WHAT IS A LETTER OF CREDIT AND WHAT PURPOSE DOES IT SERVE?

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1 LETTERS OF CRED DIT AND DISPUTES ABOUT JURISDICTION AND CHOICE OF LAW Petrologic Capital SA v Banque de Genève & another [2012] EWHC 454 (Comm) APRIL BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

2 LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION AND CHOICE OF LAW Petrologic Capital SA v Banque Cantonale de Genève & another [2012] EWHC 454 (Comm) This paper considers the recent case of Petrologic Capital SA v Banque Cantonale de Genève & another [2012] EWHC 454 (Comm) which has provided an opportunity to look at the role of documentary credit in international sales transactions and the importance of which country s law and jurisdiction governs the contract. WHAT IS A LETTER OF CREDIT AND WHAT PURPOSE DOES IT SERVE? A letter of credit serves an important role in an international sales transaction. The seller will often have to extend to a buyer a credit period, or the buyer will refuse to pay for the goods until they have been shipped; consequently, the seller will be exposed to risk of financial loss in the event that the buyer is unable or unwilling to pay for the goods. To safeguard against these risks, the parties will agree that the buyer will enter into a contract with a bank, to establish a letter of credit. The bank guarantees to the seller (the beneficiary), that the buyer will pay for the goods. The buyer s bank stands as guarantor and will be obliged to pay the seller in the event that the buyer is unable or unwilling to do so. The bank will pay the seller when the seller presents the required documents, thus it is known as documentary credit. These documents will be agreed upon by the parties in advance, and will include the Bill of Lading. The Bill of Lading acts as proof that the goods have been shipped and possession of the Bill enables the buyer to obtain title to the goods. DOCUMENTARY CREDITS GOVERNED BY UCP 600 The International Chamber of Commerce is responsible for the rules which govern the use of documentary credit. The Uniform Customs and Practice for Documentary Credits (UCP 600) establishes the rules by which the system works. These rules are comprehensive and can be accessed at: and Under the UCP 600 documentary credits are irrevocable, i.e. the bank is unable to revoke the guarantee, even if at the request of the buyer. Where documentary credits are irrevocable, these can be unconfirmed or confirmed. With unconfirmed documentary credit the seller obtains a guarantee from only the issuing bank (the buyer s bank), even if the exchange of documents and payment is being dealt with by bank in the seller s own country (the advising bank) (see Article 7 UCP and Fig. 1 below). Unconfirmed documentary credit might be unattractive, for example where the buyer s bank is the national bank of a country with an unreliable political or economic reputation, or as has happened recently a bank which is over-exposed and is likely to be unable to fulfil its obligations. Consequently, the seller might prefer the use of confirmed documentary credit BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

3 (see Article 8). The advantage here is that the seller obtains two guarantees, one from the issuing bank and the other from a bank in his own country (the confirming bank). However, this had added cost implications. Fig 1. Unconfirmed documentary credit BUYER Arranges Doc Credit ISSUING BANK Underlying Sales Contract GUARANTEE SELLER No Guarantee ADVISING BANK DOCUMENTARY CREDITS ARE SEPARATE FROM THE UNDERLYING SALES CONTRACT The UCP 600 draws a clear distinction between the documentary credit and the underlying sales contract. This means that where the seller presents the required documents to the bank, the bank must accept these documents, and pay the seller for the price of the goods. The buyer, having arranged the documentary credits on the seller s behalf, cannot order the bank to refuse to pay the seller; even where the seller has breached the underlying sales contract (i.e. the goods supplied are alleged to be of unsatisfactory quality). This separation is contained in Article 4 of the UCP 600 which states: a) A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank. b) An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like. The English courts have given effect to Article 4 of the UCP 600 and its predecessors. In Mahonia Ltd. v JP Morgan Chase Bank and another [2003] EWHC 1927 the High Court held that the bank, in that case, could revoke the letter of credit and refuse to pay the seller. This was because the documentary credit had been entered into for an illegal purpose. In Hamzeh Malas and Sons v British BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

