Mercantile-Safe Deposit & Trust Co. v. Baltimore County

⁶⁷⁰ MURPHY, Chief Judge. This case involves the refusal by an issuer of a letter of credit to honor a call for payment made by the beneficiary of the credit. The question presented is whether the beneficiary’s demand for payment must comply strictly with the terms and conditions of the letter of credit or whether substantial compliance will suffice. I Mercantile-Safe Deposit & Trust Company (Mercantile) issued Letter of Credit No. 10447 in the amount of $20,000 on September 17, 1979.

The beneficiary of the irrevocable letter of credit was Baltimore County; Mercantile’s customer was Z & C, Inc. (Z & C). The credit was to serve as a performance bond for a Baltimore County grading permit issued for a large scale residential development project undertaken by Z & C. The letter of credit authorized Baltimore County to draw on Mercantile upon presentment of a sight draft accompanied by “[a] certification from the Director of the Department of Permits and Licenses of Baltimore County, Maryland, or the Building’s Engineer stating that the permittee, Z & C, Inc., has not complied in accordance with the terms and conditions of Sediment Control Bond Grading Permit No. CGR18868 dated 9/12/77 for property known as Discovery Acres, Section V.” On April 3, 1985, the last day of the fourth extension for presentment, 1 the County submitted a draft in the amount of $20,000, a copy of the letter of credit, and a letter of certification from Ted Zaleski, Jr., the Director of the Baltimore County Department of Permits and Licenses. The certification letter stated: “This letter will serve as a certification from the Director of Permits and Licenses that I have been informed ⁶⁷¹ by Sediment Control inspection personnel that Z & C, Inc. has not complied in accordance with the terms and conditions of Grading Permit 18868. This certification is issued in accordance with Mercantile-Safe Deposit & Trust Company Letter of Credit Number 10447 dated September 17, 1979 and extended to April 3, 1985.

The accompanying sight draft drawn against your Letter of Credit dated September 17, 1979, due to expire April 3, 1985, will complete this transaction.” Mercantile refused to honor the presentment, pointing out several discrepancies between the letter of credit and the letter of certification. These included: 1) The grading permit number in the certification letter read 18868, whereas the number designated in the letter of credit was CGR 18868. 2) The certification letter stated “I have been informed” that Z & C has not complied with the grading permit, whereas the letter of credit required the Director to certify directly, through personal knowledge, not through hearsay, of the lack of compliance. 3) The certification letter did not identify Z & C, Inc. as the permittee. 4) The certification letter did not name the property, Discovery Acres, for which the permit had been issued. Although attempts were made to cure the defects before the close of business on April 3, 1985—the last day before expiration of the letter of credit—Baltimore County was ultimately unsuccessful and thus its presentment remained dishonored. Mercantile indicated other problems with the presentment in a letter to Baltimore County on April 19, 1985.

In addition to the discrepancies initially noted by Mercantile, the certification letter also failed to refer to the property by its section reference, i.e., Section V, as required, and it did not refer to the permit by its full name also as required, i.e., Sediment Control Bond Grading Permit. ⁶⁷² Baltimore County sued Mercantile on August 28, 1985 in the Circuit Court for Baltimore County, maintaining that Mercantile wrongfully dishonored the presentment because the certification letter substantially complied with the letter of credit. Mercantile contended that there must be strict, and not merely substantial, compliance with the terms and conditions of the letter of credit. Because the discrepancies between the two documents were so numerous and material, Mercantile claimed that it rightfully dishonored the County’s presentment. After a hearing on the parties’ cross motions for summary judgment, the court (DeWaters, J.) held that Baltimore County’s presentment had substantially complied with the requirements contained in the credit and that Mercantile had acted improperly in refusing to honor it.

The significant issue raised in the case prompted us to grant Mercantile’s Petition for writ of certiorari' to the Court of Special Appeals before consideration of Mercantile’s appeal by the court. II Maryland Code (1975) Title 5 of the Commercial Law Article, in § 5-103(l)(a), defines a letter of credit as “an engagement by a bank or other person made at the request of a customer and of a kind within the scope of this title (§ 5-102) that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit. A credit may be either revocable or irrevocable. The engagement may be either an agreement to honor or a statement that the bank or other person is authorized to honor.” The essential parties to the usual letter of credit include: 1) the customer 2 , 2) the beneficiary 3 , and 3) the issuer of the ⁶⁷³ credit, usually a bank. 4 In a typical transaction involving a letter of credit, illustrated by a commercial transaction involving the sale of goods, the parties interact in the following manner: “Buyer and Seller enter into a contract for the sale of goods.

The agreement includes a term whereby Buyer agrees to establish a letter of credit with a Bank in the amount of the purchase price. The Bank issues such a credit letter promising to pay Seller upon presentation of a draft and appropriate documents specified in the letter. Seller performs its obligations, and in so doing, gathers the necessary documents, e.g., bills of lading from the carrier, invoices, and inspection certificates. Seller presents the complying documents and the Bank honors the draft for payment.

Buyer reimburses the Bank, takes the documents to the Carrier, and gets the goods.” Leon, “Letters of Credit: A Primer,” 45 Md.L.Rev. 432, 433-34 (1986). The reasons a seller may insist on using a letter of credit are threefold, yet central to each is the desire to reduce or eliminate the possibility of the buyer’s failure to pay. First, the seller wishes to avoid the risk of disposing of the goods, often in a foreign market, if the buyer proves insolvent or otherwise unable to pay for the merchandise. Second, a buyer may dishonestly refuse payment, as might occur in order to take advantage of a better bargain from another seller.

