Article

Factual Summary: An ultimate buyer of rice, Hentiq 1320 (Pty) Ltd ('Hentiq') instituted an action against Mediterranean Shipping Co. ('MSC') for payment of ZAR 1,672,080 (together with interest and costs) in damages. The claim related to the delivery of rice loaded on ships of the MSC in the port of Kandla, India. The bills of lading for the rice were issued by Samsara Shipping (Pvt) Ltd, an Indian company acting as the agent/representatives of MSC, to the supplier/seller of the rice, White Fields International (Pty) Ltd ('White Fields'), also an Indian company. White Fields endorsed the bills of lading to Kingsburg Exports Ltd ('Kingsburg'/first buyer/second seller), a Hong Kong company. Kingsburg in turn endorsed them to Hentiq (the 'ultimate buyer') against acceptance by Hentiq of two bills of exchange in respect of the rice loaded on the ships.

It was common cause at the trial that the description of the rice in the bills of lading was extremely misleading. It was described as 'Indian Long Grained Parboiled Rice'. It should properly have been described as 'Indian Long Grained Parboiled Rice (100% Sortexed Rejection)' which would have indicated that the rice was not clean but contaminated with the detritus of stones, husks, soil, and other contaminants and not in an edible condition (par 3).

White Fields, the initial seller/supplier of the rice, concluded a purchase and sale contract for 1,000 metric tons of rice with Kingsburg (the first buyer of the rice). Kingsburg caused its bankers to issue a commercial letter of credit for USD 180,000 in favour of White Fields. White Fields was paid for the rice under the letter of credit on presentation of inter alia the bills of lading. The payment was obtained fraudulently as White Fields knew that the rice it was shipping was '100% sortexed rejection'. This was clear from the description of the rice in customs documentation prepared by White Fields and submitted to Indian customs. However, the bills of lading White Fields had prepared and which were issued on behalf of MSC omitted the words '100% sortexed rejection' (pars 5 and 7).

Kingsburg (first buyer/applicant of the letter of credit) on-sold the rice to the appellant (Hentiq/the ultimate buyer), but just before the last 100 metric tons of rice was to be shipped the fraud was discovered. As a result of the fraud, Kingsburg decided to cancel the contract with White Fields (initial seller/supplier of rice/beneficiary of the letter of credit).

It transpired from the evidence that although the transaction took the form of a string contract with Kingsburg (first buyer/applicant of letter of credit) selling the rice on to Hentiq (ultimate buyer) at a profit, Kingsburg was in fact acting as the financier of Hentiq (par 10 and 14). In line with Islamic financing principles, however, Kingsburg was not able to claim interest for its financing role. It could, instead, claim a profit or a commission in the context of a string sale. This was the sole reason for having structured the transaction in the abovementioned manner (par 18). The initial negotiations for the purchase of the rice were between White Fields (as the seller), and Hentiq (as the ultimate buyer). It was always the intention of the parties that the rice was to be shipped from Kandla to Durban for the benefit of Hentiq (par 9).

In evidence Mr. Soomar, manager of Hentiq (the appellant/ultimate buyer), stated that after the fraud had been discovered, he had not paid Kingsburg (second seller of the rice) the full amount of the bills of exchange but had come to an arrangement with Kingsburg to repay the debt as a whole. The manager regarded this as his moral obligation, pointing out that Kingsburg was not the supplier, did not know White Fields (the seller/supplier), and was therefore totally innocent (pars 11-14). It was further clear that the ultimate buyer's (Hentiq's) case was based on the overwhelming probability that the respondent's (MSC's) agents/representatives in India (Samsara) must have been complicit in the fraud (par 22). The KwaZulu-Natal High Court, Pietermaritzburg (court of first instance) found that the ultimate buyer (Hentiq/plaintiff in the case before the court of first instance) had not proved that it had sustained any recoverable loss and dismissed its claim. The buyer (plaintiff) appealed, with the leave of the court, to the Supreme Court of Appeal of South Africa.

Legal Analysis:

Hentiq's (the ultimate buyer's/appellant's) claim for damages was based both on contract and delict. However, for the appellant to succeed with either of these it had to prove that it had suffered damages in consequence of either the breach of contract or delict.

The KwaZulu-Natal High Court, Pietermaritzburg (court of first instance), however, found this to be an insurmountable obstacle for the appellant (Hentiq). The court of first instance held that the buyer (Hentiq) had not proved that it had sustained any recoverable loss and dismissed its claim. In delivering its judgment it said (as quoted in par 19):

"...what the plaintiff [Hentiq] is seeking to recover is the amount paid by Kingsburg in terms of the letter of credit on the basis of its own obligation to reimburse Kingsburg. Prima facie Kingsburg was entitled to recover that amount from Whitefields on the basis of its fraud. It is possible, if it could prove that the employers of Samsara were parties to the fraud, that it might equally have had claims against Samsara or even MSC. However the claims pursued in this action are not the claims of Kingsburg. Instead the plaintiff seeks to recover under the bills of lading from MSC as the carrier. It does not sue as cessionary of the claims of Kingsburg. The question that arises from this is whether the plaintiff has suffered any loss as opposed to the loss Kingsburg have suffered

It is here that there is an insuperable obstacle in the path of the plaintiff. It arises from the fact that the structure of the transactions involved back-to-back sales from Whitefields to Kingsburg and from Kingsburg to the plaintiff. Because of that structure the plaintiff had no contractual link with Whitefields and the party to which it was entitled to look for performance of the contract was Kingsburg. The latter had agreed to sell it rice of a particular description and the rice that it delivered was defective ... Whilst Whitefields was the source of the problem, at the level of contract the only party against whom the plaintiff had a remedy was Kingsburg. It was entitled to reject the rice that was tendered for delivery as being defective, to cancel the sale and to refuse to pay for it. Had it done so it would have been acting in accordance with its rights and would have suffered no loss."