4 Imex Industries Ltd [1958] 2QB 127 the court refused to grant an injunction to the buyer, which would have prevented the bank from paying the seller upon receipt of the required documents. Here the buyer had alleged that the goods were substandard and wished to prevent the bank paying the seller. Mr Justice Donovan had stated that the documentary credit was an absolute obligation to pay, irrespective of any dispute there might be between the parties whether or not the goods were up to contract. The Court of Appeal upheld the decision and stated that the court would not have the jurisdiction to prevent the payment, unless there had been fraud. In R. D. Harbottle (Mercantile) Ltd. v National Westminster Bank Ltd. and others [1978] Q.B. 146 Mr Justice Kerr stated: It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. They are the life-blood of international commerce. Such obligations are regarded as collateral to the underlying rights and obligations between the merchants at either end of the banking chain. Except possibly in clear cases of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts. The courts are not concerned with their difficulties to enforce such claims; these are risks which the merchants take. In this case the plaintiffs took the risk of the unconditional wording of the guarantees. The machinery and commitments of banks are on a different level. They must be allowed to be honoured, free from interference by the courts. Otherwise, trust in international commerce could be irreparably damaged. It is clear that a bank must pay out on a documentary credit, where the seller has complied with the documentary requirements, except in the case of fraud. The courts respect the autonomy of the documentary credit, preferring the buyer to resort to litigation against the seller, rather than granting an in injunction to prevent the bank paying out and thereby damaging the security of the bank as guarantor. As a matter of policy this approach protects the integrity of the documentary credit system and offers security to the seller; meaning that he is protected in the event that the buyer alleges that the goods supplied do not conform to the contract. RELEVANCE OF CHOICE OF LAW AND CHOICE OF JURISDICTION CLAUSES The parties have the freedom to decide what law will govern their contract. The choice of law is important as different countries legal systems will vary, and often certain national laws such as English law will be better suited to commercial transactions than others. For example English law imposes no obligation to contract in good faith, whereas the Uniform Commercial Code in the United States does impose such an obligation. Choice of jurisdiction refers to which countries court will hear a case in the event of a dispute between the parties. It is possible to have the court of one country applying the law of another country. BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

5 INTERNATIONAL RULES REGARDING CHOICE OF LAW AND JURISDICTION CLAUSES The Lugano II Convention 2007 deals with jurisdictional issues between parties in civil transactions. Article 1 concerns the scope of the convention and states that the convention applies where the parties are from a contracting state to the convention, or from a state which is a member of the European Union. Article 22 concerns issues where a particular state will have exclusive jurisdiction, and Article 23 concerns the parties ability to choose the applicable jurisdiction. Article 23 (1) states that If the parties, one or more of whom is domiciled in a State bound by this Convention, have agreed that a court or the courts of a State bound by this Convention are to have jurisdiction to settle any disputes which have arisen or which may arise in connection with a particular legal relationship, that court or those courts shall have jurisdiction. Such jurisdiction shall be exclusive unless the parties have agreed otherwise. This will be unless there has been agreement otherwise in writing, or decided through the parties practices, or a particular international trade form. FACTS OF CASE The recent case of Petrologic Capital SA v Banque Cantonale de Genève & another [2012] EWHC 454 (Comm) provides an interesting look at the use documentary credits in international sales transactions and disputes about jurisdiction and choice of law. In April 2011, the claimant entered into a contract with MIC Petrochemische Vertriebs GmbH, an Austrian company, to purchase oil from Serbia. The claimants had agreed with the seller to establish a documentary credit in the seller s favour. The beneficiary would be MIC Petrochemische Vertriebs GmbH. The claimant originally opened a bank account with the defendant bank, Banque Cantonale de Genève, on 3 rd March When opening the account the claimant signed a basic contract, which contained the general conditions. The general conditions were to be central to the case. Article 22 of the basic contract stated that: All legal relations between the client and Bank are subject to Swiss Law. The place of performance of all obligations, the place of jurisdiction for clients domiciled abroad and the sole place of jurisdiction for any proceeding of any nature whatsoever is Geneva. There was nothing in the basic contract regarding the opening of letters of credit. The claimant then gave two powers of attorney to Andre Maurer and Natalya Matyushenko, who would represent the claimant with regards to the handling and monitoring of the documentary credit. BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

