Article

Note: Petrosaudi Oil Services (Subcontractor/Beneficiary), a Barbados company, and PDVSA Servicios S.A. (Contractor/Applicant), a Venezuelan company, entered a seven-year drilling contract under which Subcontractor/Beneficiarywas to provide oil rig drilling services. The contract contained a choice of law clause designating the law of Venezuela to govern the contract and required arbitration under the UNCITRAL rules. To assure payment of invoices, Contractor/Applicant obtained a standby letter of credit issued by Novo Banco SA (Issuer) in favor of Subcontractor/Beneficiary.

The standby required, inter alia, presentation of a written demand in the form of attachment A to the standbyduly completed and signed by the Subcontractor/Beneficiary as well as a copy of a commercial invoice addressed to Contractor/Applicant.Further, the standby stated that the Issuer will pay the Subcontractor/Beneficiary upon presentation of documents without any obligation to verify the “accuracy, sufficiency, authenticity, or genuineness” of the documents within five Lisbon banking days from the date of receipt of such presentation.

When Subcontractor/Beneficiary submitted an invoice to Contractor/Applicant for work performed, the parties disagreed on whether the appropriate rate was the “operating rate” or the “repair rate.”Pursuant to the Contract, the parties commenced arbitration. The arbitral tribunal refused a request by Contractor/Applicant for an injunction to preclude Subcontractor/Beneficiary from seeking payment under the standby. Arbitrators deferred to the English High Court to determine whether there was a valid demand under the standby.

During this time, Subcontractor/Beneficiary made a demand on the standby because Contractor/Applicant had not paid. Issuer notified Contractor/Applicant that there had been a compliant presentation, and stated its intention to pay. Contractor/Applicant suedIssuer in England to enjoin Issuer from honoring the standby. The High Court of Justice, Queens Bench Division, Commercial Court, Waksman, J., issued an injunction. On appeal, the Court of Appeal (Civil Division), Lewison, LJ, and Christopher Clarke, LJ, reversed the Trial Court decision.

The court addressed two issues, namely: (a) article 141 of the Venezuelan Public Contract Law (“LCP”) and (b) invoice certification fraud.

1. Article 141 of the LCP

The Trial Court Judge granted an injunction based partly on the idea that Article 141 of the LCP did not allow for payment on a bond until the proper Article 141 procedures were satisfied. Therefore, if Beneficiary tried to make a call on the bond before (i) the completion of an Article 141 procedure with Applicant’s authorization or (ii) an arbitral award then Beneficiary cannot obtain a judgment from a Venezuelan court.

The Appellate Judge ruled that the Trial Court Judge erred in concluding that Applicant was under no obligation under the contract to pay the invoice because there was no Article 141 authorization or an arbitral award.The Appellate Court Judge stated that one needs to look to the agreement and intent between the parties in the drilling contract in accordance with what a reasonable person with the relevant background knowledge would have understood the language to mean using commercial common sense.

The Appellate Court Judge noted that the drilling industry recognizes prompt and regular payments as essential to a contractor’s cash flow and, thus,the parties must have intended for a steady stream of payments. Furthermore, at the time of contracting, Applicant had a long-established reputation for late payment or non-payment of invoices. Thus, a standbymust have been an essential precondition to Beneficiary’s willingness to contract with Applicant to ensure that the Beneficiary can obtain from a bank sums due regardless of whether there is a dispute.

The Judge observed that the main function of a standby is to reverse the risk of non-payment from the payee to the payor.The Appellate Court Judge further observed that the standby is not meant to be “a guarantee that any award against [Applicant]would be satisfied by the bank”, but instead is meant to be security for Applicant’s unpaid liabilities and to guarantee Applicant’s performance of the contract. Therefore, a standby should not be limited to providing security only when Applicant does not pay for authorized sums under Article 141 or for arbitral awards.

