Coming in October: EDI / EC and the Internet BusinessBusiness CreditCredit® National Association of Management

THE PUBLICATION FOR July / August 2003 CREDIT AND PROFESSIONALS $7.00

LETTER OF CREDIT BENEFICIARY BEATS ISSUING BASED ON CONFORMING DOCUMENTS AND UNTIMELY AND IMPROPER DISHONOR By Bruce S. Nathan, Esq.

Introduction beneficiary notice of the bank’s decision presentation of conforming docu- A letter of credit issuing bank must pay a to dishonor the beneficiary’s drawing. ments, the collateral securing letter of credit beneficiary that presents of the applicant’s reimbursement obli- documents conforming with the require- The United States District Court for the gation and the bank’s charges and ments of the letter of credit. By the same Eastern District of Missouri held that commissions earned from issuing the token, the bank can refuse to pay on a let- the bank had wrongfully dishonored letter of credit. The third contract is ter of credit where the beneficiary pre- the beneficiary’s presentation of docu- the letter of credit itself that the bank sented noncomplying documents. ments under, and demand for payment issues in favor of the beneficiary.When However,that right comes with strings:the of, the letter of credit.The court found the beneficiary presents all of the doc- bank must have given proper and timely that the beneficiary’s documents had uments required by the letter of cred- notice of dishonor,including identifying all strictly complied with the requirements it, such as a draft, commercial , documentary discrepancies and notifying of the letter of credit, and rejected the transport and documents, to the beneficiary that the bank is holding the beneficiary’s fraud claim as a ground for the issuing bank for payment, the issu- documents at the beneficiary’s disposal or dishonor.The court also found that the ing bank must pay the amount of the returning the documents to the benefici- beneficiary was entitled to payment, draft to the beneficiary or else breach ary.A bank that messes up by failing to fol- even if it had presented nonconforming the bank’s payment obligation under low any of these rules may be forced to documents, because the bank did the letter of credit. make payment to the beneficiary,notwith- not properly and timely notify the ben- standing the beneficiary’s presentation of eficiary of the bank’s decision to Each of these contracts is independent of discrepant documents. identify documentary discrepancies, the other. For example, if the beneficiary and dispose of the documents. presents the required documents, the That recently happened in Amwest issuing bank must pay on the letter of Surety Insurance Co. v. Concord Bank. Overview of Letters of Credit credit, regardless of disputes between The letter of credit beneficiary had sued Letters of credit are an integral pay- the beneficiary and the applicant in their the letter of credit issuing bank for ment mechanism in many business underlying transaction and/or the appli- wrongful dishonor of the beneficiary’s transactions. A letter of credit arrange- cant’s financial inability to reimburse the documentary presentation and demand ment involves three parties and three bank for letter of credit and for payment under the letter of credit.The independent contracts. The first con- charges. And if the issuing bank makes beneficiary had presented all of the docu- tract is the underlying contract which payment to the beneficiary based upon ments required by the letter of credit.The includes the bank’s agreement to issue the latter’s presentation of noncomplying bank messed up by, among other things, the letter of credit, the terms of the let- documents, the applicant’s/buyer’s failing to timely and properly give the ter of credit, the applicant’s obligation obligation to reimburse the bank for that to reimburse the bank for payments payment is extinguished. made to the beneficiary upon the

