Key Insights on Letters of Credit and Practical Steps for Financing Banks in Singapore
Pierre Dzakpasu and Anne Jesudason of Mayer Brown discuss Letters of Credit and Letters of Indemnity and refer to the decision on a relevant case in Singapore.
Pierre Dzakpasu
Ranked in Chambers Asia-Pacific: Restructuring/Insolvency: International
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Anne Jesudason
View firm profileThe Court’s Decision
On 24 October 2023, the Singapore Court of Appeal handed down its decision in Crédit Agricole Corporate and Investment Bank, Singapore Branch v PPT Energy Trading Co Ltd [2023] SGCA(I) 7.
The case concerned two documents:
- a Letter of Credit issued by Crédit Agricole Corporate and Investment Bank (CACIB) in favour of PPT Energy Trading Co Ltd (PPT) to finance PPT’s purchase of crude oil cargo from Zenrock Commodites Trading Pte Ltd (“Zenrock”); and
- a Letter of Indemnity issue by PPT in favour of CACIB, which included a warranty as to the marketable title of the crude oil cargo.
During the litigation, it was common ground that Zenrock (not a party to the litigation), had acted fraudulently in obtaining competing Letters of Credit over the same cargo using doctored transaction documents. The competing Letters of Credit led to interpleader proceedings between CACIB and ING Bank NV (ING) that were separate to this litigation.
In this litigation, the issues were:
- whether CACIB could rely on the “fraud exception” to refuse payment to PPT under the Letter of Credit; and
- whether CACIB was entitled to be compensated by PPT for breach of warranty under the Letter of Indemnity.
Ultimately, the Court of Appeal held the following:
CACIB could not refuse payment under the Letter of Credit based on the “fraud exception”. The Court of Appeal relied upon factual findings by the trial judge that although PPT could not be said to be an innocent bystander, it did not meet the very high threshold of actual knowledge or wilful blindness to be deemed party to Zenrock’s fraud (The authors note that recently in Winson Oil Trading Pte Ltd v Oversea-Chinese Banking Corporation Limited [2024] SGCA 31, the Singapore Court of Appeal held that the fraud exception can also be established by “subjective recklessness” as to the existence of fraud. The Court of Appeal in Winson was careful to note that subjective recklessness is a higher standard than negligence and is “only made out where there is an actual indifference to the risk of which the defendant is actually conscious.” The Court of Appeal also provided some clarity in this area by also holding that “the law should ‘call a fraud a fraud’ and the courts should apply a consistent approach in examining” fraud across “different types of financial instruments”. Thus, while more lenient than the standard the SICC applied in Crédit Agricole Corporate and Investment Bank, Singapore Branch v PPT Energy Trading Co Ltd [2022] SGHC(I) 1, it is nevertheless a difficult standard to meet in practice. It remains to be seen how this test will be applied going forward given the jurisprudential development in this area, and issuers should still be mindful of the high threshold needed to rely on the exception.).
However, CACIB did establish that PPT had breached its warranties as to marketable title under the Letter of Indemnity. Applying a totality of the circumstances test, the SGCA included the following factors when concluding that PPT lacked a marketable title (Crédit Agricole Corporate and Investment Bank, Singapore Branch v PPT Energy Trading Co Ltd [2023] SGCA(I) 7, [68].):
- the failure of Zenrock to have acted in the ordinary course of business;
- PPT’s failure to be a bona fide purchaser;
- the fact that there was a prima facie breach of warranty since the Cargo was not free of liens or encumbrances because the floating charges were crystallised before shipment (when title was argued to have passed);
- PPT had notice of the charges, since they were registered, although not necessarily of the terms of those charges (The Singapore Court of Appeal (SGCA) held at [68] that it is uncertain if the fact that PPT did not have notice of the exact terms of those charges mattered.); and
- the uncertainty created by the absence of judicial precedent on the scope of the warranty of title “free and clear of any lien or encumbrance” makes it even more important that the warranty of “marketable title” is given a broader scope to include being free from hazard or litigation.
The decision sets out a number of important principles that are relevant to lenders providing asset or trade financing through Letters of Credit. This case is particularly relevant to issuing banks that rely on Letters of Indemnity to protect their credit positions in the absence of a bill of lading.
Letters of Credit
Letters of Credit are common financing instruments that are routinely issued in asset sale transactions and trade finance transactions. They are useful tools that can be deployed throughout the life of a transaction to achieve various purposes, including to provide both interim comfort and leverage in pre-dispute situations. In the wake of this case, both issuers and beneficiaries alike should take time to understand when the payment obligation arises and whether there are any conditions to the contract’s effectiveness.
Marketable title
The Letter of Indemnity is a key source of protection for issuers, who will often seek to rely on it in the absence of original bills of lading. However, this case proves that the position is significantly more nuanced and that, from a risk perspective, paying out against a Letter of Indemnity is not identical to paying out against original bills of lading.
Key Takeaways and Practical Steps
In light of this decision, financiers that provide Letters of Credit and that rely on warranties and indemnities to protect their positions should consider the following takeaways and practical steps to better manage risk in similar scenarios.
- A financier’s obligation to pay the seller under a Letter of Credit remains independent of matters affecting the underlying sale contract.
- Although a Letter of Indemnity provided to protect a financier’s payment under a Letter of Credit is generally effective upon issue, this is not an absolute rule and will depend on the drafting of both the Letter of Indemnity and the Letter of Credit.
- Finding a breach of a warranty for marketable title is highly contextual and the court will consider the full circumstances to the extent possible. In a litigation scenario, however, the predictability of the circumstances that will be surfaced is intrinsically low. As such, specificity should be a priority when drafting warranties and pre-determined events should be contemplated (eg, inconsistent security interests and assets being subject to potential litigation).
- A bank is exposed to the risk on the terms of a Letter of Indemnity when relying on such letter that is a derivative of the underlying sale between the seller/beneficiary of the Letter of Credit and the buyer (the customer of the issuing bank). These indemnities are typically based on a traditional sale of goods and are not drafted for the purpose of indemnifying the issuing bank against losses it might suffer from issuing the Letter of Credit, resulting in the protections offered by these indemnities being less effective than what the bank may have intended.
- Financiers should not assume that the amount of indemnity available will always cover the full extent of the debt under a Letter of Credit.
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