The Appellate Judge also stated that astandby and the Contractor/Applicant’s obligations are independent. The Appellate Court Judge reasons that the Trial Court Judge’s decision puts the Subcontractor/Beneficiary in a situation where it is performing its obligations without payment until an award is made. The Appellate Court Judge stated that the Trial Court Judge’s treatment of the standby“without regard to theseparate and autonomous nature of the SBLC…and the well-known purpose of such instruments, and produced a result which was wholly uncommercial.”

2. Invoice Certification Fraud

The Trial Court Judge ruled that Subcontractor/Beneficiary’s General Counsel committed fraud and, under the fraud exception, the Issuer was barred from honoring the standby. The Trial Court Judge stated that Subcontractor/Beneficiary’s abstract focus on the word “obligated” in Article 141 was “wholly unrealistic.”

Subcontractor/Beneficiary appealed claiming that the invoices had been properly issued to Contractor/Applicant, which remained unpaid. The Court of Appeal concluded that Subcontractor/Beneficiary’s General Counsel did not commit fraud by certifying the invoice amount that Contractor/Applicant was obligated to pay.

The Appellate Court Judge stated that Subcontractor/Beneficiary and its General Counsel were right to claim that the invoice wasimmediately due and payable. The Judge reasoned that Subcontractor/Beneficiary, in accordance with the standby, served the invoice and 30 days lapsed since Contractor/Applicant received the invoice. The Appellate Court Judge rejected the argument that if an invoice is disputed within 30 days, payment is not due. Instead, the Judge stated that the drilling contract clearly stipulates that the owed amount or accrued interest is due even if it is disputed.The Appellate Judge saw no reason whySubcontractor/Beneficiary’s General Counselwould believe the invoices were incorrect and, in the absence of fraud, the Issuer must honor the standby and disputes between the parties are not to affect liability. The Appellate Judge further stated that, given Contractor/Applicants history of late payments and non-payment, Beneficiary needed an assurance through the standby to secure regular payment and steady cash flow.

The Appellate Judge stated that Issuer undertook to “guarantee the payment of any invoice issued by the [Subcontractor/Beneficiary].”The Appellate Judge stated that the standby calls for production of a copy of the invoice marked unpaid together with evidence of receipt of the invoice, drilling reports and a certificate that Applicant has an obligation to pay. The Appellate Judge further noted that the standby requires payment to be made to Subcontractor/Beneficiary after 30 days have passed since Contractor/Applicant’s receipt of the invoice.Finally, the Appellate Judge stated that under the standby Subcontractor/Beneficiary’s invoice would be deemed correct if Contractor/Applicant does not dispute it within 15 days and that Contractor/Applicant is bound to pay even if there is a dispute.

Legal Analysis:

Comment:

Although the full text of the case did not indicate if the standby LC was issued subject to governing rules, IIBLP has learned from an attorney familiar with the case that the standby was issued subject to ISP98 and, to the extent not inconsistent therewith, governed by English law. Any dispute under the standby was to be submitted to the exclusive jurisdiction of the English Courts.

Text:

The opinion contained the following excerpts from the contract:

