Can a seller terminate if a letter of credit is not opened on time?
In a recent arbitration decision a tribunal rejected the general principle that the obligation on a buyer under a sale contract to open a letter of credit is a condition entitling the seller to terminate if breached.
General law
Generally, an obligation on a buyer to open a letter of credit in accordance with the contract is a condition which, if not performed in time, allows the seller to terminate the contract and claim damages.
The usual position was set out in Trans Trust SPRL v. Danubian Trading Co [1952] 2 QB 297 in which the court stated that, where a contract is concluded, “the stipulation for a credit is a condition which is an essential term of the contract. … the provision of the credit is a condition precedent … to the obligation of the seller to deliver the goods. If the buyer fails to provide the credit, the seller can treat himself as discharged from any further performance of the contract and can sue the buyer for damages for not providing the credit.”
An unpredictable turn
In London Arbitration 12/18, the buyer had to open a letter of credit within two banking days from the date of the contract. There was a dispute as to the date the contract became effective but the tribunal held that even if a letter of credit had not been opened two days from the date of the contract, the seller was not entitled to terminate.
The tribunal reviewed the case law and considered that there was no authority for the proposition that a requirement under a contract for a letter of credit was always to be regarded as a condition. Whilst such a requirement would often be a condition precedent for the seller to perform its obligations (e.g. to load the goods on a vessel) it would not necessarily be a condition allowing termination if the buyer did not comply with the time requirements stipulated in the contract.
On the basis of the facts before them, the tribunal considered that the requirement to open a letter of credit within two days should be regarded as an intermediate term. The first shipment date was over three weeks from the date by which the letter of credit was required to be opened and the sellers themselves had acknowledged that there was a risk of delay in setting it up. In the circumstances they considered that a failure to provide the letter of credit two days after the contract date would not deprive the sellers of substantially the whole benefit of the contract so as to allow termination.
Comment
The decision (although not binding on other tribunals) suggests that there is uncertainty as to when a contractual requirement to open a letter of credit will be (i) a condition entitling the seller to terminate if it is not met or (ii) an intermediate term. Further, if it is an intermediate term, it is not clear at what point (and how far from the shipment period) a seller would be entitled to terminate if the letter of credit is not opened.
This is a questionable decision and a definitive judgment from the courts would be welcome. In the meantime, sellers should exercise caution before terminating a contract following a failure by their buyer to open a letter of credit. They could find themselves held in repudiatory breach if the provision of a letter of credit is not regarded as a condition, or if they terminate too soon. It may assist sellers to make clear in the contract that the buyer’s provision of a letter of credit is a condition of the contract (although a tribunal may not uphold the label applied by the parties).
HFW can assist with any difficult decisions as to whether and when a contract should be terminated following a buyer’s failure to open a letter of credit.
Should you have any questions, please do not hesitate to contact the authors of this briefing:
