Article

by Roger Fayers

In Uzinterimpex JSC v Standard Bank1 the commercial court had to deal with some interesting points in a case involving a guarantee subject to URDG 458. I can, however, deal here with only one of them2. The action turned largely on its facts, and a rather detailed description of the transaction involved might enable readers (perhaps by reference to their own laws) to form a view on the court's conclusion that the claimants' action in deceit failed.

The sale contract and its financing

The purchasers of consignments of cotton (AMJ), having obtained a pre-export facility from their bank (SBL) in order to make an advance payment to the sellers (Innovatsia), arranged for an advance payment guarantee (APG) as security for that payment to be issued in favour of SBL by the National Bank of Uzbekistan (NBU).

The financing of the contract was intended to work in this way. The APG was to operate in conjunction with an L/C. In respect of each consignment, Innovsatia would present documents (which included a full set of three bills of lading) under that credit at the counters of SBL, and their compliance would be determined by AMJ. If AMJ accepted the documents, then SBL was bound to accept them and would reduce the APG by the value of that consignment. In those circumstances, SBL would release the documents to AMJs to enable it to sell the cotton, but SBL would have a pledge over the documents in respect of the advance it had made to AMJ pursuant to the finance facility. Having sold the cotton, AMJ would then pay the proceeds to SBL to reduce the facility3. If, however, the documents did not conform to the requirements of the L/C and the discrepancies were not waived by AMJ, they would be rejected. A consequence of this would be that the APG would not be reduced, but AMJ would not get hold of the cotton represented by the documents presented to SBL, and SBL would not obtain the sale proceeds. Furthermore, the sellers would be able once again to regain possession of the cotton.

As it worked out, the arrangement became somewhat more elaborate. The representatives of SBL who handled it became involved in the issue and counter-signing of various letters of indemnity. These enabled AMJ to request the shipowners to make delivery of the cotton to sub-buyers or to their banks on production of a second set of bills of lading. The result was that significant amounts of the cotton were delivered to, and in some cases sold by, AMJ but (and this is the important point) without there being a commensurate reduction made to the APG. So, even though the cotton had been delivered, sold and the proceeds actually used to reduce SBL's facility, the amount of the APG was not reduced, and SBL was able to, and did, make a demand on NBU and was paid.

Innovatsia's claim

A vital point to grasp is that Innovatsia was making the claim as an assignee. As part of the settlement arrangements4, NBU assigned to Innovatsia all of its rights and interest in any rights of action it might have against SBL. Accordingly, the deceit alleged was that of SBL towards NBU.

The elements of this action (probably very much in common with the civil law) are: (a) the defendant must have made a representation that can be clearly identified; (b) it must be a representation of fact; (c) the representation must be false; (d) it must have been made dishonestly in the sense that the representor has no real belief in the truth of what he has said or was reckless as to whether it was true or false; and (e) it must have been intended to be relied upon and must, in fact, have been relied upon.

In the context of an APG, the maker of a demand that he knows is incorrect as to its amount, or is not due, is making a fraudulent demand. Questions of reliance do not really arise. If a beneficiary under an APG makes a demand which is, to his knowledge, excessive, the court will readily find that he intends the paying bank to rely upon it. Moreover, once a false statement has been made that is material, in the sense that that it is likely to induce the representee to act in the manner desired by the representor and the representee does so act, it is presumed that the representee was influenced by the statement.

The alleged misrepresentations

Briefly, the alleged representations were that in making its demand, SBL represented that, as far as it was aware, the demand was not excessive. Its knowledge of the falsity of this was elaborated in argument as follows:

"The reason why the managers of SBL knew that they were calling for more money than they were entitled to call for was that they knew that they were calling in respect of cotton which had been onsold by AMJ and where SBL had received the proceeds of sale. They knew that AML were rejecting documents dishonestly, because AMJ had onsold goods (often with the essential assistance of SBL's letters of indemnity) and paid the proceeds to SBL and they were prepared to go along with this to suit their own purposes."

