3PLR – HONGKONG AND SHANGHAI BANKING CORP (THE BANK), V. KLOECKNER & CO AG (KLOECKNER)
POLICY, PRACTICE AND PUBLISHING, LAW REPORTS 3PLR
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HONGKONG AND SHANGHAI BANKING CORP (THE BANK),
V.
KLOECKNER & CO AG (KLOECKNER)
QUEEN’S BENCH DIVISION (COMMERCIAL COURT)
8, 9, 21 MARCH 1989
3PLR/1989/7 (QB)
BEFORE HIS LORDSHIP: HIRST J
REPRESENTATION
David Donaldson QC and Richard Hacker – for the bank
Mark Havelock-Allan – for Kloeckner
Solicitors: Stephenson Harwood (for the bank); Middleton Potts (for Kloeckner).
K Mydeen Esq Barrister.
MAIN ISSUES
BANKING AND FINANCE LAW – EQUITY:- Banking practices – Set-off – Right of set-off – Contracting out – Bank providing facilities to defendant company to finance oil purchases – Defendant undertaking to repay bank without any deduction, set-off or counterclaim – Bank claiming amount owing – Defendant making counterclaim and seeking to set off amount of counterclaim – How treated
BANKING AND FINANCE LAW:– Banking Practices – Documentary credit – Set-off – Claim by beneficiary of letter of credit – Whether bank can maintain set-off in answer to claim by beneficiary of letter of credit
COMMERCIAL LAW – CONTRACT:– Right of set-off – Whether parties to contract can contract out of right of set-off – Whether parties can be precluded by contract from claiming right of set-off
OIL AND GAS LAW:– Operational Contracts – Financing off – Relevant considerations
HISTORY AND SUMMARY OF FACTS
The plaintiff bank provided facilities to the defendant company to finance oil purchases on the strength of letters of undertaking given by the defendant which contained a clause stating that the defendant expressly agreed to pay the bank the amount advanced for each purchase without any deduction or set-off. The defendant suffered substantial losses on its oil trading and the bank brought an action against the defendant claiming some $8m due to it. The bank claimed that the defendant had no defence to the claim and applied for summary judgment under RSC Ord 14 but the defendant issued a counterclaim for $10m payable under a standby letter of credit and claimed to be entitled to set off the amount claimed under the counterclaim. The defendant also applied for summary judgment under Ord 14 for the amount of the counterclaim. The bank contended (i) in respect of its own claim, that the defendant was precluded by the terms of the letters of undertaking from claiming any right of set-off against the bank and (ii) in respect of the defendant’s claim, that although it was not disputed that the defendant was entitled to slightly less than $10m payable under the standby letter of credit the bank was entitled to set off some $10·2m under assignments or undertakings relating to the defendant’s forward contracts. The defendant contended that the bank was not entitled to raise a set-off against a claim under a letter of credit. On the hearing of the two Ord 14 summonses the questions arose (i) whether the parties to a contract could contract out of their right of set-off by stipulating that if one of them had a claim against the other the right of set-off was not to apply and (ii) whether a set-off could be maintained by a bank in answer to a claim by the beneficiary of a letter of credit.
MAIN JUDGEMENT
Held –
(1) As a matter of law a person could contract out of his right of set-off. Accordingly, the bank was entitled to rely on the clause in the letters of undertaking excluding any right of set-off against the letters of undertaking and the defendant was therefore debarred from seeking to maintain a set-off against the bank’s claim (see p 519 c, post); dictum of Lord Denning MR in Halesowen Presswork and Assemblies Ltd v Westminster Bank Ltd [1970] 3 All ER 473 at 477 applied; Lechmere v Hawkins (1798) 2 Esp 626 and Taylor v Okey (1806) 13 Ves 180 not followed.
(2) A bank could claim a set-off against the beneficiary of a letter of credit, especially if the bank’s claim was for a liquidated amount and arose out of the very banking transaction which gave rise to the letter of credit. It followed that the bank was entitled to set off its liquidated claims under the defendant’s forward contracts against its admitted liability to the defendant on the defendant’s counterclaim under the standby letter of credit (see p 522 e to h, post);Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] 1 All ER 976 distinguished; dictum of Lord Denning MR in Power Curber International Ltd v National Bank of Kuwait SAK [1981] 3 All ER 607 at 612 explained.
Notes
For contracting out from the right to deduct or abate, see 42 Halsbury’s Laws (4th edn) paras 418, 428, and for set-off between bank and customer, see ibid para 451.
For commercial letters of credit, see 3(1) Halsbury’s Laws (4th edn reissue) paras 252–257, and for cases on the subject, see 3 Digest (Reissue) 665–670, 4121–4136.
Cases referred to in judgment
Agra and Masterman’s Bank Ltd v Leighton (1866) LR 2 Exch 56.
Halesowen Presswork and Assemblies Ltd v Westminster Bank Ltd [1970] 3 All ER 473,[1971] 1 QB 1,[1970] 3 WLR 625, CA; rvsd [1972] 1 All ER 641,[1972] AC 785,[1972] 2 WLR 455, HL.
Home and Overseas Insurance Co Ltd v Mentor Insurance Co (UK) Ltd (in liq)[1989] 3 All ER 74, CA.
Howe Richardson Scale Co Ltd v Polimex-Cekop [1978] 1 Lloyd’s Rep 161, CA.
Intraco Ltd v Notis Shipping Corp, The Bhoja Trader [1981] 2 Lloyd’s Rep 256, CA.
Lechmere v Hawkins (1798) 2 Esp 626, 170 ER 477.
Malas (trading as Hamzeh Malas & Sons) v British Imex Industries Ltd [1958] 1 All ER 262,[1958] 2 QB 127,[1958] 2 WLR 455, CA.
Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH [1977] 2 All ER 463,[1977] 1 WLR 713, HL.
Owen (Edward) Engineering Ltd v Barclays Bank International Ltd [1978] 1 All ER 976,[1978] QB 159,[1978] 3 WLR 764, CA.
Power Curber International Ltd v National Bank of Kuwait SAK [1981] 3 All ER 607,[1981] 1 WLR 1233, CA.
Taylor v Okey (1806) 13 Ves 180, 33 ER 263, LC.
Summons and cross-summons
By a writ issued on 7 December 1988 the plaintiff, Hongkong and Shanghai Banking Corp, brought an action against the defendants, Kloeckner & Co AG (formerly Kloeckner & Co KGaA), claiming, inter alia, approximately $US8m, being the balance due to the bank pursuant to undertakings given by Kloeckner to the bank in respect of contracts for the supply of cargoes of oil by the Gatoil group of companies (who dealt in oil cargoes through Kloeckner), and damages for breach of contract. Kloeckner denied liability and sought to set off against the bank’s claim a counterclaim under a standby letter of credit given by the bank to Kloeckner in respect of the liabilities of Gatoil to Kloeckner. By a summons issued on 5 January 1989 and a cross-summons issued on 20 February 1989 under RSC Ord 14 the bank and Kloeckner respectively applied for summary judgment on the claim and the counterclaim. The summons and cross-summons were heard and judgment was given in chambers. The case is reported by permission of Hirst J. The facts are set out in the judgment.
Cur adv vult
21 March 1989. The following judgment was delivered.
HIRST J.
INTRODUCTION
The two RSC Ord 14 summonses which are presently before the court arise out of a very substantial series of banking transactions between the plaintiffs, Hongkong and Shanghai Banking Corp (the bank), and the defendants, Kloeckner & Co AG (Kloeckner), in connection with oil trading both in pre-sold physical cargoes of oil (wet cargoes) and in relation to forward contracts (dry cargoes).
The essential background is that the London branch of the bank provided certain facilities to the Gatoil group of companies, comprising a number of companies registered overseas linked by the common ownership and control of Mr Ghattas, in connection with crude oil trading dealings between Gatoil and Kloeckner, under which Kloeckner would ‘front’ Gatoil’s contracts with the general market under an umbrella arrangement by means of back-to-back contracts.
The bank provided to Gatoil a facility used for dealings in wet cargoes, under which the bank paid Gatoil’s suppliers, sometimes via letters of credit, and received a pledge of the relevant bill of lading. Kloeckner in their turn gave to the bank an undertaking to pay the bank against delivery to Kloeckner of the bill of lading, or, where the bill of lading was not yet available, against provision by the bank of an indemnity.
The bank also advanced moneys to Gatoil against assignments by Gatoil of the proceeds of matched pairs of forward contracts in dry cargoes together with undertakings by Kloeckner to pay the difference debt to the bank. In the case of the dry cargo arrangements, identical procedures were entered into with other banks which are relevant in the present context for reasons which will shortly appear.
The bank in addition provided a standby letter of credit in favour of Kloeckner in respect of the liabilities of Gatoil to Kloeckner on dry cargo transactions.
Kloeckner are a German company who carry on a substantial steel business, but who, as is readily apparent from the facts which I am about to recite, embarked recently on massive oil trading.
By the early autumn of 1988 this trading got completely out of hand, and on 12 October 1988 Kloeckner announced losses of DM600m on forward oil contracts. There then followed a rescue operation by the Deutsche Bank, who took over the company, which has since been restructured so that its corporate status is that of an Aktiengesellschaft (AG) and no longer that of a Kommanditgesellschaft auf Aktien (KGaA).
The head of Kloeckner’s crude oil trading department (IRPH) and chief oil trader, Mr W Zeschmar, was dismissed, and he is now under arrest in Germany.
The claim by the bank in the present action is for approximately $US8m for the balance due under payment undertakings given by Kloeckner to the bank in respect of wet cargo contracts, and it is the bank’s case that Kloeckner has no defence to this claim so that the bank are entitled to summary judgment. Kloeckner deny liability, contending that the relevant payment undertakings were entered into by Mr Zeschmar in excess of his authority and by means of telexes purporting to bear not only his signature but also that of another employee who in fact played no part and had no knowledge of Mr Zeschmar’s activities. Kloeckner also raise two technical defences which I will describe shortly. In addition Kloeckner seek if necessary to set off against the bank’s claim the sums claimed on their counterclaim which I am about to describe; in answer to the set-off the bank rely on a clause in the letter of undertaking debarring any set-off, counterclaim or deduction whatsoever, but Kloeckner make rejoinder that as a matter of law a party cannot contract out of his right of set-off.
By their cross-summons under Ord 14 Kloeckner seek summary judgment on their counterclaim for $10m payable under the standby letter of credit. This was the subject matter of two successive demands by Kloeckner, the first of which for exactly $10m was rejected by the bank, but the second for a slightly lower sum was accepted. The bank do not therefore dispute liability in principle for this lower sum, but assert a set-off in the sum of approximately $10·2m under assignments or undertakings relating to dry cargo contracts; these are the subject matter of separate litigation in an action in which both the bank and serveral of the other banks referred to above are also parties. Kloeckner concede that the dry cargo claims which the bank seek to set off are arguable, but contend that as a matter of first principle the court cannot as a matter of law entertain a set-off against a claim under a letter of credit.
The issues in the summons may therefore conveniently be grouped as follows, and I shall deal with them in this order following on a brief narrative of the salient documents: (i) the two questions of pure law which arise in relation to set-off, first whether it is open to a party to contract out of his right of set-off and second whether a set-off can be maintained in answer to a claim under a letter of credit; both these are obviously questions of importance and the latter is devoid of any authority;(ii) the two other short technical defences raised by Kloeckner in answer to the bank’s claim;(iii) the questions of fact which arise in connection with Mr Zeschmar’s alleged lack of authority; this will require a more detailed narrative of the background, which it is convenient to defer until that stage.
I wish to stress that all the issues of law which arise are reasonably short and compact, and therefore appropriately dealt with under Ord 14 in accordance with the principles laid down by the Court of Appeal (eg Home and Overseas Insurance Co Ltd v Mentor Insurance Co (UK) Ltd (in liq)[1989] 3 All ER 74).
MAIN NARRATIVE OF RELEVANT DOCUMENTS
The relationship between the bank and Kloeckner began in November 1987, and until June 1988, when the wet cargo dealings began, was confined to dry cargo transactions. The typical documentation in a wet cargo transaction comprised a contract between a Gatoil company and Kloeckner for the sale of a physical cargo of oil, a letter in standard form from Gatoil to the bank pledging the shipping documents, ie the bills of lading, a request from Gatoil to Kloeckner seeking a purchase undertaking in favour of the bank, bills of lading to the order of the bank, the usual letter of indemnity to cover the situation where as so often happens the shipping documents are delayed, and an invoice from Gatoil to Kloeckner.
