Payment against letters of indemnity – is it safe?

In the commodity trading world the practice has developed of buyers paying against Letters of Indemnity instead of shipping documents but at what risk to the buyer?

In the commodity trading world, it is traditional for payment to be made by the buyer against the presentation by the seller of certain shipping documents including bills of lading. That is the case whether payment is to be made under a letter of credit (LC) or by direct tender of documents to the buyer. However, a common practice has developed, particularly in the oil trade, for parties to agree in their contracts that the seller may, instead of presenting shipping documents to trigger payment, present a letter of indemnity instead. But there are risks to the buyer in paying against such letters of indemnity. 

Such letters of indemnity generally contain undertakings from the seller that (i) it has good title to the goods in question and the right to transfer title and give delivery of the goods to the buyer; (ii) it will locate and surrender the shipping documents to the buyer and (iii) it will indemnify the buyer in respect of the consequences of the shipping documents being outstanding or any breach of the above warranties (we will refer to this type of LOI as a "payment without shipping documents LOI").

The relevant clauses in sale contracts often state that the option to provide a payment without shipping documents LOI in lieu of shipping documents is there to cover the eventuality that the seller does not have the required shipping documents at the time it wishes to make a documentary presentation to secure payment for the goods. However, the seller is not required to prove that it does not have the shipping documents before presenting such an LOI in lieu of shipping documents. Undoubtedly, sellers often present such an LOI to trigger payment when they would be quite capable of presenting shipping documents if they wished.

The most important shipping documents are often the relevant bills of lading. They are important because bills of lading give the holder the right to delivery from the carrier of the goods represented by them. As such the buyer is usually "safe" making payment against presentation of the bills of lading as, in exchange for the cash it pays to the seller, it receives the right to delivery of the goods from the carrier at the bill of lading destination. But making payment against an LOI does not give the buyer any right to delivery of the goods against the carrier because the carrier is not party to the LOI. Further, such an LOI, unless counter signed by a bank or other reliable third party, provides no security to the buyer that in parting with the purchase price it will receive the goods.

There are further limitations to the effectiveness of such LOIs. For example, the undertakings in relation to title and the ability to effect delivery are given at the time the LOI is executed and are not generally worded as continuing undertakings. As such, there would be no breach of those undertakings if the day after they are given the seller sells and transfers title to the goods to a third party. Of course if the seller were to sell the cargo to a third party it may not be able to surrender the shipping documents to the original buyers as required by the LOI. But equally it might, if it is able to arrange delivery to the new buyer by giving a letter of indemnity to the carrier for delivery otherwise than against presentation of the bills of lading (we will refer to this type of LOI as a "discharge without B/L LOI"). This issue is discussed further below.

Euro-Asian v Abilo

The potential problems associated with the use of payment without shipping documents LOIs are well illustrated by the case of Euro-Asian Oil SA v Abilo (UK) Ltd and Credit Suisse AG [2016] EWHC 3340.

A Mr Igniska controlled a number of companies involved in the import and distribution of gasoil in Romania, including Abilo, Real Oil and DG Petrol. Mr Igniska needed assistance in financing the purchase of such product from third parties and Euro-Asian agreed to help. Euro-Asian therefore agreed to buy product CIF Constanza from Abilo and then re-sell to one of Mr Igniska's other companies on extended credit terms. Payment to Euro-Asian under their contract with Abilo was to be by LC. In the case of the fourth intended delivery, and consistent with the terms of the contract, the LC provided for payment against:

“presentation of the commercial invoice and seller's letter of indemnity . . . in a format acceptable to buyer and countersigned by a first-class international bank acceptable to buyer.”

Abilo (through their bank, Credit Suisse) subsequently presented a payment without shipping documents LOI ("the Abilo LOI") to Crédit Agricole (the LC issuing bank) under the LC referring to a cargo shipped on the "Ariadne" and warranting that:

“In consideration of Crédit Agricole . . . paying us, full purchase price of US dollars 15,844,840.00, we hereby expressly warrant that we have marketable title free and clear of any lien or encumbrance to such material and that we have the full right and authority to transfer such title to you and effect delivery of the said cargo to you.”

And that they would:

“locate and surrender to you the full set of 3/3 original bills of lading issued or endorsed to the order of Crédit Agricole . . . and other shipping documents and to protect, indemnify and hold you harmless from and against any and all damages, costs and expenses (including reasonable attorney fees) which you may suffer by reason of the shipping documents including the original clean and negotiable bills of lading remaining outstanding or by reason of a breach of the warranties given above . . .”

