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LOC Refusal Leads to Liability

Letter of Credit Refusal Notice Defects Lead to Liability

INADEQUATE L/C NOTICE OF REFUSAL RESULTS IN $1.2 MILLION JUDGMENT

The United States Court of Appeals for the Fifth Circuit on April 23, 2002 issued an opinion in the case of Voest-Alpine Trading USA Corporation v. Bank of China. A bank that issued a letter of credit was held liable for the entire amount ($1.2 Million) for failure to give a timely and proper notice of refusal to the beneficiary even though the presentment contained numerous flaws.

Facts and Proceedings
A Chinese company agreed to purchase goods from Voest-Alpine ("V-A"). V-A required the customer to obtain a $1.2 million dollar of credit that was issued by the Bank of China ("Bank"). The letter of credit provided for payment to V-A after it delivered the goods and presented several designated documents to the Bank in accordance with the provisions of the Uniform Customs and Practices for Documentary Credits of the International Chamber of Commerce, Publication No. 500 ("UCP 500").

The market price of the goods declined prior to the shipment date and the customer requested a price concession from the contract price. The request was refused by V-A. The letter of credit and accompanying documents were presented by V-A to its local U.S. bank to be forwarded to the Bank. The U.S. bank informed V-A that the presentment contained several discrepancies with what was required by the terms of the letter of credit. V-A indicated that it did not feel that the discrepancies were material and instructed its bank to present the documents to the issuing Bank "on approval."

The Bank received the documents on August 9, 1995, and on August 11, 1995, notified the U.S. bank by telex that the documents contained seven discrepancies and that the Bank would contact the applicant (the customer) about a waiver and acceptance of the documents. On August 15, 1995, the U.S. bank on behalf of V-A responded that the discrepancies did not warrant dishonoring the letter of credit and demanded payment. On August 19, the Bank restated its position and added that the documents were refused according to UCP 500.

In October 1995, V-A filed suit for payment of the letter of credit. The Bank filed a motion for dismissal based on lack of jurisdiction and improper venue. The district rejected the motion and held in favor of V-A that the telex failed to provide notice of refusal and that the discrepancies were not sufficient to allow rejection of the letter of credit.

The Bank appealed the decision of the district court.

Discussion
First, the Court disposed of an issue relating to proper venue. The letter of credit was originated in China but it was negotiated in both China and Texas, and sent to V-A for its acceptance in Texas. In addition the documents were first presented by V-A to a Texas bank and payment was to be made in Texas. The Court upheld the district court determination that venue was proper in Texas.

The Bank's primary contention on appeal was that the district court was in error in concluding that the Bank failed to provide proper notice of refusal to V-A. UCP 500 requires an issuing bank in order to reject payment on a letter of credit to give notice of refusal to the beneficiary no later than the close of the seventh banking day following the day of receipt of the presentation documents. If the issuing bank does not provide timely notice, it must honor the letter of credit despite any discrepancies.

The Bank received the documents of August 9. Since August 12 and 13 were Chinese banking holidays, the deadline for giving notice of refusal (dishonor) was August 18. The Bank contended that its telex of August 11 provided the required notice of refusal.

The telex listed certain alleged discrepancies and the following statement: "WE ARE CONTACTING THE APPLICANT FOR ACCEPTANCE OF THE RELATIVE DISCREPANCY. HOLDING DOCUMENTS AT YOUR RISK AND DISPOSAL."

The district court found that the telex failed to provide the notice of refusal because:

  1. the Bank did not explicitly state that it was rejecting the documents;
  2. the Bank's statement that it would contact the applicant about accepting the documents despite the discrepancies "holds open the possibility of acceptance upon the waiver" and "indicates the Bank has not refused the documents; and
  3. the bank did not mention refusal until its August 19 telex.



The district court held the August 11 telex was merely a status report and the Bank did not reject the documents until August 19 which was too late.

The Court agreed with the reasoning of the district court and held that the determination that the August 11 telex was not a rejection of the presentation by the Bank due to the Bank's offer to contact the customer for a waiver of the discrepancies. The Court relied in part on the testimony of an expert presented by V-A who argued that the August 11 telex was, in light of standard banking practices, ambiguous.

The Court stated UCP 500 contemplates a three-step process for dishonoring letters of credit. First, the issuing bank reviews the document presented for discrepancies. Second, if the bank finds problems, it contacts the purchaser (applicant) for a waiver. Finally, after conferring with the purchaser, the bank may issue its notice of refusal.

The Court also stated the Bank failed to use the standard language for refusal, failed to comply with generally accepted trade usage, and created ambiguity by offering to contact the applicant about waiver, thus leaving open the possibility that the allegedly discrepant documents might have been accepted at a future date.

The Court held the Bank failed to provide V-A with adequate notice within the required time period that the Bank was refusing payment on the letter of credit. Without a valid excuse for nonpayment, the Bank was liable for the full amount of the letter of credit ($1.2 Million) and for V-A's legal fees.

Summary
The issuing bank failed to follow the provisions of UCP 500 and normal banking practices regarding notice of refusal of the letter of credit and therefore was liable to the beneficiary for the full stated amount of the letter of credit. The terms and conditions of a letter of credit must be strictly adhered to and any refusal by the issuing bank of a presentation must be specifically stated and made within the time period prescribed by UCP 500.

First published on BankersOnline.com 4/25/02

First published on 04/25/2002

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