Letters of credit

Today's decision in Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce, 2009 ONCA 764 provides a useful review of the law of letters of credit:

[48]         Letters of credit are an important and unique type of financial instrument designed to facilitate the flow of goods and trade.  They are frequently resorted to in transactions with international dimensions, where buyer and seller are strangers to, and distanced from, each other and are looking for some assurances to reduce the risks of dealing with each other.  In his text, Letters of Credit: The Law and Current Practice, 3d ed., looseleaf (Toronto: Thomson Canada Limited, 2009), at pp. 1-2.1 to 1-3 and 1-5, Lazar Sarna describes the need for letters of credit to reduce the uncertainty in international transactions, and the benefits to those involved:

An importer places an order for the purchase and shipment of goods with a foreign seller.  The importer has no reason either to trust or mistrust the solvency, reliability or efficiency of the foreign seller; he has no means of ascertaining whether in this specific transaction the foreign seller will ship the number and quality of goods ordered at the place and on the dates set out in the purchase order.  Similarly, the foreign seller has little assurance upon receipt of the purchase order that the importer is solvent or will pay the full amount of the purchase order without deductions, set-offs or counter-claims once the goods are delivered.  … In order to accommodate the expectations of both parties, it is often agreed that the importer will supply the foreign seller with a letter of credit which the former obtains upon application to his bank in his own jurisdiction.

…

The practical effect of financing the underlying contract by way of letter of credit is beneficial for all parties concerned.  The importer dispenses with the problem of advance payment, loss of interest while awaiting shipment, and fear of loss resulting from inadequate or late shipment.  Subject to the problem of fraud and subterfuge, the importer is assured that payment will only be made if the foreign seller strictly complies with the terms of the credit.  On the other side, the foreign seller, prior to shipment, has in hand a promise to pay for the shipment from a reputable foreign financial institution, or in the event of the intervention of a confirming bank, from a native bank.  From the point of view of the issuer, it is paid a remuneration for the opening of the credit and retains the bills of lading and other shipping documents presented with demand of payment as security for reimbursement by the customer of the amount of credit extended and paid.

[49]         Thus, letters of credit are an important mechanism for ensuring that international commerce flows smoothly, effectively, and with some degree of assurance.   As one American authority has put it, albeit colourfully, letters of credit are intended "to grease the wheels of trade and commerce": Alaska Textile Co., Inc. v. Chase Manhattan Bank, N.A., 982 F.2d 813 (2d Cir. 1992), at p. 824.  Care is required, therefore, to ensure that they are not interpreted and enforced in a way that might jeopardize their uniqueness and commercial efficacy or the relative certainty that must surround their use.  Hence the doctrines of autonomy, strict compliance and strict construction that will be discussed below.

[50]         At the same time, however, letters of credit are not completely divorced from the general rules and principles of contract law, including those invoking notions of fairness and equity: see Mutual Export Corporation v. Westpac Banking Corporation, 983 F.2d 420; Exxon Co. v. Banque de Paris et des Paysbas, 889 F.2d 674 (5th Cir. 1989), at p. 678, cert. denied, 496 U.S. 943 (1990); Timber Falling Consultants, Inc. v. General Bank, 751 F. Supp. 179 (D. Or. 1990), at p. 181; Karpassia Shipping Co., S.A. v. Chase Manhattan Bank, World Trade Center Branch No. 232, 1980 U.S. Dist. LEXIS 17285 (S.D.N.Y. 1980), at *18. (2d Cir. 1993), at p. 423.

[51]         For example, in Karpassia Shipping, at *18-19, the U.S. District Court for the Southern District of New York acknowledged the following notions of contractual interpretation in the context of a letter of credit:

A construction that will sustain an instrument will be preferred to one that will defeat it; if an agreement is fairly capable of a construction that will make it valid and enforceable, that construction will be given it.  The same general principles which apply to other contracts in writing govern letters of credit.  Where a letter of credit is fairly susceptible of two constructions, one of which makes it fair, customary and one which prudent men would naturally enter into, while the other makes it inequitable, the former interpretation must be preferred to the latter, and a construction rendering the contract possible of performance will be preferred to one which renders its performance impossible or meaningless.  Moreover, as between the beneficiary of a letter of credit and the issuer … if ambiguity exists, the words are taken as strongly against the issuer as a reasonable reading will justify.  [Citations omitted; emphasis added.]