To sue in debt or damages? A documentary credit dilemma
A good presentation under a letter of credit gives rise to a claim in debt against the issuing or confirming bank. But that debt claim is lost if, in the face of a rejection of the documents, the beneficiary takes the documents back. In those circumstances the beneficiary must ask itself the question "Do I want my documents back?"
Alternative remedies against a dishonouring bank
"Whatever view may have been taken at the time when letters of credit were in their infancy, in my view the modern cases support the proposition that if the opening or confirming bank fails to pay against presentation of conforming documents under a letter of credit payable at sight, the beneficiary may sue in debt to recover the value of the credit, provided he is willing and able to transfer the documents to the bank against payment….. If the beneficiary is willing and able to transfer the documents to the bank, therefore, he is entitled to recover the face value of the credit as a debt. If he is not willing or able to hand over the documents, the position is different, as Sir Christopher Staughton pointed out in Seaconsar Far East v Bank Markazi. Since the contract provides for payment against documents, the beneficiary is not entitled to recover the full value of the credit otherwise than on surrender of the documents."
When Moore-Bick LJ says that if the beneficiary is not willing "to hand over the documents, the position is different" he means that in those circumstances the beneficiary will need to claim in damages not debt (assuming it suffers a loss by virtue of the dishonour of the credit).
In the "Erin Schulte" the L/C concerned was confirmed by Standard Chartered Bank ("Standard Chartered") and supported a sale of oil by Gunvor; Gunvor being the beneficiary under the L/C. Gunvor made a compliant presentation under the L/C which included the bills of lading in respect of the oil. Standard Chartered wrongly rejected that presentation. Gunvor therefore sued Standard Chartered who thereafter settled the litigation by paying the sum due under the L/C in full.
In the meantime Gunvor, in order to avoid delay at the discharge port, had arranged for discharge of the oil there by issuing a letter of indemnity ("the LOI") to the carrier in respect of liabilities they might face by giving delivery without presentation of the bills of lading.
Standard Chartered were unable to obtain reimbursement from the issuing bank and therefore sought to exercise the "security" they claimed to have as a result of being, they said, the lawful holders of the bills of lading. They sought to do that by suing the carrier in the "Erin Schulte" case for the full value of the cargo for mis-delivery; that is for giving delivery without presentation of the bills of lading. As a result of the LOI, Gunvor were obliged to indemnify the carrier against such a claim.
In the "Erin Schulte" the Court of Appeal concluded that Teare J. (the judge at first instance) was wrong to have concluded that Standard Chartered became the lawful holder of the bills of lading on presentation under the L/C but was right that it did so upon their eventual, post litigation, payment of the amount claimed under the L/C despite having rejected the presentation and indicated they were holding the documents to Gunvor's order. The Court of Appeal said that it was to be inferred that as Gunvor (a) had not taken the documents back (by virtue of the delivery of the cargo against the LOI the bills of lading had no value to Gunvor) and (b) had claimed against Standard Chartered in debt (as well as damages in the alternative), Gunvor were agreeing to Standard Chartered unwinding their rejection and taking up the documents including the bills of lading in return for payment. This was to be inferred, the Court of Appeal concluded, because a claim in debt carried with it an obligation to surrender the documents. Judgment was therefore given against the carrier which Gunvor were liable under the LOI to cover.
To claim in debt or damages – that is the question
The dilemma a beneficiary therefore faces in the circumstances of a dishonour of an L/C is whether to simply leave the documents with the bank and claim the sum due under the L/C as a debt or take the documents back and seek to realise their value elsewhere; claiming the shortfall from the bank as damages if they realise less than the sum which the bank should have paid under the L/C. That decision will, at least in part, depend on the beneficiaries' assessment of the merits of the bank's rejection of the presentation. If a beneficiary is supremely confident that they have made a good presentation they may wish to leave the documents with the bank and sue in debt. But that is a risky course as if the bank succeeds in establishing that the presentation was discrepant there is a danger (especially when the L/C is the mechanism for payment for perishable goods) that by the time the dispute about discrepancy is resolved the documents will be worthless.
The beneficiary may also be exposed to liability to third parties if leaving the documents with the bank. For example if the beneficiary is the charterer of the carrying vessel or exposed to demurrage liabilities under its own purchase contract, the beneficiary may incur significant liability for demurrage pending the resolution of the claim in debt. This is so because there is nothing it can safely do to facilitate delivery of the cargo as, having decided to claim in debt, the bills of lading have to be left available for the bank to take up as and when they decide to pay, or are required to pay pursuant to a judgment. The beneficiary is therefore unable to surrender the bills to the carrier to facilitate discharge of the goods. The vessel will just have to sit and await the resolution of the claim under the L/C. In a contested case, it is not difficult to anticipate delays of two or three years before liability under the L/C is finally determined and the recalcitrant bank pays. True, the beneficiary may be able to recover such costs under a separate claim for damages against the bank but apart from the uncertainty of such a claim, including potential arguments about failing to mitigate loss, racking up huge demurrage bills would certainly escalate the sums in dispute well beyond the sum due under the L/C.
As articulated above, the alternative to maintaining a claim in debt is, in essence, to take back the documents and claim the sum due under the L/C subject, as the Court of Appeal in The Erin Schulte observed, to giving credit for the value of the documents. But this course is not without potential pitfalls. Since one is in the territory of a claim for damages, there is again the obligation on the beneficiary to mitigate its losses. In the usual scenario involving an L/C supporting a commodity sale, where the goods concerned are on the water on their way to, or have already arrived at, the delivery destination identified in the bills of lading, the options open to the beneficiary with regard to the disposal of the goods are bound to be limited; indeed, the goods may be regarded in the market as ‘distressed’. Naturally, if a beneficiary in those circumstances does its best and disposes of the bills of lading, and the goods represented by them, on the best terms reasonably available, then it should have no worries. However, one needs little experience of litigation to anticipate the sort of arguments that might be run by the bank about the reasonableness of the conduct of a beneficiary in disposing of the bills of lading or goods in such circumstances. In addition to potential criticism in relation to the price achieved under such a substitute sale, the beneficiary might find themselves in a position where they are required to sell to a party, including possibly the original buyer, without the provision of payment security. What might be the position in those circumstances if the bills having been presented to the buyer, the buyer fails to pay for the goods. Would this be a novus actus, meaning that the beneficiary is limited to claiming the sum that would have been due under the L/C less the notional substitute sale price, despite the default in payment by the buyer?
CommentAs Moore-Bick LJ observed in the "Erin Schulte" "There is surprisingly little authority…on the nature of a claim for dishonour of a letter of credit." The "Erin Schulte is better known as an authority on the operation of Section 5 (2) (a) of the Carriage of Goods by Sea Act 1992. As a result the guidance the decision provides within its four corners as to the options available to an L/C beneficiary facing rejection, valid or otherwise, is less well known. The purpose of this piece is to highlight that guidance and venture to suggest that it is vitally important for a beneficiary when faced with such a rejection to make a conscious decision as to whether to claim in debt or damages and to ensure they deal with the documents presented to the bank in a manner consistent with that decision.