Books

Fraud and other defences to a claim on a guarantee or counter-guarantee

Summary of defences to a claim

621. The assurance of payment on first written demand accompanied, under the URDG, by a statement of breach is considered of paramount importance to the functioning of the demand guarantee system and the confidence of its users. It is therefore only in exceptional circumstances that courts will grant an injunction to prevent a beneficiary from making a demand or an issuer96 from making payment where the specified documents are presented. There are, however, extreme cases where the courts will intervene to protect the applicant for the credit from a demand that is unjustified or to which there is some other defence. Such cases fall outside the scope of the URDG and depend on the applicable law. States parties to the 19⁹⁶ UN Convention on Independent Guarantees and Stand-by Letters of Credit will apply article 19 of that Convention, which sets out exceptions to the payment obligation, while article 20 provides for provisional court measures designed to ensure that the beneficiary does not receive payment in cases falling within the scope of article 19(1)(a), (b) or (c). The subject is complex and only an outline of the key issues can be given here. Depending on the jurisdiction, courts may grant an interim injunction preventing the payment of the guarantee where:

• fraud has been committed by the beneficiary or by others to the knowledge of the beneficiary;

• documents presented have been forged or are otherwise a nullity;

• the issue of the guarantee has been induced by misrepresentation by the beneficiary and the guarantee has been cancelled by the issuer;

• though the demand is a conforming demand, the proposed payment would be in breach of the mandate given by the instructing party to the counter- guarantor or by the counter-guarantor to the guarantor, in the absence of a waiver;⁹⁷

• the beneficiary has been guilty of unconscionable conduct, that is, conduct that, though falling short of fraud, is unfair, abusive or dishonest, as where the beneficiary has itself impeded performance;

• the making of the demand is in breach of an agreement between the instructing party and the beneficiary,

[Page247:]

• the transaction or payment under it would be illegal; or

• the issuer exercises a right of set-off in respect of a cross-claim against the beneficiary.

In general, however, the issuer of the guarantee or counter-guarantee is protected from liability where it makes payment without, or prior to, knowledge of the vitiating factor. It is therefore more difficult to obtain an injunction against the issuer than against the beneficiary.

622. It should be emphasized that there are substantial differences between legal system as to the applicability and scope of any of these defences, so it is important to obtain legal advice from a local expert.

Fraud⁹⁸

623. Many of the principles governing fraud in relation to documentary credits apply equally to demand guarantees. The main difference arises from the fact that, in the case of a documentary credit, the issuer is the first port of call for payment, whereas a demand guarantee ought not to be invoked unless there has been a breach of the underlying relationship and therefore ought to be exceptional. In all jurisdictions, it is accepted that fraud is a defence to a claim by the beneficiary, though the standard of proof is usually high, since courts are reluctant to find fraud except on the clearest of evidence, for fear of undermining the integrity of the banking system and the attractiveness of demand guarantees compared to suretyships, where the debtor’s breach must first be established and the issuer has no duty to make its own investigations as to the presence or absence of fraud. The evidence of fraud must thus be compelling. It is not sufficient that the balance of convenience lies in favour of the party invoking fraud as a defence to payment. But there are differences between legal systems as to what constitutes fraud, whose fraud is relevant, whether the defence of fraud is confined to fraud in regard to the demand guarantee itself or extends to fraud in the underlying transaction, at what time fraud needs to be established in the proceedings – particularly relevant where the beneficiary is seeking summary judgment without a trial – and in what circumstances fraud affects the issuer’s right to make payment following a complying presentation of the requisite documents. Where the instructing party has evidence of fraud, it should seek an injunction to restrain the beneficiary from presenting a demand, if it has not already been presented, and the bank to restrain payment. It is usually unwise to bring proceedings against the issuer without joining the beneficiary as defendant, because the court may be reluctant to make a finding of fraud against a person who has not been joined as a party and therefore has no opportunity to contest the fraud allegation.

[Page248:]

What constitutes fraud?

624. In some legal systems fraud connotes dishonesty, that is, knowledge on the part of the beneficiary or its agent that there is no basis for the demand or deliberately turning a blind eye to factors indicative of fraud by others. In other systems the test is objective; it suffices that the demand is made without any conceivable justification, even if made in good faith. However, even in systems that require dishonesty, the absence of a conceivable basis for the demand may constitute a separate ground for refusal to pay. Article 19 of the UN Convention on Independent Guarantees and Stand-by Letters of Credit (1995) avoids reference to fraud or bad faith altogether and refers simply to a demand that “has no conceivable basis.” A demand made when it is clear that there has been no default by the applicant in its performance of the underlying transaction is, dependent on the jurisdiction, treated either as fraud or as unconscionable conduct (also known as unfair or abusive demand in civil law jurisdictions) that justifies the granting of injunctive relief.

