January 25, 2017

Letters of Credit: Autonomy Principle Affirmed (Court of Appeal)

In proceedings where Clyde & Co acted for the successful appellant, PetroSaudi, the Court of Appeal has held that a solicitor who signed demands under a standby letter of credit correctly understood the statement of law he was certifying. Overturning the High Court's decision that the signatory was fraudulent in his representation of law, Christopher Clarke LJ (with whom Lewison LJ agreed) held that the signatory's understanding not only was far from fraudulent but in fact was "the same conclusion as I have reached" and "consistent with commercial good sense".

Standby Letters of Credit

The commercial purpose of a standby letter of credit is to ensure that the beneficiary can obtain payment from a creditworthy bank of sums due under a principal contract, regardless of whether those sums are disputed or whether the counterparty is unable or disinclined to pay. Indeed in countries with a payment risk such as Venezuela, failure to procure or provide a letter of credit may prevent parties from concluding a contract in the first place, certainly where Contractors are negotiating contracts with state entities such as PDVSA.

Standby letters of credit are sometimes described as 'equivalent to cash' or 'the life-blood of international commerce'. English law provides that an issuing bank's obligation to pay out against a compliant demand is a sacrosanct and free-standing obligation, independent of the parties' performance of obligations under the principal contract. This 'autonomy principle' has only a handful of tightly circumscribed exceptions. One of these – the fraud exception – permits a bank to withhold payment where it is clearly established that there was fraud in procuring the letter of credit or where the presentation itself is clearly fraudulent.

The Background

In 2009 the appellant, PetroSaudi Oil Services (Venezuela) Ltd ("POS"), supplied a drill ship to PDVSA Servicios SA ("PDVSA"), a Venezuelan state entity, pursuant to a contract under Venezuelan law.  In light of what the judgment describes as "Venezuela's dilatory payment history", an autonomous standby letter of credit governed by English law and issued outside Venezuela was procured in favour of POS to provide security in respect of payments from PDVSA.

POS conducted drilling services and rendered invoices totalling some USD 129 million to PDVSA under the drilling contract. An agreed credit period elapsed without payment of any of these invoices. The dispute over payment of these and other invoices was referred to arbitration.

The drilling contract contained two terms intended to ensure payment by PDVSA of invoices before an arbitral award: a "pay now, argue later" clause and a clause for payment based on deemed acceptance of invoices. By its First and Second Partial Awards, however, the UNCITRAL arbitrators held that both these terms were rendered null and void by the effect of Article 141 of the Venezuelan Public Contracting Law, which prohibits payment by state entities before certain procedures of verifying and authorising payment of invoices are carried out.

The arbitrators initially restrained on an interlocutory basis POS from seeking payment of invoices under the letter of credit. Subsequently POS was permitted to call on the letter of credit in respect of operating expenses. Following the tribunal's decisions on the effect of Article 141, the tribunal ruled that it had procedural authority to protect the rights asserted by PDVSA if appropriate to do so, however in this case it was not appropriate: POS had free-standing payment rights under the letter of credit, which rights had been not only contemplated but signed up to by PDVSA, and those rights fell to be determined by the English courts. Consequently the arbitrators lifted the injunction. The significance and effect of the arbitrators' decision was itself a matter of dispute between the parties.

The Presentation

Following the removal of the injunction, POS issued proceedings in the English High Court seeking a declaration that an intended presentation would be compliant with the terms of the letter of credit and that the issuing bank would be liable to pay the full amount of the demands.

The following day POS made its presentation to the issuing bank. The POS company director, who was also its General Counsel, certified the representation required by the letter of credit that PDVSA was "obligated to [POS]… to pay the amount demanded under the Drilling Contract".

On receipt of the demands, the issuing bank gave notice that it considered there had been a compliant presentation and stated its intention to pay the proceeds to POS. Before the bank could do so, however, PDVSA sought an injunction restraining the bank from paying out and requiring POS to withdraw the demands. The trial of the matter was listed by consent for an expedited hearing; remarkably between the issuing of the Claim Form and completion of the final trial there were just 11 days.

First Instance

The High Court considered the meaning of the words in the certificate that PDVSA was "obligated to [POS]… to pay the amount demanded under the drilling contract". In evidence the signatory asserted that PDVSA had an underlying payment obligation in respect of invoices duly submitted under the drilling contract which Article 141 of the Venezuelan Public Contracting Law prevented it from discharging at present; accordingly the representation in the certificate was true as a matter of law and of his honest belief.

