Consequences of Failure to Issue a Conforming Credit

CONSEQUENCES OF FAILURE TO ISSUE A CONFORMING CREDIT

3.01 Issuance of a credit that complies in all material respects with the requirements of the underlying business arrangements is essential for either of the parties to the concluded deal, including their financier. If the credit conforms, no problem arises: the beneficiary has received the instrument he contracted for, and it is now his turn to do what he promised the other contracting party. But a credit may fail to conform for a number of reasons. The applicant’s instructions for its opening can deviate from the terms agreed with the beneficiary. The issuer may neglect to loyally follow the provisions of the application which the applicant had submitted to it, with the result that the credit issued omitted to call for a particular document, e.g. a certificate of inspection or surveyor’s report. A credit may be issued or advised to the beneficiary in an untimely fashion, or inaccurately,¹ or misdirected to a wrong location.

3.02 In situations of that type, it is obvious that the sales or other bargain between the beneficiary and the applicant may not only fall through, but the applicant or the beneficiary, or both of them, can also suffer heavy financial losses because a proper letter of credit is not set up. Without doubt, in some cases the parties are able to rectify the problem by agreeing a fresh date for the opening of the facility or arranging necessary amendments to it. Unfortunately, in a drastically falling market, the applicant sometimes refuses to cooperate; indeed, he will regard the difficulty as a welcome escape route from the transaction which the credit was supposed to finance. Against a background of such circumstances, the object of this chapter is to determine who should be liable for the financial consequences arising from the failure to issue a conforming credit or, alternatively, from the beneficiary’s receipt of the bargained letter of credit. The chapter comprises two sections. It considers first the beneficiary’s responsibility upon receipt of a non-complying credit and then goes on to its core, namely, the ways in which an applicant or a beneficiary may recover financial damage incurred due to carelessness on the part of the bank involved.

A. Beneficiary’s Duty upon Receipt of a Non-conforming Credit

3.03 Upon receipt of an advice of credit, it behoves the beneficiary to scrutinize its provisions to ascertain that the documents required to be presented for payment of the sum specified in the credit are such as he can generate. He should equally take care to make certain that they correspond to the terms he negotiated with the applicant, the party whose application brought about the issuance of the facility.² Accordingly, he will prima facie be responsible for failing to discern a material departure of the credit from the stipulations in the underlying bargain. Actual knowledge of the deviation is unnecessary; the notice may be constructive, this being an instance of the rare commercial cases to which the doctrine of constructive notice³ —whereby a person is deemed to have known that which he has the means of knowing⁴ —applies by way of exception.

3.04 If the beneficiary does, however, notice a significant divergence (for example, as to the mode of availability of the credit,⁵ period of its validity,⁶ its description of the requisite documents,⁷ the latest time for negotiation, the deliverable quantity of the merchandise, date of shipment, the sum on the credit and the currency of account⁸), the buyer-applicant will ordinarily be in repudiatory breach of his obligation to open the bargained letter of credit. The breach therefore entitles the beneficiary to treat the underlying contract as repudiated by the applicant and claim damages suffered because of the repudiation.⁹ However, he typically adopts that course only in limited circumstances, as, for instance, where certain disagreements have reached a crisis point, or when faced with a supervening plunge in the market, so that the non-conformity of the credit becomes an opportunity to abandon the contract lawfully. Nevertheless, for the recovery of damages to stand, he will have communicated to the applicant his acceptance of the non-furnishing of the desired credit as terminating the underlying contractual arrangements.¹⁰ An unaccepted repudiation is inoperative to put an end to the contract.¹¹

3.05 Rather than treat the applicant’s breach in the indicated manner, the most common practice is for the beneficiary to notify the applicant of the fault rendering the credit unacceptable and request an amendment to correct it. Usually, the applicant will swiftly inform the issuing bank to carry out the modification, particularly in a string of contracts where his own customers (sub-buyers) in the chain are pressing for the merchandise which the applicant himself expects to finance with the credit. A comparatively less taken route entails the seller-beneficiary waiving the imperfection by signifying that he considers the facility satisfactory and effective.

