Article

Factual Summary: Recognizing that there was an unsatisfied demand for shrimp in the US, particularly during the Christmas season, Wholesaler contracted with Retailer for the supply of massive quantities of raw and cooked shrimp to Retailer's Sam's Club division. To obtain the shrimp, Wholesaler contracted with Supplier in Thailand. Supplier required assurance of payment. Wholesaler financed the period between delivery of the shrimp by Supplier and payment by Retailer by establishing a line of credit with Lender.

Under the line of credit, Lender issued LCs payable to Wholesaler. The LCs issued in 1993 contained a "Special Condition" which the trial court explained as providing that "prior to payment the documents evidencing shipment be delivered to [Wholesaler]. [Wholesaler] would then, with the assistance of a customs broker, use the documents to ensure that the shrimp cleared United States Food and Drug Administration inspection. It was only upon delivery of documentary proof from the customs agent that the goods had cleared inspection that payment was made under the Letters of Credit." Bank would draw on the line of credit to effect payment. Because Wholesaler had no assets other than inventory and accounts receivable, Lender demanded and received as collateral, a standby LC issued by Nationsbank for which Retailer applied. The standby was unclear whether a drawing could occur as a result of the failure of Retailer to pay or the failure of Wholesaler to repay the loan without regard to failure by Retailer. During the 1993 season, the drawings on the LCs exceeded the amount for which they were issued, but shipments continued after the LCs had expired. Nonetheless, the Supplier/Applicant was paid.

In addition to payment through LCs, the parties utilized documentary collections on a D/P basis.

During this period, negotiations took place to establish a more comprehensive banking relationship. A special US$15,000,000 credit line was established for LCs issued to supply retailer although the amount was increased to US$25,000,000.

Concerned with the length of time between payment under the LCs and repayment by Retailer, Lender obtained amendments and extensions to the standby in its favor so that the amount was increased to correspond with its Retailer-related credit line.

Nonetheless, Lender sought to reduce the time gap and its exposure. There were discussions regarding Lender's delay in issuing LCs which were of concern to Supplier. To address this problem, Lender issued a US$2,262,900 LC which provided "Payment of drafts or drafts drawn hereunder will be effected when accompanied by required documents and after receipt from the applicant of a signed purchase order(s) issued by [Retailer] and related delivery receipt(s) showing container number(s), number of cartons and evidencing that goods have been received by [Retailer's] Distribution Centre(s)." Under this term, Supplier could not be paid until Retailer issued a purchase order and receipt. The trial court noted that "The difficulty that this presented for [Supplier] was that, by entering into this arrangement, it ceded control over when it would receive payment to a third-party - [Retailer]. If [Retailer] did not require the shrimp, it would not issue the purchase orders that were a prerequisite for payment. Moreover, by delaying the delivery of the receipts, [Wholesaler] and [Lender] could control the flow of money to [Supplier]."

Supplier understood these arrangements. Its thenpresident testified "that under the arrangements found in the Letters of Credit issued during 1994, the documents specified would be delivered to [Wholesaler], that [Wholesaler] would use the documents to assist in having the shrimp inspected and cleared by the United States Food and Drug Administration and delivered to the third party warehouse utilized by Sam's Club. It would remain there until a purchase order was received from [Retailer]. Only then would [Supplier] be paid." Under this arrangement, payments were made until September 1994 despite discrepancies and continued shipments after the expiration of the LCs.

In October 1994, two LCs were issued by Lender containing the same special condition, each in the amount of US$1,287,975.

Payment of drafts or drafts drawn hereunder will be effected when accompanied by required documents and after receipt from the applicant of a signed purchase order(s) issued by Sam's Club and related delivery receipt(s) showing container number(s), number of cartons and evidencing that goods have been received by Sam's Club Distribution Centre(s).

Documents may be delivered to the applicant, if requested by them, against their signed receipt and prior to payment in order to provide clearance of the merchandise to secure inspection by the U.S. FDA authorities and to effect delivery of merchandise to Sam's Club when approved.

The appellate court quoted the trial judge's observation that "the Special Condition created an arrangement that "was not typical" because the seller no longer "control[led] the satisfaction of conditions necessary for payment." This differed from the standard letter of credit requirements that call for payment to be made upon delivery of the title documents to the Bank. While the new arrangements provided added protection for CIBC, they created a potential difficulty for Beneficiary/Supplier." During the 1995 Christmas season, Retailer withheld in excess of US$3,000,000 due to quality complaints about the raw shrimp but no action was taken by Wholesaler with respect to Supplier and there was testimony suggesting that the problems may have resulted from shrimp from other suppliers or that too much shrimp had been ordered by Retailer. In any event, Retailer did not deliver purchase orders with the result that Supplier was unable to obtain payment for "substantial amounts of shrimp".