The critical document, which is the basis of the bank’s claim, is the purchase undertaking, and I quote a typical example in full:
‘We refer to the contract dated 6th September 1988 between Gatoil S.R.T. S.A., and Kloeckner and Co KGaA, Duisburg for the purchase by Kloeckner of:
Type of product
Saharan Blend crude oil as usually made available for export.
Quantity
600,000 barrels plus or minus 5 per cent
Price
The simple average of the midpoints of daily spot quotations for dated Brunt effectively published as quote Brunt (DTD) unquote in the Platt’s crude oil marketwire telex for the last two publications preceding B/L date, the publication on B/L date if it exists, plus the first two publications following the B/L date plus usd 0.25/BBL F.O.B. Bejaia.
Parity
Latest 3rd October 1988.
Payment
30 days from bill of lading date additional 30 days at cost
We have duly noted that your bank possesses a security interest in this cargo and we, Kloeckner and Co KGaA, irrevocably undertake to make payment in full of Gatoil’s invoice without any discount, deduction, offset, or counterclaim whatsoever on the due date, i.e. 60 days from bill of lading date directly to the Hongkong and Shanghai Banking Corporation—London account with the Hongkong and Shanghai Banking Corporation New York in favour of Gatoil SRT S.A. Payment will be made directly by our bank on our behalf against presentation to us of below listed documents:—Seller’s original commercial invoice signed by the seller’s duly authorised signatory.—Full set of 3/3 original clean on board ocean bills of lading issued or endorsed to the order of Kloeckner and Co KGaA Duisburg and other usual shipping documents. In the event of non-availability of documents as specified above payment shall be made upon presentation of the following documents:—Seller’s original commercial invoice signed by the seller’s duly authorised signatory. (Telex acceptable with hard copy to follow).—A letter of indemnity countersigned by Hongkong and Shanghai Banking Corporation—London (Telex letter of indemnity acceptable with hard copy to follow).
Best regards
Kloeckner and Co KGaA
- Zeschmar/K.-H. Escher.’
It will be noted that the signatories or purported signatories are Mr Zeschmar and Mr H Escher, who was an employee of Kloeckner assigned to IRPH from another division. There were in all three purchase undertakings given by Kloeckner to the bank as follows: (i) a purchase undertaking dated 13 June 1988, signed by Mr Zeschmar and Mr Noll, who was Mr Escher’s superior, in the sum of approximately $9·8m, which was paid in full, including interest on its due date, 17 August 1988;(ii) a purchase undertaking dated 9 August 1988, signed by Mr Zeschmar and Mr Escher, in the sum of approximately $8·5m, of which the principal was paid on its due date, 14 October 1988, but not the interest of approximately $65,000, which remains unpaid and is part of the subject matter of the bank’s claim;(iii) the purchase undertaking quoted above dated 22 September 1988 in the sum of approximately $7·8m, of which both the principal and interest remain unpaid, and are therefore also the subject of the bank’s present claim.
A typical dry cargo transaction comprised a telex from Gatoil to Kloeckner, with a copy to the bank, confirming that Gatoil irrevocably assigned to the bank the proceeds of two specified cargoes, one sale contract and one purchase contract, accompanied by a calculation of the difference due to Gatoil. This was followed almost immediately by an irrevocable undertaking from Kloeckner to the bank, of which I quote a typical example:
‘We refer to Gatoil’s telex 1443 dated 18th April, 1988, and we hereby agree to the captioned assignment and we irrevocably undertaking to pay to Gatoil Overseas Inc.
about USD 297,000.00 around July 15th,1988
To:
Hong Kong and Shanghai Banking Corporation—New York
Account:
Hong Kong and Shanghai Banking Corporation—London
Attn:
Mr. Richard Tatum
Best regards
- Zeschmar/F. Noll
Kloeckner + Co KGaA.’
The amount referred to coincided precisely, of course, with the difference specified in the first telex.
The standby letter of credit dated 5 October 1988 was for a maximum of $10m, partial drawing allowed payable at sight against presentation of specified conventional documents. It was stipulated that, except as otherwise stated, the credit was subject to the Uniform Customs and Practice for Documentary Credit (1983 revision)(UCP).
