended that "the resolution of this issue can be reached by relying solely on the rules provided in ISP98." The court noted that the determination of whether a bank was justified in refusing to honor a credit subject to rules of practice was a question for local law. In the US federal system, federal courts would also defer to state law. Since the court concluded that the result would be the same under either local law or ISP98, it did not resolve the issue.

2. ISP98; Standard Standby Practice: The court stated that "ISP98 reflects generally accepted practice, custom, and usage of standby letters of credit."

3. Standard Standby Practice; ISP98 Rule 4.01 (Examination for Compliance): Applicant argued that the reference in ISP98 Rule 4.01 (Examination for Compliance) to the effect that the ISP rules are to be "read in the context of standard standby practice" signified that "Massachusetts law should apply to determine whether the [Issuer] complied with 'standard standby practice'." As indicated, the court did not decide whether this argument was correct, but concluded that the result would be the same under either Massachusetts law or ISP98.

4. Strict Compliance; "Technical Variance": Noting that the incorrect reference to the issuance date of the standby letter of credit in the certification was a term that was not required by the terms of the standby, the court concluded that there was no discrepancy and only a "technical variance". In summarizing its conclusions, it stated that "Because the City's presentment would have been acceptable absent the reference to the issuance date of the expired letter of credit, this Court cannot conclude that the Bank was required to dishonor payment."

5. Compliance; Rev. UCC Section 5-108; Standard, Mislead: The court also asked whether the reference to the incorrect date of issuance in the certification "could mislead the [Issuer] to its detriment". Its conclusion was that "it is clear that the mere reference to the date of the expired letter of credit could not possibly have caused the documents to mislead the Bank to its detriment."

6. Inconsistency; ISP98 Rule 4.03 (Examination for Inconsistency): In determining whether or not the documents complied with the terms of the standby, the court reasoned that the Applicant's argument could be reduced to whether the statement required in the credit was inconsistent with that which appeared in the presented document. It noted that the "heading" which contained the reference to the issuance date of the first standby instead of the second standby was not required by the terms of the second standby. The court stated that "The Certification, while incorrectly referencing the issuance date of the First Letter of Credit, contained the exact wording that was presented within the quotation marks and called for by the New Letter of Credit. The Bank was only required to examine the documents for inconsistency within this paragraph. Because the information that was required in the New Letter of Credit was contained in the presentment documents, the Bank correctly honored the draft."

7. Inconsistency; ISP98 Rule 4.03 (Examination for Inconsistency): The court also noted that one of the other required documents, the draft presented by the City, "contained all of the information specified in the New Letter of Credit. Both the name of the issuing bank and the letter of credit number were properly identified."

Comments:

1. Standard of Examination: Although not well formulated, what the applicant was suggesting was that the standard by which the compliance of the documents with the terms and conditions of the standby letter of credit should be measured should be gleaned by the court cases that have considered that issue. While this argument has a certain appeal, it is at best redundant. Courts and lawyers have long struggled with the question of compliance. In the fashion typical of lawyers, they have sought to generalize their approach and resolve future questions by resort to a general formula. In the case of compliance, the formula is the so-called standard of "strict compliance". The phrase is recited in most cases and even used in Revised UCC Section 5- 108(a). When carefully considered in light of the alleged discrepancies, however, these decisions are rarely consistent with one another and vary considerably in their rigor of application. What is "strict" is in the eye of the judge. Its only clear meaning, however, is that the standard is not that to be applied to determine performance under a bilateral contract. Although the term is not used in rules of practice such as the UCP or ISP, the understanding of compliance with respect to documents presented under a letter of credit in standard international letter of credit practice depends on the purpose of the document or term in letter of credit practice. To use the most common example in commercial letters of credit, the compliance of the description of the goods depends on which document and what the term is in the credit and in the document. In the commercial invoice, it must be very close ("correspond") as provided in UCP500 Article 37(c). In all other documents, however, general terms may be used provided that they are not inconsistent with the description in the credit.

2. Compliance: The court is correct in its twopronged analysis of the issue before it. The first aspect of the question is whether or not the appearance of incorrect extraneous data would render the certification non compliant. The second aspect is whether the incorrect information could have caused the bank to conclude that the presentation was being made under a different letter of credit.

