Topics:
Reasonable Time; Instruction of the Jury (outside the presence of counsel); UCP 400 Art. 16;
Principals:
Defendant/General Contractor/ Beneficiary: Eastern General Contractors
Plaintiff/IssuerRhode: Island Hospital Trust National Bank
Sub-contractor: Trolley Tree and Landscaping
Applicant: Future Real Estate
Transaction: Construction project.
LC: Standby L/C for an aggregate of US $100,000. Subject to UCP 400.
Procedural History:
The trial court granted the issuer's Motion for a Directed Verdict. Upon appeal, the Supreme Court of Rhode island, Lederberg, J., vacated the trial court's order and remanded the case for a new trial by the Superior Court.
Rule:
Issuer that examined documents and gave notice of dishonor within three banking days (one on which it was closed due to a hurricane) may not have acted within a reasonable time as required by UCP 400 Art. 16.
History: A subcontractor obtained a standby letter of credit in favor of the general contractor as a substitute for a performance bond from the issuer which acted at the request of a third party applicant.
When the beneficiary became dissatisfied with the subcontractor's performance it cancelled the contract, completed the work, and posted a drawing on the standby. The issuer received the documents on September 26, 1985. The next day, a Friday, a hurricane struck and the issuer did not open. The bank re-opened on September 30, the following Monday, which was the expiry date of the standby. The issuer examined the presentation the following day, October 1, and noted three discrepancies. The presentation did not contain a required draft, one invoice contained an incorrect addressee, and the amount of the draw was not specified.
That afternoon, the issuer telephoned the beneficiary and informed it of the absence of the draft. The issuer offered to prepare a draft for the beneficiary's signature. It was disputed whether the beneficiary was informed of the other discrepancies and of the need to seek waiver from the applicant.
The issuer did prepare a backdated draft which the beneficiary signed and returned. On October 8, the issuer sought the applicant's waiver which was refused. Accordingly, the issuer dishonored the standby, noting two discrepancies: the draft was not received within the validity of the credit and the wrong addressee on the invoice.
When the beneficiary continued to seek payment, the issuer brought a declaratory action seeking a determination that the beneficiary had failed to comply with the terms of the credit. The beneficiary counterclaimed for payment. The trial court awarded a directed verdict in favor of the issuer. On appeal, this verdict was vacated and remanded.
The trial court ruled that action within three days was "prima facie evidence of a reasonable time" under Rhode Island's version of prior UCC 5- 112(1)(a). That section states that banks may defer honor until the close of the third banking day following presentation. The court added that because the beneficiary presented with less than three days left prior to expiry, it undertook the risk of not being able to timely cure any discrepancies.
At trial, the beneficiary offered the expert testimony of one of the issuer's former vice presidents, John Donnelly. The opinion reports Donnelly's testimony as follows:
"When a stand-by letter of credit is drawn against, it's generally because there is a dispute involved. it's generally drawn at the end of the validity of the letter of credit which is near the expiry date. . . . There's always the possibility of litigation with a stand-by letter of credit."
Because of these implicit characteristics of standby letters of credit, Donnelly asserted that common and prudent banking procedure, consistent with the requirements of the UCP, would give such standby letters of credit priority over other types of credits and would ensure that the expiry date of a standby letter of credit would be ascertained immediately upon receipt of a presentation for payment. If the date of receipt was close to the expiry date of the credit, Donnelly testified, the presentation should be reviewed and "the appropriate actions should be taken." On the basis of his knowledge of the UCP and of common banking procedures, Donnelly testified that in his opinion Hospital Trust did not review Eastern's presentation within a reasonable time.
In addition, the trial court excluded evidence which may have shown that the telephone conversation had been recorded. It was not produced during discovery, which permitted the inference that the recording was destroyed.
Briefing:
1. Reasonable time; UCP 16(c): The court held that the trial judge had over-relied on prior - 5-112. The court noted that the credit was subject to the UCP, not the UCC; thus, "reasonable time", not the three day standard, would apply to the case. The court stated that the purpose of the reasonable time rule is to afford the beneficiary the time to cure a curable discrepancy, determining that the discrepancies in this case were curable. The court went on to note that Donnelly's testimony had certainly created an issue of fact over whether the issuer acted in a reasonable time. As such, the directed verdict was improper.
2. Evidence: Destruction of telephone recordings: Outside of the presence of the jury, the trial judge excluded evidence that a recording of the pivotal telephone conversation between the document checker and the beneficiary "may have existed but was subsequently destroyed". Based on the doctrine that permits inferences to be drawn by the destruction of evidence, the appellate court held that this doctrine led to the conclusion that evidence of possible existence and destruction should not have been withheld from the jury.
