Supreme Court confirms that the situs of a debt due under a letter of credit is the location of the issuer

The Supreme Court has confirmed the position in English law regarding the location of debts created by letters of credit in Taurus Petroleum Limited v State Oil Marketing Company of the Ministry of Oil, Republic of Iraq [2017] UKSC 64.

In deciding that the situs of a debt created by a letter of credit is the place of residence of the issuing bank, the Supreme Court unanimously held that the previous authority on this issue: Power Curber International Ltd v National Bank of Kuwait SAK [1981] 1 WLR 1233, was wrong in principle and should not be followed.

In Power Curber, by majority decision, the Court of Appeal held that the situs of a debt created by a letter of credit was the place of payment. This contradicted the long standing principle in English law that the situs of a debt is the place of the residence of the debtor. The principle from Power Curber stood for over 35 years and created some uncertainty as to why debts which arose under a letter of credit were treated differently to other debts under English law.

The instant decision by the Supreme Court will be welcomed by financial institutions as providing helpful clarity for parties creating and enforcing obligations under letters of credit. As highlighted in our Middle East e-bulletin, the decision will assist foreign parties to enforce arbitral awards (or judgments) in the English courts by using a third party debt order against a letter of credit issued from London. Indeed, the impact of the decision is not only limited to third party debt orders, but will also be of assistance in any disputes involving letters of credit, which are very often international in nature and can result in complex conflict of law issues.

It is anticipated that the Supreme Court decision in this case will be followed in other jurisdictions, further reinforcing certainty as to the location of the debt obligation. The judgment refers to at least one other jurisdiction which has applied Power Curber in its courts, and to a number of other jurisdictions where it has been cited in legal texts (in all cases without analysis of the reasoning, which was why they did not assist the submission that Power Curber should be followed). The reversal of the proposition under English law is therefore likely to have a ripple effect.

Background

The claim in this case arose out of a series of contracts between Taurus Petroleum Limited (“Taurus”), a Swiss domiciled oil trading company, and the State Oil Marketing Company of the Ministry of Oil, Republic of Iraq (“SOMO”). Disputes between Taurus and SOMO were referred to arbitration in accordance with the terms of the contracts. A final award was made whereby SOMO was ordered to pay Taurus approximately US$9 million, but the debt was not paid.

Subsequently, Taurus learned that a third party company had purchased two parcels of crude oil from SOMO, the price for which was to be paid under letters of credit issued by the London branch of Crédit Agricole SA (“Crédit Agricole”). The letters of credit featured two unusual conditions. The first was that the proceeds of the sales of oil were to be paid into an account held by the Central Bank of Iraq (the “CBI”) at the Federal Reserve Bank of New York. The second condition was a promise to both SOMO (described as ‘the beneficiary’) and CBI to pay the money on presentation of certain documents.

Taurus sought to enforce the arbitral award in England as a judgment, applying for a third party debt order to recover the funds receivable by SOMO pursuant to the letters of credit. A third party debt order would operate to discharge Crédit Argicole’s debt by paying the sums due under the letters of credit directly to Taurus.

SOMO contended that the debts created by the letters of credit were situated in New York and so the courts of England and Wales did not have jurisdiction.

High Court decision

The High Court held that the situs of the debt was London (the location of the issuing bank, the London branch of Crédit Agricole) rather than New York (the place of payment). However, it found that the letters of credit formed a single joint promise in favour of both SOMO and CBI. As a joint debt, the court could not make a third party debt order, because SOMO was the sole judgment debtor of the arbitral award.

Court of Appeal decision

Both parties appealed to the Court of Appeal.

On the question of the location of the debt, the Court of Appeal held that it was bound to follow the decision of the Court of Appeal in Power Curber. Power Curber was a split decision, in which the majority held that the situs of a debt due under a letter of credit was the place of payment, not the place at which the letter of credit was issued. Accordingly – overturning the first instance decision – the Court of Appeal in the instant case held that the situs of the debt was New York (the place for payment to be made under the letters of credit).