(1) Waiver of breach

3.06 Waiver of a material defect in a credit, or of a failure to open the facility in time, generally deprives the beneficiary, in the former case, of the right to rely on the defect to deny conformity of the credit with the underlying contract, and, in the latter case, of the right to complain that the payment instrument was not given to him before the stipulated cut-off date lapsed.¹² In a sale of goods contract, the deprival implies the buyer-applicant’s provisional discharge of the purchase price and performance of the condition precedent to the seller-beneficiary’s obligation to make the agreed shipment.¹³ Hence, showing a failure to comply with the obligation will provide a basis for the buyer to collect damages from the seller.¹⁴

3.07 Identification of waiver. The burden of establishing waiver rests on the claimant-applicant, the party asserting it.¹⁵ A waiver in the context under focus often manifests itself in the beneficiary’s letter, email, word of mouth, or conduct which induces the applicant to reasonably believe that the beneficiary approves whatever discrepancies there may be in the credit. The approval clearly exists in his omitting to object, or unjustifiable delay in objecting, to an apparently non-conforming credit,¹⁶ by shipping the goods contracted for and tendering documents to a nominated bank for payment pursuant to the credit.¹⁷ The assent also occurs if he obtains an amendment to the credit, for example, by granting an extension of the expiry date and the time stipulated for shipment instead of refusing the issued, albeit defective, credit outright.¹⁸ Additionally, the assent effectively takes place upon his requesting the opening of a credit despite knowing that the latest date for the applicant to do so has passed.¹⁹ In Ian Stach Ltd v Baker Bosley Ltd,²⁰ Diplock J. considered and correctly regarded such a request as a waiver of the date (1 August) at which the credit at the centre of dispute before him should have been established in favour of the seller-beneficiary. Furthermore, a waiver of the time stipulated for the opening of a credit may be implied from the seller’s act of entering into negotiations with the buyer about an amendment to a defective credit, and his express reservation of rights will normally be ineffective to preclude the waiver.²¹

(2) Characterization of beneficiary’s presumptive approval of defects in credit

3.08 There is a degree of uncertainty about the legal complexion of the assumed acceptance of the non-conformities in the credit. Some judges refer to it as a variation of the original provision in the underlying contract or estoppel, as opposed to waiver. Admittedly, as McNair J. doubtless thought in Soproma SpA v Marine & Animal By-Products Corp,²² ‘whether the matter is put as waiver, variation or estoppel’ makes no difference to the legal result of the presumed approval of an otherwise defective credit: the buyer-applicant’s obligation to establish a letter of credit to effect payment of the purchase price of the goods stands discharged in any event. However, it does matter greatly.

(a) Why the characterization matters

3.09 Classification of a non-conforming requirement in a credit as proposing a variation of the contract of sale, and the beneficiary’s conduct as acceptance of the proposal, will require the applicant in the individual cases to prove the consideration for such acceptance; should he overcome that hurdle, the variation gives him fresh contractual rights in substitution for the original position of the contract. On the other hand, viewing the approval of the defect in the credit as a waiver, an act of concession or a grant of an indulgence creates no new stipulation in place of the original one; the old term continues to be in force, and the beneficiary can withdraw the indulgence upon giving the applicant a sufficient advance notice, a point covered in the ensuing subsection. Furthermore, characterizing the beneficiary’s act as generating an estoppel would need a claim which alleges the beneficiary’s assent to the departure of a term in a credit from the underlying contract to satisfy the stringent conditions of the doctrine of estoppel,²³ including the requirements²⁴ that the claimant-applicant altered his position in reliance upon a clear and unequivocal representation of the beneficiary.

