Article

Factual Summary:To provide security for losses in its CA$ 500,000 investment in Proteus Capital Corp., a non-bank fund that trades in the foreign exchange market, investors were required to post an LC in lieu of cash collateral. Accordingly, Applicant caused its bank to issue an LC for CA$ 250,000 payable to the market maker with which the fund dealt.

In accordance with the investment procedures, Applicant was notified of losses of CA$ 141,817.74 and asked whether he wished to continue his investment or to redeem his position. It was indicated that his trading position in the fund would be held in abeyance until a subsequent contact was made. A series of communications ensued and the LC was extended once but Applicant never advised the fund that his position should be re-activated. When it was about to expire a second time, Beneficiary inquired whether it would be extended again. Although Issuer indicated that there would be an extension, Beneficiary indicated that it would draw on the LC unless it actually received the amendment. The amount claimed was not only the amount at the time of the initial contact but subsequent incremental losses of CA$ 83,514.93 since his account was not, in fact, being held in abeyance although Applicant was not so notified.

At that point, Applicant obtained an ex parte injunction ordering Issuer to pay the proceeds of any drawing into the court. When a drawing was made the same day, Issuer notified Beneficiary of the injunction order and paid the proceeds into the court. Subsequently, the court ordered its clerk to pay out a portion of the fund that was not in dispute, leaving a balance of CA$ 97,000.00 Beneficiary petitioned the court for an order setting aside the injunction and paying to it the balance of the funds. Held: Petition dismissed.

Legal Analysis:

1. Independence: Citing Canadian case law and UCP500 Articles 3, 4, and 9, Beneficiary argued that Issuer was obligated to honor the letter of credit and that the injunction order improperly interfered with its obligation since Applicant had not established that the fraud exception was applicable.

2. Injunction, Standard: The court noted that under applicable law, the standard by which injunctive relief should be granted is: (a) Is there a serious issue to be tried? (b) Will [the Applicant] suffer irreparable harm if no injunction is granted? and (c) Does the balance of convenience between the parties favour the granting of an injunction?

3. Injunction: Citing Bank of Nova Scotia v. Angelica-Whitewear Ltd. [1987] S.C.J. No. 5 [S.C.C.] which it described as "[t]he seminal case in Canada dealing with letters of credit and the principle of autonomy", the court indicated that its elements were: 1) there must be a proper demand; 2) the beneficiary must have committed fraud; and 3) the bank must have had knowledge of the fraud prior to the drawing.

4. Injunction: The court noted that the LC required that the documents must indicate that there was a default in the arrangements made by the fund and that the amount claimed was due and payable. Noting that the amount drawn down was the full amount of the LC, whereas Beneficiary admitted that only CA$ 224,514.93, less than the entire LC amount, was due the court concluded that "Letter of Credit tendered by [Beneficiary] did not accord with the terms and conditions on which the Letter of Credit was issued." Furthermore, the court noted that, absent the injunction, the entire amount would have been removed from Canada and sent to London.

5. Injunction: Describing its decision as a "technical answer" to the petition, the court indicated that Beneficiary did not come before the court "with clean hands", a concept in equity jurisprudence that requires one seeking equitable relief to itself not have committed any wrong. The court described the effect of its order as "akin to a pre-judgment remedy" under which Applicant "voluntarily paid into Court the Disputed Amount." As a result, the standard by which it examined the issues in the case was not under LC law but under general law related to pre-judgment attachments.

6. Injunction: Beneficiary had argued that it is not enough to show that there is a dispute, but that Applicant must "demonstrate a serious issue to be tried" and must "establish a strong prima facie case for fraud". The court, however, concluded that "the strong prima facie test proposed by the [Beneficiary] has no application in this proceeding." It suggested that, where the LC test applied, the drawing in excess of the amount claimed would not constitute fraud for LC injunction purposes. Under this test, it concluded that there was a serious issue and that the balance of convenience favored the Applicant since the funds would otherwise be placed outside the jurisdiction of the court which also would give rise to irreparable harm. In reaching this conclusion, it quoted from the offering brochure of the fund to the effect that with regard to Legal Risks, "It may be very or even impossible to pursue a legal action against [Beneficiary] and/or its directors due to the fact that they are all located in a foreign jurisdiction and therefore may not be subject to the laws of Canada or its provinces. [emphasis added]"

7. Injunction: In summarizing its conclusions, the court stated that "[t]he ultimate problem in this case is that the [Beneficiary] allowed [Applicant] and others to make major speculative investments without paying any money or putting down any cash through the mechanism of a letter of credit, frankly better suited and designed for international transactions involving hard goods and real products than for currency and futures speculation."

Comment:

1. Taken as an exercise of the Canadian court in equitable jurisprudence, this case is not remarkable. Its implications for LC jurisprudence, however, are significant. Should it be followed, it could call into serious question the viability of standby letters of credit in Canada.

2. It is apparent that the court fails to appreciate the role of standbys in commercial transactions. Its concluding comment about the better use of an LC for transactions involving "hard goods and real products" is not only outdated and outmoded but disregards the freedom of commercial parties to arrange their affairs in a flexible manner suited to their needs. Ultimately, this view impedes the growth of commerce and commercial law.

3. What has taken place is that the court order compelled the issuer to pay the proceeds of the LC into the registry of the court although the documents complied on their face with the terms and conditions of the LC. Such an order interferes with the independence of the LC. To be proper, it must result from a determination that there is LC fraud. Here, however, no such determination was made. Indeed, the court suggested that the claim for an amount slightly in excess of that which was due would not constitute LC fraud. The test that it used, however, to determine the propriety of the order was the standard test applicable to injunctive relief, namely whether there was a serious issue, would be irreparable harm, and whether there would be undue inconvenience to the beneficiary. Applying these tests, as opposed to the LC fraud test, its decision is sound.

4. The question is whether or not the court should have applied the LC fraud test. By re-characterizing the action as one for pre-judgment attachment, the court has, in effect, deprived the Beneficiary of the benefit of the LC. The payment into the court was not voluntary as to Beneficiary or the Issuer. The Issuer's obligation was to pay the Beneficiary. It did not do so because of the court's order. Whether that order was proper must be tested under LC law and not under the general rules that would apply to attachment.

5. Nor is the court correct in characterizing the drawing as "improper". This concept is alien to LC law and practice. What the court meant was that, while the documents complied on their face, the Beneficiary was claiming more than it was entitled to claim. Such a drawing is either fraudulent, in which case an injunction would lie, or it is not, in which case, the Applicant must seek remedies directly against the Beneficiary after the LC has been paid. The court appears to forget that the LC was in lieu of posting cash collateral. Had cash been posted, Beneficiary would have been free to claim against the cash in its own jurisdiction. It should be equally free to claim against the LC unless there is LC fraud.

6. Nor does this decision help Canadian investors in the future. Instead of permitting them to have LCs issued by Canadian banks in Canada, they will no doubt in the future be required either to post cash or to have their LCs confirmed in other jurisdictions, increasing the costs of the transactions and affording the Canadians even less protection that they have currently.

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.