At several points, the court notes that the "heading" and reference to the issuance date of the first standby (whereas the certification was being presented under the second standby) were not required. The court is correct in its conclusion that the presence of extraneous information by itself does not constitute a discrepancy even if the information is incorrect.

Which brings us to the second question. It could be phrased whether the certification was inconsistent with the draft and would have been so phrased under the inconsistency rule of UCP500 Article 13 (Standard for the Examination of Documents). As the court properly notes, however, ISP98 has abandoned the inconsistency rule except to the extent required by the express terms of the standby letter of credit as provided in ISP98 Rule 4.03 (Examination for Inconsistency). Under ISP98, the test of whether or not this incorrect extraneous information complied would be whether or not it could have misled Issuer into thinking that the presentation was made under a different letter of credit. As the court indicates, there was no possibility of such a mistake. The court does not detail its reasons, but they must include the fact that the draft signals the correct number and what is in all likelihood the relatively small number of standbys issued by the bank. Moreover, the first standby required that the operative letter of credit instrument be presented. The opinion does not recite this requirement for the second standby nor mention this factor. However, it does state that the second standby was "substantially identical" to the first one. If the operative credit instrument was presented, there could have been no possible doubt as to which standby the presentation related.

3. "Strict Compliance"; Revised UCC Section 5-108(a): The court cites a series of Massachusetts cases for the proposition that documents must strictly comply with the terms of the credit. Ironically, one of the cases cited, Banco Espanol de Credito v. State Street Bank & Trust Co., 385 F.2d 230, 234 (1st Cir.1967) is one of the cases that is regularly criticized as adopting a different rule of compliance, namely that of substantial compliance. The reality is that the jurisprudence on letter of credit compliance is woefully impoverished and that the threadbare phrase "strict compliance" has no analytical value beyond the most primitive notions.

The Middlesex court, however, avoids one of the worst errors inherent in the term "strict compliance", namely the notion that there must be literal replication of the terms of the standby. It notes that:

"The strict compliance rule, however, is not absolute, as a bank may "not reject a demand for payment on the basis of hypertechnical reading of a letter of credit." [quoting from] Exotic Traders Far East Buying Office, 717 F.Supp. at 16. Rather, "a variance between documents specified and documents submitted is not fatal if there is no possibility that the documents could mislead the paying bank to its detriment." [quoting from] Flagship Cruises, Ltd. v. New England Merchants Nat. Bank of Boston, 569 F.2d 699,705 (1st Cir.1978)".

4. Standard to be Applied to Standbys: The standard adopted in ISP98 Rule 4.01 (Examination for Compliance) is determined by the application of the terms of the standby itself, the ISP, and standard standby practice. In fact, the ISP contains a number of specific rules that reflect on questions of compliance. At least two of them are applicable to this case, namely the rule on consistency between documents and the rule regarding required formulations of terms.

5. Relationship of ISP98 to Local Law: In arguing that the ISP required that the decision as to whether or not certain documents complied with the terms and conditions of the standby was to be reached under local law, the applicant got both the ISP and local law rather muddled. The relationship between ISP98 is in some ways more simple than the applicant suggests and in others far more nuanced. (1.) In fact, ISP98 was drafted in a manner to be consistent with local law and with Revised UCC Article 5 which is the Massachusetts statute governing letters of credit and which would have been applicable to this standby. Any differences would fall into one of several categories: i) Not addressed. Either ISP98 or local law does not address the issue while the other does or does so with more specificity; ii) Addressed but conflict. The issue is addressed under both ISP98 and local law and the two conflict with each other. (2.) Under Rev. UCC Section 5-116(c), applicable rules would govern to the extent of any conflict. This result is consistent with ISP98 Rule 1.02(a) which provides that its rules supplement local law to the extent not prohibited. (3.) Of course, both the ISP and local law should be construed in such a way as to reach a consistent result wherever possible without doing violence to the international character of the ISP. (4.) There is, of course, a question as to what constitutes "local law". As indicated, in most of the states in the US, local law primarily consists of a fairly detailed statutory formulation in the form of Revised UCC Article 5. In addition and in most countries where there is no statutory law, local law may also consist of court opinions in previous letter of credit cases. The effect and significance of these cases varies. Where they are decided under the prior statute in the US or under different or no rules of practice, their significance may be peripheral if any.