(b) Cases in point

3.10 It must be confessed straightaway that the uncertainty as to the proper characterization of the supposed assent of the beneficiary arises primarily from dicta in Enrico Furst & Co v WE Fischer Ltd²⁵ and WJ Alan & Co v El Nasr Export and import.²⁶ In the first of these cases, the defendant sellers argued in their defence to the buyers’ claim for damages for non-delivery of 400 tons of cast-iron piping and tubing materials, that the buyers failed to give them an irrevocable letter of credit opened in London in compliance with the contract of sale. Of course, they would be home and dry on the defence if matters rested there. But the buyers replied that the sellers procured changes to the credit, and neglected at the time to include among the desired amendments the deficiency now raised in opposition to the action. They contended further that, due to the neglect, the sellers should be deemed to have waived their right to use the non-conformity of the credit as a reason to justify their failure to ship the goods. Diplock J. accepted the contention, noting that the sellers’ conduct ‘was a classic case of waiver, indistinguishable from the decision in Panoutsos v Raymond Hadley Corp’.²⁷ The judge discussed Panoutsos²⁸ and identified the indicated waiver as falling within the principle laid down by Bowen L.J. in Birmingham & District Land Co. v London & North Western Railway Co.,²⁹ and then came to the conclusion that:

3.11 The italicized words deserve scrutiny, especially the element of the buyer’s reliance on the supposition that the beneficiary will not use the defects in the credit as a ground to rescind the sale contract. Reliance has without doubt been long accepted as an essential requirement of the cardinal doctrine of estoppel which Lord Cairns L.C. originally laid down in Hughes v Metropolitan Railways Co.,³¹ and is framed by Bowen L.J. in the Birmingham & District Land case as follows:

In WJ Alan & Co. v El Nasr Export and Import,³³ negotiated amendments to a confirmed credit expressed in pounds sterling overlooked the necessity of changing that currency to Kenyan shilling, the money of account stated in the underlying contract of sale of coffee. Nevertheless, the sellers shipped the goods and obtained payment in sterling against their documents tendered under the credit; but in consequence of the devaluation of the pound, the amount received was substantially less than the originally contemplated sum. They therefore felt entitled to recover the difference by having the price of the coffee calculated in Kenyan currency. The Court of Appeal disagreed with them and dismissed their action with costs in favour of the buyers. Lord Denning M.R. explained that the sellers ‘waived the right to have payment by means of a letter of credit in Kenyan currency and accepted instead a letter of credit in sterling’³⁴ by operating the credit they could have rejected. He approved Diplock J.’s pronouncements in Enrico, considered Panuotsos, and formed the opinion that waiver in these cases, including the present one before him, is an instance of the application of the principle stated in Hughes v Metropolitan. In his view, all that is required of the buyer is that he ‘acted on the belief induced by the other party’.³⁵ Megaw L.J., in contrast, commented that the credit denominated in sterling was an offer by the confirming bank on the buyers’ instructions to vary the term concerning the currency of account in the sale contract and the seller accepted the offer by conduct.³⁶ He added: ‘If there was no variation of the contract … the buyer would still be entitled to succeed on the ground of waiver, and the relevant principle is that which was stated by Lord Cairns in Hughes v Metropolitan Railway Co’.³⁷ The third member of the court, Stephenson L.J., preferred to ‘leave open the question whether the action of the other party [i.e. buyer] induced by the party [i.e. seller] who ‘waives’ his contractual rights can be any alteration of his [buyer’s] position’.³⁸

3.12 Analysis. It is perhaps appropriate to start by remarking that the House of Lords’ decision in Equitable Trust Co. of New York v Dawson Partners Ltd³⁹ is conclusive against the initial facet of Megaw L.J.’s observations. A nominated bank⁴⁰ and the applicant on whose request a credit has been opened are not in a principal and agent relationship. American courts hold the same view.⁴¹ Indeed, were such agency relations recognized, there would be scope for an argument that the confirmer might owe tortious or contractual duty of care to the credit applicant. Accordingly, no offer by the confirmer in Alan on behalf of the buyer to the sellers-beneficiary could possibly exist as a matter of authority and on principle.