When Supplier inquired, there were negotiations and various solutions were proposed including picking up excess quantities in Retailer's warehouse, cooking the raw shrimp, and, with Supplier's knowledge, selling the shrimp to other buyers. Lender agreed to payment for the cooked shrimp although the LCs did not so provide. Other payments under the LCs and documentary collections were also made. Supplier continued to deliver shrimp under the LCs through December 1994 and under documentary collections through June 1995. Meanwhile, Retailer "continued to draw on the shrimp which had been delivered to the warehouse".

Delivery occurred in the amount of US$6,964,417.30. The trial court observed that "in the normal course, this would have resulted in the delivery by [Retailer] to [Wholesaler] of purchase orders and delivery receipts. These would have been delivered to [Lender] which would then have released the payments to Supplier. No purchase orders were forthcoming." Wholesaler, however, advised Lender that "there were no outstanding delivery receipts and there would be no further shipments to [Retailer]".

Wholesaler then wrote Supplier informing it of a draft letter to it from Lender stating that "Due to the passage of time and the fact that all of the conditions for payment will not be met, we advise that the letters of credit have expired and are no longer of any force". Wholesaler suggested that Supplier release its claims which it refused to do and it formally demanded payment. Supplier had shipped shrimp valued at US$39,833,42, had been paid US$29.452.366, leaving US$10,381,035 outstanding under the LCs.

Subsequently, Lender wrote Supplier "A requirement of payment is that we receive a signed purchase order issued by [Retailer] and related delivery receipts showing the container numbers, number of cartons and evidencing that goods have been received by [Retailer's] Distribution Centers. We have been advised by the applicant that no such documents will be forthcoming for your outstanding presentations. Over eighteen months have passed since your documents were presented, however, as mentioned, drawings are incomplete because of the lack of the signed purchase orders and delivery receipts. Due to the passage of time and the fact that all of the conditions for payment will reportedly not be met, we advise that the letters of credit have expired and are no longer of any force."

During this time, the amount owed Lender by Wholesaler under the line of credit had been reduced from a debt of US$15,000,000 to US$6 in less than a year. The trial court stated that "[t]he question is how this happened in a period when [Wholesaler] was advising [Lender] that no purchase orders or receipts were forthcoming from [Retailer] and no payments were apparently being made pursuant to the Letters of Credit."

The trial court noted that Lender would have known the payments made to Supplier and the amount of shrimp for which Retailer took delivery and have been aware of an inconsistency, although it did not make any inquiry and, as its employee testified, "recognized that it was surprising that [Supplier] continued to ship product when no payments were being made." Nor did Lender advise Supplier that no further purchase orders would be presented during this period.

Supplier/Beneficiary sued Issuer for wrongful dishonor. The trial court entered judgment in favor of Supplier/Beneficiary. On appeal, the judgment of the trial court was affirmed and the appeal was dismissed.

Legal Analysis:

1. UCP, Subject to: Although the trial judge had concluded that UCP500 was not incorporated in the LCs, each LC stated "this cable is the operative instrument and subject to the U.C.P.1993 revision ICC Publication No.500 and engages us in accordance with the terms thereof." The appellate opinion challenged the trial court's conclusion as "erroneous".

2. Independence, Exception; Equity: The appellate opinion framed the issue before it as whether Issuer was entitled to rely on the doctrine of strict compliance where it structured the LC in a manner that would prevent Beneficiary from being able to draw while delivering the goods and collaborated in the liquidation of the goods in a manner that reduced Applicant's indebtedness to it although Applicant had not paid for the goods.

The appellate opinion stated its view that "[c]ourts ha[d] held that the equitable doctrines of waiver and estoppels appl[ied] in letter of credit cases." It observed that an issuer "may be precluded from relying on the doctrine of strict compliance in certain situations." It gave as examples waiver ("either expressly or by its conduct"), delegation of "its duty to evaluate a beneficiary's documentary presentation independently," unjust enrichment by the LC transaction, engaging "in improper consultations with its customer concerning whether to accept or refuse the documents tendered," inducing the beneficiary to believe that the LC would be honored until it was too late for the beneficiary to correct discrepancies, and failure to provide timely notice of refusal. In connection with these "exceptions", it cited a series of US cases which it described as "instructive" despite their origin. "Their common rationale is that the conduct of the issuing bank has put it in a position where its obligation under the letter of credit to act independently of the underlying relationships between it and its customer, or between its customer and the beneficiary, has been compromised."