The Court of Appeal also held by a majority that SOMO was not the sole beneficiary of the letters of credit, and so it could not order a third party debtor order.

Supreme Court decision

Taurus appealed to the Supreme Court which had to decide, amongst other things, whether:

1. the situs of the debt was London or New York;
2. Crédit Agricole’s debt under the letters of credit was owed solely to SOMO, or to both CBI and SOMO; and
3. the contractual commitments to CBI in the letters of credit prevented the making of a third party debt order.

(1) Situs of debt

The Supreme Court unanimously agreed that the decision in Power Curber was wrong in principle and should not be followed. Accordingly, the situs of the debt was London, the location of the issuing bank.

Lord Clarke, giving the majority leading judgment, agreed with Taurus: there was a long standing rule which went back at least to the beginning of the last century, providing that the situs of a debt is the debtor’s residence, the place where the debt is recoverable. He held that Power Curber was therefore wrongly decided and none of the references put forward by SOMO persuaded him otherwise. No other English cases were identified which had considered the principle in Power Curber. The only English text that addressed Power Curberprovided “a distinct lack of enthusiasm for the majority view”. The only international jurisdiction which had directly applied the principle in Power Curber was Canada - and in that case, the Canadian court merely cited Power Curber as authority without applying any analysis of its own.

Lord Neuberger agreed, adding that there was no reason for holding that a debt due under a letter of credit should be treated differently from other debts for the purpose of deciding its situs. He commented that the majority in Power Curber “provided very brief and unconvincing reasons to support their decision” and said that “such unreasoned distinctions do the common law, and in particular, commercial law, no favours”.

(2) Identification of beneficiary

The Supreme Court was divided on whether the letters of credit created a debt in favour of SOMO alone, or SOMO and CBI jointly. In the majority, Lords Clarke, Sumption and Hodge determined that SOMO was the sole beneficiary of the letters of credit, with Lords Neuberger and Mance dissenting.

In reaching their decision, the majority used the provisions of Uniform Customs and Practice for Documentary Credits (“UCP”) 600 as a guide to their interpretation of the letters of credit, noting that UCP 600 defined ‘beneficiary’ as “the party in whose favour a credit is issued”. It followed from UCP 600 that SOMO was the sole beneficiary. Accordingly, they held that the letters of credit created two separate obligations: (1) an obligation to pay the debt which was owed to SOMO; and (2) an obligation as to the manner in which the debt would be paid, which was owed to both SOMO and CBI.

(3) Third party debt order

In the circumstances, the majority (Lords Neuberger and Mance again dissenting) concluded that it was permissible to grant a third party debt order. Crédit Agricole’s obligation under the letters of credit to SOMO was a debt, and the obligation owed to both SOMO and CBI was an obligation as to the manner in which that debt would be discharged. Upon discharge of the debt, neither obligation would have any further content. Compliance with the third party debt order would therefore discharge Crédit Agricole as against both SOMO and CBI.

Accordingly, the appeal was allowed.

Comment

As explained in the introduction, the key message for financial institutions to take from the Supreme Court judgment in the instant case is the certainty as to the location of the debt obligation under a letter of credit, being the place of residence of the issuer.

A further noteworthy aspect of the judgment is that the Supreme Court was divided on the approach to be taken to the construction of the letters of credit. Such division in the highest appellate court in the jurisdiction will always invite scrutiny, particularly in circumstances where the then president of the court was dissenting. The majority placed particular importance on the provisions of UCP 600 to assist construction of the letters of credit. UCP 600 seeks to facilitate the flow of international trade by creating a set of international rules which establish uniformity in the practice of letter of credit. Arguably the majority took the more practical and commercial approach, taking a narrow view of the effect of the added conditions and refusing to infer from the terms of the letters of credit some form of transfer of beneficial interest.