Put this way, Innovatsia was seeking to establish a dishonesty in SBL's (admittedly self-serving) conduct in relation to the issue of the letters of indemnity, and then in showing that this dishonestly tainted its making the demand it made under the APG. At first sight, this connection would seem to be well made. The whole scheme depended upon the issue of what were false bills of lading, giving rise to a potential fraud on Innovatsia, the third party buyer and the third party buyer's bank5. Furthermore, the process was certainly attractive from SBL's own point of view since the outcome was for the sub-sale proceeds to be used to reduce the AMJ facility, yet allowing any reduction in the APG to await the provision of a compliant set of documents (which itself would include the original bills of lading). Because SBL was aware of receipt of the proceeds and the reduction in the facility, surely it was dishonest not to reduce the APG and yet still make a demand for the whole amount?

The court's judgement

However, when the court analyzed the transaction and addressed the case as finally argued by Innovatsia and after having listened carefully to the evidence given by the SBL representatives concerned, things looked different.

To a large extent the arrangement itself put AMJ in effective control of the level of any demand. The court considered the relevance of the use of false bills of lading and the issue of letters of indemnity and concluded that this did not of itself form the basis of the claim in deceit. The SBL representatives might perhaps have grasped the inappropriateness of the letter of indemnity system sooner. Nevertheless, the evidence was that an appreciation of the inconsistency between realization of the sale proceeds on the part of AMJ and the rejection of documents presented by the sellers had not registered within the bank until after the demand under the APG.

This left having to prove that SBL dishonestly demanded from the NBU more than it was entitled to. Having heard the evidence given by SBL's representatives, the court concluded that Innovatsia had "fallen well short" of proving this to the necessary high standard required. In assessing the evidence given, the court followed observations made in an earlier case6.

"Speaking from my own experience, I have found it essential in cases of fraud, when considering the credibility of witnesses, always to test the veracity of their evidence by reference to the objective facts proved independently of their testimony, in particular by reference to the documents in the case, and also to pay particular regard to their motives and to the overall probabilities."

Whilst recognizing that the letters of indemnity created what it called an "unsatisfactory backdrop" to the demand, the court accepted the evidence the bankers gave: that from the outset everyone was quite open about the potential disparity between the sale process and the documentary process and the odd consequence of sub-sales being achieved without a commensurate reduction being made in the APG; that AMJ (and not the bank) were in the "driving seat" as to the acceptance or not of the documents; that there had been no sudden decision to "go along with" a dishonest plan of AMJ; that there was evidence of similar practice in other banks; and that there could be identified neither motive on the bank's part nor personal advantage to their representatives in adjusting the demand.

Concluding comments

This decision was essentially one on the facts and depended largely on the evidence given by the bankers involved. The judge accepted their evidence, and it resulted in his finding that whilst they might (as he put it) "have hoisted in the inappropriateness of the [letter of indemnity] system it is clear that the penny had not dropped even after the demand".

Accordingly, he was "not remotely surprised that, when focusing on the proper call, they concentrated on the terms of the APG".

It appears that it may be quite common in L/C transactions for banks to "go along with" arrangements of their customers and so "oil the wheels of commerce".

That they expose themselves to liability for the tort of deceit is clear. The decision in Standard Chartered Bank v Pakistan National Shipping Corporation (No. 2)7 was not referred to. This is strange because it involved an allegation of deceit by a confirming bank upon an issuing bank and the judgements of the court of appeal (again after consideration of bankers' testimony) particularly stressed the high standard of commercial honesty required by the law.

It is thought that there may be an appeal. If so, it will be interesting to see whether this decision is upheld.

Roger Fayers' e-mail is r.fayers@ntlworld.com

1. [2007] EWHC 1151 (Comm).

2. Arguments were also advanced on the basis of an implied term in the APG, and claims were made for restitution and for damages in conversion.

3. This exemplifies the practice that developed early in letter of credit transactions and gave rise to the evolution of the letter of hypothecation or, more commonly in England, the letter of lien or letter of trust.

4. Most of the 50,000mt of cotton was delivered. In arbitration proceedings between Innovatsia and AMJ. The arbitrators awarded USD 8.1m to Innovatsia, which they were unable to enforce due to the insolvency of AMJ.

5. SBL did not contend to the contrary. Despite its motive being to "oil the wheels of commerce", there was no legal justification for such activity; see Brown Jenkinson & Co v Percy Dalton (London) Ltd [1957] 2 QB 621.

6. The Ocean Frost, per Goff LJ [1985] 1 Lloyds Rep 1 at page 57.7 [2000] 1 Lloyds rep 218.