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01 Nov 2017

Letters of credit in the Supreme Court: Some unintended consequences?


In Taurus Petroleum v SOMO the Supreme Court has granted a third party debt order and receivership order against an issuing bank over the proceeds of a letter of credit. Its decision appears to be contrary to the commercial and legal structure of a letter of credit and the terms of UCP 600. It has overridden legitimate third party interests under the credit. It may also have opened the door wider to effective injunctions by foreign courts obtained by a buyer to prevent an issuing bank making payment under a letter of credit. The law of unintended consequences may have come into play.

Letter of credit cases rarely reach the Supreme Court. In Taurus Petroleum Limited v State Oil Marketing Company of the Ministry of Oil, Republic of Iraq, however, one has done so1.

Taurus – The background 

Taurus is an oil trading company. SOMO is the Iraqi state marketing company responsible for the sale of Iraqi oil. In February 2013, Taurus obtained an arbitration award against SOMO for about US$8.7million arising out of a dispute between them.

In March 2013, Taurus (a) obtained leave to enforce the arbitration award under Section 66 of the Arbitration Act and (b) obtained an interim third party debt order ("TPDO") and a receivership order in respect of sums payable by the London branch of Crédit Agricole to SOMO under two letters of credit, issued by Crédit Agricole on behalf of a company or companies in the Shell Group in respect of consignments of oil sold by SOMO to Shell. Part of the proceeds of the letters of credit were paid by Crédit Agricole into court in March 2013 so Crédit Agricole dropped out of the picture.

The TPDO and receivership order were subsequently set aside by Burton J and that decision was upheld by the Court of Appeal (albeit on different grounds). However, the monies remained in court pending the outcome of the proceedings and the appeal to the Supreme Court.

The terms of the letters of credit 

The letters of credit were issued in the form of telexes from Crédit Agricole addressed to the Central Bank of Iraq ("CBI") and appear to have been in a standard form for such credits. Each included the following provisions:

  • CBI was asked to advise the letter of credit to SOMO after adding CBI's confirmation;
  • The letter of credit was available by deferred payment 30 days from bill of lading date against the presentation of documents at the counters of CBI in Baghdad for negotiation;
  • There were what are described in the judgment as "special conditions" in the following terms:

    "[A] Provided all terms and conditions of this letter of credit are complied with, proceeds of this letter of credit will be irrevocably paid in to your account with Federal Reserve Bank New York, with reference to "Iraq Oil Proceeds Account".


    These instructions will be followed irrespective of any conflicting instructions contained in the seller's commercial invoice or any transmitted letter.

    [B] We hereby engage with the beneficiary and Central Bank of Iraq that documents drawn under and in compliance with the terms of this credit will be duly honoured upon presentation as specified to credit CBI A/c with Federal Reserve Bank New York.2
  •  The letter of credit was subject to UCP 600;
  • The letter of credit was not assignable and not transferable; and
  • There were also further "special instructions to [CBI]":

    Upon receipt of your authenticated telex/SWIFT confirming that you have taken up documents in strict conformity with credit terms and conditions and couriered them to us, we undertake to effect payment at maturity as per your instructions, provided that such telex/SWIFT is received at least 1 New York/London banking day prior to due date. Otherwise, payment will be made 1 New York/London banking day later.

The regime relating to payments for Iraqi oil

It is well known that under a 2003 UN Resolution imposing sanctions on Iraq, proceeds of sale of Iraqi oil were to be paid into an account held by CBI at the Federal Reserve Bank of New York. 95% of the receipts were to be used for development within Iraq and the balance for reparations to Kuwait.

Decision of the Supreme Court

By a majority of 3 to 2, the Supreme Court restored the original interim TPDO and the receivership order.

The reasons given, in summary, were as follows:

  1. SOMO was the beneficiary of the letters of credit and the debt owed under the credits was owed by Crédit Agricole to SOMO.
  2. The "situs" of the debt under the letters of credit was England, where the branch of Crédit Agricole had issued them, not New York where the proceeds were payable. Here, the Supreme Court unanimously overruled the judgment of the Court of Appeal given in 1981 in Power Curber International Limited v National Bank of Kuwait SAK ("Power Curber") [1981] 1 WLR 1233.
  3. Any obligation owed by Crédit Agricole to CBI as to the making of payments to the special account under the special conditions did not give CBI any proprietary interest in the proceeds of the letters of credit arising out of an assignment by SOMO to CBI of its right to payment, but (at most) was a contractual entitlement as against Crédit Agricole to the proceeds, which did not override the imposition of the TPDO. The making of the TPDO would in effect discharge the liability of Crédit Agricole under the credit as a matter of English law. 
  4. That no principle of "honest dealing" applied to entitle CBI to the payment.