6 The letter of credit was opened on 21 st April The seller the presented the required documents to the bank and sought payment of 2,385,506. The claimant instructed the bank not to pay out the money, and asked the Court of First Instance of Geneva to prevent the bank from paying the money to the seller. The claimant argued that firstly that the goods had been disposed of to a third party and secondly that it was a victim of a fraud perpetrated by, or with the participation of its own signatory (at [20]). Obtaining an ex parte order from the Court of First Instance of Geneva, which was later set aside, the claimant appealed to the Geneva Court of Appeal and was unsuccessful. The claimant further appealed to the Geneva Supreme Court. In order to prevent the bank paying the seller (in case the Swiss injunction was lifted), the claimant sought an injunction from an English court preventing the bank paying the seller, an injunction preventing the seller from using the letter of credit and an order that the bank release the money it was holding as security to honour the letter of credit. The claimant argued that the applicable law for the letter of contract was the law of England and Wales, whilst the bank argued that the applicable law was Swiss. KEY ISSUES The key issue was whether the English courts had jurisdiction. The claimant submitted that the English courts had jurisdiction and that English law governed the contract between the claimant and the bank in establishing the Documentary Credit. The claimant argued that the English courts had jurisdictions and that the documentary credit was governed by English law. The claimant submitted that this was because: (i) (ii) (iii) The instruction given by the claimant to the bank to establish the documentary credit contained a clause which gave the English courts exclusive jurisdiction; The documentary credit stated that the English courts would have jurisdiction and that the documentary should apply to the contract between the claimant and bank; and The claimant should be able to enforce the jurisdiction agreement in the credit pursuant to the Contracts (Rights of Third Parties) Act 1999 on the grounds that the jurisdiction agreement purports to confer a benefit on the claimant (at [2]). JUDGMENT Mr Stephen Males QC sitting as a deputy High Court judge dismissed the claimant s argument. He agreed with the bank that the Geneva court had jurisdiction and that Swiss law applied to the documentary credit. Males QC was of the opinion that the claimant s dealings with the bank were subject to the General Contract which had clearly contained a clause which gave the Geneva court exclusive jurisdiction. The power of attorney The claimant executed a power of attorney so that two of its representatives could deal with the bank on its behalf. This power of attorney stated that the dealings between the bank and the claimant and its representatives were covered by the Bank s terms and conditions (where Swiss law and the Geneva court jurisdiction applied), and reiterated that Swiss law and the jurisdiction of the Geneva court would apply to All legal relations between the parties. Another power of attorney was created, this time giving the representatives the authority to arrange a documentary BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

7 credit and this also contained a clause stating that Swiss law applied and that the Geneva court had exclusive jurisdiction. The claimant s argument based on the Lugano II Convention Males QC stated: The only basis on which the claimant seeks to found the jurisdiction of the English courts against the bank, a Swiss company, is Article 23 of the Lugano Convention, and in order for the English courts to have jurisdiction, that the clause giving the English courts jurisdiction needed to be agreed upon by both parties. Males QC questioned whether the banks general conditions would apply to the documentary credit. The claimants argued that the bank s general conditions did not apply as it did not refer expressly to documentary credits. Males QC rejected the claimant s argument stating that the general conditions contemplated expressly that documentary credits would, or at any rate might, form part of the business relationship of the parties (at [32]). Therefore, Males QC was of the opinion that there was no reason why the documentary credits should not be governed by the law and jurisdiction agreed upon by the parties in the general conditions (at [32]-[33]). Males QC turned to the power of attorney (which stated that Swiss law was applicable and that the Geneva court had jurisdiction) and stated: The specific power of attorney is therefore a powerful and to my mind conclusive indication that the parties relationship, so far as letters of credit were concerned, was to be subject to Swiss law and jurisdiction (at [34]). Therefore, Males QC rejected the claimant s submission that the general conditions did not make provisions for documentary credits. Subsequently, the general conditions governed the documentary credit agreement between the bank and the claimant. Were the general conditions varied by the contract for the letter of credit? The claimant and the bank had initially contracted on the bank s general conditions. These general conditions as discussed above covered the choice of law and jurisdiction that would govern the dealings between the parties. It was the bank s contention that the choice of law and jurisdiction clause covered the parties contract regarding the opening up of the documentary credit. The claimant in addition to the above arguments, sought to argue that the general conditions were varied by the parties, when they had entered into the contract for the letter of credit. This argument was rejected by Males QC. This was because although the claimant s instructions to the bank regarding the setting up of a documentary credit in the buyer s favour, had contained a term which had stated that English law and jurisdiction applied, it had no effect in varying the general conditions. This term was just one of the terms that the claimant wished to be included in the documentary credit and it would govern the contractual relationship between the bank and the seller (at [39]), and therefore it had no effect on the relationship between the between the bank and the claimant. Consequently, there was no evidence that the parties had agreed to vary the BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