3.13 We proceed, then, to the question of reliance by the buyer on the belief induced by the beneficiary. Is it really a requirement of the concept of waiver as the Court of Appeal understood and employed it in Panoutsos? It is submitted that it is not. If otherwise, then what action of the buyers in Alan and in Enrico may legitimately be said to constitute an alteration of their position in reliance on the sellers’ omission to ask for the currency stated in the credit to be changed to make it conform to the sale contract? Alternatively, can we seriously urge the courts to regard the mere silence of the sellers to complain about the non-compliance as a clear and unequivocal representation to the buyers? The principle of Hughes v Metropolitan Railway Co., as Bowen L.J. in Birmingham and District Land case on the one hand, and the House of Lords in Tool Metal Manufacturing⁴² as well as in Woodhouse AC Israel Cocoa⁴³ on the other hand, respectively define and confirm it, is normally associated with the doctrine of promissory estoppel. But the precept of waiver which Panoutsos establishes on the subject under consideration, as will now be discussed, is distinct and separate; its application denies the assumed requirement of reliance, and sets forth the simple rule, uncluttered by the necessity of the buyer’s reliance, that a beneficiary should be considered to have waived a non-complying provision in a credit or relinquished his right to insist on a credit opened at the stipulated time, if, in the events which happened in the particular case, his conduct or communication reasonably conveyed to the buyer the impression that he, the beneficiary, still wanted the credit.

3.14 Panoutsos and its forebears examined. Incidentally, Panoutsos⁴⁴ is the pioneering decision on this branch of letter of credit law, but has illustrious ancestry in decisions on charterparty contracts relating to claims alleging the abandonment of a charterer’s right to adduce a breach of the charterparty as a reason for declining to perform his obligation to load the vessel or the relinquishment of a shipowner’s entitlement to withdraw a ship following non-payment of hire on the due date. The facts of Panoutsos are uncomplicated. Under a sale agreement for shipments of flour by instalments, the sellers were to be paid by means of a ‘confirmed bankers’ credit’. But the buyer opened an unconfirmed credit, which was evidently in breach of the contract. Nevertheless, the sellers utilized the credit for five of the anticipated shipments, and then cancelled the balance of the contract, citing the buyer’s default on his promise to set up the agreed confirmed credit. Bailhache J. held⁴⁵ that: ‘When the sellers know that the credit is not in order, and yet proceeded to act upon it as if it is in order, they must be taken to have waived the [non-conformity] so long as they choose to act upon that credit’.⁴⁶ The Court of Appeal affirmed.⁴⁷ Viscount Reading C.J., in giving the judgment of the court, acknowledged that:

Crucially, it will be observed that the basis on which both the courts put the beneficiary’s waiver pertains to the beneficiary’s election to operate the credit regardless of his knowledge that the credit was not in accordance with the contract. None of the four judges went further to emphasize or even drop the hint that the buyer’s reliance on the beneficiary’s conduct was necessary to found waiver. The Court of Appeal derived support from Bentsen v Taylor Sons & Co (No.2).⁴⁹

3.15 A term in a charterparty in Bentsen described the ship on 29 March as ‘now sailed or about to sail’ from Mobile, Alabama, to the United Kingdom. However, the sailing did not start until 23 April. The defendant charterers were aware of the delay on 16 May. Following that knowledge, instead of taking the procrastination as an occasion to terminate the charterparty, they wrote to the shipowner asking: ‘If April 24th is the sailing [date], have you any proposal respecting the charter?’ A follow up letter says: ‘You must … clearly understand that if you send [the vessel] out to load under our charterparty, we shall protest against loading’.⁵⁰ An action to recover freight from them succeeded in the Court of Appeal. The defendants waived their right to throw up the charterparty contract, having affirmed the charter by their June letter, thus rendering immaterial the shipowner’s breach of the promise as to the ship being set to sail immediately. Lord Esher M.R. said that when the defendants knew of the delay they

The Master of the Rolls and Bowen L.J. concluded that the defendants had failed to live up to their duty in the circumstances, in that no reasonable business person looking at the defendants’ correspondence could doubt that it did lead the shipowner reasonably to suppose that the charter remained operative and binding notwithstanding the protracted interruption in the sailing of the ship. Kay L.J. gave a concurring judgment⁵² to the same effect.