His Honour Judge Waksman QC, sitting as a judge of the Commercial Court, disagreed, holding that PDVSA was not obligated to pay POS for the sums claimed in the presentation, because any underlying liability arising from the invoices could not yet be enforced and PDVSA had no present obligation to pay. The judge found that the representation certified by the signatory was false.

The judge went on to consider whether the fraud exception to the autonomy principle was engaged. It was not alleged that the signatory believed the underlying invoices to be anything other than accurate. Nonetheless, the judge rejected the signatory's evidence that he actually and honestly believed in the legal construction he advanced in evidence. Accordingly the judge restrained the bank from paying out under the letter of credit.

The High Court also rejected, obiter, an argument from PDVSA that the certificate was a continuing representation which POS was obliged to withdraw or retract if the presentation had been honestly made but turned out to be incorrect. Finally, the High Court rejected PDVSA's argument that as a matter of Venezuelan law POS's demands were themselves made in breach of the Drilling Contract as it must be revised in light of Article 141.

POS appealed the judgment both as to the finding of deceit and as to the construction of the certificate as a matter of law. PDVSA submitted that the judge had been wrong to reject its argument as to the continuing representation, but did not appeal the point under Venezuelan law.

Judgment on Appeal

In allowing POS's appeal, the Court of Appeal held that Mr Buckland's understanding of the meaning of the certificate was entirely correct as a matter of law. A statement that PDVSA was obligated to pay meant that PDVSA had become liable to make the payment, even though precluded from discharging that liability until the Article 141 procedure had been complied with or an award made. Such a conclusion was consistent with the contractual award for interest, and would otherwise mean the Contractor had to continue performance with no enforceable right to payment or suspension.  

The judgment notes that there is nothing legalistically contrived in recognising different types of debt obligation. In Charter Reinsurance v Fagan [1997] AC 313, Lord Hoffmann acknowledged the elasticity of the word “pay”, recognising that in some contexts it signified only that a liability has been incurred. Lord Hoffman gave the example of the question “What did you pay for the dress?” addressed to a wife who had purchased on credit. In that example the time for payment would not have occurred when the question was asked, but were the wife to answer "I have not paid anything yet" she would be giving the question an unnatural meaning.

In the present case, payment under the letter of credit had been wrongly restrained and the appellant was entitled to an order requiring the issuing bank to make full payment forthwith in settlement of the demands already presented. In light of its ruling on the construction of the certificate, the Court of Appeal was not required to determine PDVSA's submission that POS was under a continuing duty to withdraw or retract its presentation. It also made clear its disquiet at the approach taken by the judge in finding a General Counsel fraudulent in regard to a representation of law.

Discussion

Clearly the decision strongly vindicates the conduct, integrity and professionalism of PetroSaudi and its General Counsel, Mr Buckland, throwing out any suggestion that they or he acted in any way inappropriately in enforcing the rights given to them, let alone fraudulently.

The judgment is notable for the emphasis it places on the commercial function of letters of credit. Christopher Clarke LJ confirms that, in the absence of fraud, it is the function of a letter of credit to pay the amount called for on presentation of conforming documents. Disputes between the parties are not to affect liability thereunder. The construction contended for by the signatory was consistent with commercial good sense and, on that account, preferable to the rival one. The availability of the letter of credit was of critical importance to the Contractor and its financiers given PDVSA’s payment history. Indeed, the fact Article 141 might well preclude POS from securing regular payment would, in itself, be good reason for requiring an independent and autonomous letter of credit governed by English law, issued by a body outside Venezuela.

Another notable aspect of the judgment is found in the passages dealing with the fraud exception to the autonomy principle. The Court of Appeal expressed disquiet at the first instance finding of fraud arising from the High Court's decision on the construction of the certificate. The following passage is significant and has potential to influence similar cases in the future:

"Whilst there is only one true construction of an instrument such as the certificate, different legal minds may obviously take different views on such a question. Had it been necessary to do so I would wish to have given anxious consideration to the question whether, despite the well-recognised advantages of a trial judge and the inhibition rightly felt by this court in overturning findings of fact, the judge was entitled to conclude that [the signatory] was fraudulent (i.e. conscious of the falsity of what he was saying or with no honest belief in, or a reckless indifference to, its truth) in holding the view that I currently hold, when making what was, in essence, a representation of law".

There is some suggestion here that the fraud exception (and perhaps the wider law of Deceit) is to be approached with care where the meaning of a representation is a matter of law, rather than fact. The judgment confirms that the courts alone decide the true meaning of legal propositions. At the same time, it offers a measure of comfort to anyone required to make a representation of law without the benefit of a judicial determination. The courts should not be quick to find deceit in circumstances where different legal minds take different views.