Letter of credit beneficiary beats issuing bank based on conforming documents and untimely and improper dishonor.
A letter of credit issuing bank must pay a letter of credit beneficiary that presents documents conforming with the requirements of the letter of credit. By the same token, the bank can refuse to pay on a letter of credit where the beneficiary presented noncomplying documents. However, that right comes with strings: the bank must have given proper and timely notice of dishonor, including identifying all documentary discrepancies and notifying the beneficiary that the bank is holding the documents at the beneficiary's disposal or returning the documents to the beneficiary. A bank that messes up by failing to follow any of these rules may be forced to make payment to the beneficiary, notwithstanding the beneficiary's presentation of discrepant documents.
That recently happened in Amwest Surety Insurance Co. v. Concord Bank. The letter of credit beneficiary had sued the letter of credit issuing bank for wrongful dishonor of the beneficiary's documentary presentation and demand for payment under the letter of credit. The beneficiary had presented all of the documents required by the letter of credit. The bank messed up by, among other things, failing to timely and properly give the beneficiary notice of the bank's decision to dishonor the beneficiary's drawing.
The United States District Court for the Eastern District off Missouri held that the bank had wrongfully dishonored the beneficiary's presentation of documents under, and demand for payment of, the letter of credit. The court found that the beneficiary's documents had strictly complied with the requirements of the letter of credit, and rejected the beneficiary's fraud claim as a ground for dishonor. The court also found that the beneficiary was entitled to payment, even if it had presented nonconforming documents, because the bank did not properly and timely notify the beneficiary of the bank's decision to identify documentary discrepancies, and dispose of the documents.
Overview of Letters of Credit
Letters of credit are an integral payment mechanism in many business transactions. A letter of credit arrangement involves three parties and three independent contracts. The first contract is the underlying contract which includes the bank's agreement to issue the letter of credit, the terms of the letter of credit, the applicant's obligation to reimburse the bank for payments made to the beneficiary upon the presentation of conforming documents, the collateral securing payment of the applicant's reimbursement obligation and the bank's charges and commissions earned from issuing the letter of credit. The third contract is the letter of credit itself that the bank issues in favor of the beneficiary. When the beneficiary presents all of the documents required by the letter of credit, such as a draft, commercial invoice, transport and insurance documents, to the issuing bank for payment, the issuing bank must pay the amount of the draft to the beneficiary or else breach the bank's payment obligation under the letter of credit.
Each of these contracts is independent of the other. For example, if the beneficiary presents the required documents, the issuing bank must pay on the letter of credit, regardless of disputes between the beneficiary and the applicant in their underlying transaction and/or the applicant's financial inability to reimburse the bank for letter of credit payments and charges. And if the issuing bank makes payment to the beneficiary based upon the latter's presentation of noncomplying documents, the applicant's/buyer's obligation to reimburse the bank for that payment is extinguished.
The primary concern of the letter of credit issuing bank is to determine whether the beneficiary has presented documents that comply with the terms of the letter of credit. The bank deals only in documents presented by the beneficiary when deciding whether to pay on a letter of credit. If the documents comply, the bank must pay the beneficiary; if the documents do not comply, the bank cannot make payment under the letter of credit unless the applicant agrees otherwise. Most courts hold that the documents must strictly comply with the letter of credit before payment can be made.
A major concern is where the issuing bank decides that the documents presented do not comply with the letter of credit and refuses to make payment to the beneficiary. Where a letter of credit issuer fails to follow the requirements for communicating notice of dishonor and disposing of documents, the beneficiary may still be entitled to payment under the letter of credit, despite having presented nonconforming documents. This tempers the effect of the requirement that the beneficiary presents documents that strictly comply with the requirements of a letter of credit. Worse yet for the bank, if the documents presented by the beneficiary do not comply with the letter of credit, the applicant may be released from its obligation to reimburse the bank. Therefore, a careful beneficiary presenting noncomplying documents should recognize that it may still have claims against the issuing bank if the bank messes up and fails to timely and properly communicate its decision to dishonor a letter of credit draw.