J ULY/A UGUST 2003 1 Credit Column BUSINESS CREDIT

The primary concern of the letter of cred- the documents presented do not comply presented to Concord a sight draft in it issuing bank is to determine whether with the letter of credit’s terms and condi- the face amount of the letter of credit, the beneficiary has presented documents tions, the bank must give notice of rejec- $1,200,000, and a written certification that comply with the terms of the letter tion by telecommunication,or if that is not required by the letter of credit. On of credit. The bank deals only in docu- possible by other expeditious means,with- December 5, 2000, more than 15 days ments presented by the beneficiary when out delay and no later than the close of the after Concord had received Amwest’s deciding whether to pay on a letter of seventh banking day following the day of documents, Concord delivered to credit. If the documents comply,the bank receipt of the documents. The bank’s Amwest written notice that Concord must pay the beneficiary; if the docu- notice of dishonor must list all of the dis- was dishonoring Amwest’s drawing ments do not comply, the bank cannot crepancies in the documents presented,in because the certification was false. make payment under the letter of credit other words every ground for the letter of unless the applicant agrees otherwise. credit issuing bank’s refusal to make pay- On December 15, 2000, Amwest com- Most courts hold that the documents ment on the letter of credit. If the issuing menced suit against Concord, alleging, must strictly comply with the letter of bank fails to follow all of these require- among other claims, that Concord had credit before payment can be made. ments and gives an untimely, incomplete wrongfully dishonored Amwest’s drawing or improperly communicated notice of and demand for payment of $1.2 million A major concern is where the issuing rejection, and/or improperly disposes of due under the letter of credit. Amwest bank decides that the documents present- the documents, the bank is precluded claimed that its sight draft and certifica- ed do not comply with the letter of credit from claiming that the presented docu- tion presented to Concord had strictly and refuses to make payment to the bene- ments are nonconforming and must make complied with the requirements of the ficiary.Where a letter of credit issuer fails payment to the letter of credit beneficiary. letter of credit. Amwest also argued that to follow the requirements for communi- Concord had messed up by failing to cating notice of dishonor and disposing of The reason for this procedure and the properly and timely notify Amwest of the documents, the beneficiary may still be penalty it imposes on the letter of credit existence of nonconforming documents entitled to payment under the letter of issuing bank is to force the bank to and properly dispose of the presented credit, despite having presented noncon- respond in a timely manner to a letter of documents.As a result, Concord was pre- forming documents. This tempers the credit beneficiary’s presentation and noti- cluded from asserting Amwest’s noncon- effect of the requirement that the benefi- fy the beneficiary of all the mistakes in forming documents as the basis for ciary presents documents that strictly the letter of credit drawing and of the dishonoring the letter of credit. comply with the requirements of a letter resulting refusal by the issuing bank to of credit.Worse yet for the bank,if the doc- pay on the letter of credit.This is designed Concord argued that it had properly dis- uments presented by the beneficiary do to give the beneficiary an opportunity, honored Amwest’s drawing because not comply with the letter of credit, the prior to expiration of the letter of credit, Amwest had submitted a false certifica- applicant may be released from its obliga- to correct the mistakes in the documents tion to Concord. That amounted to a tion to reimburse the bank. Therefore, a initially presented and make a second fraudulent drawing that excused Concord careful beneficiary presenting noncom- presentation of conforming documents from having to make payment to Amwest plying documents should recognize that it that would require payment by the bank. under the letter of credit. may still have claims against the issuing bank if the bank messes up and fails to Amwest Surety Insurance Co. Concord Had Wrongfully timely and properly communicate its deci- v. Concord Bank Dishonored Amwest’s sion to dishonor a letter of credit draw. On October 25, 1999, Concord Bank Drawing Under the issued an irrevocable letter of credit in Letter of Credit Requirements for the the amount of $1,200,000 to Amwest Amwest Is Entitled to Payment Based Issuing Bank’s Rejection Surety, as beneficiary. Concord issued the on Presentation of Conforming of Noncomplying Documents letter of credit at the request of Concord’s Documents, Notwithstanding Simply stated, when determining whether customer, CMRConstruction Inc. CMR Concord’s Fraud Claim to honor a letter of credit beneficiary’s had to arrange for the issuance of the let- The court held that Concord had presentation of documents, the issuing ter of credit as collateral for the wrongfully refused to honor Amwest’s bank must examine the documents and issuance of performance and payment drawing under the letter of credit. That decide whether to accept or reject them bonds by Amwest, as surety on behalf of was based on Amwest’s presentation of within a reasonable time, not to exceed CMR, to secure CMR’s performance, as conforming documents to Concord. The seven banking days, following the day of general contractor, of a contract with the independence principle that underpins receipt of the documents,according to the city of St. Louis, Missouri for the letter of credit law works in tandem with Uniform Customs and Practice for construction of a parking garage. the strict compliance standard a bank Documentary , International must follow in reviewing documents sub- Chamber of Commerce, Publication No. On November 17, 2000, while the letter mitted by a beneficiary as part of a letter 500 (“UCP”)1. If the bank determines that of credit was still in effect,Amwest had of credit drawing. The bank’s obligation

