Letters of Credit under commodity contracts – keep the focus
This blog takes a look at the issues concerning the timing of the provision of letters of credit under commodity contracts and the importance, from both the buyer's and seller's perspective, of keeping an "eye on the ball".
Many commodity contracts provide for payment to be secured by a letter of credit ("LC"). In those circumstances the provision by the buyer of an LC will almost always (i) amount to a condition of the contract and (ii) be required before the seller is obliged to load or otherwise deliver the goods. With regard to (i) the date by which the LC must be provided is not always clear. Some contracts helpfully expressly stipulate the deadline for the LC but many do not. As a result it is necessary to infer a deadline; for there must be a deadline. In seeking to identify that deadline other terms of the contract, in particular shipment and delivery terms, are of significant assistance; as are previous court decisions which provide some, albeit not universal, guidance.
In our experience both buyers and sellers can, shall we say, be a little relaxed about the timing of the provision of a required LC. Indeed buyers, not wishing to tie up valuable credit lines, might deliberately delay putting up the LC if they have doubts as to whether the seller is going to perform. This can lead to what the buyer might regard as an opportunistic, though technically valid, termination of the contract by the seller if the LC is not in place by the contractual deadline. On the other hand, from a seller's perspective, a relaxed attitude, if amounting to an indication that it intends to perform despite the buyer's failure to put up the LC in time, may waive the right to terminate the contract on that basis.
This blog attempts to shine a light on some of the key considerations which should not be overlooked in operating a commodity contract requiring the provision of an LC.
(a) The buyer's perspective
In terms of the date by which the buyer needs to put up the LC if the contract specifies the date that should be treated as the deadline. If the contract does not have an express deadline the deadline to be inferred will depend on the terms of the contract; in particular the shipment/delivery terms and possibly any terms relating to nominations and the narrowing of the shipment and delivery ranges.
The legal cases decided by the English Courts in this area provide some guidance but a number of statements of the judges dealing with these cases have been what lawyers call "obiter; meaning they are not essential to the decision they made and are therefore more open to challenge in future cases. However, as a general rule (which, as always, is subject to the express terms of the contract) the LC must be in place by, at least, the beginning of the contractual shipment or, as the case may be, delivery period. We say "at least" as there are certain obiter judicial comments that support the argument that the LC must be in place a reasonable time before the beginning of the shipment or delivery period. The justification for an earlier date is that the seller will usually need some time to make the necessary arrangements to ready the goods for shipment or delivery and it is unreasonable to require such steps to be taken before it has received the payment security of the LC. The downside, however, in requiring the LC to be in place a reasonable period before the commencement of the shipment or delivery period is the resultant uncertainty this creates. This is because it is difficult to predict what a tribunal may, in due course, find to be such a reasonable period in the circumstances of any individual case. This uncertainty is all the more unsatisfactory when the obligation to put up the LC on time is a condition of the contract giving the seller the option to terminate the contract for breach if the buyer fails to meet the relevant deadline.
It is vital that a buyer does not lose focus on the deadline for provision of the LC or get lulled by "noise" coming from the seller or elsewhere into thinking they can delay provision of the LC. For example the fact that the seller indicates it maybe in difficulty performing or might be delayed in giving delivery doesn't alter a buyer's obligation in respect of the provision of the LC. The case of Kronos Worldwide Limited v Sempra Oil Trading SARL  EWCA Civ 03 provides a good example of a buyer taking their eye off the ball in respect of the provision of an LC and paying a price for doing so.
In that case Kronos sold a cargo of gasoil to Sempra on FOB terms with a narrowed loading range of 25-30 June 2001. Kronos then asked Sempra to agree to postpone the loading range to 1-5 July 2001 because there had been slippage in the refinery delivery schedule. Sempra refused and their nominated ship arrived at the loading port on 28 June 2001. She then had to wait to commence loading until 9 July 2001. It was common ground that the LC should have been in place before 28 June 2001 (although the Court did not need to decide how long before). But because of the issues in respect of the availability of the product, Sempra delayed putting up the LC and only provided it when Kronos advised Sempra that the product was ready for loading which only occurred on 6 July 2001. Sempra claimed demurrage in respect of the delay to the ship whilst awaiting the availability of the gasoil. Kronos response was that they were not liable for such demurrage since in the absence of the LC they were under no obligation to load the goods and so were not liable for the delay or the demurrage. On an appeal from a rather surprising first instance decision, the Court of Appeal agreed with Kronos and rejected Sempra's claim. Mance LJ said; "I have no doubt that the provision of a letter of credit should be regarded as a condition precedent to any obligation on the part of the seller to perform any aspect of the loading operation which is the seller's responsibility".
(b) The seller's perspective
The reader would be quite right to wonder whether Kronos might have said anything in the context of advising Sempra of their difficulties in meeting the contractual loading range which might amount to a waiver of their right to insist on timely provision of the LC. The answer to that question would be that it was common ground in that case that there was no such waiver although it is doubtful if any such waiver of itself would have assisted Sempra as the fundamental principle, as enunciated by Mance LJ, is that there is no obligation on the seller to load until the LC is in place.
Waiver, however, is a real "danger" for a seller facing a failure by the buyer to put up the LC in time. This is because it is relatively easy (particularly if there is imperfect communication between operations and finance teams) to inadvertently waive the right to insist on strict performance of the buyer's obligations in this respect. Any communication from a seller to a buyer which conveys an intention to perform the contract despite a failure by the buyer to put up the LC in time can amount to a waiver of the right to insist on strict compliance by the buyer and loss of the right to terminate the contract on the basis of that breach. If that happens it is not entirely straight forward to re-establish a deadline for the LC. This will need to be done by a carefully drafted message giving the buyer a reasonable period of additional time to provide the LC and formally making the time for provision of it of the "essence of the contract" (that is re-establishing a deadline which if not met will entitle the seller to terminate the contract for breach).
It is therefore also important for the seller to keep a close eye on the deadline for the buyer's provision of the LC so that they can be careful to not inadvertently waive their rights. To an extent once the deadline for provision of the LC has passed that can be achieved by expressly stating that communications are without prejudice to the right to treat the buyer's breach as repudiatory although delay in exercising that right can itself amount to waiver.
In considering waiver it is also important to identify what right it is that has or may be waived. Waiving the right to terminate the contract for breach in failing to put up the LC in time is one thing; waiving the requirement to put up an LC at all is quite another. As to the latter, it would take a very clear indication indeed from a seller that it was willing to ship or deliver the goods without first receiving the LC for such indication to amount to a waiver of the right to withhold shipment or delivery pending receipt of the LC.
In our experience the timing of the provision of an LC required under a commodity contract is often treated as a relatively unimportant administrative matter by both buyer and seller; at least until the actual shipment or delivery is imminent, if not very imminent. This can be potentially disastrous for the buyer as the delay in provision of the LC can give a savvy seller justification (indeed a get out of jail card) to side step performance of what has become an unprofitable contract.For the reasons given above it is, we suggest, important for both buyers and seller to keep a keen focus on the deadline for the provision of any LC required under the contract so that contractual rights are not lost by a failure to provide the LC in time or, as the case may be, react to a failure to provide an LC on time.