Austria: Prudence Warranted When Issuing Letters of Credit

Last Updated: 18 October 2005
Article by Fabian Tibor

The plaintiff in Case 1 Ob 38/03z -a banking corporation under Egyptian law with a Jordanian branch (the issuing bank)- has a long-standing business relationship with a Jordanian company. This Jordanian company ordered sanitary equipment from an Austrian company.

The payment for the sanitary equipment was agreed in the form of a letter of credit. The plaintiff's Jordanian branch opened a letter of credit upon instruction of the Jordanian company. As the Austrian defendant (the advising bank) did not want to commit to the payment of the letter of credit, an irrevocable letter of credit not confirmed by the advising bank was issued. The defendant was to reimburse itself from the funds of the issuing bank to its account at the reimbursing British bank. By the terms of the issued letter of credit, an allowance for three drawings was agreed upon.

The letter of credit was first drawn in October 1995 and this transaction went smoothly. However, the second transaction in 1996 became the issue of this litigation. At this time the plaintiff requested the advising bank not to pay the Austrian beneficiary, since it suspected fraudulent activities in the transaction. In addition, the issuing bank claimed that not all the prerequisites for payment had been fulfilled (ie, the bill of lading was not endorsed).

The advising bank did not stop payment as it claimed that all prerequisites for payment had been fulfilled. The defendant did not follow the instruction of the issuing bank not to honour the letter of credit and paid the beneficiary the amount due under the letter of credit. It reimbursed itself through the reimbursing British bank and sent the documents to the issuing bank. Subsequently the issuing bank sued the advising bank, since the advising bank did not return the reimbursed sum.


The advising bank, after paying the beneficiary under the letter of credit, acquired the rights arising out of the letter of credit. Therefore, it had a right to be paid under the letter of credit provided the documents complied with its terms and did not have to return the reimbursed sum. The court discussed various legal grounds supporting the claim of the issuing bank, namely compensation for damages and claims for unjust enrichment, as well as any set-off rights of the advising bank and applicable law issues. However, as it was unclear whether the documents conformed to the terms of the letter of credit, no concluding judgment could be made.

Compensation for damages

The Supreme Court ruled that the advising bank, as appointee of the issuing bank, had to comply with the issuing bank's instructions even when they were in breach of the beneficiary's rights under the letter of credit. Even if the advising bank did not abide by the instruction of the issuing bank, compensation could be sought by the issuing bank only for actual damages, which the court determined did not occur since the issuing bank was itself under an obligation to pay the beneficiary under the letter of credit. In this case non-compliance with the instruction of the advising bank would not give rise to damage claims. The court determined that the issuing bank could not escape its contractual responsibilities towards the beneficiary. Therefore, the advising bank's reimbursement at the reimbursing bank, although unauthorized, did not result in damages as, nevertheless, the letter of credit would have to be honoured.

Claim for unjust enrichment

The issuing bank claimed that the advising bank misappropriated its funds without title by mingling the issuing bank's money with its own (through the transfer of funds to the advising bank's account), thus unjustly enriching itself. Therefore, the issuing bank purported to have a claim for unjust enrichment pursuant to Section 1041 of the Civil Code despite the existence of a contractual relationship between the parties.

The Supreme Court based its decision on previous holdings regarding situations involving contractual claims and claims based on unjust enrichment. Despite the competition between these, the Supreme Court stated that it would not decide in favour of a claim of unjust enrichment if the reason for the transfer of assets between the parties was based on legislation or a contract.

The Supreme Court held that in a three-party relationship, a claim of unjust enrichment cannot be made if a contract between the parties exists on which the claim can be based. It held that if the documents had complied with the letter of credit, then the advising bank would have acquired a valid claim against the issuing bank by way of subrogation. In such case the issuing bank could not be considered to have lost assets unjustifiably by the advising bank going against its instruction. The advising bank, on the other hand, would not have been unjustly enriched by the reimbursement. It could base its claim on the subrogation of rights from the letter of credit, so that no claim for unjust enrichment would exist.

The Supreme Court held that even if the conditions of payment under the letter of credit had not been fulfilled, the plaintiff would not be entitled to make an enrichment claim since it would have a claim for breach of contract, which takes precedence over claims for enrichment.

Set-off of claims

The Supreme Court rejected the advising bank's argument that it offset its obligation with its claim under the letter of credit acquired by subrogation. If the advising bank made the payment because the documents complied with the conditions of the letter of credit, then the issuing bank had no claim against the defendant against which to offset the obligation. On the other hand, if the documents were not in order then the defendant could not acquire a claim under the letter of credit, so the set-off of claims would not be possible in both cases due to lack of reciprocity.

Applicable laws and jurisdiction

The decision also gives some guidance on the law applicable to the claims at issue. For breach of contract claims the law governing the contract applies. Claims for unjust enrichment are subject to the law governing the location where the enrichment occurs and the set-off is subject to the law governing the obligation against which the set-off is made. In the present case the relationship between the issuing bank and the advising bank was subject to Austrian law because, under Austrian collision rules, the relevant criterion is the residency of the relevant branch of the advising bank. The court held that the enrichment occurred in Austria because, in case of bank transfers, the place of the bank administering the account into which the transfer is made is decisive. Therefore, in any case the set-off was subject to Austrian law as both claims against which the set-off was directed were governed by Austrian law.

The court did not follow the issuing bank's objection that it had neither a seat nor a place of business in Austria and that, therefore, the Austrian courts did not have jurisdiction for set-offs and counterclaims of the advising bank. The issuing bank argued that all claims against it should be filed with the Jordanian courts. However, the Supreme Court affirmed the competence of the Austrian courts - this is always the case if the defendant can present a counterclaim.


Important lessons can be learnt from the Supreme Court's decision, including the following:

  • If the issuing bank fears that the advising bank (together with the beneficiary) might also act in its own interest when processing the letter of credit, it should agree with the advising bank that it will and may not, by subrogation or any other act, acquire any rights under the letter of credit;

  • If the issuing bank gives instruction not to pay under an unconfirmed letter of credit, it must not forget also to revoke the authority of the advising bank to reimburse itself and inform the reimbursing bank accordingly; and

  • To prevent any discussion of whether set-off is possible, the issuing bank and the advising bank should contractually agree that no party can offset any claims in connection with the letter of credit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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