Article

Factual Summary: Joint Venture had contracted to sell equipment for making building materials to Buyer who caused a transferable LC (LC1) to be issued in its favor by 1st LC Issuer. Because neither Joint Venture nor its members had sufficient available credit facilities to obtain an LC required to purchase the machinery from Manufacturer, Joint Venture Member approached Principal of Company, asking it to obtain an LC (LC2) in favor of Manufacturer. As security, it caused LC1 issued by 1st LC Issuer to be transferred to Company. At the request of Company, 2nd LC Issuer opened its commercial LC in favor of Manufacturer.

The machinery arrived before the documents and, at the request of Company, 2nd LC Issuer issued a steamship indemnity to enable Company to obtain the machinery. LC2 honored.

After the documents arrived, Company as transferree of LC1 sought to draw on it and submitted a request to 2nd LC Issuer to forward the documents to 1st LC Issuer. The request was on a form entitled a "Collection Order" that stated that it was subject to URC 522. On the order form, Company selected an option naming 2nd LC Issuer as a negotiating bank.

On that day, 2nd LC Issuer credited the account of Company and reimbursed itself for the payment on the LC issued by 1st LC Issuer. 2nd LC Issuer then forwarded the documents to 1st LC Issuer. Thereafter, 1st LC Issuer sent a notice of refusal, claiming the following discrepancies:

(1) There is no number on invoice (invoice was not numbered).

(2) There is no initial signature beside correction seals on invoice, draft, packing list and fax copy of shipping advice.

(3) In 120MM RMP rogid pipe, making M/C model number KC/RP-120' on packing list and inspection certificate. [Rogid] was illogically spelt according to the context ([Rogid] should have been [rigid])[.]

(4) In RMP drying and grinding machines model number KC/DG-200, on inspection certificates appendix, [machines] should have been [machine].

2nd LC Issuer took the position that these reasons for refusal were valid discrepancies and disputed them with 1st LC Issuer. Company was kept informed of their correspondence.

Later, Company submitted a revised collection order to 2nd LC Issuer. In this collection order, 2nd LC Issuer was authorized only to collect, not to negotiate.

There were other disputes, including an action on the Mainland for a freeze order by the applicant for LC1 due to the alleged poor quality of the machinery. Arbitration was also invoked pursuant to the contract terms. The arbitrators concluded that the machinery should first be installed.

Company's Principal sued Issuer at the provincial branch that issued the LC. The defense was that Beneficiary had already negotiated the documents and could not claim payment. The court ruled that the rejection was proper. On appeal the Supreme People's Court affirmed the decision regarding standing of transferee but did not rule on whether the documents were discrepant.

2nd LC Issuer also sued 1st LC issuer in Beijing but the action was dismissed on the grounds that it was brought in the wrong venue and would have to be filed in the same provincial court as had transferee's action.

In any event, no funds were paid by 1st LC Issuer. When Company refused to refund the payment credited to its account by 2nd LC Issuer, 2nd LC Issuer sued Company for the amount due. The court entered judgment for 2nd LC Issuer.

Legal Analysis:

1. Negotiation: Company and its Principals argued that LC2 Issuer had not negotiated documents under LC1 but only acted as a collecting bank on behalf of Principal/Transferee. The court rejected this argument, describing 2nd LC Issuer's case as "overwhelming". It noted testimony from the Company and Principal did not specify the nature of 2nd LC Issuer's obligations. The court also noted that LC1 was available by negotiation, the choice of the option "negotiation" by Principal/Transferee in the collection order, that 2nd LC Issuer was named internal records, and the finding of LC1 by 2nd Issuer.

2. Estoppel: Company and its Principals argued that 2nd LC Issuer asserted ownership over the documents negotiated, estopping it from relying on recourse agent there. The court agreed that 2nd LC Issuer had acquired rights under LC2 but disagreed that negotiation gave rise to estoppel as the parties had agreed to reimburse 2nd LC Issuer.

3. Negotiating Bank, Duty: Company and its Principal argued that 2nd LC Issuer in negotiating had a duty to seek additional time to cure, failed to pursue 1st LC Issuer, failed to sue 1st LC Issuer in an appropriate forum without delay, and failed to preserve Principal/Transferee's cause of action. In rejecting these arguments, the court noted "[2nd LC Issuer] had negotiated the [1st Issuer] LC for US$652,775.68 pursuant to the collection order dated 25 May 1993 and had sought reimbursement of US$764,362.50 from the [1st Issuer] on such basis. The evidence for the [2nd LC Issuer's] case is overwhelming." The court observed that 2nd LC Issuer "had responded to the [1st Issuer] promptly and correctly over the discrepancies" and noted that the 21-day rule of UCP400 Article 45 allowed no time for cure and, that in light of the circumstances, that any extension would have been permitted "[g]iven the frivolous nature of the alleged discrepancies and the insistence on them by [1st Issuer]".

The court also accepted undisputed expert testimony that:

[I]n the light of the [provincial Chinese] Court's favourable decisions on the frivolous discrepancies, there was no point for the [2nd Issuer] to go to [that court] to sue the [1st Issuer] again. I also accept that it is not a wise move for the [2nd Issuer] to sue the [1st Issuer] in Hong Kong as such action would be met with a very strong application to stay on the basis of forum convenience. I therefore do not think that the [2nd Issuer] can be faulted on this.

4. Recourse: Principal/Transferee argued that 2nd LC Issuer would not have recourse on LC1. The court rejected this argument, stating that:

All relevant contemporaneous documents show that there was a right of recourse of the [2nd Issuer] as against the [2nd LC Applicant]. If the [2nd Issuer] should have been contented not to have any right of recourse against the [2nd LC Applicant], it would have been simple and straightforward for it to have asked [1st LC Applicant] to be the applicant of the [LC1] rather than going through the trouble of having the [1st Issuer] LC transferred to the [2nd LC Applicant] and increasing the banking facilities for the [2nd LC Applicant].

Comments:

1. "Clean"; Applicant Controlled Conditions: Company's Principal was said to have asked Joint Venture Member "whether the [1st Issuing] Bank LC was 'clean,' meaning whether the terms were not complicated or difficult to comply with. If payment was dependent on documentation to be issued by the buyer and the buyer could control payment, the 1st defendant would not deal with it. [Joint Venture Member] then read this LC and replied that it was clean and it should not be difficult to get payment under it."

This use of the term "clean" is troubling because it is incorrect and confusing. It is disturbing because it suggests a culture in which LCs are screened for applicant controlled conditions. While it is eminently sensible for beneficiaries and sureties who rely on LCs to screen for them, the fact that there exists a colloquial tem to describe this phenomenon testifies to its widespread character. While this practice will not lead to the demise of commercial letters of credit, it will hasten it.

[JEB/dgd]

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