Court of Appeal decision of 12 May 2017 in Scope Telematics International v Stoic Co Ltd and Co-operative Bank of Kenya
Letters of credit are often described as “the lifeblood of international commerce.” In a 2017 decision, the Court of Appeal sitting at Nairobi reaffirmed the legal principle that a letter of credit transaction is separate from the underlying contract between the parties and rejected an argument seeking to prevent payment on a letter of credit due to an alleged breach of the underlying contract.
In this case, the first respondent, Stoic Co. Ltd. had contracted to buy tracking devices from the appellant, Scope Telematics International, with payment for the devices being secured by a letter of credit opened with the second respondent, Co-operative Bank of Kenya, as the issuing bank. The contract between the parties also provided for resolution by negotiation of any disputes that may arise, and in the event that negotiations failed, then by arbitration. If arbitration in turn failed then the dispute would be determined by the courts of Ireland.An issue later arose as to the quality and functionality of the goods delivered. With the date for the maturity of the letter of credit fast approaching and with the relevant documents having been received by the second respondent from the advising bank, Stoic filed an application before the High Court in Nairobi seeking orders from the court restraining Scope Telematics from demanding payment on account of the supply of the goods. The application was filed by way of notice of motion. Scope Telematics and the bank both opposed the application.
On 31 July 2015, the High Court issued orders in favour of Stoic, granting an order restraining Scope from demanding payment for the units delivered or demanding release of the funds from
the bank pending arbitration.
Scope Telematics thereafter appealed to the Court of Appeal against the orders. Having considered the arguments made by the parties, the Court identified three broad issues upon which the appeal could be determined: firstly, whether the application was properly before the court, secondly, whether the judge correctly applied the principles attending letters of credit and, thirdly, whether the applicant was entitled to interim protection under the Arbitration Act.
On the first issue, the Court held that “where there is a clear procedure for the redress of any particular grievance prescribed by the Constitution or Statute, that procedure should be strictly
followed.” Rule 2 of the Arbitration Rules made it mandatory for an application under either sections 6 or 7 of the Arbitration Act to be made by summons in the suit. In this instance, the 1 st respondent had not offered any reasons for failing to premise its application upon a suit as required by the rules but had instead chosen to rely on Article 159 of the Constitution for the proposition that justice was to be administered without due regard to technicalities. However,the manner of instituting a suit could not be regarded as a mere technicality and for this reason the application was fatally and incurably defective.
On the second issue, the Court reiterated that “a letter of credit exists separately and distinct from the underlying contract and it’s not dependent or based upon such a contract in any manner.” It further held that a court could only interfere with a letter of credit where fraud had been established and the bank was notified of the same or where encashment of the letter of credit would result in irreparable harm or injustice to one of the parties.
On the third issue the court found that there was no evidence tendered that Stoic would suffer irreparable harm or injustice and there was therefore no ground on which the judge could have
exercised his discretion in its favour. There were therefore no circumstances present that would warrant the court deviating from well accepted international norms and customs regarding the irrevocability of the letter of credit.
This judgment holds two important lessons for practitioners and the business community. From a practitioner’s perspective, it is essential to comply with the provisions of rule 2 of the Rules in seeking protection under sections 6 & 7 of the Act.
From a business perspective, business people need to exercise caution in entering into transactions that are financed by letters of credit. They should realise that in the event of a dispute regarding the underlying contract the bank issuing the letter of credit will still be bound to pay up on the letter of credit, providing conforming documents are supplied to it.
Summary by Dr. Henry Kibet Mutai