Article

Factual Summary: To assure payment for the purchase of yarn from a Chinese manufacturer (Manufacturer), American distributor (Buyer) obtained a standby letter of credit for USD 160,000 in favor of Manufacturer. Buyer utilized a third party financial services company (Applicant) to apply for standby which was issued by Bank (Issuer). The goods were accepted. The first three payments were made to Manufacturer in China. For the fourth purchase, Buyer received an email communication which appeared to be from an employee of Manufacturer instructing it to divert payment to Manufacturer’s U.K. subsidiary at an account at Lloyds TSB Bank. Numerous emails were exchanged regarding this wire and Applicant had its bank trace the funds transfer. The trace indicated that Lloyds had rejected the funds due to improper “wire details”. Subsequently, Buyer received an email which also appeared to be from the same employee, requesting that payment be made to a Natwest Bank account in the U.K. to the same entity. When the funds were wired, an email was received indicating that the wired funds had been received. During this time, Seller/Beneficiary received and inadvertently responded to emails that resembled those of Buyer/Applicant but were from Fraudster

Later, Buyer’s employee in China informed Buyer that Manufacturer had not been paid; when the employee provided Manufacturer with copies of the various documents, denials were given and eventually Buyer requested Applicant to retrieve the wire payment, but it was unable to do so. Later, Manufacturer presented complying documents to Issuer, demanding payment on the standby.

Buyer then sued Manufacturer seeking to enjoin the drawing on the standby. Ruling on a provisional injunction and applying ISP98 and Canadian common law, the Judge granted safeguard orders in favor of Buyer and Applicant set to expire at the beginning of trial. The order was contingent on Issuer deciding to honor LC, deposit the proceeds into either the Superior Court or a licensed trust company if it did. This arrangement was regarded as providing adequate security to Buyer

Legal Analysis:

Issuer’s Obligation; Independence Principle; Fraud Exception

The Judge stated the principles governing letters of credit under the law of Canada, “the issuing bank must pay the beneficiary the amount of the letter upon presentation of documents that appear to comply with the terms and conditions of the standby letter of credit, subject to the fraud exception.” In explaining the fraud exception, the Judge drew on Bank of Nova Scotia v. Angelica-Whitewear Ltd. [1987] 15 C.R. 59 which was summarized as follows:

The Angelica-Whitewear decision established the following principles with regard to the fraud exception for letters of credit:

a. The object of the fraud may be either the documents or the underlying transactions (the commercial contract), of such a character as to make the demand for payment under the credit a fraudulent one (at 83);

b. The fraud must be connected to the beneficiary of the letter of credit. As Le Dain J. stresses: "In my view the fraud exception to the autonomy of a documentary credit should extend to any act of the beneficiary of a credit the effect of which would be to permit the beneficiary to obtain the benefit of the credit as a result of fraud" (at 83, see also Global Steel Ltd. v. Bank of Montreal, 1999 ABCA 311 (CanLII),at paras. 21-22);

c. The scope of the fraud exception in Québec is the same as in common law, (at 81-83). Accordingly, this fraud exception is not limited to the definition of fraud in article 1401 C.C.Q., but includes the common law definition of fraud: see, in particular, Derry v. Peek, [1889] 14 A.C. 337 (H.L.), at 374, and Cineplex Odeon v. 100 Bloor West General Partner Inc., [1993] O.J. No. 112 (O.C.J. Gen. Div.), at paras. 20-21, 26, 29 and 30;

d. From the contractual standpoint, the bank may refuse to pay if "fraud was so established to the knowledge of the issuing bank before payment of the draft as to make the fraud clear or obvious to the bank" (at 84);

e. From the judicial standpoint, the court may issue an interlocutory injunction (or safeguard order) to prevent payment under the letter of credit only if the applicant fulfils the following condition: "[a] strong prima facie case of fraud would appear to be a sufficient test on an application for an interlocutory injunction" (at 84).

Injunction; Safeguard Order

The Judge indicated the elements of an order intended to safeguard parties:

In principle, a safeguard order may be issued only if the plaintiff meets the following four conditions: (1) urgency; (2) a serious question to be tried or a prima facie case; (3) irreparable harm or the creation of a situation that the final judgment will not be able to rectify; (4) if the prima facie case is doubtful, the balance of convenience favours it.

