Article

Factual Summary:

Pursuant to a distribution agreement between the manufacturer, the Brazilian distributor, and the distributor's U.S. purchasing agent, a standby for US$ 250,000 was opened by the issuer in favor of the beneficiary/manufacturer. Prior to issuance of the LC, the Brazilian distributor had guaranteed the obligations of its U.S. purchasing agent to the manufacturer.

By the terms of the LC, the standby con tained a fixed expiration which was to be automatically renewed yearly unless the issuer gave "written notice that we [the issuer] have elected not to renew the letter of credit beyond such date." It also required presentation of a default statement "that the amount of the draft which this statement accompanies will be applied by us to indebtedness due and owing Comp Service Ltda. for invoices which Comp Service Ltda. defaulted on the payment terms to 3Com Corp."

On three occasions, the issuer requested the advising bank to "please obtain authorization to cancel" the standby. The beneficiary, however, refused to agree to its cancellation. Immediately prior to the expiration date, the issuer sent another communication containing the statement: "Cancel ... standby LC and release us from liabilities...." Subsequently, the beneficiary drew on the standby for obligations owed by the applicant and, pursuant to its terms, presented the required default statement.

Claiming that the LC had expired and that no invoices had been issued by the beneficiary to Brazilian distributor, the issuer dishonored the first drawing. It also dishonored a second drawing on the ground that the LC had been cancelled.

The beneficiary filed an action against the issuer for wrongful dishonor and the issuer cross-claimed for fraud in the transaction. The trial court granted the beneficiary's motion for summary judgment and denied the issuer's cross motion.

Legal Analysis:

1.Choice of Law: Forum's Law: Even though the LC was issued in Brazil and the beneficiary performed in California, choice of New York as forum and reliance on New York law in the parties' briefs constituted implied consent justifying use of forum's law.

2. Risk of Ambiguity of Notice of Non-Renewal (Evergreen Clause):The LC did not specify the precise form of notice of non-renewal to be given. It required "written notice that we have elected not to renew the letter of credit beyond such [expiry] date." Looking to the UCP provisions on amendment, the court concluded that "by analogy, if an irrevocable credit cannot be 'amended' without clear notice, an instruction such as a notice of termination should require clear notice." It also concluded that the UCP required clarity with regard to expiry dates and that the burden of notice in the LC itself was assumed by the issuer.

3. Notice of Non-Renewal Must be "Clear and Unequivocal".Applying New York law, the court also concluded that clear and unequivocal notice of non-renewal was required. It based this conclusion on the strict compliance cases and the rule that the failure to make LC requirements explicit is a risk borne by the issuer.

4. Language of Notice Not to Renew Not Clear and Unequivocal The issuer argued that its communication ("Please cancel the standby letter of credit and release us from liabilities.") constituted an 'election not to renew', especially when viewed in the context of prior communications regarding cancellation which were merely worded in the form of a request. It contended that in this communication, "cancel" should be read as "terminate".

The court rejected this approach, noting that cancel was ambiguous and had been used in a different sense (immediately cancel) in the prior telexes. To conclude that its use in the final telex meant "we elect not to renew" or "we terminate" was not justified by the language nor the context. It concluded that the failure to unambiguously give notice of intent to terminate rendered the notice ineffective.

5. Fraud in the Transaction:The issuer claimed that the drawing was fraudulent in that the statement of default (that the drawing was for "indebtedness due and owing by [the applicant] to [the beneficiary] for invoices which [the applicant] defaulted on the payment's terms to [the beneficiary]") was false because the beneficiary knew that the default was that of the purchasing agent and not the applicant.

Noting that the text of the LC was unclear as to what invoices were covered and that the applicant had separately guaranteed its purchasing agent's debts to the beneficiary, the court concluded as a matter of law that the applicant was responsible for the debt and that there was no material fact demonstrating the existence of fraudulent intent on the part of the beneficiary.

Comment:

1. On the whole, this opinion is sound in its approach to the problem of notice. It starts with the proposition that the principles underlying the UCP inform the answer to this question even though the UCP does not expressly address the issue of evergreen clauses and notices of non-renewal. In so doing, it quite properly looks to the rules relating to amendments and expiry and, accordingly, comes to the principle of irrevocability. Because an LC is irrevocable, it should not be lightly terminated and any notice which effects the termination must be so understood in the ordinary course of business.

2. Where the court slips in its analysis is in the legal phase where it draws upon some of the silly rhetoric with regard to rules of construction. As is well understood, resort to general rules of contract construc tion signals the absence of any principled basis for understanding the terms of the LC or is a mask for a result-driven analysis. In this vein, the court suggests that the language would be construed against the "drafter" which it states in this case is the issuer. How it knows this fact is unclear'perhaps the parties agreed. The point, however, is that whoever drafted the language used in the LC, it was adopted and used by the issuer in its irrevocable undertaking and its obligation should be so measured. Not only does this approach meet the commercial expectations of the parties (that the issuer is responsible for its undertaking and the language embodied therein) but it avoids the fruitless factual determination of who drafted what when. Hopefully this dicta will slip into deserved obscurity and the general principle and approach of the case will receive the attention and approval which it well deserves.

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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 ICC or the other partners in DC-PRO.