XCHRX ENGINUITY LTD. v. QUALI-SOURCE LTD.

No. A853 of 1995

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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JUDGMENT

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1. The defendant appeals against an order of the Master made on 9 March 1995 that judgment be entered for the plaintiff against the defendant in the sum US$34,020 with costs.

2. In its statement of claim, the plaintiff alleges that, in terms of a contract entered into between the plaintiff and the defendant on 29 October 1993, the plaintiff supplied one of six "automatic FAC'SIM production certifiers for 3.5" MFD" on 12 December 1994. The plaintiff says that, in pursuance of its obligations under the contract, the defendant provided the plaintiff with an irrevocable letter of credit drawn on the Dao Heng Bank. On 23 December 1994, the Dao Heng Bank advised the plaintiff's bank that payment under the letter of credit was refused because of certain discrepancies. The Dao Heng Bank referred these discrepancies to the defendant for acceptance, but the defendant refused to confirm acceptance of the delivery under the letter of credit. The plaintiff claims the sum of US$34,020 "under the said letter of credit and/or pursuant to the said contract.".

3. The letter of credit was issued by the Dao Heng Bank and dated 23 November 1994. The applicant is the defendant, and the beneficiary is stated to be the plaintiff. The letter provides for a list of documents to be presented, including a cargo receipt certifying that the goods have been received in good order and "conditions", showing description, quantity and value of the goods, and a "quality approval certificate issued by the applicant". The letter is said to cover "1 set of automatic Pac'Sim production certifier for 3.5" MFD including six modules".

4. The quality approval certificate is dated 12 December 1994, refers to the letter of credit and is signed by the defendant. It refers to "1 set of Automatic FAC'SIM 3.5" MFD Production Certifier including 6 modules".

5. On 23 December 1994, the Dao Heng Bank issued an "Advice on Refusal". The relevant parts of this read - "We are referring the discrepancies to the applicant for acceptance. We shall revert in due course. Discrepancies. 1. Documents showing description of goods "FAC'SIM" i/o "PAC'SIM" stipulated by l/c. 2. Commercial invoice showing quantity of goods as 1 i/o 1 set."

6. I take "i/o" to mean "instead of", and "l/c" means, of course, "letter of credit".

7. In its draft defence and counterclaim, the defendant admits that the discrepancies were referred to it for acceptance. The defendant alleges that the machine supplied by the plaintiff was defective and that it justifiably terminated the agreement. In its draft counterclaim, the defendant claims a declaration that the contract has been terminated, or rescission, and damages.

8. Whether or not the bank was justified in failing to pay because of the discrepancies I have mentioned is not a matter for me to decide. The plaintiff is not suing the bank. I will say, however, that the basic principle is that the documents produced to the bank must comply strictly with the terms and conditions of the credit. I suppose the bank would not be justified in assuming that "PAC'SIM" was identical with "FAC'SIM", and that "1" was the same as "1 set".

9. Mr Bell argues that the plaintiff's action is based both on the contract and the letter of credit. He says that a letter of credit should be treated in the same way as a cheque. If the action were to be equated with one based on a cheque, the position would be that, save in exceptional circumstances or upon strong grounds, which are not present here, the defendant will not be allowed to set up a set-off or counterclaim for some other breach, and the plaintiff would be entitled to judgment for his claim without a stay in execution. A bill of exchange or a cheque is to be treated as cash. It is to be honoured unless there is some good reason; for example, an arguable case based on fraud or failure of consideration, which is not the case here.

10. Whatever contractual relations are created as between the bank and the defendant and as between the bank and the plaintiff under the letter of credit, there was no new contractual relationship set up under it as between the plaintiff and the defendant. The letter of credit does not constitute an undertaking to pay by the buyer to the purchaser; that undertaking arises by virtue of the sale agreement. The relationship between the plaintiff and the defendant is one of seller and buyer; the letter of credit was provided as a means of payment by the buyer to the seller under the contract of purchase and sale, and, in this case, constituted a conditional payment. If the buyer has failed to pay, that failure is a failure to comply with its obligations under the contract of sale; not any new obligation to pay undertaken by the defendant to the plaintiff under the letter of credit. Accordingly, it is my view that the plaintiff has no cause of action against the defendant based on the letter of credit because it cannot be construed as an undertaking by the defendant to pay the plaintiff and creates no obligation on the defendant to pay the plaintiff. The undertaking and the obligation are contained in the contract of sale. For this reason, in my view, this action cannot be equated with an action based on a cheque or a bill of exchange in which there is a cause of action separate from and independent of the contract of sale.

11. I suppose it might be possible to say that there was some collateral agreement between the plaintiff and the defendant under which the defendant agreed that it would instruct the bank to pay where there were discrepancies arising from typing, clerical or technical mistakes in the documentation, but this is not pleaded. If it were pleaded and denied, it may be that evidence would be required to establish such an agreement.

12. The special treatment afforded to bills of exchange under the Order 14 procedure is explained by Lord Russell of Killowen at 732G in Nova (Jersey) Knit v Kammgarn Spinners [1977] 1 W.L.R. 713 -

"It is in my opinion well established that a claim for unliquidated damages under a contract of sale is no defence to a claim under a bill of exchange accepted by a purchaser; nor is it available as a set-off or counterclaim. This is a deep rooted concept of English commercial law. A vendor and purchaser who agree upon payment by acceptance of bills of exchange do so not simply upon the basis that credit is given to the purchaser so that the vendor must in due course sue for the price under the contract of sale. The bill is itself a contract separate from the contract of sale. Its purpose is not merely to serve as a negotiable instrument, it is also to avoid postponement of the purchaser's liability to the vendor himself, a postponement grounded upon some allegation of failure in some respect by the vendor under the underlying contract, unless it is total or quantified partial failure of consideration."

13. I am not sure that this favourable treatment always works justly. Very few transactions of substance these days are settled by payment in cash. Payment may be made by, for example, cheque, bill of exchange, letter of credit, bank guarantee, credit card, direct bank debit, either immediately or after a period of time. Whichever method of payment is selected may be by pure chance or whim. It seems strange that the rights of the payer should depend on an arbitrary choice of the method of payment. It is, of course, common to give cheques for purchases before the buyer has had an opportunity to test the goods bought. If the goods are found to be seriously defective, why should it be thought just that the buyer has to pay and then fight to oblige the seller to comply with his side of the bargain? The answer cannot be, in the modern times, that payment by cheque is equivalent to cash. Insofar as anyone might think, if they do, that payment by cheque is equivalent to cash, the same would apply to the other common methods of payment. The answer, I suppose, can be only that, as Lord Russell says, the idea is "a deep rooted concept of English commercial law". That may be so, but giving special treatment to the beneficiary under a letter of credit, which does not constitute, as between the seller and the buyer, "itself a contract separate from the contract of sale" does not have that justification. I am not prepared to extend the special treatment given to bills of exchange to the situation before me.

14. If the plaintiff's action is treated as an action for the purchase price based on the contract of sale, there is clearly a triable issue between the parties based on the allegations that the machine is seriously defective and that the contract has been justifiably terminated. There is no reason to think that this defence is not bona fide; the defendant seems to have complained about defects in the machine on 28 December 1994, shortly after it was installed.

15. In the result, the appeal succeeds. The order of the Master is set aside, the plaintiff's summons of 10 February is dismissed, and the plaintiff is ordered to pay the defendant's costs both here and before the Master.

(J.K. FINDLAY)

Judge of the High Court