Describing the requirement of a serious question or prima facie case as, “not very demanding, and its basic purpose is to set aside frivolous and vexatious actions,” the Judge concluded that such a case had been shown because Buyer/Applicant had been defrauded and “at least one email was sent from the [Seller/Beneficiary] email address "Jimmy ", dated November 24, 2014, specifying "ADAH EDOH INC." as the beneficiary of the payment for order P.O. 300105, the same beneficiary as in the email from "Jimmy" (which did not have a clear email address), and to whom the wire transfer of USD 155 402.24, made by [Applicant] on December 10, 2014, on behalf of [Buyer], was sent.”

The Judge indicated that the question before the court was whether there was a default by Buyer/Applicant, which involves determination of which the payment made was at Seller/Beneficiary’s request, or whether it is estopped to deny it, or its negligence, act, or omission constituted a participation in the fraud.

The Judge also stated, “It remains to be determined on the merits whether the computer belonging to [Seller/Beneficiary] - or to its employee Fei - was infected by malware from a phishing email, due to inadequate protection. In that case, [Seller/Beneficiary] could possibly be liable.”

The Judge stated that if the payment released Buyer from its obligations, there would be no default, making a statement of default under the standby terms fraudulent and within the fraud exception.

Irreparable Harm

Because the Seller/Beneficiary was in China, making it necessary to seek to recover it outside of the jurisdiction of the court, the Judge concluded that Buyer/Applicant “will suffer irreparable harm, or a situation will be created that cannot be rectified by the final judgment.”

Balance of Convenience; Jurisdiction

In weighing the balance of convenience, the Judge noted that neither Buyer/Applicant nor Seller/Beneficiary were residents of Canada but had used a standby issued by the Montreal branch of Canada Bank. Noting that “[t]he situs of a letter of credit is the place in which it is payable,” the Judge concluded that the Canadian court had jurisdiction and that, “the balance of convenience favours maintaining the status quo, that is, keeping the amount that may be payable under the letter of credit in Québec.”

Comment: The Judge stated “The letter is truly a three-party contract, involving Bank (as the issuing bank), Accord on behalf of Alessandra (as the applicant), and Baoding (as the beneficiary).”

This statement is not completely accurate. The LC is an undertaking to the beneficiary and is unilateral since the beneficiary makes no undertaking to the issuer. If, as the court recognizes, it is independent, one aspect of that independence is from the agreement between the applicant and issuer. Even if issuance of the LC is fraudulently induced by the applicant, the issuer cannot excuse its obligation to the beneficiary based on the defense of fraud in the inducement or procurement. There are two separate contracts here: Issuer-Applicant on the one hand and Issuer-Beneficiary on the other hand. There is usually a third contract, typically between Beneficiary and Applicant, which leads to the application for the issuance of the LC. Therefore, it is not accurate to say that the LC is a three-party contract.

TEXT OF STANDBY [PARAGRAPH 23]:

TO Receiver

HZCBCN2H

Bank of Hangzhou Co

432 Fengqui Road

Hangzhou 310006

Hangzhou

27 Sequence of Total

1/1

20 Transaction Reference Number

OSB8330MTL

23 Further Identification

ISSUE

30 : Date

140812

40C Applicable Rules

OTHR/ISP98

77C Details of Guarantee

WE ISSUE OUR IRREVOCABLE STANDBY LETTER OF CREDIT NO. OSB8330MTL

PLEASE ADVISE THE BENEFICIARY WITHOUT ENGAGEMENT ON YOUR PART ATTENTION FEI LINTAO T: 011 86 573 8892 9381, C: 011 86 138 0671 9055, EMAIL: SALES AT BAODING-TEX.COM

QUOTE

AMOUNT: NOT EXCEEDING USD160,000.00

DATE OF EXPIRY: FEBRUARY 10, 2015

PLACE OF EXPIRY: CANADA

BENEFICIARY : TONG XIANG BAODING TEXTILE CO., LTD., 388 DONGSHENG DADAO, LONGXIANG JIEDAO, TONGXIANG, ZHEJIANG, PR CHINA 314504

