Letter of Credit

In Canadian Pioneer, the court wrote:

"A letter of credit issued by a bank is, in effect, a guaranteed by the bank that upon presentation of predetermined documentation, the bank will pay the beneficiary named in the letter. Letters of credit are the backbone of commercial credit and are not to be interfered with lightly by the courts."

However, a letters of credit can be distinguished from a guarantee. In Commercial Guide, the authors wrote:

"The letter of credit is not subject to the same defenses to payment demands as a guarantee is: the only defense to payment on a letter of credit, if the documents are in order and the terms of the credit are satisfied, is the defense of fraud."

In Bank of Nova Scotia, Justice LeDain of Canada's Supreme Court wrote:

"The fundamental principle governing documentary letters of credit and the characteristic which gives them their international commercial utility and efficacy is that the obligation of the issuing bank to honour a draft on a credit when it is accompanied by documents which appear on their face to be in accordance with the terms and conditions of the credit is independent of the performance of the underlying contract for which the credit was issued. Disputes between the parties to the underlying contract concerning its performance cannot as a general rule justify a refusal by an issuing bank to honour a draft which is accompanied by apparently conforming documents."

In Lava Systems, Justice Cameron of Ontario wrote:

"A letter of credit is a specialized form of commercial credit. It is an autonomous contract between an issuer, normally a bank, and the beneficiary, normally a supplier, customer with a possible warranty claim, or creditor of the bank’s customer. The issuer’s customer is not a party to the letter of credit. The letter of credit is independent of any agreement or the equities between the beneficiary and the issuer’s customer or the issuer and its customer. Subject to fraud, the letter of credit is payable by the issuer in accordance with its terms, independent of the performance of the underlying contract for which the credit was issued. The funds paid are those of the issuer, not its customer."

REFERENCES:

• Bank of Nova Scotia v Angelica-Whitewear Ltd. (1987) 1 SCR 59
• Babe, J. and others, editors, Commercial Law Guide (Toronto: CCH Canadian Ltd., 2006)
• Canadian Pioneer Petroleums v Federal Deposit Insurance Corp. 2 WWR 563 and also at 30 Sask. R. 315 (1984)
• Lava Systems Inc. v Clarica Life 31 CBR 4th 284; affirmed on appeal as Richter & Partners v Clarica Life Insurance  27 BLR 3d 19 or 161 OAC 53 (ONCA, 2002)