Supreme Court of Canada Denies Leave Application: Strong Case of Fraud Required to Refuse Payment of Letter of Credit

On April 25, 2024, the Supreme Court of Canada (SCC) denied leave to appeal the recent ruling of the Alberta Court of Appeal (ABCA) in Pacific Atlantic Pipeline Construction Ltd v. Coastal GasLink Pipeline Ltd. (Decision). In the Decision, the ABCA refused to enjoin Coastal GasLink Pipeline Ltd. (CGL) from drawing on a letter of credit provided by Pacific Atlantic Pipeline Construction Ltd. (PAPC) to CGL pending the conclusion of an arbitration between CGL and PAPC. 

Letters of credit are intended to facilitate prompt payment or guarantee the due performance of contractual obligations. Canadian courts have consistently recognized the vital role of letters of credit in international commerce and have generally refrained from interfering with a beneficiary’s right to draw upon them except in cases of clearly demonstrated fraud.

The Decision reaffirms that fraud remains the sole recognized exception to the right of a beneficiary to draw on a letter of credit. The SCC’s refusal to grant leave to appeal marks the end of a six-month effort by CGL to draw on the letter of credit. This case also serves as a caution to letter of credit beneficiaries — a counterparty may attempt to delay a draw on a letter of credit by seeking injunctive relief from the courts, even in circumstances in which the counterparty has not proven or even alleged fraud by the beneficiary. 

Background

CGL contracted with PAPC to construct certain sections of the Coastal GasLink Project in British Columbia. PAPC provided security to CGL for the performance of its obligations in the form of a C$117,162,384 irrevocable standby letter of credit designating CGL as beneficiary (Letter of Credit). 

In 2022, CGL terminated the contract for cause because of serious concerns about the ability of PAPC to perform its contractual obligations. PAPC commenced arbitration claiming damages for wrongful termination, and CGL counterclaimed claiming damages for failure to perform. 

In October 2023, CGL sought to draw the full value of the Letter of Credit. Thereafter, PAPC applied to the Court of King’s Bench of Alberta (ABKB) for an injunction to stop CGL from doing so.

Injunction Application

In October 2023, PAPC applied to the ABKB and obtained a “short-term” interim, interim injunction to restrain CGL from drawing the letter of credit pending a full hearing about the injunction application. 

In December 2023, a different justice of the ABKB heard the injunction application of PAPC on the merits. At that hearing, and notwithstanding the unbroken line of jurisprudence in Canada holding that an applicant that seeks to enjoin a beneficiary from drawing on a letter of credit must show a strong prima facie case of fraud by the beneficiary, PAPC argued that a lower standard should apply. Specifically, PAPC argued that when an injunction is sought only against the beneficiary, in this case CGL, and not the issuing bank of the letter of credit, all that must be shown is a serious case to be tried. This standard is significantly less demanding than the strong prima facie standard. Justice Whitling of the ABKB rejected this argument. He held that “the courts of Canada have been reluctant to grant injunctions which impair the operation of irrevocable letters of credit. A more generous attitude would compromise the liquidity and utility of those instruments.” Accordingly, he denied the application of PAPC but he nevertheless extended the interim, interim injunction to allow PAPC to appeal his judgment to the ABCA (2023 ABKB 736).

On February 29, 2024, the ABCA released the Decision. In the Decision, the ABCA dismissed the appeal of PAPC and reaffirmed that a high bar is required to obtain an injunction that restrains a beneficiary from drawing on a letter of credit. In doing so, the ABCA noted that “the rationale for the stricter standard — to avoid undermining the international commercial utility and efficacy of letters of credit — applies equally regardless of whether the application is brought against the issuing bank or the beneficiary” (2024 ABCA 74).

The decision of the SCC to deny leave to appeal the Decision is consistent with a recent decision of the SCC in Eurobank Ergasias S.A. v. Bombardier Inc. (Eurobank). In Eurobank, the SCC confirmed the long-standing rule in Canada that fraud remains the sole exception to the ability of a beneficiary to draw on a letter of credit. Further, the “fraud exception is limited to cases of obvious fraud ‘to avoid unduly interfering with the commercial utility and efficacy of letters of credit’” and “a mere absence of good faith may not be sufficient.”

Notably, the finding of fraud in Eurobank is in stark contrast to the findings of the ABKB, as upheld by the ABCA in the Decision. In Eurobank, the Quebec Court of Appeal (QCCA) concluded that the beneficiary drew on the letter of credit in the face of both a written undertaking not to draw and an Interim Order made by an ICC Tribunal. In upholding the Superior Court of Quebec, the QCCA concluded that the beneficiary had acted with “some measure of impropriety, dishonesty and of legal bullying that could not be qualified other than having the color of fraud.”

In contrast, the ABKB rejected PAPC’s allegations of bad faith and dishonest performance against CGL and made overt findings to the contrary. Justice Whitling of the ABKB found, as a fact, that CGL did not act in an “abusive manner” towards PAPC and did not “… li[e] to or intentionally deceive[] PAPC…in order to achieve a benefit that it was not entitled to.” He held that at most the evidence supported a misunderstanding induced by “wishful thinking” on the part of PAPC that CGL would not draw on the Letter of Credit before the conclusion of the arbitration between PAPC and CGL. The ABCA unanimously upheld these findings in its Decision and dismissed the appeal of PAPC.

Key Takeaways

There are several key takeaways from the Decision, as follows:

1. Although letters of credit are intended to be the equivalent of cash, payable on short notice, a counterparty may be able to delay a draw on a letter of credit by seeking injunctive relief from the courts and by appealing those decisions.
2. A party seeking to enjoin a beneficiary from drawing on a letter of credit must show a strong prima facie case of fraud by the beneficiary. The mere suspicion of fraud is insufficient, and accusations of bad faith fall short of the mark.
3. Documenting the decision-making process leading to a decision to draw on a letter of credit is important. Having a robust, well thought-out process that supports the bona fides of a draw is helpful if the counterparty later alleges fraud or bad faith against the beneficiary.

The authors, along with Alyssa Duke and Laura Cundari, were counsel for the Respondent, Coastal GasLink Pipeline Limited Partnership, by its general partner Coastal GasLink Pipeline Ltd. The authors also wish to acknowledge the significant contributions of Karen O’Keeffe, senior legal counsel for Coastal GasLink Pipeline Ltd.

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