Requirements for the Issuing Bank's Rejection of Noncomplying Documents
Simply stated, when determining whether to honor a letter of credit beneficiary's presentation of documents, the issuing bank must examine the documents and decide whether to accept or reject them within a reasonable time, not to exceed seven banking days, following the day of receipt of the documents, according to the Uniform Customs and Practice for Documentary Credits, International Chamber of Commerce, Publication No. 500 ("UCP") (1). If the bank determines that the documents presented do not comply with the letter of credit's terms and conditions, the bank must give notice of rejection by telecommunication, or if that is not possible by other expeditious means, without delay and no later than the close of the seventh banking day following the day of receipt of the documents. The bank's notice of dishonor must list all of the discrepancies in the documents presented, in other words every ground for the letter of credit issuing bank's refusal to make payment on the letter of credit. If the issuing bank fails to follow all of these requirements and gives an untimely, incomplete or improperly communicated notice of rejection, and/or improperly disposes of the documents, the bank is precluded from claiming that the presented documents are nonconforming and must make payment to the letter of credit beneficiary.
The reason for this procedure and the penalty it imposes on the letter of credit issuing bank is to force the bank to respond in a timely manner to a letter of credit beneficiary's presentation and notify the beneficiary of all the mistakes in the letter of credit drawing and of the resulting refusal by the issuing bank to pay on the letter of credit. This is designed to give the beneficiary an opportunity, prior to expiration of the letter of credit, to correct the mistakes in the documents initially presented and make a second presentation of conforming documents that would require payment by the bank.
Amwest Surety Insurance Co. v. Concord Bank
On October 25, 1999, Concord Bank issued an irrevocable letter of credit in the amount of $1,200,000 to Amwest Surety, as beneficiary. Concord issued the letter of credit at the request of Concord's customer, CMR Construction Inc. CMR had to arrange for the issuance of the letter of credit as collateral security for the issuance of performance and payment bonds by Amwest, as surety on behalf of CMR, to secure CMR's performance, as general contractor, of a contract with the city of St. Louis, Missouri for the construction of a parking garage.
On November 17, 2000, while the letter of credit was still in effect, Amwest had presented to Concord a sight draft in the face amount of the letter of credit, $1,200,000, and a written certification required by the letter of credit. On December 5, 2000, more than 15 days after Concord had received Amwest's documents, Concord delivered to Amwest written notice that Concord was dishonoring Amwest's drawing because the certification was false.
On December 15, 2000, Amwest commenced suit against Concord, alleging, among other claims, that Concord had wrongfully dishonored Amwest's drawing and demand for payment of $1.2 million due under the letter of credit. Amwest claimed that its sight draft and certification presented to Concord had strictly complied with the requirements of the letter of credit. Amwest also argued that Concord had messed up by failing to properly and timely notify Amwest of the existence of nonconforming documents and properly dispose of the presented documents. As a result, Concord was precluded from asserting Amwest's nonconforming documents as the basis for dishonoring the letter of credit.
Concord argued that it had properly dishonored Amwest's drawing because Amwest had submitted a false certification to Concord. That amounted to a fraudulent drawing that excused Concord from having to make payment to Amwest under the letter of credit.
Concord Had Wrongfully Dishonored Amwest's Drawing Under the Letter of Credit
Amwest Is Entitled to Payment Based on Presentation of Conforming Documents, Notwithstanding Concord's Fraud Claim
The court held that Concord had wrongfully refused to honor Amwest's drawing under the letter of credit. That was based on Amwest's presentation of conforming documents to Concord. The independence principle that underpins letter of credit law works in tandem with the strict compliance standard a bank must follow in reviewing documents submitted by a beneficiary as part of a letter of credit drawing. The bank's obligation under a letter of credit is triggered by the beneficiary's timely presentation of documents that strictly comply with the letter of credit.