3.16 Erle C.J. adopted a similar approach in Dixon v Heriot.⁵³ Soon after a charterparty had been signed, shipowners undertook execution of extensive repairs to the ship at Liverpool to fit her for the chartered voyage, whereas a clause in the contract warranted that the vessel was ‘ready’ to proceed direct to Cardiff to take on the goods. Upon completion of the repairs, the charterers refused to load the vessel, pointing to non-compliance with the warranty. The shipowners admitted the breach, but argued that the charterers had waived it by their conduct. The Chief Judge in his charge to the jury said: ‘If you think that, after knowing the breach of the warranty, the defendants treated the charter as still subsisting, find for the plaintiffs’. The court ultimately decided in favour of the claimant-shipowners.

3.17 Conclusion. Altogether, the Panoutsos, Bentsen, and Dixon decisions in substance repudiate the proposition enunciated in Alan and Enrico, that the buyer must have acted in reliance on a belief induced by the beneficiary’s conduct in order to prove presumed acceptance by the beneficiary of a non-conforming credit. The indicated trilogy of decisions considers a beneficiary’s omission to reject a credit of that description a waiver, and not a variation of the related term in the underlying contract of sale. Dicta advancing a contrary position in the Alan case seem mistaken. Of course, the buyer can orally, or in writing, propose to the seller (and vice versa) that the contract of sale be varied in some respect;⁵⁴ and the latter party may accept the suggested variation as he thinks compatible with his objectives for entering into the contract. Where a dispute arises as to the enforceability of the acceptance, the buyer-applicant of course has to show the consideration for the assent for him to sustain his cause of action. But the negotiated variation is different from, and controlled by the principle of, waiver applying to the beneficiary’s failure to repudiate a defective letter of credit.

(3) Discontinuance of waiver

3.18 The theory which underlies the trilogy of cases just examined, Lord Wright points out in Tankeexpress (A/S) v Compagnie Financiere Belge De Petroles SA,⁵⁵ is an equitable principle of ‘fair dealing and justice’ rooted in reason and practical business experience.⁵⁶ As such, the precept should be operated equitably. Thus, the beneficiary ought not to be perceived as having waived his right to demand a conforming credit if it would be inequitable to so view him in the particular circumstances of the parties. An instructive situation is a contract of sale involving instalment shipments over a given period, with the credit intended to revolve for each shipment. The seller’s waiver in respect of the letter of credit for a particular delivery of the cargo will as a rule not prevent him from insisting on a complying credit for a subsequent load,⁵⁷ provided he gives the buyer-applicant a reasonable notice to the effect that he wishes to resume his strict rights under the sale contract. A notice of that sort tends to afford the buyer the opportunity to rearrange his business affairs and ask the issuing bank to amend or issue the credit as appropriate.

3.19 On the other hand, we have previously noted that the entry by a seller into negotiations with a view to amending a non-conforming credit will count as a waiver of his right to refuse the credit. However, once the discussion ends, and he remains interested in having the credit originally spelt out in the contract, he is under an obligation to fix a reasonable time for the buyer to provide the facility.⁵⁸ An unreasonable deadline usually lacks the capacity to bind the buyer.

B. Liability for the Non-issuance of a Conforming Credit

3.20 Consideration of liability for financial loss caused by the act of a bank engaged in the credit opening process may conveniently commence with the claim of a beneficiary that has lost a possibly lucrative sales contract on account of his inability to have the desired credit before treatment of the potential claim of the applicant.

(1) Beneficiary’s claim

3.21 The relations between an advising bank and the beneficiary during the setting up of a credit are of two kinds, namely, contractual and non-contractual. In the former, the beneficiary’s claim will typically be determined with reference to the standard of conduct set by the contractual relationship; in regard to the latter, the action has to proceed in tort.

(a) Claim in contract

3.22 In most cases, the bank will have already been in a relationship with the beneficiary at the time of its receipt of issuer’s instructions, requesting advice of the credit or amendment to the beneficiary. It seems accepted⁵⁹