ISSUES OF LAW ON SET-OFF
(a) Contracting out
It will have been noted that Kloeckner’s letter of undertaking specified that Kloeckner ‘irrevocably undertake to make payment in full of Gatoil’s invoice without any discount, deduction, offset, or counterclaim whatsoever on the due date’.
This very clear form of words is relied on by counsel for the bank as precluding any right of set-off by Kloeckner against the claims under the letters of credit.
Counsel for Kloeckner relies in answer on two old first instance authorities, namely Techmere v Hawkins (1798) 2 Esp 626, 170 ER 477 and Taylor v Okey (1806) 13 Ves 180, 33 ER 263. Lechmere’s case was a decision of Lord Kenyon CJ, and I quote the very short report in full (2 Esp 626 at 626–267, 170 ER 477):
‘In the summer of the preceding year, the Defendant having been in Scotland upon business, where the Plaintiff then resided, and being in want of money, applied to the Defendant for the loan of the sum he wanted. Prior to this period, the Defendant had been concerned for the Plaintiff, as his attorney; and the Plaintiff was then considerably in his debt. It was stated for the Plaintiff, that the Defendant had promised to pay this money so lent, notwithstanding the Defendant was then his debtor; and letters were produced in evidence from the Defendant to the Plaintiff, wherein he promises to pay the money the Plaintiff had so lent him, and for which the note had been given, without taking any notice of the debt the Plaintiff then owed, or affecting to set one demand against the other. Upon this evidence Erskine, for the Plaintiff, contended, that the Defendant could have no benefit of his set-off. In that case, where a creditor borrowed money of his debtor, under an express promise to pay it, it bound him under every circumstance to the absolute payment; nor could his undertaking be satisfied by setting off the debt against his own demand. Lord KENYON said he knew no such law, nor did he think there was any such legal obligation on the creditor: it might be an honorary obligation, and such as a man who gave it ought to observe; but if he thought fit not to consider such an obligation as binding, he could not compel him. There were mutual subsisting demands at the time of the action brought, and such as the statutes of set-off gave the party-Defendant power to set against the Plaintiff’s demand. Besides this, if he was to refuse the set-off here, it would drive the Defendant into a court of equity, where the judgment obtained here would be set off against the debt admitted to be due by the Plaintiff to the Defendant. He therefore over-ruled the objection, and admitted the Defendant to go into evidence of his set-off.’
This was followed eight years later in Taylor’s case (1806) 13 Ves 180 at 181, 33 ER 263 by Lord Erskine, who had by then become Lord Chancellor, who stated as follows:
‘My opinion is, that this Claim of set-off must be allowed in Equity; and, except from the Circumstance, that the Parties are not the same, it would do at Law, under the Authority of Lechmere v. Hawkins; which is precisely this Case. The Argument addressed to me yesterday for dissolving the Injunction was the same, that I used; that the express Promise bound the Party, making it an absolute Payment under all circumstances: but Lord Kenyon answered, that he knew no such Law; and did not think, there was any such legal Obligation; and the mutual Demands were within the Statute of set-off. But what weighs with me is what was said, by Lord Kenyon, who was perfectly acquainted with the Rules of Equity; that, if he should refuse the set-off, it would drive the Party into Equity.’
These two cases are cited as good authority for the proposition that a right of set-off ‘cannot be waived’ in the current edition of Halsbury’s Laws of England, 42 Halsbury’s Laws (4th edn) para 434, and, though not strictly binding on me, are of course very highly persuasive.
However in Halesowen Presswork and Assemblies Ltd v Westminster Bank Ltd [1970] 3 All ER 473,[1971] 1 QB 1 the Court of Appeal (Lord Denning MR, Winn and Buckley LJJ) held that the right in law of a banker to combine the accounts of a customer and to set off debits on or against credits on the others could be excluded by an agreement, express or implied, to keep the accounts separate. Lord Denning MR stated ([1970] 3 All ER 473 at 477,[1971] 1 QB 1 at 34):
‘Seeing that the banker’s lien is no true lien, in order to avoid confusion, I think that we should discard the use of the word “lien” in this context and speak simply of a banker’s “right to combine accounts” or a right to “set-off” one account against the other. Using this phraseology, the question in this case is: suppose a customer has one account in credit and another in debit. Has the banker a right to combine the two accounts so that he can set-off the debit against the credit, and be liable only for the balance? The answer to this question is: Yes, the banker has a right to combine the two accounts whenever he pleases, and to set-off one against the other, unless he has made some agreement, express or implied, to keep them separate.’
