Factual Summary:Applicant, a British Columbia company, agreed to pay for Chinese garlic with an LC issued by a local branch of a Taiwanese Bank for US$ 818,000 payable to beneficiary Chinese corporation. Beneficiary made four shipments of garlic to applicant and the negotiating bank forwarded the documents along with drafts to the issuing bank. The issuer took up the documents and released those relating to the first two shipments to the applicant, who obtained the goods, but issuer did not remit the funds requested. The applicant objected to the quality of the goods and requested the beneficiary not send any more garlic. The applicant then obtained an ex parte order restraining the issuing bank from paying on the LC. It also sued the beneficiary for breach of contract and equitable fraud. The issuer accepted a fifth presentation but declined to honor because it had been ordered by the court "to extend payment of the Letter of Credit...and not pay out same to any person until further order of the Court or agreement of parties." The beneficiary contended that it had not been properly served, and refused to respond, and then requested resolution of the dispute through arbitration. Applicant's counsel refused and demanded that beneficiary file an appearance and statement of defense in B.C. Court, but never made proper service. Beneficiary then shipped the sixth and final load of garlic to applicant. The issuing bank had signed over bills of lading to applicant, who obtained and sold the garlic from the third, fourth, fifth, and sixth shipments. Applicant then obtained default judge-ment against beneficiary. Ralph, J., granted it after taking testimony in chambers. The LC was ordered. to be canceled, after applicant's managing director appeared before the judge and repeated , erroneously, that the beneficiary had drawn down part of the LC. At no time had the issuer either paid or objected to the documents. When the judgment was served on the beneficiary six months later, the beneficiary demanded the value of the LC from the issuing bank, and applied to set aside the default judgement. On application, Ralph., J., set aside the default judgement for lack of proper jurisdiction and the beneficiary filed defenses and applied for an order to set aside the interlocutory injunction. The applicant subsequently became insolvent and the issuer sought a declaration that it had no liability under the LC because its failure to pay out was precluded by court order. The trial court set the injunction aside as a nullity and ruled that the issuer had no defense to its LC obligations. Applying the doctrine of frustration of purpose, the court noted that the injunction was the cause of non-payment of shipments five and six, but the court went on to state that "[h]aving accepted the documents six days prior to being served with the injunction, the bank was in breach of its obligations to pay in a timely manner the drafts in relation to shipments one to four."

Legal Analysis:

1.Jurisdiction: The beneficiary argued that there was no ground on which it could be properly served wit process in a dispute regarding the underlying transaction. The court noted that this point, accepted in the prior case regarding the default judgment, was not to be limited to failure of the applicant to "comply with the formal rules with respect to service ... invalid service is equivalent to no jurisdiction." Quoting Northern Sales Co v Government Trading Corp of Iran, 81 D.L.R. (4 th ) 316 (BCCA 1991), the court noted that it is "'simply arrogant' and contrary to 'the commercial interest of Canada as a trading nation' to assume jurisdiction over a foreign merchant without establishing a real and substantial connection to the province."

2. Injunction, Jurisdiction: The issuer argued that jurisdiction over a cause of action is unnecessary to grant an injunction. The trial court noted that the argument was technically correct. The "difficulty" in the instant case, however, was that "there was no justiciable right as between the applicant and the issuing bank, anywhere, on which to ground an injunction." The dispute regarding the underlying contract was between applicant and beneficiary. The court noted that for the injunction to lie it must have in persona jurisdiction as over the person "against whom the wrong is alleged", which it lacked against the beneficiary. The trial court concluded that there was no basic for jurisdiction which rendered the ex parte injunction a nullity.

3. Injunction, Full Disclosure: The beneficiary argued that the injunction should also be set aside because the applicant misrepresented, to the knowledge of the issuer, that it had drawn on the LC, a material fact on which the court relied in granting the injunction. Moreover, the enjoining court was unaware that the applicant had taken possession of the goods. The trial court, arguing, noted that its decision to set aside the injunction rested on the "less than full and frank disclosure and misrepresentation" as an alternative ground.

4. Independence: The parities agreed that the issuer's obligation is independent of the performance of the underlying contract between the buyer and the seller. "An issuing bank cannot be permitted to wait unit until actual performance of the underlying contract of sale to determine whether it should accept the documents and pay the draft. Its obligation and authority to pay are determined at the time of the tender by what appears, upon reasonably careful examination, on the face of the documents. As indicated above, the principles of autonomy and strict documentary compliance require that the issuing bank disregard the facts concerning the performance of the underlying contract (except, of course, in the case of fraud of which it has notice), whether existing at the time of tender or afterwards. Payment is made for documents and not for goods, and the buyer is entitled to receive conforming documents before the actual arrival of the goods."

