Peas, letters of indemnity and authority to bind

Derek Luxford, partner at Sydney-based Hicksons Lawyers, looks at the lessons to be learnt by banks and carriers from the case of the Nelson

AUSTRALIA’S High Court has recently handed down a unanimous decision in the long-running saga of Pacific Carriers Limited v Bank Nationale de Paris (the Nelson). The case, which began in early 1999, involved the ill fated voyage of the Nelson from Australia to Calcutta and the subsequent conversion of a cargo of Australian chickpeas and dunpeas.

The case had wound its way up the Australian appellate system, starting with the New South Wales Supreme Court, before special leave to appeal was granted by the Australian High Court. High Court decisions on matters involving shipping and international trade are fairly rare. As the appeal involved some important issues as to letters of indemnity, who could give them, and who was bound by them, the decision was eagerly awaited by the international trading, shipping and banking fraternity.

To give some background to the case (see Issues 19 and 23 of The Maritime Advocate) an Australian exporter (NEAT) sold a cargo of chickpeas and dunpeas to an Indian trader, Royal Trading Company (Royal). The cargo was financed for Royal by Singapore-based Swiss Singapore Overseas Enterprises Pte Ltd (SSOE) and NEAT’s export of the peas was financed by BNP Paribas (BNP). The cargo was carried in the Nelson, which was time-chartered to Singapore-based Pacific Carriers Limited (PCL). NEAT went into liquidation before judgment was handed down by the New South Wales Supreme Court.

NEAT had voyage-chartered the Nelson but was relatively inexperienced in shipping matters. There was considerable delay in discharge of the cargo in Calcutta and ultimately PCL delivered the cargo to Royal without production of the original, or any, bills of lading, but pursuant to two letters of indemnity signed by NEAT and BNP (LOI). Royal did not pay SSOE and SSOE sued the owners of the Nelson in a London arbitration for damages for the misappropriated cargo.

In the meantime, the owners of the Nelson claimed indemnity against PCL under the time charter party and PCL commenced proceedings in the New South Wales Supreme Court against BNP claiming indemnity under the LOI. BNP cross-claimed against SSOE and against NEAT. During the trial before the New South Wales Supreme Court, SSOE settled its claim with the Nelson’s owners by PCL making a significant payment to SSOE. Ultimately the New South Wales Supreme Court dismissed BNP’s claims against SSOE and NEAT and found BNP liable to PCL for damages for negligent misrepresentation in relation to NEAT’s financial strength.

BNP appealed to the New South Wales Court of Appeal and PCL cross appealed. The New South Wales Court of Appeal accepted that the LOI, as a matter of construction, required BNP to indemnify PCL, but it found that the relevant employee of BNP (Ms Dhiri) had no authority (actual or ostensible) to bind BNP and so it had not contractually agreed to indemnify PCL.

PCL appealed to the High Court alleging that the LOI bound BNP because BNP had put its signature to the LOI and PCL had acted in reliance upon that signature. BNP argued that, on its proper construction, the LOI did not require BNP to indemnify PCL and all BNP had done was to verify NEAT’s signature (BNP had always run this argument). BNP also argued that the LOI was signed by Ms Dhiri without BNP’s authority and so she did not bind BNP.

Ms Dhiri was an interesting witness who managed BNP’s documentary credit department and supervised the handling of BNP’s letters of credit. She had authority to verify NEAT’s signature on the LOI, but BNP had not provided her with actual authority to issue the LOI. Usually, BNP’s LOIs are issued by a separate department and signed under a power of attorney.
The judgment of the New South Wales Supreme Court ran to 300 pages. The judgment of the Court of Appeal was of a more modest length, and the judgment of the High Court was extremely economic, running to a mere nineteen pages. The trial judge had to deal with a multitude of complex factual and legal issues, many of which were not relevant to the subsequent appeals.

The commercial background to what the High Court described as a “disastrous venture” for NEAT was that, while the cargo was on the water between Australia and India, there was a fall in the market for legumes. This might account for Royal having dishonestly delayed accepting the cargo and failing to pay the purchase price. Royal made off with the cargo and left SSOE high and dry having honoured letters of credit which it financed as Royal’s financier. NEAT was paid under letters of credit issued on behalf of SSOE, but SSOE had not been paid. The settlement from PCL during the trial in the New South Wales Supreme Court resulted in SSOE receiving a significant settlement which then crystallised the claim which PCL made against BNP under the LOI.