Winn LJ agreed. Buckley LJ, though dissenting on another point, also agreed on the point presently at issue.
Manifestly, as counsel for Kloeckner recognised, the Halesowen case makes at the very least a major inroad into the suggested general principle stated by Halsbury’s Laws in reliance on the two old cases. However he seeks to distinguish the Court of Appeal case on the footing that it enshrines some special rule relating to bank accounts. I am unable to see any sound foundation for this distinction. Nor was counsel for Kloeckner able to suggest any rational basis for such a rule. In my judgment the Halesowen case gives me very ample grounds for departing from the two old cases. In consequence, I hold that as a matter of law the bank are entitled to rely on the clause excluding any right of set-off against the letter of undertaking, and that this effectively debars the set-off which Kloeckner seek to maintain.
(b) Letters of credit
Counsel for Kloeckner submits that there can in law be no set-off by a bank against a beneficiary of a cross-claim in response to a claim by the latter under a letter of credit. He relies by analogy on the very well known line of cases which establish that the bank’s obligation under a letter of credit or performance bond is quite independent of any disputes between the customer and the beneficiary, so that the bank must pay in full irrespective of any right of set-off being asserted between the parties to the underlying transaction. This rule is typified by the decision of the Court of Appeal in the leading case of Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] 1 All ER 976,[1978] QB 159. This was of course a performance bond case, but the decision reflected the same rule which applies to letters of credit. In the leading judgment Lord Denning MR stated ([1978] 1 All ER 976 at 981,[1978] QB 159 at 169):
‘A performance bond is a new creature so far as we are concerned. It has many similarities to a letter of credit, with which of course we are very familiar. It has been long established that when a letter of credit is issued and confirmed by a bank, the bank must pay it if the documents are in order and the terms of the credit are satisfied. Any dispute between buyer and seller must be settled between themselves. The bank must honour the credit. That was clearly stated in Malas (trading as Hamzeh Malas & Sons) v British Imex Industries Ltd [1958] 1 All ER 262 at 263,[1958] 2 QB 127 at 129. Jenkins LJ, giving the judgment of this court, said: “… it seems to be plain that the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes on the banker an absolute obligation to pay, irrespective of any dispute which there may be between the parties on the question whether the goods are up to contract or not. An elaborate commercial system has been built up on the footing that bankers’ confirmed credits are of that character, and, in my judgment, it would be wrong for this court in the present case to interfere with that established practice.” To this general principle there is an exception in the case of what is called established or obvious fraud to the knowledge of the bank.’
Lord Denning MR then proceeded to indentify the one well-established exception, namely where there is obvious fraud to the knowledge of the bank, and thereafter to discuss particular features of performance bonds both generally and in relation to that particular case. He then continued ([1978] 1 All ER 976 at 983,[1978] QB 159 at 171):
‘All this leads to the conclusion that the performance guarantee stands on a similar footing to a letter of credit. A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice.’
Browne and Geoffrey Lane LJJ delivered concurring judgments.