J ULY/A UGUST 2003 2 BUSINESS CREDIT Credit Column under a letter of credit is triggered by the communicated its notice of dishonor to ments that strictly comply with the beneficiary’s timely presentation of docu- Amwest.It is undisputed that Amwest had requirements of a letter of credit,the ben- ments that strictly comply with the letter presented its sight draft and certification eficiary is entitled to payment from the of credit. to Concord on November 17, 2000. issuing bank.While there is a limited fraud Concord had to communicate notice of exception to this rule, the issuing bank However, there is a limited fraud excep- dishonor to Amwest not later than will not find it easy to invoke fraud as a tion to the independence principle and November 28, 2000, the seventh banking ground for dishonoring a letter of credit strict compliance requirements of letter day after Concord’s receipt of the docu- draw,as Concord had discovered. of credit law. According to Article 5 ments. However, Concord waited until (Section 5-109) of the Uniform December 5, 2000, more than 15 days A letter of credit beneficiary might even Commercial Code,which also governs let- after it had received Amwest’s drawing,to be entitled to payment, notwithstanding ters of credit, an issuing bank can dishon- give notice of dishonor to Amwest. That its presentation of nonconforming docu- or a letter of credit drawing where “a was simply too late for dishonor, and as a ments. The letter of credit issuing bank presentation is made that appears on its result, Concord was precluded from would be precluded from asserting non- face strictly to comply with the terms and asserting the existence of nonconforming conforming documents as a ground for conditions of the letter of credit, but a documents as a ground for dishonor. dishonor when it messes up by failing to required document is forged or materially timely and properly give notice of dis- fraudulent or honor of the presentation The court also refused to accept honor, identify discrepancies in the docu- would facilitate a material fraud by the Concord’s claim that the certificate pre- ments, and/or advise the beneficiary that beneficiary on the issuer or applicant.” sented by Amwest was fraudulent as a suf- the rejected documents are being held at ficient excuse for Concord’s late notice of the beneficiary’s disposal or return the The court held that the fraud exception dishonor of Amwest’s drawing.The court documents to the beneficiary. These did not apply to Concord’s obligation to did not find that Amwest had either pre- duties leave no room for deviation. But a honor Amwest’s drawing based on con- sented any fraudulent documents or com- letter of credit beneficiary should not forming documents. Amwest was entitled mitted any fraud that would have press its luck. The beneficiary should to payment of the letter of credit because warranted dishonor by Concord or make sure that it can present documents it had presented the sight draft and certifi- excuse any delay in Concord’s communi- that strictly comply with the require- cation required by the letter of credit.The cating notice of dishonor to Amwest. ments of the letter of credit.The benefici- court rejected Concord’s argument that ary cannot rely on an issuing bank’s error dishonor was warranted by Amwest’s pres- The court also rejected Concord’s notice in untimely or improperly dishonoring a entation of a false certification to Concord of dishonor because it had failed to iden- letter of credit draw or disposing of doc- because any effort to prove this would tify all of the discrepancies upon which uments presented by the beneficiary as have violated the independence principle. Concord had based its decision to dis- justification for relieving the beneficiary Any finding by the court that the certifica- honor Amwest’s drawing under the letter of the consequences of submitting non- tion was false depended on the court’s of credit. Concord also messed up by conforming documents. of facts and legal interpreta- failing to state that Concord was holding tions that were separate and apart from the the documents at Amwest’s disposal, documents Amwest had presented to and/or failing to return the documents 1UCP 500 is an internationally Concord.The court also found that Amwest to Amwest. accepted compilation of interna- had neither committed a fraudulent act nor tional customs and practices regard- presented fraudulent documents.The most Judgment for Amwest on Its ing letters of credit, which sets forth Amwest could possibly prove, the exis- Wrongful Dishonor Claim the rights and obligations of the tence of an alleged fraud in a collateral The court granted a judgment directing parties to a letter of credit transac- transaction that did not involve Amwest, Concord’s payment of Amwest’s drawing tion. It is the governing law of a let- was not the kind of fraud that would have in the amount of $1,200,000,plus interest ter of credit that incorporates it justified Concord’s dishonor of Amwest’s at the statutory rate of 9 percent per provisions. drawing on the letter of credit. annum.The court also held that Amwest, as the prevailing party in a wrongful dis- Concord Wrongfully Dishonored honor litigation, was entitled to recover Bruce S. Nathan, Esq. is a partner in Amwest’s Letter of Credit Drawing its reasonable attorneys’fees and other lit- the law firm of Lowenstein Sandler Based on Concord’s Improper and igation expenses from Concord, as PC, in New York, NY.He is also a Non-timely Notice of Dishonor allowed by UCC Article 5. member of NACM and the The court also held that Concord had American Bankruptcy Institute. He wrongfully dishonored Amwest’s letter of Conclusion can be reached via e-mail at credit drawing, even if nonconforming A word to the wise for a letter of credit [email protected] documents had been presented, because beneficiary: as a general rule, when a let- Concord had untimely and improperly ter of credit beneficiary presents docu-

J ULY/A UGUST 2003 3