Views:
One of the reasons that letter of credit law is so frustrating to general commercial lawyers as well as others is that the standard banking practice seems to change constantly. The appellate court's treatment of the reasonable time issue is a case in point. The appellate court totally misunderstood the reasonable time rule and misapplied it. Of course, the fact that courts are recognizing the UCP and applying it represents an important stage in the evolution of judicial letter of credit law. The challenge now is to assure that the UCP is interpreted in a manner consistent with sound banking practice.
As a general proposition, it is correct that the UCP trumps UCC Article 5 with respect to the issue of notice of dishonor. This conclusion obtains under revised UCC Article 5 which takes up the general UCP approach; it is even more correct with regard to prior UCC Section 5-112 which adopts an approach based upon estoppel.
By disregarding the three day time limit of prior UCC Section 5-112, however, the appellate court has failed to assess its impact upon standard banking practice and, so, has misunderstood that practice. The issue addressed by the relevant UCP rule is the amount of time available to a bank to examine documents and give notice of dishonor. The UCP scheme contains the draconian sanction of preclusion in the event that this time is exceeded. Although commonly known as the "reasonable time" rule, it should really be understood as the "unreasonable time" rule because the question which must be asked is what time is so unreasonable as to trigger the sanction of preclusion.
In making this assessment, the three day time period of prior UCC Section 5-112 is relevant. Under this approach (radically different than that taken in the UCP), after three days the issuer was deemed to have dishonored the presentation. This approach left it to the beneficiary to prove that a conforming presentation had been presented and that any notice of dishonor was insufficient and that it could have been cured. Although this approach differs from the UCP regime, the minimum three day period became an assumption underlying practice. It was reasoned that if even under the less rigorous UCC rule the bank had three days in which to act, that result would surely obtain under the far stricter UCP rule. Prior to the past two years, all of the attention with regard to UCP 500 Articles 13 and 14 and UCP 400 Article 16 focused on the outer limits of a reasonable time (or, properly speaking what is unreasonable). In the process which led to the reforms of law and practice in the L/C field, the possibility that turn around of a presentation in less than three banking days after the banking day of receipt could give rise to the preclusion rule was not seriously entertained. As a result, in the recent revisions of letter of credit law and practice, the presence of this "floor" of three days was not addressed. The only question was the existence of an outer limit.
The suggestion that there should be a different rule for standbys is interesting but wrong. While some standbys contain fewer documents than commercials, others do not. In addition, the paucity of drawings under standbys and the fact that they may be easier to expedite than commercials does not support this conclusion. The fact that some banks do expedite standby presentations has nothing to do with the question of what constitutes the outside limit of a reasonable time (or an unreasonable time) for purposes of invoking the preclusion rule. This rule has nothing to do with "goals" or "average practice" or "typical practice" (as the beneficiary's expert seems to conclude) but, as it were, what is the minimal reasonable practice. To suggest that a turn around within three banking days of the banking day of receipt is unreasonable is nonsense. The factors involved in routing and examining documents are highly complex. The possible delays and interruptions are numerous. Banks cannot and are not required to have personnel waiting for presentations of standbys and to expedite them.
A beneficiary which presents documents within less than three days of the expiry date (or even less than seven banking days) takes the risk that there may be no opportunity to correct discrepancies. In this respect, the appellate court also was mistaken in concluding that the purpose of the UCP preclusion rule was cure of discrepancies. While cure is permitted, it was not the motive for the rule. Indeed, in some countries the possibility of cure is in doubt although it is impliedly permissible under the UCP scheme. The reason for the rule is linked to the need for finality: the examining bank must take a position within a reasonable time and not delay or wait for changes in the situation or market. Notice within three banking days of the banking day of receipt, whether on a standby or a commercial presentation, constitutes notice of dishonor within a reasonable time.
It is reasonably safe to say that this over-sight will soon be corrected and that the process of formulating a statement of U.S. practice is already underway by the USCIB. It is not, however, necessary for this formulation to be promulgated to reach a sound conclusion. Indeed, the trial court did so in its opinion in which it concluded that return of documents within the three day period was prima facie action within a reasonable time. This rule is in full accord with banking practice.
This result is easier to obtain if due consideration is given to who should make it. In the Rhode Island case (as well as other recent cases on this issue), it is assumed that the question of what constitutes a reasonable time is one for the jury as a trier of fact. This approach is erroneous. The issue of the meaning of a reasonable time is a question of interpretation of the relevant UCP article. Interpretation of written rules of practice (known under the UCC as a "trade code"), has always been a matter for the court as is stated in UCC Section 1-205. What amount of time was actually taken is a question of fact for the jury. What was said is an issue of fact for the jury. Whether the time was reasonable or whether what was stated constitutes a discrepancy under the UCP and standard banking practice is a question for the court because it constitutes an interpretation of the UCP.
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