Finally, the buyer might honestly dispute payment for a legitimate reason, such as nonconformity of a prior shipment. See J. White & R. Summers, Uniform Commercial Code § 18-1, at 705-06 (2d ed. 1980). The letter of credit transaction between the issuer and the beneficiary/seller is designed to be completely independent of the underlying commercial transaction between the cus ⁶⁷⁴ tomer/buyer and the beneficiary/seller. Thus, a letter of credit that pledges the bank’s credit, regardless of what transpires in the underlying transaction, satisfies the seller’s need for assurance of payment.

Although historically letters of credit were used primarily in international transactions involving the sale of goods, both the forum and the use have since expanded. Today they are used increasingly in domestic transactions and functions as much as a means of “standby” credit as they do of commercial credit. A standby letter of credit serves a purpose similar to that of a guaranty by providing payment to a beneficiary upon default of a party that was obliged to perform. See J. Dolan, The Law of Letters of Credit: Commercial and Standby Credits ¶ 1.04, at 1-12 to -15 (1984).

Thus, in addition to serving as a medium of payment for property sold or services rendered, letters of credit also serve, as in the present case, as a “back up” device against customer default. See J. White & R. Summers, Uniform Commercial Code § 18-1, at 709 (2d ed. 1980). The Uniform Commercial Code (UCC) rules governing letters of credit were adopted by this State in 1963 and are contained in Title 5 of the Commercial Law Article. However, § 5-102(3) recognizes that Title 5 is not meant to be an exhaustive list of rules applicable to letters of credit: “This title deals with some but not all of the rules and concepts of letters of credit as such rules or concepts have developed prior to this act or may hereafter develop.” According to the Official Comment to § 5-101, the law relating to letters of credit “has been developed in the cases.” Official Comment 2 to § 5-102, subsection (3) “recognizes that in the present state of the law and variety of practices as to letters of credit, no statute can effectively or wisely codify all the possible law of letters of credit without stultifying further development of this useful financing device.

The more important areas not covered by this Title revolve around the question of when documents in fact and in law do or do not comply with the terms of the credit.” ⁶⁷⁵ The only guidance given to issuers in Title 5 regarding when documents comply with the relevant letters of credit is found in §§ 5-109(2) and 5-114(1). The former states in pertinent part: “An issuer must examine documents with care so as to ascertain that on their face they appear to comply with the terms of the credit____” Section 5-114(1) provides: “An issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying contract for sale or other contract between the customer and the beneficiary.” The UCC’s lack of guidelines by which to determine compliance with the terms and conditions of a letter of credit has given rise to two basic standards: the strict compliance test and the substantial compliance test. Under the strict compliance test, the documents offered at the time of presentment must precisely comply with the terms of the letter of credit; any deviation, however slight, allows the issuer to dishonor. The bank’s role in applying this standard is purely ministerial; it simply examines the documents presented in light of the requirements of the credit and is not placed in the time-consuming and tenuous position of deciding whether a discrepancy is material.

As stated in Consolidated Aluminum Corp. v. Bank of Virginia, 544 F.Supp. 386, 395 (D.Md.1982) aff'd, 704 F.2d 136 (4th Cir.1983): “The rule of strict compliance and the ministerial nature of the issuing bank’s responsibility to determine whether or not documents presented by the beneficiary conform to the terms and conditions of the letter of credit serve two purposes: (1) providing certainty of payment to the beneficiary and (2) allowing the issuing bank to evaluate precisely its risks under the letter of credit. It is the certainty of payment that gives the letter of credit its unique value as an instrument to secure obligations of all kinds in myriad contexts. By the same token, the fact that the bank’s obligation is defined solely by the terms ⁶⁷⁶ and conditions of the letter of credit allows the bank to evaluate precisely the extent of the risks involved in its undertaking pursuant to the letter of credit. As both courts and commentators have pointed out, it is this strict construction of letters of credit which gives them their unique usefulness” (footnote omitted).

The strict compliance standard has been applied by the majority of federal jurisdictions. It has been held, for example, that invoices describing goods as “imported acrylic yarn” did not strictly comply with the condition in the letter of credit that it be accompanied, at presentment, by an invoice covering “100% acrylic yarn.” Courtaulds North America, Inc. v. North Carolina Nat’l Bank, 528 F.2d 802 (4th Cir.1975). The court said: “This is not a Pharisaical or doctrinaire persistence in the principle, but is altogether realistic in the environs of this case; it is plainly the fair and equitable measure. (The defect in description was not superficial but occurred in the statement of the quality of the yarn, not a frivolous concern)” (emphasis in the original).

Id. at 806 . Bd. of Trade of San Francisco v. Swiss Credit Bank, 728 F.2d 1241 (9th Cir.1984), likewise adopted the strict compliance test when it held that the beneficiary’s partial shipment of the goods in question by air failed to comply with the credit’s condition that they be shipped by boat. The court stated: “The issuer of a letter of credit should not be placed in the position of having to determine whether an unauthorized method of shipment is material. In this instance, whether air shipment would have been considered hazardous by the parties or apt to cause damage to sensitive electronic equipment is not the type of evaluation that should be required in a transaction where promptness and certainty are of the essence.

Absent a waiver, an issuer may insist on strict compliance with the terms of a letter of