THE BANK OF CHINA v. XINYUAN TRADING CO. LTD. AND ANOTHER

CACV 276/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 276 OF 1998

(ON APPEAL FROM HCA 18159 OF 1998)

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REASONS FOR JUDGMENT

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Mortimer V-P (giving the reasons for judgment of the Court) :

1. On 5 March 1999 we allowed the appeal and discharged the order of Yam J of 6 November 1998 restraining the Bank of China (BOC) from making a demand for payment under a letter of credit (the L/C) dated 3 July 1998 issued by the Jian Sing Bank (JSB). We now give our reasons.

The underlying transaction

2. By a contract dated 25 June 1998 (the Head Contract) the defendant agreed to sell to the plaintiff a quantity of fuel oil. In its turn the plaintiff sub-sold the oil to Kaiyuan Industrial (Hong Kong) Ltd under a contract dated 25 June 1998. Kaiyuan in turn by a second sub-sale dated 26 June 1998 sold the oil to Bao Chang Investment Holding Ltd.

3. Under the Head Contract, on the plaintiff's instructions JSB issued the L/C in favour of the defendant for US$1.58m.

4. On 14 July 1998 BOC presented to JSB a full set of documents required by the L/C. These included a draft drawn by the defendant on JSB payable to the order of BOC at 90 days after sight.

5. JSB took one objection to the documents. The bill of lading did not name the vessel's master as was required. However, the plaintiff accepted the documents and confirmed that JSB could pay on the draft at the maturity date. JSB informed BOC who in turn informed the defendant.

6. Following JSB's acceptance of the draft and the other documents, BOC discounted the draft and paid the defendant on about 23 July 1998. Thereafter, it appears that the plaintiff discovered that Bao Chang only received a small percentage of oil and not the amount stated in the presented documents - the invoice, the bill of lading and the receipt. The plaintiff contends that the defendant admitted in meetings between the parties the short shipment and that the documents were forged. However, BOC were not informed of the allegations either by the plaintiff or JSB. Instead they requested BOC's consent to extend the draft's maturity date from 15 October 1998 to 15 November 1998. This request was declined and BOC demanded payment on the due day.

7. The plaintiff then commenced this action against the defendant (not BOC) and applied for an injunction to restrain BOC from demanding payment under the letter of credit on the grounds of the alleged fraud. Before the judge, it was additionally argued that BOC could not demand payment because it was a mere collecting bank and was, in these circumstances, simply an agent of a fraudulent defendant. The judge granted the injunction on the basis that there was a serious question to be tried whether BOC was a negotiating bank or a collecting bank.

The L/C and BOC as holder for value

8. There are a number of cogent reasons why it was necessary to allow this appeal and discharge the injunction. The first concerns the nature of the letter of credit. The letter of credit was on its face a negotiable credit. It contained express conditions which contemplated negotiation by banks other than by BOC. Note the condition on page 2 of the L/C:

"If explicitly requested and instructed by the negotiating/presenting bank on their covering Schedule, we shall discount such draft(s) after our acceptance with discount interest at our prevailing interest rate and related charges, if any, for account of beneficiary."

The L/C also provided for drafts drawn by the beneficiary on JSB.

9. Under the L/C, BOC discounted the draft for value and made payment to the defendant. Thereafter BOC was the holder for value and entitled to payment in its own right and not as agent of the defendant beneficiary. Up to the time of this negotiation BOC was unaware of any allegation of fraud. The plaintiff did not discover the facts which led to the allegation until two months later on 17 September 1998. But, in any event the right of payment on documentary credits is usually unaffected by the underlying transaction and any dispute about it. As a holder for value, BOC, not being tainted in any way by any allegation of fraud, was entitled to demand payment. See Hasan v Willson [1977]1 Lloyd's Rep 431.

Were there other circumstances entitling the Court to interfere?

10. The circumstances in which the court will interfere to prevent payment to a bank on documentary credits are extremely limited. In cases where fraud is alleged, it will only do so where the bank is fraudulent or knowingly assists in fraud so that the documentary credit is tainted.

11. As was pointed out by Nazareth JA (as he then was) in Ever Eagle Co. Ltd v Kincheng Banking Corp [1993]2 HKC 157 at 160E-G:

"Moreover ... the letter of credit is autonomous, and the Bank is not concerned in any way with the merits or demerits of the underlying transactions. As [was] pointed out by Lord Diplock at p.183 D of the America Accord [1983] AC 168 ... banks 'deal in documents and not in goods' as article 8 of the Uniform Customs puts it. To address the matter in terms of the buyer's right to reject the goods would, as his Lordship pointed out at p.185E, 'destroy the autonomy of the documentary credit which is its raison d'etre; it is to make the seller's right to payment by the confirming bank dependent upon the buyer's rights against the seller under the terms of the contract for the sale of goods, of which the confirming bank will have no knowledge.'

See also the authorities cited by Nazareth JA in his judgment.

12. The integrity of documentary credits as a completely separate transaction from the underlying contract has long been recognised as essential for international trade. The courts must be vigilant not to diminish this fundamental principle.

BOC not a party

13. Finally, the BOC was not a party to the action. No claim is made by the plaintiff against BOC and it is trite law that the courts can only intervene by way of granting an interlocutory injunction to a party in proceedings who asserts a cause of action against the other party. See United Trading Corp SA v Allied Arab Bank; Murray Clinton v Rafidair Bank [1985] 2 Lloyd's Rep 554 and The Siskina [1979] AC 210.

14. For these reasons, we allowed the appeal and discharged the injunction against BOC.

Costs

15. Both on the appeal and before the judge in addition to the plaintiff, the JSB appeared to support the application and to resist the appeal. An injunction was granted against BOC - a non-party. The JSB - another non-party - appeared below and on appeal. In these unusual circumstances and giving weight to the misconceived nature of the proceedings, we ordered that the costs of the appeal and the costs below should be borne not only by the plaintiff but also the JSB.