    Lord Sumption said (at [70]) that:

    "The issuing bank had a personal obligation to SOMO to pay it by crediting CBI's New York account. That obligation was modified by the overriding effect of the [TPDO]….[The] obligation owed by the issuing bank to CBI was to discharge the debt owed to SOMO by crediting CBI's New York account".

    Lord Mance and Lord Neuberger dissented. Lord Mance said, in summary, that the effect of the special conditions was to amount to an irrevocable agreement between Crédit Agricole, CBI and SOMO that (i) any payment under the credit should be made to CBI and (ii) SOMO should have no right against Crédit Agricole to demand such payment.

    Lord Neuberger held that the special conditions meant the debts under the credit were owed to CBI, and not to SOMO, either by a form of assignment or by novation; and if he was wrong on this the TPDO and receivership order should in any event not be made having regard to the contractual rights of CBI.

The decision of the majority of the Supreme Court does give rise to some concerns.

The commercial background and legal structure of letters of credit 

The commercial background to a letter of credit is familiar but bears setting out briefly. This is of course a very simplified example.

A ‎seller in country B sells goods to a buyer in country A. The seller wants security of payment and the buyer security of getting the goods (or at least the related documents of title to them).

The buyer will have a bank, usually in country A, but the seller wants payment at a place of its choosing (usually country B). So, via a letter of credit, bank X in country A authorises bank Y in country B to accept the shipping documents (and any other documents the buyer may require), and in return bank Y is authorised to: pay, incur a deferred payment obligation, negotiate (i.e. in effect buy the documents) or accept a bill of exchange drawn under the credit either on bank X or bank Y.

The credit may be confirmed, i.e. bank Y gives an independent undertaking to the seller ahead of presentation that it will honour the payment if the documents conform with the credit. But even without that undertaking bank Y is authorised to and can, if it wishes: pay, incur its deferred payment obligation, negotiate or accept a bill of exchange. It does so essentially as principal albeit as part of an agency relationship with bank X. In the words of UCP in doing so bank Y is "acting on its nomination" i.e. as agent of bank X. Of course bank Y does not have to act on its nomination but it is usual (or at least common) for it to do so, and that is what the letter of credit and UCP will allow.

The result is that under a letter of credit, in most cases at least once the documents are presented to banks, the principal‎ obligation of bank X is to indemnify/reimburse bank Y for the payment/obligation bank Y has incurred to the seller. Bank X retains an obligation to the seller but this only arises in a situation either where bank Y fails to meet its own obligation to the seller, or bank Y chooses not to incur such an obligation. But at the time of issue of the letter of credit there can be no assumption that bank Y will not do so.

This commercial structure is followed through in the legal structure set out in UCP 600. In particular, the issuing bank's undertakings are set out in article 7 of UCP 600.

‎Importantly, under Article 7a, the obligations to the beneficiary to pay, incur a deferred payment obligation, negotiate or accept a draft only kick in where there is failure by the nominated bank to do so. Otherwise, the obligation is to reimburse the nominated bank (article 7c).

The construction of UCP and the credits

The Supreme Court judges all approached the matter as one of construction of the letters of credit (and the special conditions) together with UCP 600. However, although the judgments make reference to the fact that UCP governed the letters of credit, they contain almost no reference to its terms other than to state (no doubt correctly so far as it goes) that a beneficiary has rights against the issuing bank under the credit. In particular, and remarkably, no reference is made to Article 7 which sets out, in very clear terms, what obligations are undertaken by an issuing bank and to whom. As has been said, Article 7 states that, in the normal course, the principal obligation of the issuing bank is to reimburse the nominated bank (here CBI) in respect of obligations CBI undertakes to SOMO.

The special conditions

In the Supreme Court (and indeed the Court of Appeal), it is said that the "special conditions" inserted in the credit were very unusual with the suggestion that the courts were here dealing with a situation very much out of the ordinary. This appears to derive from submissions by Counsel for Taurus, rather than any evidence as such.