However, there is a limited fraud exception to the independence principle and strict compliance requirements of letter of credit law. According to Article 5 (Section 5-109) of the Uniform Commercial Code, which also governs letters of credit, an issuing bank can dishonor a letter of credit drawing where "a presentation is made that appears on its face strictly to comply with the terms and conditions of the letter of credit, but a required document is forged or materially fraudulent or honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant"
The court held that the fraud exception did not apply to Concord's obligation to honor Amwest's drawing based on conforming documents. Amwest was entitled to payment of the letter of credit because it had presented the sight draft and certification required by the letter of credit. The court rejected Concord's argument that dishonor was warranted by Amwest's presentation of a false certification to Concord because any effort to prove this would have violated the independence principle. Any finding by the court that the certification was false depended on the court's consideration of facts and legal interpretations that were separate and apart from the documents Amwest had presented to Concord. The court also found that Amwest had neither committed a fraudulent act nor presented fraudulent documents. The most Amwest could possibly prove, the existence of an alleged fraud in a collateral transaction that did not involve Amwest, was not the kind of fraud that would have justified Concord's dishonor of Amwest's drawing on the letter of credit.
Concord Wrongfully Dishonored Amwest's Letter of Credit Drawing Based on Concord's Improper and Non-timely Notice of Dishonor
The court also held that Concord had wrongfully dishonored Amwest's letter of credit drawing, even if nonconforming documents had been presented, because Concord had untimely and improperly communicated its notice of dishonor to Amwest. It is undisputed that Amwest had presented its sight draft and certification to Concord on November 17, 2000. Concord had to communicate notice of dishonor to Amwest not later than November 28, 2000, the seventh banking day after Concord's receipt of the documents. However, Concord waited until December 5, 2000, more than 15 days after it had received Amwest's drawing, to give notice of dishonor to Amwest. That was simply too late for dishonor, and as a result, Concord was precluded from asserting the existence of nonconforming documents as a ground for dishonor.
The court also refused to accept Concord's claim that the certificate presented by Amwest was fraudulent as a sufficient excuse for Concord's late notice of dishonor of Amwest's drawing. The court did not find that Amwest had either presented any fraudulent documents or committed any fraud that would have warranted dishonor by Concord or excuse any delay in Concord's communicating notice of dishonor to Amwest.
The court also rejected Concord's notice of dishonor because it had failed to identify all of the discrepancies upon which Concord had based its decision to dishonor Amwest's drawing under the letter of credit. Concord also messed up by failing to state that Concord was holding the documents at Amwest's disposal, and/or failing to return the documents to Amwest.
Judgment for Amwest on Its Wrongful Dishonor Claim
The court granted a judgment directing Concord's payment of Amwest's drawing in the amount of $1,200,000, plus interest at the statutory rate of 9 percent per annum. The court also held that Amwest, as the prevailing party in a wrongful dishonor litigation, was entitled to recover its reasonable attorneys' fees and other litigation expenses from Concord, as allowed by UCC Article 5.
A word to the wise for a letter of credit beneficiary: as a general rule, when a letter of credit beneficiary presents documents that strictly comply with the requirements of a letter of credit, the beneficiary is entitled to payment from the issuing bank. While there is a limited fraud exception to this rule, the issuing bank will not find it easy to invoke fraud as a ground for dishonoring a letter of credit draw, as Concord had discovered.
A letter of credit beneficiary might even be entitled to payment, notwithstanding its presentation of nonconforming documents. The letter of credit issuing bank would be precluded from asserting nonconforming documents as a ground for dishonor when it messes up by failing to timely and properly give notice of dishonor, identify discrepancies in the documents, and/or advise the beneficiary that the rejected documents are being held at the beneficiary's disposal or return the documents to the beneficiary. These duties leave no room for deviation.
But a letter of credit beneficiary should not press its luck. The beneficiary should make sure that it can present documents that strictly comply with the requirements of the letter of credit. The beneficiary cannot rely on an issuing bank's error in untimely or improperly dishonoring a letter of credit draw or disposing of documents presented by the beneficiary as justification for relieving the beneficiary of the consequences of submitting nonconforming documents.
(1) UCP 500 is an internationally accepted compilation of international customs and practices regarding letters of credit, which sets forth the rights and obligations of the parties to a letter of credit transaction. It is the governing law of a letter of credit that incorporates it provisions.
Bruce S. Nathan, Esq. is a partner in the law firm of Lowenstein Sandler PC, in New York, NY. He is also a member of NACM and the American Bankruptcy Institute. He can be reached via e-mail at firstname.lastname@example.org
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|Title Annotation:||Credit Column|
|Author:||Nathan, Bruce S.|
|Date:||Jul 1, 2003|
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