English Court re-affirms autonomous nature of letters of credit and rejects frustration argument

The attempt by SalamAir to injunct LATAM from calling on three letters of credit is a useful reminder of (i) the reluctance of the English Court to intervene in the operation of letters of credit and (ii) the difficulty of frustration arguments in aircraft operating leases.

Background

In 2017 LATAM had leased three A320 aircraft to Omani airline SalamAir under six year operating leases. SalamAir had provided LATAM with three standby letters of credit confirmed by Barclays as security for their obligations under the operating leases. In 2020, SalamAir suffered financial difficulties and agreed to redeliver the aircraft to LATAM in June 2020. As a result of the defaults and early termination of the leases, LATAM’s right to call under the letters of credit had accrued. Following the redelivery of the aircraft, SalamAir applied, unsuccessfully to the English Court, without notice to LATAM, for an injunction to restrain LATAM from making demand under the three standby letters of credit.

When will a Court interfere with the operation of a letter of credit?

The Court reaffirmed the importance attached to the autonomous nature of letters of credit and similar instruments and the need to ensure certainty of payment. It is a fundamental principle of English law that the Court will only ever intervene with operation of letters of credit in exceptional circumstances. SalamAir accepted that the Court would only restrain a credit provider from paying out where the validity of the instrument is in question or where the bank knows that the demand is fraudulent (the enhanced merits standard). Neither of these circumstances applied in this case.

However, SalamAir argued that the Court could take a broader approach where the application was to prevent the beneficiary from calling the letters of credit, where it was not only the fraud exception that could apply. SalamAir relied on the Court of Appeal decision of Themehelp v West [1996] QB 84, where the buyer of shares in a company obtained an injunction restraining the seller from claiming under a performance guarantee in respect of an instalment of the purchase price. In that case, the buyer had argued that it entered into the contract by reason of the seller’s fraud, but did not argue that the requirements of the fraud exception would have been satisfied for the purposes of the injunction against the seller.

The Court was prepared to assume in SalamAir’s application that it was arguable that in some circumstances an injunction to prevent the beneficiary from making a demand can be obtained even if the applicant is not able to satisfy the requirements of the fraud exception. However, it confirmed that there are limitations:

1. The Court of Appeal decision is only authority that an injunction may be obtained against the beneficiary when the applicant has a claim in fraud against the beneficiary;
2. The injunction in Themehelp was sought “well before” the seller’s right to claim under the performance guarantee had accrued (whereas in this case LATAM’s right to call on the letters of credit had already arisen);
3. There is nothing in the Themehelp case to suggest that the enhanced merits standard should not also apply to this situation.

The Court concluded that an anti-beneficiary injunction should meet the same enhanced merits test as an injunction against the credit-provider. SalamAir was relying on the underlying aircraft leases as having been frustrated due to flight restrictions as its basis for the injunction. There was no claim of fraud by LATAM or that LATAM was not entitled to make the demand under the leases. Therefore the Court concluded that SalamAir was not entitled to the injunction.

Frustration argument

As the basis for the injunction, SalamAir asserted that the leases had been frustrated following the imposition of travel and flight restrictions by the Omani authorities in March 2020. Although the Court did not have to determine whether or not the leases were in fact frustrated, it noted that such an argument was very weak.

In the context of the aircraft operating lease, the “hell or high water” clause (which provided that the obligation to pay rent was absolute i.e. come hell or high water) was fundamentally inconsistent with any suggestion that regulations in Oman preventing SalamAir from using the aircraft during the pandemic restrictions amounted to a frustration of purpose. The risk that SalamAir might be unable to undertake passenger flights in Oman for some significant period, or that there might be a dramatic and long-lasting fall in the demand for air travel more generally, were risks inherent in aviation and more importantly were risks assumed by SalamAir under the leases.

If total destruction of the aircraft, or dispossession through requisition, do not relieve SalamAir of the obligation to pay rent under the “hell or high water” provision, then the Court noted it would be highly improbable that the Omani regulations would have this effect.

Autonomy principle and frustration argument in U.S. courts

Although outside of the aircraft lease context of the SalamAir case, courts in the United States generally reach the same conclusions regarding both the autonomous nature of letters of credit and the enforceability of “hell or high water” provisions. Courts recognise the independence principle, also called the autonomy principle, as the foundation upon which letter of credit law in the United States is built (See BasicNet S.p.A. v. CFP Servs. Ltd., 4 N.Y.S.3d 27 (1st Dep’t 2015)). Codified in the Uniform Commercial Code, this principle states that

“[r]ights and obligations of an issuer to a beneficiary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary.”  U.C.C. § 5-103. 

The Court in BasicNet acknowledged that only “staunch recognition” by the courts of this principle “will give letters of credit the continuing vitality that arises from the certainty and speed of payment under letters of credit.”

Similarly, “hell or high water” clauses are generally enforceable in U.S. courts.  The enforceability of such clauses turns on whether (1) the parties are “sophisticated”, and (2) the contractual terms are clear and “unambiguous”.   Courts in New York have held that litigants cannot rely on “’frustration of purpose’” or similar common law doctrines” when a lease contains a “hell or high water” provision.

Conclusion

The English Court’s re-affirmation of the autonomous nature of letters of credit is of particular importance in the current environment and will no doubt provide some comfort to beneficiaries of letters of credit that their security remains intact and recoverable.

Furthermore, the English Court’s comments in respect of Salam Air’s frustration arguments provide confirmation of the widely held industry view that the “hell or high water” obligation for lessees to pay lease rental under an operating lease is absolute and not impacted by the current Covid-19 pandemic and accompanying flight restrictions.