Pacific Atlantic Pipeline Construction Inc. v. Coastal Gaslink Ltd. [2024]

Factual Summary:

At the request of its customer, Pacific Atlantic Pipeline Construction Inc. (Contractor/Applicant), HSBC Bank Canada (Issuer) issued a CAD 117,162,384 standby letter of credit in favour of Coastal Gaslink Ltd. (Principal/Beneficiary). Contractor/Applicant, a wholly owned subsidiary of Bonatti, S.p.A. (Contractor Owner), was engaged by Principal/Beneficiary in 2012 to construct certain sections of a liquid natural gas pipeline in British Columbia (the Contract). The standby LC was obtained to support performance by Contractor/Applicant.

When construction work was impacted by the pandemic and other matters, a dispute arose regarding Contractor/Applicant’s performance. After unsuccessful mediation between the parties, Principal/Beneficiary terminated the contract. After Contractor/Applicant initiated arbitration and Principal/Beneficiary lodged counterclaims, Beneficiary received a third-party report estimating damages caused by Contractor/Applicant; partially relying on the report, Principal/Beneficiary presented a demand to Issuer for full standby payment. As the demand complied and Issuer had no knowledge of fraud, Issuer intended to honour despite Contractor/Applicant alleging fraud.

Thereafter, Contractor/Applicant applied for an interlocutory injunction to restrain Principal/Beneficiary from demanding payment. The trial court denied the requested injunction on the merits but issued an interim injunction to allow Contractor/Applicant time to file an appeal. The Court of Appeal of Alberta, Crighton, Pentelechuk and Antonio, JJ., affirmed.

Analysis:

Contractor/Applicant alleged the trial court erred in three respects: (1) the court applied an incorrect standard of proof regarding Contractor/Applicant’s request for an interlocutory injunction; (2) the court erred in finding that Principal/Beneficiary properly demanded standby payment; and (3) the trial court erred in its breach of the duty of honest performance analysis.

Turning first to the proper standard of proof for obtaining injunctive relief regarding a letter of credit demand in Canada, Contractor/Applicant argued that the standard of “serious question to be tried” should have been applied as opposed to “strong prima facie case” because Contractor/Applicant pursued an interlocutory injunction against Principal/Beneficiary, not Issuer. Contractor/Applicant noted the dearth of case law on point and claimed further “that a lower standard is warranted for a number of reasons, including because a ‘beneficiary can handle its own affairs and is only at risk of an injunction if it has breached its contractual duties’.” (para.8). As an initial matter the appellate court commented on the idiosyncratic nature of letters of credit:[[1]]

The stricter standard [of proof] ensures courts do not too readily interfere with the operation of letters of credit and undermine their utility and efficacy. The characteristic that gives [LCs] international commercial utility and efficacy is that they operate independently of disputes about performance of the underlying contract. They are intended to provide beneficiaries a ‘ready means of obtaining prompt payment’. Where a beneficiary presents an issuing bank a draft accompanied by documents that appear on their face to be in accordance with the terms and conditions of the [LC], the bank is generally obliged to honour the draft[.]

In acknowledging the few cases dealing with applicant injunctions against LC beneficiaries, the appellate court cited two actions that either applied or discussed application of the “strong prima facie case” standard.[[2]] Unpersuaded that a lower standard of proof was warranted, the appellate court affirmed the trial court’s decision and concluded that the higher standard should apply irrespective of whether injunctive relief is pursued against a bank or a beneficiary: “[t]o hold otherwise would be to allow an applicant to do indirectly what they could not do directly.”

Turning to whether the trial court erred in ruling that Principal/Beneficiary made a proper demand both pursuant to the LC terms and conditions and underlying contract, Contractor/Applicant alleged that the demand was made for an “improper purpose.” The standby, obtained to support performance obligations, was drawn on after practical project completion (albeit by other contractors), i.e. Principal/Beneficiary “was exercising its discretion outside that contractual purpose.” The appellate court rejected this argument. There was no such limitation as forwarded by Contractor/Applicant; instead, “[t]he triggering event was simply that ‘the counterparty has failed to … perform its obligations’.”

As the appellate court viewed it, accepting Contractor/Applicant’s argument would seem to “differentiate those beneficiaries with more resources and liquidity than those with less”. Such an approach would make little commercial sense and could even “encourage beneficiaries to draw hastily on [LCs].” The appellate court viewed either result unfavorably. In affirming the trial court’s ruling that Principal/Beneficiary made a proper demand, the appellate court turned to the final argument concerning an alleged breach of the duty of honest performance.

Contractor/Applicant argued that the trial court erred in requiring a showing of deceit, dishonesty or deception to support a claim for breach of the duty of honest performance (i.e. good faith in contractual dealings). Rather, Contractor/Applicant argued that such a “breach can arise where one party leads another into misapprehension, is aware of the misapprehension, and does not correct it”. In this way, Contractor/Applicant continued (from the trial phase) to allege that Principal/Beneficiary, by way of representations made during 2022 meetings when the parties were attempting to resolve their dispute, promised not to demand standby payment pending arbitration.

The appellate court rejected this claimed error which was based on a mixture of fact and law and was therefore owed deference. The trial judge “did nothing other than apply” the appropriate legal standards regarding an allegation of breach of the duty of honest performance. The appellate court agreed with the trial court that, at most, Contractor/Applicant demonstrated a “misunderstanding induced by wishful thinking” on behalf of Contractor/Applicant that Principal/Beneficiary would not demand payment prior to arbitration conclusion. Finding no reviewable error, the appellate court affirmed all aspects of the trial judgment, dismissed the appeal and terminated the short term interim injunction.

Comment:

As reported in DCW May 2024, leave to appeal this action to the Canadian Supreme Court was denied. Despite efforts in recent years to expand the exception to LC autonomy, Canadian law still requires an applicant to demonstrate: (1) a strong prima facie case of fraud (or breach of an express forbearance agreement); (2) irreparable harm absent relief; and (3) a balance of the equities favouring the applicant. This tripartite test resembles that found in US UCC Rev. Section 5-109(b). Official Comment 5 to Section 5-109 cautions courts against granting “similar relief” against Issuers or other persons: “the same principles apply when the applicant or issuer attempts to achieve the same legal outcome by injunction against presentation.” See Ground Air Transfer, Inc. v. Westates Airlines, Inc., 899 F.2d 1269 (1st Cir. 1990).  

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[[1]]: Quoting Bank of Nova Scotia v. Angelica-Whitewear Ltd., [1987] 1 SCR 59 [Canada]

[[2]]: Citing Café Can Cun Co. v. Halcor Development Corp., 2018 ABQB 303 [Canada] (applying “strong prima facie case” standard regarding interlocutory injunction against beneficiary); and Veolia Water Technologies, Inc. v. K+S Potash Canada General Partnership, 2019 SKCA 25 [Canada] (discussing without ruling that “strong prima facie case” standard would apply equally to injunction sought for beneficiary breach of forbearance agreement)