Article

Factual Summary: In February 2010, Tokyo Boeki Steel & Materials Ltd., Tokyo (Seller) entered into Sale Contract with Chinese Buyer to sell 40,000 metric tons (+10%/-10%) of steam coal and to ship the coal from an Indonesian port to a Chinese port.

To secure payment by Buyer, Bank of Communications Co. Ltd., Shanxi Provincial Branch in China issued an LC by SWIFT for USD 3,000,000 (+10%/-10%) subject to UCP600 in favor of Seller, available with Advising Bank (Nominated Negotiating Bank) in Tokyo at sight.

The LC required the party to present commercial invoices, bills of lading, certificate of analysis, certificate of weight, certificate of origin and certificate of ship's clearance at the loading port.

The Commercial Invoice from the Certificate of Analysis contained the following information:

PENALTY

(A) ash: US$0.50/metric ton deducting of invoice value for each 1% in excess of 10% fractions pro-rata.

(B) total sulphur: US$0.50/metric ton deduction of invoice value for each 0.1% in excess of 1.0% fractions pro-rata.

(C) total moisture: total moisture in excess of 25% will be deducted from the bill of lading weight for invoicing.

(D) adjusted price: base price x (cv kcal/kg - 5900kcal/ kg)

(E) size; US$0.01/metric ton deduction of invoice value for each 1% below 90%.

Two months after the Sale Contract, the price of coal in the Chinese market reportedly declined by more than 15%.

After shipment, Seller received a complete set of required documents and presented them to Negotiating Bank in Tokyo.

In accordance with the actual data copied on the Commercial Invoice from Certificate of Analysis and the formula set forth in "SPECIFICATION" and "PENALTY" above, the tentative adjusted price per metric ton became USD 75.99 (see (D) above) by using the actual calorific value of 5978kcal/kg (see (h) above), then deducting from it USD 0.07 per metric ton of size (see (E) above), resulting in a final adjusted price per metric ton of USD 75.92 (that is, USD 75.99 minus USD 0.07).

Although the gross weight of coal indicated in Bill of Lading was 39,925 metric tons, the actual total moisture was 26%. Therefore, 399 metric tons was deducted from the original gross weight using the predetermined formula set forth in (C) above. Thus, the invoicing weight was computed as 39,526 metric tons. After calculating the invoicing weight, the Commercial Invoice showed a total price in the amount of USD 3,000,813.92.

It is notable that the entire Commercial Invoice was full of detailed calculation formulas.

On examining the documents presented on March 31, 2010, Negotiating Bank alleged three discrepancies, effected negotiation under reserve and sent documents to Issuer in China.

Issuer also alleged the same three discrepancies and, by SWIFT of April 7, 2010, informed Negotiating Bank of its refusal of the documents and reimbursement stating as follows:

"WE HEREBY REFUSE THE DOCUMENTS PRESENTED DUE TO THE FOLLOWING DISCREPANCIES MENTIONED IN YR MT742:

1) T[O]T[A]L MOIS[TURE]: 26PCT

2) INHE[RENT] MOIS[TURE]: 9.5PCT

3) SIZE 0-50MM: 83PCT NOT STRICTLY AS PER LC REQUIRED. DOCS HELD UNTIL WAIVER RECEIVED FROM APPLICANT OR UNTIL WE RECEIVE FURTHER INSTRUCTIONS FROM YOU."

Following the refusal of the documents, Issuer returned the documents to Seller through Negotiating Bank.

In an attempt to mitigate their losses in light of the decreasing cost of coal, Seller found a new Chinese buyer and, with the returned documents in possession, delivered the coal to the new Chinese buyer, resulting in a loss net loss.

On November 15, 2010, Seller sued Issuer's Tokyo Branch for LC payment in the Tokyo District Court. It should be noted that Seller did not sue Issuer's Branch in China.

The case raised three different issues: (1) whether the Japanese court has jurisdiction; (2) whether there are discrepancies justifying Issuer's refusal; and (3) whether Issuer may refuse to pay until the returned documents are re-presented to Issuer.

The district court ruled in favor of the Issuer on two of the three issues. Seller appealed to the Tokyo High Court which reversed the judgment of the lower court. The Supreme Court of Japan rejected the Issuer's petition for acceptance of final appeal.

Legal Analysis:

I. Judgment by the District Court:

1. Jurisdiction. Issuer (actually, Issuer's Tokyo Branch) argued that compelling it to submit to Japanese jurisdiction constitutes special circumstances that would be inconsistent with the basic principles of ensuring a fair, proper and speedy trial and therefore, jurisdiction of the Japanese court over Issuer should be denied.

