Letter of Credit Enforced Against Issuing Bank

A bank may not be able to rely upon the defence of non-compliance with a letter of credit in refusing to pay if it knowingly contributed to the circumstances which prevented compliance. 

The case of Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce, 97 O.R. (3d) 481 (C.A.), addresses this issue. 

A letter of credit was issued by the bank to a vendor selling shrimp to a customer of the bank for resale to an ultimate purchaser which required presentation to the bank of receipts from the ultimate purchaser before payment could be made to the vendor under the letter of credit. The customer failed to provide the bank with the receipts and the bank used the proceeds of sale to pay down the customer’s line of credit with the bank instead of paying the vendor under the letter of credit. The court did not allow the defence of non-compliance with the letter of credit because the bank knowingly contributed to the circumstances preventing such compliance. 

In the Nareerux case, a Thai based vendor sold shrimp to a US based customer of the bank for resale to a large US retail chain in reliance upon a letter of credit issued by the bank. Payment under the letter of credit was to be made to the vendor upon presentation to the bank by the customer of purchase orders and receipts showing the shrimp had been taken by the retail chain. The vendor was not paid under the letter of credit for all of the shrimp supplied because the customer failed to present all of the receipts even though the bank knew shrimp had been taken by the retail chain, and the bank applied the sale proceeds it received from the customer to the balance owing under the customer’s line of credit with the bank instead of paying the vendor. The bank also allowed the customer’s inventory which included the shrimp to be sold to buyers other than the retail chain and used the proceeds from those sales to further reduce the customer’s line of credit balance. The vendor successfully sued the bank to recover its damages in the amount remaining unpaid under the letter of credit, and the bank appealed.

The Court of Appeal dismissed the appeal and held that the bank was not entitled to rely upon the defence of non-compliance with the requirement for presentation of receipts under the letter of credit because it knowingly contributed to the circumstances that undermined the prospect of strict compliance. The court held that the bank had collaborated with the customer to ensure that the proceeds from the sale of shrimp covered by the letter of credit were used to reduce the bank’s exposure under the customer’s line of credit instead of being paid by the bank to the vendor under the letter of credit. The court upheld the findings made at trial that the bank’s conduct was a direct breach of the principle of autonomy underpinning a letter of credit transaction, as well as a breach of the implied duty of good faith not to act to defeat or eviscerate the purpose of the letter of credit.

In holding that the bank could not rely upon the doctrine of strict performance to avoid paying under the letter of credit, the court stated (at pages 497 and 498, with footnotes omitted) as follows:

The central issue on this appeal, however, is whether [the bank] CIBC had become disentitled by its conduct to rely upon the doctrine of strict compliance in the circumstances. Courts have held that the equitable doctrines of waiver and estoppel apply in letter of credit cases. … Examples of circumstances in which an issuer of a letter of credit has disentitled itself to do so include those in which the issuer (i) has waived strict compliance, either expressly or by its conduct; (ii) has delegated its duty to evaluate a beneficiary’s documentary presentation independently; (iii) has been unjustly enriched by the credit transaction; (iv) has engaged in improper consultations with its customer concerning whether to accept or refuse the documents tendered; (v) has induced the beneficiary to believe the credit would be honoured until after its expiry date, when it was too late for the beneficiary to correct the situation; and (vi) has failed to provide prompt notice of dishonour to the beneficiary.  

In confirming that Canadian jurisprudence supports an implied duty of good faith in the performance of letters of credit, the court held (at page 503) that the bank breached such a duty, as follows:

It gave the Bank the opportunity to exert what was tantamount to a discretionary control over the documentary compliance and the timing of payment to [its customer] Thai Fisheries. Contracts in which performance is dependent upon the exercise of discretion on the part of one of the parties are contracts that are particularly characterized by the implied duty of good faith performance. In such circumstances, the discretion must be exercised reasonably and in good faith.   

In short, the bank placed its interest as lender ahead of its duty as contracting party under the letter of credit, thereby interfering with the guiding principle of autonomy and independence as well as the contractual duty of good faith.