5. Injunction, Effect; Release of Documents; Cancellation: The issuer argued that it was obligated not to honor the presentation by the injunction. The trial court agreed, but noted that the issuer was not prevented from refusing subsequent documents presented or declining to release them to the applicant. "The release of the documents which, under the terms of the Letter of Credit and by the law which pertains thereto, obligated the bank to pay. While it could not pay while the injunction was outstanding it clearly contemplated that it would be paying when the injunction which was interlocutory in any event was no longer valid." "The bank decided for apparently commercial reasons, to release the documents to the applicant allowing the buyer to take possession of the garlic and to sell it. The commercial reasons may very well have been valid and prudent. As the bank pointed out in argument, it would have no recourse against the applicant if the injunction was lifted, and it had to pay the beneficiary. The applicant had no obligation to reimburse the bank unless it received the documents allowing it to take possession. The bank pointed out that garlic is perishable. "This position taken by the bank is similar to the position it took when it agreed to issue the Letter of Credit in the first place. It assessed the risk of the applicant not being in a position to reimburse it for payment and decided to accept the risk. Likewise, when it decided to release the documents to the applicant in the circum-stances, it accepted the risk that the applicant might not be in a position to reimburse it when it had to pay out on the Letter of Credit. The bank, of course, by its action, removed any recourse the beneficiary might have if the bank had refused the documents in the circumstances and returned them to the beneficiary. The bank also, by actions in accepting the documents and releasing them to the applicant, created a crystallized irrevocable obligation to pay to the beneficiary on each and every shipment for which it accepted and released the documents." The issuer argued that the judgment rendering the LC canceled caused it to change its position to its detriment by canceling the LC and severing its relationship with the applicant. The court ruled that the effect of setting aside the default judgment by another judge of the court in the earlier hearing and its decision that the injunction is a nullity "was to review the Letter of Credit since it was only cancelled in conformity with the Court ordered default judgment...". The issuer argued that "it would now be unjust to revive its obligations since the applicant is now bankrupt and the bank no longer has recourse to it for reimbursement if it meets its own obligations". The court concluded that the issuer had acted reasonably in severing its relationship with the applicant. The court ruled that the doctrine of impossibility of performance was only available as to the 5 th and 6 th shipments and not shipments 1-4. The court also noted that the bank was aware that the scope of the injunction could not have covered the amount misrepresented to the court to have been drawn before it was issued and as to which the court was not informed that the documents were release to the applicant. The court commented that despite this knowledge, the issuer "chose to read the injunction as prohibiting any payment on the Letter of Credit and refused to pay that which it know or should know or should have known was not intended by the Court to be prohibited."

6. Injunction, Effect of Cancellation of LC and Later Revival; Frustration: In searching for legal principles to apply to the question of the impact of the revival of the LC after cancellation due to court order when the issuer has allegedly detrimentally on the order, the court turned to the contractual doctrine of frustration of purpose. The court concluded that the ensuing delay in the performance of the issuer's obligation due to the order was the equivalent of delay due to temporary supervening illegality. It noted that. the effect of the delay depended on factors such as the obligations of the contract, the seriousness of the delay, and whether the delay rendered the contract futile or changed its nature.

7. Injunction, Effect of Setting It Aside: In applying the doctrine of frustration to the effect of the revival of the LC, the court concluded that at the time of the insolvency of the applicant, it became "impossible of performance" even though the insolvency occurred after the action to set aside the judgment had been commenced. The court explained its decision by stating that "[o]ne essential part of the Letter of Credit is the recourse of reimbursement by the purchaser which the bank has upon payment to the beneficiary. Thus, there can be no ordering of specific performance because the parties, upon revival of the Letter of Credit and the setting aside of the injunction cannot be put in the same position in which they were prior to the Court ordered intervening events. Thus, the contract created by the Letter of Credit was incapable of performance, that is not merely temporarily suspended, as was the case until [the entry of the default judgement] but impossible of performance." Having noted that the date of entry of the default judgment was the point in time where the obligation of the issuer was rendered impossible, the court considered the effect of the issuer's actions prior to this date, including the release of the document to the applicant. It also noted that the issuer had accepted presentations 1-4 before the entry of the injunction, including presentations 3 and 4 six days before. With regard to the latter two presentations, the court stated that "having accepted the document six days prior to being served with the injunction, the bank was in breach of its obligations to pay in a timely manner the drafts in relation to shipments one to four. Thus, it cannot be said that the cause of the bank's inability to honour its obligation or comply with the terms of the contract by which it was bound was the injunction and then the subsequent default judgment. The cause was the bank's own failure to meet the strict obligations imposed upon it by the Letter of Credit agreement. The first four shipments and the drafts for payment of them were not only not impossible of payment but were not paid because of the breach of its contractual obligations by the bank". Quoting Professor Goode in Commercial Law (1985) at 136- 7, it stated that "self induced frustration does not terminate a contract ... ".

