Rarotonga, 2010


Online Lawyer

Most Popular
Contracts / Torts / Evidence / Limitations / Tenant Plus / welfare (ontario works) / odsp / human rights / employment / consumer / COVID Litigation

home / about / Little Friends Lefkada (Greece) / testimonials / E-Colleagues / Conditions of Use

Civil and

Canadian Animal Law

Contract - Guarantees III

. 7636156 Canada Inc. (Re)

In 7636156 Canada Inc. (Re) (Ont CA, 2020) the Court of Appeal explains the role of a letter of credit (LOC) as guarantee, here to satisfy a tenant's obligations under a commercial lease:
[36] The LOC is a standby letter of credit, which consists of an undertaking by the issuing bank, BNS, to honour drafts or other demands for payment by the beneficiary Landlord upon compliance with the conditions specified in the credit: Kevin McGuinness, The Law of Guarantee, 3rd ed. (Toronto: LexisNexis, 2013), at §16.4.

[37] By its terms, the LOC was subject to the version of the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits (“UCP”) in effect on the date it was issued by BNS, which was the 2007 Revision, ICC Publication no. 600 (“UCP 600”). Under article 1 of UCP 600, the rules for documentary credits apply to any standby letter of credit.

[38] The formation of a standby letter of credit involves three parties: the account customer of the issuing bank who applies for the credit, in this case the Tenant; the issuing bank, BNS; and the beneficiary of the credit, the Landlord. A standby letter of credit is a performance-securing mechanism in that it constitutes an obligation of the issuer to the beneficiary to make payment on account of any default by the applicant customer in the performance of an obligation upon certification by the beneficiary that the applicant has failed to fulfil its obligations to the beneficiary: McGuinness, at §16.45. As such, the starting point in any standby letter of credit transaction is the formation of an underlying contract between the applicant customer of the issuing bank and the beneficiary of the credit.

[39] Nevertheless, a fundamental characteristic of standby letters of credit is their autonomy from the underlying transaction between the applicant and the beneficiary. This critical characteristic was explained by the Supreme Court of Canada in Bank of Nova Scotia v. Angelica‑Whitewear Ltd., 1987 CanLII 78 (SCC), [1987] 1 S.C.R. 59, at pp. 70 and 103:
The fundamental principle governing documentary letters of credit and the characteristic which gives them their international commercial utility and efficacy is that the obligation of the issuing bank to honour a draft on a credit when it is accompanied by documents which appear on their face to be in accordance with the terms and conditions of the credit is independent of the performance of the underlying contract for which the credit was issued. Disputes between the parties to the underlying contract concerning its performance cannot as a general rule justify a refusal by an issuing bank to honour a draft which is accompanied by apparently conforming documents. This principle is referred to as the autonomy of documentary credits.

[I]t is essential that [the issuing bank’s] obligation to pay should not be subject to determination after the event by what actually transpired in the performance of the underlying contract. That is the other side of the principle of autonomy. The obligation of the issuing bank to the beneficiary of a credit must at all times be independent of the actual performance of the underlying contract. [Emphasis added.]
[40] Article 4(a) of UCP 600 elaborates on the autonomy of the obligation arising between the issuing bank and the beneficiary:
A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such a contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. [Emphasis added.]
Article 5 reinforces the autonomous character of a letter of credit by stating that “[b]anks deal with documents and not with goods, services or performance to which the documents may relate.”

[41] The autonomous nature of letters of credit is essential for their commercial risk-minimization function. As described by McGuinness, at §16.47:
The beneficiary of a letter of credit obtains a gold standard of payment assurance for the underlying commercial transaction. Stand-by letters of credit create a potential obligation for the issuer that is completely independent of the business arrangement for which it was an inducement.
[42] A standby letter of credit is drafted to define the scope and terms of the issuer’s undertaking so that the issuer need only examine the terms of the letter of credit and the documents presented by the beneficiary to determine whether there is a liability to pay: McGuinness, at §16.44. When the documents specified under a letter of credit are delivered, or “presented”, to an issuing bank, the bank must examine the presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a “complying presentation”: UCP 600, arts. 2 and 14(a). When an issuing bank determines that a presentation is complying, it must honour: UCP 600, arts. 7(a) and 15(a). When an issuing bank determines that a presentation does not comply, it may refuse to honour, in which case it must give a single notice to that effect to the presenter: UCP 600, arts. 16(a) and 16(c).

The fraud exception to the principle of autonomy of letters of credit

[43] An exception exists to the general rule that an issuing bank is obliged to honour a draft under a documentary credit when the tendered documents appear on their face to be regular and in conformity with the terms and conditions of the credit. The exception arises in the case of fraud by the beneficiary which has been (a) sufficiently brought to the knowledge of the bank before payment of the draft, or (b) demonstrated to a court called on by the customer of the bank to issue an interlocutory injunction to restrain the bank from honouring the draft: Angelica-Whitewear, at p. 71.

[44] In Angelica-Whitewear, the Supreme Court described the scope of the fraud exception at p. 83:
In my opinion the fraud exception to the autonomy of documentary letters of credit should not be confined to cases of fraud in the tendered documents but should include fraud in the underlying transaction of such a character as to make the demand for payment under the credit a fraudulent one … In my view the fraud exception to the autonomy of a documentary credit should extend to any act of the beneficiary of a credit the effect of which would be to permit the beneficiary to obtain the benefit of the credit as a result of fraud.
[45] The beneficiary under a letter of credit is not entitled to make a demand for payment under a letter of credit where there is no right to make such demand as between the beneficiary and the applicant under the terms of the underlying contract: McGuinness, at §17.338. However, given the principle of the autonomy of letters of credit, the fraud exception is carefully constrained to protect the commercial utility of the letter of credit: 430872 B.C. Ltd. v. KPMG Inc., 2004 BCCA 186, 26 B.C.L.R. (4th) 203, at paras. 30-31. The fraud exception does not encompass a demand for payment made in the face of a legitimate contractual dispute but requires some impropriety, dishonesty, or deceit, which would include instances where the demand can be said to be clearly untrue or false, utterly without justification, or made where it is apparent that there is no right of payment: Royal Bank v. Gentra Canada Investments Inc. (2001), 2001 CanLII 6996 (ON CA), 147 O.A.C. 96 (C.A.), at para. 8; Cineplex Odeon Corp. v. 100 Bloor West General Partner Inc., [1993] O.J. No. 112 (Gen. Div.), at paras. 31-32; McGuinness, at §17.343.

[46] In a case where no application is made for an injunction to restrain payment under a letter of credit and the issuing bank has to exercise its own judgment about whether to honour a draft, establishing the fraud exception requires showing that the “fraud was so established to the knowledge of the issuing bank before payment of the draft as to make the fraud clear or obvious to the bank”: Angelica-Whitewear, at p. 84. As Blair J. (as he then was) put the matter in Cineplex Odeon, “the exception is ‘fraud’, not something less than fraud”: at para. 29.

[47] When presented with documents that appear on their face to be regular, an issuing bank has no duty to satisfy itself by independent inquiry that the beneficiary has not engaged in fraud. It is only when the fraud appears on the face of the documents or when fraud has been brought to its attention by its customer or some other interested party that the bank must decide whether fraud has been established requiring it to refuse payment: Angelica-Whitewear, at p. 88.
The case continues to consider several LOC cases on the issue of a bankruptcy trustee's disclaimer of a commercial lease [para 60-108].


The author has waived all copyright and related or neighboring rights to this Isthatlegal.ca webpage.