Readers will be well aware that the acceptance of an LOI in lieu of production of the original bills of lading is not an uncommon commercial practice, but it is also a risky practice. An LOI given on behalf of cargo interests (as occurred here) and relied upon by the shipowner/charterer may be no more than a piece of paper until it is honoured by the bank or other indemnifying party. The carrier will not normally know the details of financial and other arrangements between the primary party to such an indemnity (in this case NEAT) and the bank which endorses it (in this case BNP).

The document sent by NEAT to BNP for signature was in relatively standard form addressed to PCL and providing that it would “indemnify you, your servants and agents and hold all of you harmless in respect to any liability, loss or damage of whatsoever nature which you may sustain by reason of delivering the goods to receivers …” as directed by Royal.
The LOI was signed under the stamp of NEAT and at the foot there was provision for it to be counter-signed for and on behalf of BNP with a place for BNP’s signature. The signature of Ms Dhiri and the bank’s stamp were affixed to the LOI next to the words “banker’s signature”. Ms Dhiri sent the document to NEAT and NEAT sent it to PCL.

The High Court accepted that Ms Dhiri understood that all she was doing was authenticating the signature. However, the High Court took the view that this was not strictly relevant as the meaning of widely used commercial documents such as the LOI must be construed objectively. PCL was not in a position to know what Ms Dhiri thought she was doing or signing, nor was it relevant. What was relevant was the meaning which a reasonable person in PCL’s position would understand, especially when PCL had not directly corresponded with BNP in any material way.

The High Court said that there was nothing in the terms of the LOI to indicate that BNP was merely authenticating execution by NEAT, and there was nothing in the surrounding circumstances to suggest that PCL would accept such limited authentication. A reasonable reader in the position of PCL would have understood the LOI as bank-endorsed indemnity, and would have understood that the bank was undertaking liability as an indemnifying party to support the liability undertaken by NEAT. Hence, the High Court held that the LOI bound BNP.

On the issue of the authority of Ms Dhiri, the High Court held that she had no actual authority to sign the LOI. Nevertheless, the High Court held that BNP was still contractually bound by the LOI because, where an officer is held out by a company as having authority, and a third party relies on it as having apparent authority, and there is nothing in the company’s constitution to the contrary, the company is bound by its representation of authority. The High Court found that there was nothing in BNP’s publicly available company constitution to suggest otherwise.

Although BNP had argued that such ostensible authority was dependent upon any representations it made as regard Ms Dhiri’s authority, the High Court said this was irrelevant because Ms Dhiri’s signature and her use of the bank’s stamp was, in itself, a representation by BNP of Ms Dhiri’s authority to sign the LOI.

The High Court commented that the issue of the LOI was a transaction forming part of the ordinary course of business of the bank providing documentary credits in connection with international sale of goods transactions. The High Court observed that the importance to a third party such as PCL of the difference between a bank’s signature to an LOI in the capacity of an indemnifying party, compared to a bank’s signature by way of clarification only of the signature of its customer, should have been and was obvious to Ms Dhiri and the other BNP employees who gave evidence during the trial.

The High Court found that PCL assumed that Ms Dhiri had authority to bind BNP and that PCL acted to its detriment and was induced and assisted by the conduct of BNP in placing Ms Dhiri in a position which equipped her to deal with the LOI as requested by PCL. It would therefore be unjust to permit BNP to depart from the assumption made by PCL.

This decision brings some much-needed commercial and business common sense to the issue of the international sale of goods transactions involving many parties in many jurisdictions where time is of the essence. It is essential that parties in these transactions can rely upon documents purporting to be signed by a bank as the indemnifying party for an obligation of payment by its customer.

International shipping and the international sale of goods relies on these documents being issued routinely and in forms understood and acted upon internationally. If a bank wants to step aside and limit its role to simply verifying a signature or something less than indemnifying a party to a transaction, then it must do so clearly and it must take steps (internally and externally) to makes its limited authority clear to all parties who might have occasion to rely upon documents issued in the ordinary course.

This case provides a risk management lesson for banks. There is also a risk management lesson for carriers in that they would be well-advised to insist on receiving an LOI or guarantee that is properly executed and purports to bind the bank. Sometimes, that might not be practical because of constraints of time and the reluctance of parties to depart form normally internationally understood practices.

An LOI issued by a customer of a bank and verified by a bank as an indemnifying party is a crucial document in the international sale of goods and related shipping transactions. Banks need to understand the effect they have in putting their names, signatures and stamps to such documents. They are contractually binding and will be relied upon by many parties along the chain. Banks who fail to honour their signatures do so at their peril.