8 general conditions. Males QC acknowledged that if there was an absence of an express law and jurisdiction clause between the parties, then there was some authority the choice of law and jurisdiction in the letter of credit should govern the relationship between an applicant and issuing bank: see Bastone & Firminger Ltd v. Nasima Enterprises (Nigeria) Ltd [1996] CLC 1902 at 1910). But such an argument was not relevant, as the general conditions applied and expressly dealt with law and jurisdiction. Why shouldn t Swiss law and jurisdiction apply? Males QC observed: There is no reason in principle why the parties should not agree that their own relationship should be subject to Swiss law and jurisdiction, while the credit which the bank was to open in favour of the beneficiary would be subject to English law and jurisdiction (at [41]). Males QC refused to allow the claimant to rely on the terms relating to the beneficiary (seller) and stated that as a matter of contractual construction, the parties had agreed that Swiss law and the jurisdiction of the Geneva court would govern their dealings (at [43] [44]). The parties had shown no intention in their dealings to vary the choice of law and jurisdiction in the general conditions. The general conditions had governed their dealings in the opening of the account and in setting up a letter of credit. The claimant s argument that they should be able to enforce the terms in the letter of credit (between the beneficiary and the bank) under the Contract (Rights of Third Parties) 1999 was rejected by Males QC (at [52]). This was because the claimant was seeking to enforce the jurisdiction clause in order to prevent the bank performing its contractual obligations, i.e. paying the seller upon the presentation of the required documents. Thus, Males QC did not believe a benefit had been conferred upon the claimant within the meaning of s.1(1)(b) Contract (Rights of Third Parties) IMPORTANCE In giving his judgment, Males QC stated it was important that the court refused the claimant s request to grant an injunction to prevent the bank paying the beneficiary under a documentary credit. Males QC reiterated: Except in clear cases of fraud, the courts have firmly resisted such attempts (at [55]). Therefore, if the court allowed the claimant to rely upon the jurisdiction clause in the letter of credit, this would detract from this clear rule and would risk undermining the autonomy of such credits (at [56]). This approach gives effect to Article 4 of the UCP 600 which made it clear that there should be a distinction between the letter of credit and the underlying sales contract. The approach of the court relied on straight forward contractual construction to determine choice of law and jurisdiction. Put simply, the claimant could not demonstrate of the BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL

9 facts that there had been a mutual intention to vary the general conditions. Therefore, the claimants arguments were rejected, and the court refused jurisdiction. It is an interesting case as it provides an insight into the problems of conducting international commerce. CONCLUSION Petrologic Capital SA v Banque Cantonale de Genève & another [2012] EWHC 454 (Comm) is an interesting case as it demonstrates the importance of choice of law and jurisdiction. The court clearly rejected any attempt to circumvent the general conditions. Males QC identified the claimant s attempts at risking the commercial reputation of letters of credit. Had the claimant been successful, then the English courts would have restricted any attempt to prevent the bank from paying the buyer under the documentary credit. The only exception would be where there was fraud, as the claimant was arguing had occurred here. This decision whilst not departing from the approach taken by the English courts as to letters of credit, does highlight the importance of the autonomy of letters of credit and the fact that the court will dismiss an attempt vary choice of law and jurisdiction without clear evidence that both parties had intended to do this. AUTHOR Chris Monaghan is a lecturer at BPP Law School and module leader for Commercial Contract on the LLB. His areas of expertise and interest are Commercial Law, Public Law and Criminal Property Offences. BPP LAW SCHOOL OPINION PIECE LETTERS OF CREDIT AND DISPUTES ABOUT JURISDICTION APRIL