Clause 803 Payment of invoices

  1. [Applicant] shall pay to [Subcontractor/Beneficiary] the amounts invoiced after deduction for applicable withholding taxes as specified in Paragraph 608(b) but without any set-off whatsoever.
  2. Payments shall be made by [Applicant] in sufficient time for receipt by [Subcontractor/Beneficiary]of the full invoiced amount net of any bank charges by [Subcontractor/Beneficiary] within thirty (30) days of the date that the relevant invoices received by [Applicant]. [Applicant] shall be liable to pay interest at the rate specified in Appendix A should there be delay in [Subcontactor/Beneficiary] receiving any amount due under the invoices before the aforesaid thirty (30) days; whether or not the relevant invoice has been accepted, deemed accepted or disputed by [Applicant]. Interest shall be calculated from the date the invoice becomes overdue until date of payment.
  3. If [Applicant] for just cause and in good faith disputes an item invoiced, [Applicant] shall within fifteen (15) days after receipt of the invoice notify[Subcontractor/Beneficiary] of the amount disputed and specify the reason therefore, failing which [Applicant] shall be deemed to have irrevocably accepted the invoice as correct and that the amounts dated therein as due and owing to [Subcontractor/Beneficiary].
  4. In the event an amount is disputed, notwithstanding such dispute, [Applicant] shall pay [Subcontractor/Beneficiary] the disputed amount within the time limit applicable to the relevant invoice wherein such dispute arose. [Subcontractor/Beneficiary] shall refund said amount or part thereof with interest, calculated from the date falling thirty (30) days after [Subcontractor/Beneficiary’s] receipt of payment of the invoice relevant to the disputed amount until the date of refund, upon [Subcontractor/Beneficiary] accepting and agreeing to such disputed amount or part thereof or the mutual agreement of [Applicant] and [Subcontractor/Beneficiary] in respect of such disputed amount or part thereof, or [Applicant] proving Contractor is not entitled to the same in accordance with paragraph 1304.
  5. [Subcontractor/Beneficiary] shall have the right upon three days prior written notice to suspend some or all performance and/or terminate this contract if [Applicant] fails or refuses to timely pay [Subcontractor/Beneficiary] any amount due and owing to the [Subcontractor/Beneficiary]. If [Subcontractor/Beneficiary] chooses to suspend this Contract the Operating Rate shall continue to apply and be payable during period of suspension. Exercise of the right of suspension will not preclude [Subcontractor/Beneficiary] from terminating this Contract for the same reason at any time thereafter.”

    Clause 805 (1)

    “on the effective date [Applicant] would provide the [Subcontractor/Beneficiary] with a guarantee from [Issuer] in terms agreed between [Applicant], [Subcontractor/Beneficiary] and [Issuer] as set out in Appendix H in the amount of US$130m to secure payment to [Subcontractor/Beneficiary] under the Contract and to guarantee the performance of the Contract by[Applicant];”

Clause 1304 provided for arbitration in relation to any disputes arising out of or relating to the Contract, which would be conducted in accordance UNCITRAL Rules.”

Clause 1305 provided as follows:

“Each Party hereto agrees that all laws, rules and regulations of any federal state or local government authority having jurisdiction over the Operating Area, which are now or may become effective, will apply to the performance of this contract in such jurisdiction. In the event any provision of this contract is inconsistent with or contrary to any applicable federal, state or local law, rule or regulation, said provision shall be deemed to be modified to the extent required to be consistent with said law, rule or regulation, and as so modified, said provision and this Contract shall continue in full force and effect provided that [Applicant] shall indemnify and hold harmless [Subcontractor/Beneficiary] on demand against any cost, expense, liability or loss of right revenue or benefit arising as a result of such modification or change of law, or regulation. If any act or omission by [Subcontractor/Beneficiary] in response [Applicant’s] explicit instruction violates such law [Applicant] shall indemnify [Subcontractor/Beneficiary] on demand for any consequences thereof."

The opinion contained the following excerpts from The Venezuelan Public Contracting Law:

Article 141 of the Venezuelan Public Contracting Law (“LCP”) provides “Conditions for Payment” (in translation from Spanish) as follows:

Article 141. The principal shall pay the obligations assumed under the agreement in compliance with the following:

  1. Verification of the compliance in the supply of the good, rendering of the service, performance of the work or any part thereof.
  2. Receipt and review of the invoices presented by the contractor.
  3. Confirmation, by the supervisor or engineering inspector, of compliance with the established conditions.
  4. [Authorization] for payment by the persons of competent jurisdiction."

The standby provided:

“We the beneficiary of the standby hereby demand payment of USD$… in words and figures under the standby.”

“We certify that [Contractor/Applicant] is obligated to the [Subcontractor/Beneficiary]… to pay the amount demanded under the drilling contract executed among the [Subcontractor/Beneficiary] and [Contractor/Applicant].”

[JK]

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