However, district court determined that the Japanese court had jurisdiction because Issuer had established minimum contacts by maintaining a branch in Tokyo, the LC's place of performance being in Tokyo, and because in the present case there were no such special circumstances frustrating the basic principles of ensuring a fair, proper and speedy trial among the parties.

The court followed the precedent of its ruling dated September 26,2003 (2001(WA)21385)(1706 KIN'YU HOMU 40 ) of a similar case where a Japanese seller sued the Indian issuer's Tokyo branch in Japan.

The district court rejected Issuer's argument and decided affirmatively on this issue. On appeal, the Tokyo High Court affirmed.

2. Discrepancies. Issuer's notice of refusal listed the following three discrepancies:

(1) Total Moisture: 26%

(2) Size 0-50mm: 83%

(3) Inherent Moisture: 9.5%

Issuer argued for a narrow and literal interpretation of the first two alleged discrepancies. As to the third alleged discrepancy, "Inherent Moisture: 9.5%", Issuer argued that the word "approx." appearing in LC's SPECIFICATION as "inherent moisture(air dry basis): 13% approx." only allowed 10% more or less of inherent moisture as per UCP600 article 30(a), and that the allowable moisture range was limited to "11.7% ~14.3%" only and that the indication of "inherent moisture 9.5%" in Commercial Invoice clearly constituted a discrepancy subject to Issuer's refusal.

The court, during its analysis of the discrepancies, listened to expert witness testimony in line with Seller's allegation that the alleged discrepancies were groundless. The expert noted that, with regards to the first two alleged discrepancies of Total Moisture and Size, the Commercial Invoice, as described in the preceding Factual Summary, correctly stated the data from Certificate of Analysis and based on this data, it accurately followed the formula as designated under the PENALTY provisions in the LC. Furthermore, it correctly determined the final adjusted price per metric ton of coal and the proper invoicing weight. The expert opined that Issuer's narrow and literal interpretation of its own LC terms wrongfully created alleged discrepancies and destroyed the entire purpose and function of this LC.

The expert also opined that Issuer's argument was mistaken as to the third alleged discrepancy because the inherent moisture of coal in question represented a quality rather than a quantity of coal and that UCP600 article 30(a) therefore did not apply.

To reinforce this opinion, the expert referred to a Japanese commentary published in 1967 on the revision of UCP151 which stated that, while the ICC Swedish Committee proposed expanding the applicable scope of allowing 10% more or less from the three limited items of the "amount, quantity and unit price" that it was currently limited to and apply it to all other items appearing in an LC and that the word "etc." be added to the words of the "amount, quantity and unit price" in that article, the ICC Banking Commission dismissed the proposal and decided to maintain the wording in force at that time. According to the expert opinion, no change in substance of the succeeding UCP's had been made up to UCP600.

The district court, however, ruled that the clauses of "SPECIFICATION" and "PENALTY" were functionally separate and independent of each other and that when determining whether the presentation was complying, it was sufficient to check whether each "SPECIFICATION" figure in the LC was the same as indicated in the documents presented. The court ruled that if any discrepancies were found, then it should be concluded that the documents were in disagreement, regardless of any adjustments that had been made under the PENALTY clause.

The court concluded that Seller's claim was unfounded because, based on the preceding discussion, the discrepancies of Total Moisture and Size were adequately determined to have existed. This determination rendered further inquiry as to Inherent Moisture: 9.5% and the third issue, namely "whether Issuer may refuse to pay until the returned documents are re-presented to Issuer", unnecessary.

II. The High Court's Reversal of the Judgment in Prior Instance 1. Seller's Arguments on Appeal.

1. Seller appealed to the Tokyo High Court, advancing the following argument.

(a) First, Seller argued that in light of the practice and the intention of the parties to the transaction as reasonably interpreted, the figures in the "SPECIFICATION" and "PENALTY" clauses in the LC should have been interpreted as being integrated, because they were closely related instead of being separate and independent of each other.

As per evidence exhibited, there were cases of LC transactions related to coal/iron ore where figures in specification and penalty clauses in the LCs were interpreted to be integrated with the claimed amounts under Commercial Invoices. LC issuers duly paid as these figures represented the adjusted amounts calculated in accordance with those figures.

(b) Second, Seller argued that regarding Total Moisture and Size in the present case, since the actual data figures on the Commercial Invoice were different from those shown in the LC "SPECIFICATION", the actual trading value of coal was structured to be adjusted under the "PENALTY" clause. Therefore, the Commercial Invoice showing the adjusted amount was in accordance with the "PENALTY" clause and correctly complied under the LC terms with no resulting discrepancy in the listed figures for "Total Moisture" or "Size."

(c) Third, Seller argued that since it had presented and delivered the documents to Issuer in accordance with the LC, as of that time Issuer had lost the possible defense of simultaneous performance regarding representation of the documents by Seller.