It may respectfully be suggested that that is not in fact the case. As established, there was a perfectly standard letter of credit structure where CBI was the advising (and indeed confirming3) bank. In that context, the requirement of the special conditions (no doubt insisted on by CBI as a term of credits it advised for oil contracts) that payment by Crédit Agricole be made to a specific account at CBI (and nowhere else), provided the terms of the credit were complied with, is not of itself unusual and in practical terms does no more than to reflect what is said in Article 7. The only unusual feature was that as a result of the UN arrangements when CBI obtained the proceeds they would be paid, not to SOMO, but to the benefit of the Iraqi government and towards Kuwaiti reparations. But that was a matter between CBI and SOMO and nothing to do with Crédit Agricole. Arrangements (and restrictions on the beneficiary) as to what is done with the proceeds may well arise between a nominated bank/confirming bank and its beneficiary under a normal financing/security structure.

An adverse effect on letters of credit?

The contractual structure under UCP is quite plain. The issuing bank gives undertakings and incurs payment obligations both to the nominated bank and to the beneficiary but in the normal course the principal obligation is to pay the nominated bank, not the beneficiary. The reimbursement obligation to the nominated bank is not, as is suggested by the majority of the Supreme Court, some sort of obligation collateral to the issuing bank's liability to the beneficiary; if anything it is the reverse.

If the Supreme Court really intends to suggest that in the normal course a judgment creditor can "intercept4" the proceeds of a letter of credit at the level of the issuing bank, on the basis that the advising bank has no more than a contractual entitlement which can be overridden by a TPDO or receivership order, then that is an outcome which is profoundly regrettable. It is a completely unjustified inference with the rights of third parties under legitimate and normal contractual arrangements. Indeed, once it is accepted that this is possible post- judgment, what reason of principle is there not to "intercept" such payments pre-judgment via freezing orders or receivership orders?  It is to be hoped that a cottage industry of attempts to intercept payments under letters of credit issued in London will not arise. If it does it would be a major disincentive to any seller accepting a letter of credit to be issued by a London bank or for banks elsewhere to be parties to such a credit. At the very least, nominated or confirming banks may have to intervene to protect their rights; and on one view of the majority decision they may not be successful.

The situs issue

This may look like a technical point, but it is potentially important in particular to sellers and their banks who have incoming letters of credit issued abroad. As the Supreme Court said, the traditional rule is that the "situs" of a debt is the place of residence of the debtor. However, in the Power Curber case the Court of Appeal held that in the case of a letter of credit the situs of the debt was the place where payment was to be made by the advising bank. In that case, there was a letter of credit issued by the National Bank of Kuwait ("NBK") in Kuwait which was payable to Power Curber via an advising bank in North Carolina. The buyers obtained a "provisional attachment" from the Kuwait court in respect of the letter of credit which NBK relied on as a reason not to pay. However, the Court of Appeal held that the letter of credit was governed by the law of North Carolina as the place of payment and the situs of the debt was in North Carolina and not Kuwait. Hence the attachment could not prevent judgment being given against a branch of NBK in London in respect of the otherwise unarguable debt. The Power Curber principle may look anomalous but it is accepted to be the law in several other common law jurisdictions, as the Supreme Court recognised.

However, the finding of the Supreme Court that the situs of the debt owed under the credit is that of the issuing bank does raise a question as to how the English court will now react to the (unfortunately not uncommon) situation where an order is obtained (often by the buyer) in the jurisdiction of the issuing bank to attach or prevent payment under a letter of credit payable in London where a dispute has arisen with the seller. Not only in Power Curber but in other cases the English courts have traditionally taken a robust approach to such applications (see for example Bank of Baroda v Vysya Bank [1994] 2 Lloyds Rep 87, a decision of Mance J, now Lord Mance). The question arises as to whether such a robust response as against the issuing bank will be possible in the future to such injunctions/attachments, given it is now accepted that the situs of the debt is indeed in the issuing bank's jurisdiction. There may be answers to that problem but they are not so clear.


1  [Read the full judgment here]  The parties are referred to here as "Taurus" and "SOMO".
2  The [A] and [B] were not in the credits but were used in the judgments of the Court of Appeal and Supreme Court for clarity.
3  It appears to be accepted CBI did not in fact confirm the credit but the judge recorded that the balance of the proceeds of the credits which were not paid into court were paid to CBI's account in New York under the credits.
4  A phrase used by Lord Clarke at [56]


Richard Gwynne

Richard Gwynne

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