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Supreme Court finds debt created under letter of credit is situated where debtor resident

News / / Supreme Court finds debt created under letter of credit is situated where debtor resident

The Supreme Court has recently issued judgment in this matter concerning an attempt to enforce an arbitration award in London by obtaining a third party debt order over sums payable to the debtor under letters of credit issued by a London bank in respect of unrelated transactions.

The Supreme Court considered the question as to where a debt created under a letter of credit is located. Under English law, a debt is generally situated wherever the debtor is located. However, there has been a longstanding exception to this general rule in the case of letters of credit, where the debt created by the letter of credit had been held to be located in the place where the debt is payable. The Supreme Court has now confirmed that letters of credit are not a special case and that the general rule as to the location of the debt is applicable.

The background facts

Disputes had arisen under contracts for the sale and purchase of crude oil and LPG between a Swiss domiciled oil trading company, Taurus Petroleum Ltd (“Taurus”), and the State Oil Marketing Company of Iraq (“SOMO”). The disputes were referred to arbitration and Taurus obtained an award against SOMO for over US$8 million, which SOMO failed to honour.

Taurus saw an opportunity to enforce the award when it became aware that SOMO had agreed to sell two parcels of crude oil to a third party and that payment was to be made by SOMO under letters of credit (“the L/Cs”) issued by the London branch of Credit Agricole. It, therefore, applied to the English Court for permission to enforce the arbitration award as a judgment and also sought a third party debt order (“TPDO”) in respect of the amount payable to SOMO under the L/Cs (with a view to satisfying the outstanding debt) and the appointment of a receiver over funds receivable by SOMO under the L/Cs.

SOMO was named as beneficiary under the L/Cs, but the L/Cs provided for payment to be made to an account belonging to the Central Bank of Iraq (“CBI”) in New York. This arrangement had been put in place to comply with a United Nations Security Council Resolution regarding the proceeds of sales of oil by Iraq.

Taurus were initially granted the TPDO and the receivership order, following a without notice application, and the sums payable to SOMO under the L/Cs (approximately US$ 9.4 million) were paid into court. SOMO sought to set aside the TPDO and the receivership order on grounds including: (1) that the English Court had no jurisdiction to make the TPDOs in respect of the L/Cs because the debt was located in New York, that being where the L/C was payable and; (2) that the debt under the L/C was either the sole property of CBI or was the joint property of SOMO and CBI, such that the Court could not make a TPDO in respect of it.

SOMO succeeded in having the TPDO and the receivership order set aside in the Commercial Court. The Commercial Court decision was also upheld by a majority decision in the Court of Appeal. Taurus subsequently obtained permission to appeal to the Supreme Court, which disagreed with the Commercial Court and the majority of the Court of Appeal and ruled in Taurus’ favour.

Supreme Court Judgment

Location of Debt

The general position under English law is that a debt is located in the place where the debtor resides. In this case, that would have meant that the debt was located in London, that being the location of the bank that issued the L/Cs. However, since the 1981 Court of Appeal decision in Power Curber v. National Bank of Kuwait, English law had provided for an exception to this rule in the case of letters of credit. In that case, it was held that the debt arising under a letter of credit was located in the place where it was payable against documents. That would mean that the debt in this case was located in New York, as that was the location of the CBI account to which payment was to be made.

The Supreme Court overturned the decision in Power Curber as being “incorrect” and held that there is no justification for an exception to the general rule regarding the location of a debt in the case of letters of credit. The situs of the debt owed under unconfirmed letters of credit is, like other debts, wherever the debtor payer (i.e. the issuing bank) is located.

The L/Cs were unconfirmed credits and were expressly subject to UCP 600. Under the UCP, a bank branch is to be treated as if it were a separate entity. The debts under the L/Cs were, therefore, situated in England. This meant that the English Court could, in principle, make a TPDO in respect of the sums payable to SOMO under the L/Cs.

Interpretation of the L/Cs – who was the owner of the debt created by the L/Cs?

The issue to be decided was whether the bank’s debt under the L/Cs was owned only by SOMO, only by CBI or jointly by SOMO and CBI. A TPDO over the sums payable to SOMO under the L/Cs could only be made if the debt was owned by SOMO, but not if it was owned solely or jointly by CBI. The Supreme Court was split 3-2 on this issue, with the majority considering that SOMO was the sole owner of the debt created by the L/Cs.

The majority held that the bank’s primary obligation to make payment was owed to SOMO alone. There was a separate collateral obligation owed to SOMO and to CBI jointly, but this was merely an ancillary obligation as to the manner of payment, which depended on the continued existence of the debt owed to SOMO. SOMO was named as the “beneficiary” under the L/Cs and since the debts created by the L/Cs were owned by SOMO alone, the Court was justified in granting a TPDO in respect of them.

Receivership

As to the question of receivership, the Supreme Court found that there was sufficient connection between SOMO and the English jurisdiction to warrant the granting of the receivership order. It was foreseeable that a majority of the L/Cs against which SOMO sold oil would be subject to English law and it was, therefore, predictable that SOMO would be sued in an English court if it failed to honour an arbitration award. Had a TPDO not been available, the Supreme Court concluded that a receivership order could have been made, since, in any event, it would not have been prejudicial to the bank.

Comment

The Supreme Court decision clarifies a long-standing oddity in English law in relation to the situs of debts under letters of credit. The position has been brought into line with the general rule that a debt is located in the place where the debtor resides.

This decision will be of interest to traders looking to enforce judgments or awards against recalcitrant debtors. London remains a major global financial centre and vast numbers of letters of credit are issued by banks in London in support of international trade. The Supreme Court’s decision opens the door to the possibility of enforcing arbitration awards and judgments in London by seizing funds payable to the debtor under letters of credit via a TPDO requiring the issuing bank to pay the funds to the creditor (or into court) instead of to the debtor as the beneficiary under the letter of credit. 

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