The court of first instance also then added (as quoted in par 20):

'Commendable though this stance might be as an exemplar of honest dealing, and understandable as it is given that the structure of these transactions was dictated by Mr Soomar's [the manager of Hentiq's] Islamic faith, the problem remains that as a matter of law the contract remains one of purchase and sale between Kingsburg and the plaintiff [Hentiq]. It is not a loan by Kingsburg to the plaintiff any more than there was a contract of sale in respect of the rice between Whitefields and the plaintiff. In terms of the contract of sale Kingsburg concluded with the plaintiff it undertook to deliver rice of a certain description and it failed to do so. As a matter of law there is therefore no obligation on the plaintiff to pay Kingsburg for that rice. The fact that it chooses to do so does not give rise to a loss recoverable from MSC.

Whilst I accept that the transactions between the plaintiff, Kingsburg and Whitefields were structured in the particular form that I have described in order to meet the dictates of the Islamic faith, that does not mean that the court can treat them as if they had a different form or give them an effect other than that which they have in law. Nor has any evidence been led before me to show that what Mr Soomar described as a moral obligation has, by virtue of its Islamic context, a specific legal content. ... [I]t has not been submitted, nor has any evidence been tendered to show, that the conventional transactions into which the parties entered were, as between the plaintiff and Kingsburg, overlain by a legal obligation arising from Islamic principles, that imposed a legal duty on the plaintiff to compensate Kingsburg for its loss arising from the payment of the letter of credit. Absent any such evidence the obligation that the plaintiff perceives that it owes to Kingsburg remains a moral and not a legal obligation. The fulfillment of such an obligation does not give rise to loss of a character recoverable by way of the contractual claim advanced in this action.'

The appellant (Hentiq/ultimate buyer) submitted that it was very probable that persons acting on behalf of Samsara, the respondent's (MSC's) agents in India, were complicit in the fraud that was committed by White Fields, the seller/supplier of the rice, and that the appellant's main cause of action was based on that fraud. All that therefore had to be illustrated at this stage of the proceedings was that an amount was payable by the respondent to the appellant in consequence of the appellant's belief that it had received conforming rice (cargo), which belief had been engendered by the fraud (par 22). Furthermore, the intervention of a second seller (Kingsburg) did not relieve the respondent of its obligations to the appellant. The appellant also rejected the court of first instance's finding that it was open to the appellant to reject the rice as being defective, to cancel the sale and refuse to pay for it. The appellant also argued that if it had instituted an action against the second seller (Kingsburg), the latter would argue that it had simply acted as a financier and that the appellant had no complaint against it for the supply of defective goods and that it was not the true suppliers/sellers of the rice (par 23). In other words, the true substance of the agreement between Kingsburg (second seller) and the appellant was different from the form as set out in the documents (par 24).

Moreover, it was argued that in order for the appellant to obtain delivery of the rice (which it believed to have been described correctly in the bills of lading), the appellant had to enter into a transaction which made it liable to Kingsburg (the second seller), namely, that it had to accept the bills of exchange drawn on it by Kingsburg. The appellant argued that the agreement between these two parties was to the effect that after the outcome of this case there was to be a so-called 'an adjustment of rights between Kingsburg and the appellant' (par 25).

The appellant also referred the Supreme Court of Appeal to the principle set forth in Par Excellence Colour Printing (Pty) Ltd v. Ronnie Cox Graphic Supplies (Pty) Ltd 1983 (1) SA 295 (A), namely, that a party which had settled a damages claim against it and agreed to pay an amount set forth in the settlement agreement was entitled to recover the settlement figure from the party legally responsible for its having to pay the damages and that it did not have to prove the quantum, provided that it acted reasonably in concluding the settlement. Applying this principle to the given set of facts, the appellant further argued that it would have been a 'bold legal adviser' who would have advised it (the appellant) not to have paid the bills of exchange accepted by it. Intrinsically, its agreement with Kingsburg (second seller) amounted to a settlement as contemplated in the Par Excellence case (par 25).

The Supreme Court of Appeal, however, disagreed and stated that such a principle could apply only to the quantum of a settled claim where the liability of the party settling the claim was unassailable (pars 28 and 30). That, however, was not the case in this instance. The court was also of the view that there was nothing, in view of the evidence given by the appellant, that proved that the relationship between the appellant and Kingsburg was not what it purported to be and was in agreement with the finding of the court of first instance in this regard (par 29). The Supreme Court of Appeal held that the claim was correctly dismissed by the court of first instance and accordingly dismissed the appeal.

Comments:

The judgment of the court of first instance, confirmed by the Supreme Court of Appeal, rests on solid legal principles and cannot be faulted. This case illustrates the danger of a fraudulent letter of credit transaction against the background of financing in terms of Islamic principles.

* Professor of Law, Department of Mercantile Law, School of Law, University of South Africa.

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.