Credit Suisse countersigned the Abilo LOI becoming jointly and severally liable with Abilo under it. Crédit Agricole then paid under the LC.

However, the "Ariadne" cargo had in fact been used to satisfy the previous delivery under the contract between Euro-Asian and Abilo and had been discharged some 3 months earlier. Accordingly, Euro-Asian received no fourth delivery; although the relevant bills of lading were subsequently provided by Credit Suisse to Crédit Agricole.

Euro-Asian brought a claim against both Abilo and Credit Suisse for breach of the warranties and undertakings in the Abilo LOI. Euro-Asian asserted that Abilo/Credit Suisse were in breach of the warranties in the Abio LOI as the documents presented under the Albilo LOI referred to the "Ariadne" and that cargo had already been sold (and delivered) under an earlier transaction. As such Abilo did not have title to the product concerned and did not have the right or authority to effect delivery of the product at the time the Abilo LOI was issued. Further, Euro-Asian argued that Abilo had failed to surrender the original bills of lading as required by the Abilo LOI as the bills when eventually indorsed to and surrendered to Crédit Agricole were no longer negotiable but "spent" bills due the fact that the cargo had been discharged and delivered to others.

Credit Suisse argued that the arrangements made outside the sale contract and Abilo LOI meant that the obligations ostensibly arising under the Abilo LOI were not effective. However, the Court rejected those arguments. The Court also found that the undertakings in the Abilo LOI were breached in that Abilo did not, at the time the Abilo LOI was given, have title to or the right to deliver the "Ariadne" cargo. It also held that there was a breach of the undertaking in the Abilo LOI in relation to the surrender of the bills of lading ("the bills of lading undertaking"), as the bills were already spent when they were eventually surrendered. Judgment was given against both Abilio and Credit Suisse under the Abilo LOI.

The judgment records that Abilo was a company without any significant assets so it was fortunate that Euro-Asian contracted on terms that required the Abilo LOI to be countersigned by a "first-class international bank acceptable to buyer". But for that they would, according the Court, have been left holding worthless shipping documents and have had no effective right of recourse against anyone.  Or would they?

Are my bills of lading spent?

The Judge's reasoning on the bills of lading undertaking issue is very brief but proceeds on the basis that (i) the bills of lading which Abilo were bound to surrender under the Abilo LOI had to be negotiable and (ii) when the "Ariadne bills were surrendered they were not negotiable since they no longer gave the holder a right to delivery because the goods had already been discharged. With respect to the learned Judge the later part of that reasoning is questionable.

A carrier's obligation is to give delivery against presentation of the original bills of lading and it will be exposed to liability for damages for conversion and/or wrongful delivery if it does otherwise; e.g. by delivering against a discharge without B/L LOI. For example, in The Erin Schulte [2014] EWCA Civ 1382 it had been conceded by the Claimants that the bills of lading in that case were spent after discharge against a discharge without presentation of B/L's LOI but the Court of Appeal observed that "the right to obtain delivery.. from the carrier did not cease when the goods were discharged against the letter of indemnity…" and as such the bills still provided a right to delivery of the goods against the carrier (alternatively damages for conversion/wrongful delivery).

In this case it does not appear that the cargo was delivered by the carrier against the bills of lading as it is recorded that the bills of lading, indorsed in favour of Crédit Agricole, were eventually surrendered to Crédit Agricole. In the above circumstances, it seems that the bills were not spent at the time of surrender to Crédit Agricole and Abilo arguably complied with the bills of lading undertaking. If that is right, one can easily see the potentially limited value of payment without shipping documents LOIs.

Comment

As mentioned above, unless worded as continuing warranties, assurances given by the issuer of the payment without shipping documents LOI about title and ability to give delivery would not be  breached by a subsequent transfer of title others.

Furthermore, it is highly arguable that the issuer could comply with the usual undertaking in relation to the surrender of the bills of lading by surrendering the bills of lading to the beneficiary of the LOI even if the cargo had already been discharged. That is not to say that in such circumstances the buyer will not have a claim against the seller for non-performance of the sale contract (or even possibly fraud) but as banks do not generally underwrite the performance of the underlying sale contract such a claim, unlike a claim under a payment without shipping documents LOI countersigned by a bank, may be worth very little.

The judgment in the Euro-Asian case is currently subject to appeal, and it may be these issues receive further consideration by the appeal court.