2. Reversal judgment by the high court:

Three judges of the Tokyo High Court unanimously decided that Seller's claims, supported by its contentions, were well founded and reversed the decision of the lower court. The high court offered the following rationale for reversing the lower court:

(1) Alleged discrepancies of Total Moisture and Size

In international trade of iron ore or coal where it is generally difficult to procure a homogeneous quality of such merchandise for sale, a peculiar method of determining the price is sometimes used by setting a standard reference with a standard price beforehand and by adjusting the standard price in accordance with the preset calculation formula for the price adjustment clause, depending on the actual quality of the merchandise tendered. In connection with the underlying trade of coal, Seller and Buyer agreed to use this method and the LC indicated an appropriate price adjustment clause.

Although the clause in the LC was titled as "PENALTY", it was the functional equivalent of a price adjustment clause. The difference of prices between "SPECIFICATION" and "CERTIFICATE OF ANALYSIS" were adjusted under the clause of "PENALTY" and the Commercial Invoice adequately reflected the correct adjusted amount. There was no inconsistency between the LC terms and presented documents and therefore no discrepancies existed.

The clause reading "PENALTY" was indicated in the LC in a different column from that of "SPECIFICATION" of coal however, because "PENALTY" contained an important formula to figure out the actual trading value of coal, the "PENALTY" clause should have been interpreted to be used in conjunction with the "SPECIFICATION" clause. It was erroneous to consider "PENALTY" as separate and independent of "SPECIFICATION" solely because the "PENALTY" clause was indicated in a different part of the LC.

(2) Alleged discrepancy of Inherent Moisture

As noted by Seller, in the course of revision of UCP151 to UCP222, the ICC Swedish National Committee's proposed to expand the scope of the word "approximately" to all other items in LC than three limited items of the "amount, quantity and unit price." However, this proposal was rejected by ICC Banking Commission, and thus UCP600 article 30(a) did not apply to the interpretation of "Inherent Moisture: 13% approx." stipulated in this LC. Moreover, because LC did not define "approx." in that context, the allowable range of Inherent Moisture remained to be solved. In other words, there was an ambiguity of the allowable range of Inherent Moisture.

There are three possible interpretations of "Inherent Moisture: 13% approx.". First, it could be determined that there was a discrepancy when Inherent Moisture was not 13% exactly; second, that there was a discrepancy when it substantially deviated from 13%; or third, there was no discrepancy, regardless of its deviation from 13%.

Seller persuasively argued that because the coal in this case was intended for fuel for power generation, and also because the purpose of the sale contract of coal could be accomplished so long as the gross calorific value was secured, the figure of Inherent Moisture in SPECIFICATION was solely for reference.

Additionally, Seller advanced reasonable grounds that in interpreting LC terms, an ambiguity should be constructed against Issuer unless Seller's interpretation of that ambiguity was so unreasonable that it could never prevail.

In view of the foregoing, the high court dismissed Issuer's allegation of the Inherent Moisture discrepancy.

(3) Re-presentation of the documents by Seller to Issuer

The high court found that on March 31, 2010, Seller presented and delivered the complying documents to Issuer through Negotiating Bank in Tokyo. Seller had completed the requirements for "presentation" under the definition set forth in UCP600 Article 2. Since presentation had been completed, Issuer's voluntary return of the documents to Seller had no effect on the status of Seller's presentation.

The high court also decided that Seller was not obligated to re-present its complying documents and that Issuer was required to pay Seller the amount stated in the Commercial Invoice, along with any interest.

Furthermore, the high court ruled that any dispute regarding Seller's profits from reselling the coal in question to another Chinese buyer would have to be settled in a separate case.

Comments:

The LC used in this case was undesirable in light of UCP600 article 4(b), because it contained excessive details reflecting the underlying sale contract of coal. However, the LC was binding because the parties accepted it as issued.

The district court made up of three judges totally ignored both the expert opinion and Seller's contentions and was bold enough to offer a unique but wrong ruling that the clause of SPECIFICATION and that of PENALTY in LC were functionally separate and independent of each other. Fortunately the high court unequivocally reversed the ruling and reached the right decision.

For the convenience of the parties related to the LC, the Negotiating Bank's issued an LC advising form that contained such information as Issuer's name, and the required documents by electronically sorting out data in the transmitted LC's. In the present case, the LC, the text of which was made up of four sheets, indicated the clauses of "SPECIFICATION" and that of "PENALTY" were separately listed on different sheets and in different columns. It was a pity that a major Negotiating Bank in Japan failed to understand the structured purpose of the LC and wrongfully alleged discrepancies which were invoked by Issuer.

[KI/mjb]

* Katsuto IIDA is Honorary Professor of Law, at Tezukayama University (Japan)

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