Article

Factual Summary: Applicant/principal undertook to provide a letter of credit to reimburse the beneficiary for any claims the beneficiary/surety paid under its bond covering the applicant's work for the Denver International Airport.

The bank issued the credit for US$ 50,000 which provided, "Funds under this Letter of Credit are available to you against your sight draft(s), signed by your authorized corporate officer drawn on us bearing the clause 'Drawn under the Credit #6743950.'"

Subsequently, the beneficiary presented a sight draft for US$ 50,000 which stated that it was drawn under credit number 6743950 and which was apparently signed by a corporate officer of the beneficiary/ surety. The opinion indicates that "[a]pproximately one week later," the issuer dishonored because the drawing had nothing to do with the applicant or the reason for which the latter of credit was issued. Although it apparently gave no reason for the written dishonor in the written notice and there was a dispute as to whether the reason for dishonor was given in a prior telephone message, the issuer claimed that the drawing was occasioned by a debt owed the beneficiary by Dwight Bauer Floor Company, a separate corporation owned by a relative of the principal of the applicant (Bauer Floor Covering, Inc.) but with no business ties or relationship to it or its principal.

After notifying the beneficiary that it would not honor the sight draft, the issuer sought a declaratory order that it did not have to do so on the basis of fraud in the transaction and the beneficiary counter-claimed on the basis that dishonor was wrongful. The trial court granted summary judgment in favor of the issuer. On appeal, affirmed.

Legal Analysis:

1. Notice of Dishonor: The court rejected the beneficiary's argument that dishonor was precluded under UCP400 Article 16(d), because the issuer had failed to state the reason for dishonor. The appellate court noted that it was a question of fact whether such notice had been given in a prior telephone call. Summary judgment was, nonetheless, appropriate because this issue was not discussed by the trial court.

2. Independence Principle: Fraud Exception: While it noted that the documents conformed with the terms and conditions of the letter of credit and recognized the role of the independence principle "to protect the commercial utility of letters of credit" the court concluded that dishonor was justified when there was fraud.

3. Fraud in the Transaction Available under the UCP:The beneficiary argued fraud is not a defense available under UCP400. However, the appellate court looked to UCC Article 5 since UCP400 is silent regarding fraud.

4. Fraud in the Transaction: Drawing an inference from language in prior UCC Section 5-114(2) permitting a bank to honor notwithstanding the presence of alleged fraud, the appellate court concluded that "a bank may dishonor a sight draft drawn on a letter of credit which appears to be valid on its face and is made in compliance with the terms of the letter of credit if it determines there was fraud in the transaction."

The appellate court cautioned that under prior UCC Section 5-114(2), the type of fraud which must be present to justify dishonor of a letter of credit must be "fraud so egregious as to vitiate the entire transaction. Because the facts demonstrated that when the beneficiary drew, "it had no right to do so," the court concluded that there was fraud in the transaction.

5. Fraud in the Transaction: Not Customer Fraud: The appellate court noted that under Kansas law, "fraud in the transaction 'must stem from the conduct of the beneficiary against the customer, not by the customer against the issuer of the letter of credit,'"citing InterFirst Bank Geenspoint v. First Federal Savings & Loan Ass'n,242 Kan. 181, 187;747 P.2d 129 (1987)).

Since the beneficiary's attempted drawing had nothing to do with the applicant, the issuer was able to invoke this defense.

Comment:

1. Fraud as a Defense: This case nicely reaffirms the ability of an issuer or confirmer to refuse to honor on the basis of fraud. It also reminds us that, in doing so, the issuer bears the heavy burden of proving letter of credit fraud.

2. Letter of Credit Fraud: Egregious& Not Induced by Applicant: This case also reminds us that the fraud must be serious in which there is no colorable basis for drawing and cannot be fraud by the applicant which induced issuance of the letter of credit.

3. Parties: Unfortunately, in discussing the role of the stranger corporation, the opinion refers to the applicant as a "party" to the letter of credit. Of course, it is not. Nonetheless-as this opinion demonstrates- question of who the applicant is and the purpose of the letter of credit can play a role in the question of fraud.

4. Preclusion and Fraud: The court declines to consider the applicability of the UCP preclusion rule because it was not considered by the trial court. That rule would not have affected the result. The preclu sion rule does work to preclude the defense of fraud. Fraud need not be stated in the Notice of Dishonor and, indeed, can be raised at any time.

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.