How Liquid Is Your Letter Of Credit?

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Bennett Jones LLP

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Bennett Jones is one of Canada's premier business law firms and home to 500 lawyers and business advisors. With deep experience in complex transactions and litigation matters, the firm is well equipped to advise businesses and investors with Canadian ventures, and connect Canadian businesses and investors with opportunities around the world.
Other than cash, a standby letter of credit (LoC) is generally considered the most liquid form of performance security. While beneficiaries generally believe drawing on an LoC...
Canada Litigation, Mediation & Arbitration
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Other than cash, a standby letter of credit (LoC) is generally considered the most liquid form of performance security. While beneficiaries generally believe drawing on an LoC should be a relatively simple process, many do not understand the extent to which the counterparty could try to stop you. This issue was addressed in Pacific Atlantic Pipeline Construction v. Coastal Gaslink Pipeline Ltd (2023) ABKB 736.

Pacific Atlantic Pipeline Construction Ltd v Coastal Gaslink Pipeline Ltd, 2023 ABKB 736

In this case, Coastal Gaslink Ltd. (CGL) contracted with Pacific Atlantic Pipeline Construction Ltd. (PAPC) to construct portions of the coastal gaslink pipeline project (Project). During the Project, disputes arose in connection with the performance of PAPC's work and CGL ultimately terminated the contract and arbitration proceedings were commenced.

In connection with the dispute, CGL sought to draw-down on an LoC provided by PAPC as contract security. However, PAPC applied to the Court for an interim injunction in an attempt to stop CGL from calling on the LoC until the conclusion of the arbitration process.

Despite there being no prerequisite conditions to calling on the letter of credit in the contract, PAPC made several arguments in support of their position that CGL should not be permitted to call on the LoC pending resolution of the arbitration. These arguments included:

  1. CGL had stated that they did not want to put PAPC out of business by calling on the LoC. PAPC argued that these statements created an unenforceable verbal collateral contract; and
  2. That drawing on the LoC constituted a breach of CGL's duty of honest performance because:
    1. CGL was required to use discretion when drawing on the LoC to ensure it aligned with the "purposes of the contract", where the purpose of the contract was paying for and completing construction work and the work had been substantially completed by the time CGL called on the letter of credit; and
    2. CGL's actual goal in drawing on the LoC was to gain leverage during the arbitration and not for a legitimate purpose.

Although not specifically identified by the Court, the three-part test to determine whether or not to grant an interim injunction includes: (1) is there a serious issue to be tried? (2) would the applicable suffer irreparable harm that cannot be compensated in damages if an injunction is not granted? and (3) does the balance of convenience favor granting an injunction?

Here, the Court noted that the PAPC must first prove a strong prima facie case that drawing on the LoC would violate a contractual obligation owed by CGL. For the following reasons, the Court concluded that PAPC failed to meet this requirement:

  • While PAPC established a strong prima facie case that the CGL's representatives did state that they did want to put the contractors out of business, this was not enough to establish a legally binding contract. As such, PAPC did not establish a prima facie case that a contract was created out of these statements.
  • The Court also noted that both parties were sophisticated and had internal policies that required the documentation of agreements. As such, the fact that there was no written agreement or even an email showed that any statements made by CGL were not intended to be relied on by PAPC as a contractual commitment.
  • In response to PAPC's argument that CGL has breached its duty of honest performance, the evidence showed that CGL did consider the point in time in which they called on the LoC. However, using the LoC as leverage was not considered a breach of the duty of honest performance as the duty does not stop a contracting party from pursuing their own economic interests. The Court also confirmed that applying the duty of honest performance here would be extending this duty too far.

In conclusion, the Court confirmed that since LoCs are customary in many commercial arrangements, Courts should limit circumstances where an injunction can be used to stop a beneficiary from enforcing their rights. The Court also reiterated the necessity for a strong prima facie case to obtain an interim injunction and since the court found that PAPC was unable to demonstrate one, PAPC's application was denied.

Interestingly, despite denying PAPC's application, and after the oral hearing of the application, the Court did grant an interim injunction until January 8, 2024, since the courts were closed over the holidays and to not otherwise impact PAPC's timely right to file an appeal. The justification for granting this interim injunction is unclear and may create some uncertainty regarding the enforcement of LoCs.

Takeaways

Although PAPC was ultimately unsuccessful in preventing CGL from drawing on the LoC, this decision reinforces that a party may still try to seek an injunction to prevent a beneficiary from drawing on an LoC—particularly when the merits of an underlying dispute have not been determined. However, in such circumstances, this decision confirms that:

  • Absent clear contractual pre-conditions, Courts are reluctant to interfere with a beneficiary's right to call on an LoC;
  • Courts should be reluctant to extend the duty of honest performance in these circumstances; and
  • Although Court did not grant the interim injunction, it did grant a temporary injunction to allow for an appeal which effectively constitutes an interim, interim injunction. Although the circumstances of this case were unique in this regard (i.e., the application arose during the holidays), this approach could create some uncertainty in similar, future cases.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

How Liquid Is Your Letter Of Credit?

Canada Litigation, Mediation & Arbitration

Contributor

Bennett Jones is one of Canada's premier business law firms and home to 500 lawyers and business advisors. With deep experience in complex transactions and litigation matters, the firm is well equipped to advise businesses and investors with Canadian ventures, and connect Canadian businesses and investors with opportunities around the world.
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