8. Default, Effect of Revival of LC After Its Cancellation: The issuer argued that the beneficiary bore responsibility for the consequences of the ex parte injunction and default "because it failed to act in a timely way to seek redress", specifically to more to set aside the injunction. The court, however, noted that the forum was likely not the one in which to contest the underlying contract and that the beneficiary had acted correctly in not appearing but merely protesting by telefax and correspondence to the applicant's counsel and the court. "It does not lie in the mouth of the applicant nor in that of the bank to say, we improperly brought you before the Courts in B.C. and you should bear the consequences of failing to properly attorn to the jurisdiction. The bank is not entirely innocent in the impropriety of obtaining these orders. It is true it did not appear before the Court and make submissions and directly join in allowing misrepresentation and non-disclosure to ground the granting of the orders. But, it was a party and was served with the mistaken material sand rather than brining any misrepresentations to the attention of the court, it took full advantage of those mistakes and chose not to pay out even on the first two shipments which the Court had been told had been 'drawn down'. The same submissions and misrepresentation were put before the judge granting the default judgement and again the bank did nothing although it had notice of the mistakes or misrepresentations."

9. Notice of Refusal, Effect of Injunction; UCP500 Article 14: The issuer argued that the documents did not comply with the terms and conditions of the LC. He court rejected this argument, noting that "the only time for complaint ... is when the 'required documents' are tendered." " The bank could have refused to accept the documents and if it had within the stipulated seven days of receiving them, the remedy of non-payment would have been available. However, the bank accepted the documents and has no right now to complain. The parties are bound by the terms of the Letter of Credited to Article 14 of the UCP500 which contains rules respecting exactly this situation." 10. LC Law: The court quoted with approval the statement of Anderson, J., in Banco National d Cuba v Bank of Nova Scotia (1988) 4 O.R. (3d) 110 (H.C.J.), affirmed on other grounds (Ont. CA.) that "the realm of documentary credits is, in many respects, a world apart, technical and commercial, and those also would move within it would have their courses determined and constrained by its technicalities and conventions as closely as the payers in a game of chess."

11. Independence; Quality of Goods: The issuer argued that it was excused from its obligation to pay because the goods were not as agreed. The court rejected this argument, noting that it "violates the autonomy principle in UCP500 and the common law. Bankers deal in documents, not goods. An issuing bank cannot set up a breach of the underlying sales agreement as a reasons to beckon a draft drawn of the Letter of Credit. The autonomy principle is fundamental to the commercial efficiency of letters of credit and cannot be disregarded."

12. Set Off: The issuer claimed a set off agent the beneficiary for any liability on the LC for the diminution in market value due to the defects in the goods. The court noted that the "beneficiary's recovery against the issuing bank under a letter of credit is in no way limited to the market value of the goods or services delivered pursuant the underlying contract." It stated "a set off-in these circumstances is not only contrary to the autonomy principle, but also unsupported by the authorities concerning set-offs generally. A set-off will only be awarded where the defendant has a claim against the plaintiff arising from the same contract or an interrelated contract between the same parties. In a transaction secured by Letter of Credit, the inter-connectedness necessary for a set-off is absent. In my view, because of the overriding principles invoked by the parties by providing for a Letter of Credit they chose to be bound by the autonomy principle. There can be no set-off at common law". The court also noted that if the issuer had paid promptly for shipment 1-4, "there would have been no issue of non-payment and certainly no issue of set-off".

Comment:1. The applicant took possession of shipments 1 and 2 more than 10 days before it sought the injunction, using B/Ls bearing the endorsement of the issuer. Having obtained the documents, the applicant has converted them and the goods that they represent and is left to its remedies on the underlying contract. 2. This case serves as a potent reminder to banks faced with an injunction. The injunction does not operate to excuse the duty to examine any documents presented and to give notice of refusal, stating all the discrepancies on which it is based. If a bank fails to give timely notice, it will be exposed to liability under the UCP500 Article 14 preclusion rule should the injunction be lifted. The issuer's conduct is even more surprising when it is recognized that four presentations had been made before the injunction, in the case of the first two presentations, 16 calendar days before the application and of the third and fourth presentations 4 calendar days before. 3. Even more troubling was the failure of the applicant to disclose to the court in seeking the ex parte injunction that it had possession of the goods and the failure of the bank to clarify this nondisclosure of which it had notice. 4. The most troubling aspect of this basically sound opinion is the court's reliance on the doctrine of frustration to excuse the issuer from its obligation under the LC. While the release of the collateral may have been reasonable and foreseeable as a result of the injunction, it was a business risk taken by the bank and the failure of the beneficiary to resist the order of a court that had no power over it should not excuse the issuer from its obligations under the credit, especially where it failed to provide timely notice of refusal.


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.