Invoking fraud: procedural aspects

625. Where the issuer is satisfied that a presentation is affected by fraud, it may on its own initiative refuse payment and, in proceedings commenced against it by the beneficiary, plead fraud as a defence. On the other hand, the issuer may be reluctant to refuse payment if there is a prospect of the court finding that it has no clear evidence of fraud. In order to protect itself and avoid damage to its reputation, the issuer will therefore usually inform the applicant that it intends to pay unless, within a very limited period, the applicant obtains an injunction to restrain the bank from making payment. However, this is neither an obligation of the issuer nor best practice. It may be that the issuer has become aware of the fraud before presentation by the beneficiary, in which case the issuer will decline to make payment regardless of whether the demand is a complying demand. It need not in such a case seek a court injunction to restrain presentation by the beneficiary. Where the issuer has no, or no sufficient, evidence of fraud at the time of presentation but declines to pay because it suspects fraud, it may still rely on a plea of fraud, but only if it has acquired the necessary evidence before the case comes before the court, whether at a trial or on an application by the beneficiary for summary judgment.⁹⁹ Similarly, if the issuer obtains the evidence after presentation but before payment, it may withhold payment but, in case of doubt, seek to protect itself by applying to the court for an injunction to restrain payment or for an order declaring the presentation to be of no effect.

626. It is not only a court that can grant injunctive relief. In arbitration proceedings between the beneficiary and the applicant (more rarely also involving the issuer) governed by the ICC Arbitration Rules (2021), the arbitral tribunal is empowered

[Page249:]

by article 28 to impose any interim or conservatory measure it deems appropriate, including an order requiring the beneficiary of a demand guarantee to withdraw its demand for payment.

Forged or otherwise invalid documents

627. Jurisdictions differ as to whether the issuer is obliged to pay against a document it knows to be forged if the forgery was not committed by or known to the beneficiary or its agent but by a third party without the knowledge of the beneficiary or its agent. In some jurisdictions, it has been held that forgery is a defence only if committed by or known to the beneficiary or its agent. In other jurisdictions the view is taken that the presentation of a forged document, from whatever source, is not a valid presentation and that the issuer should not be forced to pay against a document that the issuer knows is forged and has no value. Thus, in a state that has ratified the 1995 UN Convention on Independent Guarantees and Stand-by Letters of Credit, it is enough that any document is not genuine or has been falsified (article 19(1)(a)). Even where the issuer has to pay, it is entitled to be indemnified by the applicant. The issuer will in any event be protected if it makes payment without knowledge of the forgery, being entitled to pay if the document appears on its face to be genuine (see article 19(a)). “On its face” refers to the document as a whole, not simply the front page. A document may also be invalid on other grounds under the applicable law, for example it was issued by a person not legally empowered by that law to issue it or by an agent having neither actual nor apparent authority from its principal to issue it.

Cancellation of guarantee for misrepresentation

628. Like any other contract or similar engagement, a guarantee may be cancelled by the issuer where under the applicable law its issue has been induced by fraud or other misrepresentation, though the guarantor is protected if it makes payment before acquiring knowledge of the fraud or misrepresentation.

Breach of mandate

629. While the beneficiary is unlikely to know of the instructions given by the instructing party to the issuer and will be entitled to retain a payment received without knowledge that in making it the issuer has exceeded its mandate, the court may grant an injunction restraining presentation and/or payment of a demand where the payment would exceed the issuer’s authority from the instructing party.

Unconscionable or unfair conduct

630. In some jurisdictions, it is not necessary to show fraud to obtain an injunction. It suffices that the beneficiary has been guilty of unconscionable or unfair conduct (abus de droit), as where the beneficiary itself impeded the work the non- performance of which triggered the demand or led the guarantor to believe that no demand would be made or that the contract price for which the guarantee

[Page250:]

was given and to which the guarantee amount was linked had been reduced downwards without a corresponding reduction in the amount of the guarantee.

Breach of agreement between instructing party and beneficiary

631. Depending on the jurisdiction, an injunction may be granted to restrain the presentation of a demand that is in breach of an agreement between the instructing party and the beneficiary.

Illegality of intended payment

632. It is clear that the issuer is neither obliged nor entitled to make a payment that would be illegal under the law of the due place for payment, which often coincides with the law of the currency of payment, for example because it would be in breach of sanctions legislation prohibiting payments to the country where payment is due. Furthermore, under article VIII(2)(b) of the Articles of Agreement of the International Monetary Fund, exchange contracts that involve the currency of any member and that are contrary to the exchange control regulations of that member, maintained or imposed consistently with the Fund Agreement, are not enforceable in the territories of any member. It is beyond the scope of this work to go into further detail regarding article VIII(2)(b), and reference should be made to standard texts.¹⁰⁰

Set-off

633. May the issuer set off against the beneficiary’s demand an amount due from the beneficiary to the issuer under a separate contract? Jurisdictions are divided on the question whether set-off is available at all and, if so, on the conditions that need to be satisfied to establish a right of set-off. However, unless otherwise provided by the applicable law, the issuer is considered entitled to exercise a right of set-off against the amount of a claim under the guarantee in respect of the issuer’s own claim against the beneficiary under a separate contract or other relationship between the issuer and the beneficiary. In this regard, see paragraph 162 of the ISDGP. Set-off is not a defence, it is merely a pro tanto reduction of a claim by offset of a crossclaim, though it does not preclude a separate defence on some other ground such as illegality.

Position of issuer

634. Leaving aside set-off, the issuer is protected if it pays against an apparently conforming presentation and without knowledge of any vitiating factor. In determining compliance, a guarantor may not rely on resources or verify facts other than those specifically provided in the guarantee or available from the guarantor’s own records or an index specified in the guarantee. In this regard, see article 7 of the URDG and paragraph 139 of the ISDGP.

---

---