Canada: Strict Compliance With Letter Of Credit Not Always Enough – Fairness And Equity In Letter Of Credit Transactions

Last Updated: November 17 2009
Article by Martin Sclisizzi and Daniel Zacks

Most Read Contributor in Canada, September 2016

Case Commentary: Nareerux Import Co. Ltd. v. Canadian Imperial Bank Of Commerce

In the recent decision of Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce, the Ontario Court of Appeal considered principles of fairness and equity in letter of credit transactions. The Court recognised an implied contractual duty of good faith not to act in a way that defeats the purpose and objective of a letter of credit.

The case concerned letters of credit issued by CIBC in favour of Thai Fisheries Co. Ltd. to ensure payment by Douglas R. Robertson International Inc. ("Robertson") for approximately $40 million worth of shrimp. Robertson intended to sell the shrimp to Sam's Club.

Robertson financed the shrimp purchase through a credit facility arranged with CIBC. The possibility of a delay between Robertson's obligation to pay Thai Fisheries under the Letters of Credit and Robertson's shrimp sale to Sam's Club caused CIBC concern over its risk exposure in the credit facility. CIBC sought to address its concern by incorporating a "Special Condition" into the Letters of Credit that would delay payment to Thai Fisheries until Robertson presented to CIBC receipts from its shrimp sale to Sam's Club.

The Special Condition created an atypical arrangement. Whereas under a conventional letter of credit a seller controls the satisfaction of the conditions necessary for payment, the Special Condition transferred such control to the purchaser. If Sam's Club did not purchase shrimp from Robertson, the prerequisite for payment under the Letters of Credit would not be met. Additionally, by delaying presentation of Sam's Club receipts, Robertson could control the flow of money to Thai Fisheries.

The relationship between Robertson and Thai Fisheries degenerated. Robertson did not present receipts for Sam's Club shrimp purchases and, as a result, Thai Fisheries did not receive payment for over $6 million of shrimp. Meanwhile, Robertson used the proceeds from the sales to pay down its line of credit with CIBC. CIBC knew this was happening; further, CIBC permitted Robertson to sell approximately $4 million of shrimp to other purchasers, ensuring that Thai Fisheries would never receive payment for those shrimp.

Upon receiving notice from CIBC that the Letters of Credit had expired, Thai Fisheries sued for the unpaid monies.

The trial judge ruled in favour of Thai Fisheries, awarding it the full amount of money owed to it under the Letters of Credit. There were three grounds of liability. One, CIBC participated in Robertson's sales to buyers other than Sam's Club, which prevented Sam's Club from issuing the receipts necessary for Thai Fisheries to receive payment; two, CIBC breached fiduciary obligations to notify Thai Fisheries that Robertson was selling to buyers other than Sam's Club and choosing to act as a lender seeking satisfaction of what it is owed; and three, this conduct constituted a breach of an implied duty to Thai Fisheries to act in good faith.

In its appeal, CIBC relied on a defence of strict compliance, arguing that it had strictly complied with the terms of the Letters of Credit. The presentation of receipts from Sam's Club was a precondition to payment; as no receipts were presented by Robertson, CIBC was not liable to pay the proceeds of the shrimp sale to Thai Fisheries. Moreover, it was the responsibility of Thai Fisheries, a commercially sophisticated party, to inspect the terms of the credit before accepting it. Once Thai Fisheries accepted the Special Condition, CIBC was required to strictly comply with it.

In upholding the trial judge's decision, the Court held that CIBC was disentitled to rely on a defence of strict compliance. Because CIBC knowingly contributed to the circumstances that frustrated the Special Condition, and then used that non-compliance to justify the refusal of payment to Thai Fisheries—all while applying the proceeds from the shrimp sales to reduce Robertson's overage—CIBC had directly breached the contractual obligations it had to Thai Fisheries.

More significantly, the Court held that CIBC had also indirectly breached its contract with Thai Fisheries by breaching an implied contractual duty of good faith. While the law does not recognise a stand-alone duty of good faith in the performance of a contract, "the jurisprudence establishes that there is an implied contractual duty of good faith not to act in a way that defeats or eviscerates the very purpose and objective of the agreement".

The Letters of Credit allowed CIBC to exert a discretionary control over documentary compliance and timing of payments. Contracts in which performance depends on the exercise of discretion contain an implied duty of good faith performance. By participating in a ploy with Robertson to frustrate compliance with the Special Condition, CIBC exercised its discretion in its own self-interest to the effect of rendering the Letters of Credit commercially meaningless. This was a breach of the implied term of good faith.

Although Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce does not import a broad duty of good faith into the law of letters of credit, it should nonetheless be considered when issuing letters of credit. Where the terms of a letter of credit provide a party with discretionary control over some aspect of compliance, that control must be exercised in good faith.

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