6. Standard Standby Practice in ISP98: Whatever the significance of local law under ISP98, the applicant was incorrect in its suggestion that the reference to standard standby practice in ISP98 Rule 4.01 (Examination for Compliance) signifies local law (and probably relevant court opinions). While local law may be relevant and, where mandatory, will govern, the reference to standard standby practice which appears throughout ISP98 is a reference to those practices of banks with respect to standby letters of credit that form the basis for the expectations and conduct of banks and bankers that deal with standbys. How to distinguish between the practice of a particular bank or a particular region and a practice that is an international standby practice is a matter of delicate judgment. It involves several assessments, including the extent to which the practice is observed, the impact of the practice on the integrity of the undertaking, its consistency with fundamental principles underlying independent undertakings, its consistency with other rules of practice, whether it is neutral, its rational basis, and its impact on practice. ISP98 reflects an attempt on the part of a serious segment of the standby letter of credit community to articulate those practices of standby letters of credit that deserve to be regarded as standard standby practices. While not every provision of ISP98 is such a practice since some provisions are in effect "traffic rules" which required some balanced decision, many of its provisions do reflect standard standby practice. However, the articulation of any practice in a complete and systematic manner is no easy task. Therefore, ISP98 provides a cardinal rule of interpretation of its provisions, that they are not be read in a vacuum, but in the context of the standard practice that they have attempted to capture. This approach is signaled in ISP98 Rule 4.01 but stated more fully in Rule 1.03 (Interpretative Principles). Consequently, while court opinions may have some bearing on the result in the Middlesex case, they are not "standard standby practice". That practice, to the extent that it is not stated in the ISP, is to be found in the practices of letter of credit banks, the opinions of international organizations that reflect those practices, and in the literature that describes those practices.

7. Consistency and Inconsistency: The court tackles the question of whether the documents comply from the perspective of "inconsistency". As it uses the term, it seems to mean whether the required statement in the certification was consistent with the statement in the document. Because the court also refers to the correct reference in the draft (which was inconsistent with the non-required statement in the certification), it also implicitly raises the issue of inconsistency between documents.

While the term "inconsistency" is usually used to refer to a variance between documents (the only frame of reference in UCP500 Article 13), it can also mean an internal inconsistency within a document.

With respect to this presentation, there are two possible arguments. One is that the certification referencing the issuance date of the first standby is inconsistent with the draft referencing the issuance date of the second standby. The other is that the certification does not comply because the referenced date is inconsistent with the terms of the credit. The latter issue would not typically be characterized as one of "inconsistency" but rather one of compliance.

8. Procedural Posture: The posture of the case is interesting. The motion arose in the context of a counter claim by the applicant for wrongful honor. One would have thought that the applicant's reimbursement agreement would have been relevant. The expectation would be that this agreement would have provided for a standard that differed from that applicable to the beneficiary, namely that there must be some harm to the applicant other than a mere discrepancy. In any event, in this case the court hit on the same analysis. One wonders, though, whether the bank had such an arrow in its quiver.

9. ISP98 Generally: This opinion represents a signal victory for the ISP. It is a case in which a court was given the conceptual tools to cut through the nonsense argument that an insignificant technical error in a document justified refusal of an otherwise complying presentation without doing violence to important principles of letter of credit law and practice or reaching a decision which cannot be squared with other decisions on the same issue. While it may be hoped that a similar decision would be reached under UCP500 or local law absent applicable rules, and such a decision has been reached in some cases, there are far too many misleading signals in the UCP and the case law to give any assurance as to what might be the result when different norms apply. The point of the ISP was to assure beneficiaries that they would be paid unless they simply failed to make a presentation that complied and to reduce or eliminate hyper technical arguments. This decision is one that should be read by every attorney for a beneficiary of a standby.

[JEB/at]

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