Counsel for Kloeckner also placed particular reliance on the decision of the Court of Appeal in Power Curber International Ltd v National Bank of Kuwait SAK [1981] 3 All ER 607,[1981] 1 WLR 1233, where it was held that the bank was obliged to honour a letter of credit notwithstanding a successful application by the buyers to the Kuwaiti court for an order of provisional attachment of the sums due payable by the defendant bank to the plaintiff sellers under the letter of credit. Lord Denning MR, in considering whether the English court should recognise the order of the Kuwaiti court, stated ([1981] 3 All ER 607 at 612–613,[1981] 1 WLR 1233 at 1241):
‘On this question of recognition, I must draw attention to the importance of letters of credit in international trade. They are the means by which goods are supplied all the world over. It is vital that every bank which issues a letter of credit should honour its obligations. The bank is in no way concerned with any dispute that the buyer may have with the seller. The buyer may say that the goods are not up to contract. Nevertheless the bank must honour its obligations. The buyer may say that he has a cross-claim in a large amount. Still the bank must honour its obligations. A letter of credit is like a bill of exchange given for the price of goods. It ranks as cash and must be honoured. No set-off or counterclaim is allowed to detract from it (see Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH [1977] 2 All ER 463,[1977] 1 WLR 713). All the more so with a letter of credit. Whereas a bill of exchange is given by buyer to seller, a letter of credit is given by a bank to the seller with the very intention of avoiding anything in the nature of a set-off or counterclaim. This is borne out by the Uniform Customs and Practice for Documentary Credits which have been adopted by the banks in all, or practically all, the countries of the world, from China to Andorra, from Cuba to Nauru. All subscribe to the Uniform Customs and Practice which declare in the general provisions and declaration “… (c) Credits, by their nature, are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts …” If the court of any of the countries should interfere with the obligations of one of its banks (by ordering it not to pay under a letter of credit), it would strike at the very heart of that country’s international trade. No foreign seller would supply goods to that country on letters of credit because he could no longer be confident of being paid. No trader would accept a letter of credit issued by a bank of that country if it might be ordered by its courts not to pay. So it is part of the law of international trade that letters of credit should be honoured and not nullified by an attachment order at the suit of the buyer.’
Griffiths LJ and Waterhouse J delivered concurring judgments.
Counsel also relied on the well-known passage in the judgment of Donaldson LJ in Intraco Ltd v Notis Shipping Corp, The Bhoja Trader [1981] 2 Lloyd’s Rep 256 at 257:
‘In refusing to interfere with the sellers’ right to call upon the bank to make payment under its guarantee, the learned Judge acted in conformity with the well-established principle that the Court will not grant such an injunction unless fraud is involved (see Richardson (Howe) Scale Co. Ltd. v. Polimex-Cekop and Another ([1978] 1 Lloyd’s Rep 161)). We agree with him. Irrevocable letters of credit and bank guarantees given in circumstances such that they are the equivalent of an irrevocable letter of credit have been said to be the life blood of commerce. Thrombosis will occur if, unless fraud is involved, the Courts intervene and thereby disturb the mercantile practice of treating rights thereunder as being the equivalent of cash in hand.’
Counsel for Kloeckner submitted that the rationale of the principle laid down in these cases is that the beneficiary should have the assurance of a certain paymaster, and should be able to treat the payment mechanism as an equivalent to cash in hand, free from the taint of any argument he may have with the bank’s customer concerning some other transaction, that there is no reason why the rule of no set-off should not equally apply to the relationship between the bank and the beneficiary and that as a matter of policy there is every reason why it should so apply. He accepted that there was no authority directly in support of his proposition but submitted that the reason was (i) cases in which the beneficiary is indebted to the bank are comparatively rare, seeing that in letters of credit cases that the established banking relationship is almost invariably between the buyer and his bank, and the choice of bank from the beneficiary’s point of view is purely fortuitous, and (ii) where such cases occur, banks usually honour in full their letter of credit obligations and pursue their own claims independently.
Counsel for the bank submitted that all these cases, and the dicta contained in them, must be interpreted by reference to their essential ratio decidendi, namely that the relationship between the bank and the beneficiary is entirely independent of any differences which may arise between the buyers and the sellers in connection with the underlying contract. They are therefore no authority whatsoever in the present situation, which relates to cross-claim by the bank themselves against the beneficiary.
In the very rare cases, such as the present, where there was a claim as between the bank themselves as claimants and the beneficiary there was no good reason for extending the rule in the Edward Owen line of cases, which arose from quite different circumstances.
Alternatively, counsel for the bank submitted that any restriction to a right of set-off by the banks themselves should be no greater than that in relation to bills of exchange, which are also intended to ‘equivalent to cash’ ie that (as is well settled) a set-off is permissible where the cross-claim is liquidated, though not where it is unliquidated (see Agra and Masterman’s Bank Ltd v Leighton (1866) LR 2 Exch 56 and Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH [1977] 2 All ER 463,[1977] 1 WLR 713).