The appellate opinion noted that the duty of the issuer to pay had to be "carried out irrespective of any dispute between the buyer and seller or between bank and customer." [Emphasis in original] The opinion concluded that Issuer had "permitted its conflicting concern respecting its financial overexposure in the creditor/debtor relationship with Applicant, to interfere with its payment obligation to Beneficiary under the Letters of Credit."

The appellate court also referred to the opinion in Lectrodryer v. SeoulBank, 77 Cal.App.4th 723, 91 Cal.Rptr.2d 881, which it determined was based in part on the issuer's application of a prepayment by the applicant to debts owed by applicant to it and, despite waiver by applicant of discrepancies, refused.

The appellate opinion referenced themes. "This type of communication between the issuing bank and the payor of the letter of credit cannot be allowed. First, such contact clearly violates the independence principle inherent in the UCP and in letter of credit law. A bank has an independent obligation to the beneficiary; to permit the payor to pressure or collude with the bank to dishonour the draft destroys the very principle upon which the commercial utility of letters of credit rests."

3. Examination; Independence: Citing the US decision in E & H Partners v. Broadway National Bank, 39 F.Supp.2d 275, 38 UCC Rep.Serv.2d 912, the court concluded that when there were improper communication between the issuer and applicant, the issuer could not refuse. The conduct cited included repeatedly urging issuer to dishonor and hiring a lawyer to find discrepancies. The appellate court quoted the E & H Partners opinion: "This type of communication between the issuing bank and the payor of the letter of credit cannot be allowed. First, such contact clearly violates the independence principle inherent in the UCP and in letter of credit law. A bank has an independent obligation to the beneficiary; to permit the payor to pressure or collude with the bank to dishonour the draft destroys the very principle upon which the commercial utility of letters of credit rests."

4. Special Arrangement of LC: The trial judge stated that the LC reflected an arrangement that was not typical because the Supplier/Beneficiary no longer controlled the satisfaction of conditions necessary for payment. The appellate court noted that created a potential difficulty for Supplier/Beneficiary in that it "ceded control over when it would receive payment to Ultimate Buyer. Moreover, by delaying the delivery of the receipts, Buyer/Applicant and Issuer could control the flow of money to Supplier/Beneficiary."

5. Independence Principle of LC; Implied Duty of Good Faith: The appellate court concluded that when Issuer applied monies paid for the purchase of the goods to pay down its loans, rather than holding them on account for Supplier/Beneficiary, Issuer defeated the purpose of LC in violation of its duty to consider Supplier/Beneficiary's draw on the credit independently. This conduct defeated the security offered to Supplier/Beneficiary through the LC in the first place according to the court. The court stated that Issuer's position as secured creditor of Buyer/ Beneficiary did not immunize it from its obligations to Supplier/Applicant as the issuer of the credits.

6. Disentitlement of Defense of Non- Compliance: The appellate court concluded that Issuer knowingly contributed to the circumstances that undermined the prospect of strict compliance, and then used that non-compliance to justify the refusal of payment. It ruled that Issuer was thus precluded from raising the defense of non-compliance since equity would not permit it to do so.

Comment:

This decision will come as a surprise to LC bankers and even more so to credit officers and banks. The conduct of CIBC is not particularly surprising. The bank was attempting to limit its exposure and to protect itself.

Because of the terms of the LCs, the supplier was effectively operating on an open account basis. The problem had as much to do with Wal-Mart which could effectively dictate terms to its suppliers.

By its decision, the court applies principles of equity to the obligation of the issuer of a letter of credit whose terms are clear if unfavorable to the beneficiary. Based on the notion that a letter of credit ought to be fairer than its terms provide, the court grants relief based on an implied duty of good faith. While such a duty might exist in the relationship between Supplier and Wal-Mart or even between the bank and its customer in terms of its lending relationship, it is difficult to understand how it can apply to an LC transaction. The documents did not comply. Indeed, they apparently could never have complied. There is no basis for the court's conclusion that funds are owed on the LCs.

The decision should be compared with that of the US Court of Appeals for the Ninth Circuit in Sewchez Intern. Ltd. v. The CIT Group, abstracted in this volume.

[JEB/ny]

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