APPLICANT: ACCORD FINANCIAL, INC. / FINANCIERE ACCORD INC., ON BEHALF OF ALESSANDRA YARNS, LLC, 3500 DE MAISONNEUVE OUEST, SUITE 1510, MONTREAL, QUEBEC, CANADA H3Z 3C1

DEAR SIR(S):

WE HEREBY AUTHORIZE YOU TO DRAW ON THE BANK OF NOVA SCOTIA, TRADE SERVICE CENTRE, MONTREAL, 1800 MCGILL COLLEGE AVENUE, 12TH FLOOR, MONTREAL, QUEBEC, CANADA H3A 3K9 FOR ACCOUNT OF ACCORD FINANCIAL, INC. / FINANCIÈRE ACCORD INC., UP TO AN AMOUNT OF ONE HUNDRED SIXTY THOUSAND AND 00/100 UNITED STATES DOLLARS (USD160,000.00)

AVAILABLE BY YOUR DRAFT AT SIGHT, INDICATING L/C NUMBER AND DATE,

1. YOUR SIGNED STATEMENT CERTIFYING THAT ALESSANDRA YARNS, LLC (THE CUSTOMER) IS IN DEFAULT OF ITS OBLIGATIONS UNDER (PURCHASE ORDER / INVOICE NUMBER), AND THAT YOU HAVE REQUESTED PAYMENT OF THE SAID AMOUNT FROM THE CUSTOMER AND TWENTY (20) DAYS HAVE ELAPSED FROM INVOICE DATE.

2. COPY / PHOTOCOPY OF UNPAID INVOICE AND ASSOCIATED SIGNED PURCHASE ORDER REFERENCING “EX WORKS” ON THE FACE OF THE DOCUMENT.

3. COPY / PHOTOCOPY OF ORIGINAL SIGNED “COMBINED TRANSPORT BILL OF LADING”. THIS DOCUMENT SHOULD EVIDENCE THE CONTAINER AND SEAL NUMBERS, BE STAMPED “SURRENDERED” AND REFERENCE ALLESSANDRA YARNS, LLC AND THE ASSOCIATED PURCHASE ORDER NUMBER.

4. COPY / PHOTOCOPY OF PACKING LIST WITH DETAIL ATTACHED, BOTH REFERENCING ALESSANDRA YARNS, LLC AND THE ASSOCIATED PURCHASE ORDER NUMBER.

5. COPY/ PHOTOCOPY OF SIGNED “ORDER AUTHORIZATION FORM” FROM ACCORD FINANCIAL, INC. TO TONG XIANG BAODING TEXTILE CO., LTD.

THIS CREDIT IS ISSUED TO GUARANTEE PAYMENT OF SHIPMENT OF SPOOLS OF CORE SPUN YARN.

MULTIPLE DRAWING ARE NOT PERMITTED. ONLY ONE DRAW PERMITTED, NOT TO EXCEED THE AMOUNT OF THE UNPAID INVOICE OR ONE HUNDRED SIXTY THOUSAND AND 00/100 UNITED STATES DOLLARS (USD 160,000.00), WHICHEVER IS LESS.

OUR RESPONSIBILTY UNDER THIS CREDIT SHALL NOT EXCEED THE AMOUNT OF ONE HUNDRED SIXTY THOUSAND AND 00/100 UNITED STATES DOLLARS (USD 160,000.00).

WE HEREBY ENGAGE WITH YOU THAT A SINGLE DRAFT DRAWN IN CONFORMITY WITH THE TERMS OF THIS CREDIT WILL BE DULY HONOURED IF PRESENTED TO US ON OR BEFORE THE EXPIRY DATE.

EXCEPT SO FAR AS OTHERWISE EXPRESSLY STATED, THIS STANDBY LETTER OF CREDIT IS SUBJECT TO THE INTERNATIONAL STANDBY PRACTICES 1998 (ISP98), INTERNATIONAL CHAMBER OF COMMERCE PUBLICATION NO. 590.

UNQUOTE

[ZTS]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.