Quite apart from the question of general principle raised, counsel for Kloeckner also sought to rely on two considerations related to rules of the UCP, which, as already noted, were incorporated in the standby letter of credit. These were based on two grounds. (a) Article 10(a) of the UCP lays down that provided that the stipulated documents are presented and the terms and conditions of the credit complied with an irrevocable credit providing for sight payment constitutes a definite undertaking by the issuing bank to pay or that payment will be made. (b) If the rule was otherwise, the beneficiary in a string of sales would be in difficulty if he needed to transfer the letter of credit to his supplier under art 46 of the UCP.
Let me first dispose of these two last points, neither of which in my judgment has any substance. Article 10(a) does no more than state the absolute obligation of the banker to pay, thus providing a solid foundation for a claim by the beneficiary against the bank for payment, but has no bearing whatsoever on the validity or otherwise of a set-off against that undoubted liability. The point under art 46 also fails, first because there is no vested right in the beneficiary to transfer, since under art 46(b) it is provided that the bank shall be under no obligation to effect such transfer except to the extent and in the manner expressly consented to by the bank, and second because such a transfer would not be of a debt as such (subject possibly to the set-off) but rather of a contractual right to engender a debt by presentation of the documents.
Dealing now with the general point of principle, I do not think that the analogy with the Edward Owen line of cases is a sound one. The basis of those decisions is that the bank’s obligation to the beneficiary under the letter of credit is wholly independent from any disputes between the buyer and the seller in relation to the underlying contract. The reason of policy on which this doctrine is based is that otherwise a letter of credit would be almost valueless, since, as the everyday experience of the Commercial Court and the City of London arbitration community shows, such disputes (eg as to short delivery, damage in transit, defects of quality and the like) are commonplace; if, therefore, every time such a dispute arose (or was even alleged by the buyer to arise) the buyer was free to stop payment under the letter of credit, the assurance given to the seller by a letter of credit would be severely undermined, and the lifeblood of international trade would truly be afflicted by a thrombosis.
The present situation is quite different; it is only on the rarest occasions, as counsel for Kloeckner recognised, that a separate dispute will arise between the bank and the beneficiary, since from the beneficiary’s point of view the choice of paying bank is fortuitous, and it is only in the rarest cases that there will be any antecedent banking connection between them that could give rise to such a dispute. Moreover, if a beneficiary wished to avoid the nomination of a particular bank as paying bank he would, as counsel recognised, be in a position to do so before completion of the underlying contract, though I accept that it is unlikely that he would always be alert to the risk. Consequently the same policy reasons do not apply to the present problem and give no justification for a similar restriction.
There is thus nothing in the Edward Owen line of authorities which compels me to adopt the conclusion sought by counsel for Kloeckner. I should add that the statement in Lord Denning MR’s judgment in the Power Curber case [1981] 3 All ER 607 at 612,[1981] 1 WLR 1233 at 1241 that ‘No set-off or counterclaim is allowed to detract from [the letter of credit]’, must be interpreted as meaning a set-off or counterclaim by the buyer against the seller and not one by the bank against the seller, the latter situation not being under consideration in that case.
There are two striking features of the present case. First the standby letter of credit was opened for the specific purpose of financing the liabilities on the dry cargo transactions, so that it would seem very unjust if the bank were precluded from enforcing a set-off in relation to the present claims which arise directly out of the selfsame transactions. Second, this is a liquidated set-off, and it would seem to me anomalous that such a set-off should be unavailable in letter of credit cases but available against bills of exchange, which, as the judgments quoted above show, are closely analogous in that a bill of exchange is also virtually equivalent to cash.
Had it been necessary to decide the point I should have been prepared to hold that there is no principle equivalent to that laid down in the Edward Owen line of cases that debars a bank setting off against a beneficiary under a bill of exchange a claim by the bank themselves against that beneficiary. Given the additional circumstances present here, namely that the bank’s claim is liquidated and relates to the very banking transactions which gave rise to the letter of credit itself, the case in favour of a right of set-off seems to me overwhelming.
It therefore follows that in the present case it is open to the bank to set off their liquidated claims under the dry cargo transactions (which are admittedly arguable) against their admitted liability to Kloeckner on the counterclaim under the standby letter of credit.
[His Lordship dealt with the outstanding questions of fact in the remainder of his judgment, which was not released for publication.]
Order accordingly.
