Documentary Credit World

Topics: Autonomy (Independence); Bill of Lading; Circular Contracts; Damages; Fraud; Letter of Indemnity; UCP600 Articles 4, 14(b) & 16; Warranties

Note: To secure its purchase of 920,000 (+/- 5%) barrels of Djeno crude oil, Zenrock Commodities Trading Pte. Ltd. (Applicant/Fraudster) applied for and caused Crédit Agricole Corporate & Investment Bank, Singapore Branch (Issuer) to issue a UCP600 letter of credit in favour of PPT Energy Trading Co. (Seller/Beneficiary). Issuer held a “registered floating charge over goods purchased by” Applicant/Fraudster; additionally, as Applicant/Fraudster claimed it would on-sell the crude oil to Total Oil Trading S.A. (TOTSA), Issuer received a signed acceptance from TOTSA for an assignment of the proceeds due under the on-sale contract. Among other terms, the LC required presentation of original B/Ls. In the event that originals were unavailable, the LC provided for an alternate presentation of a signed invoice and signed letter of indemnity (LOI).

Unknown to Issuer when preparing the LC, Applicant/ Fraudster had been engaged in “round-tripping” contracts regarding the crude oil. The oil had originally been purchased by Applicant/Fraudster from SOCAR Trading S.A. (SOCAR), then on-sold to Shandong Energy International (Singapore) Pte Ltd. (Shandong), which in turn sold the oil to Seller/Beneficiary. To secure the LC, Applicant/Fraudster had presented Issuer with a copy of the purchase contract between itself and Seller/ Beneficiary as well as a purported copy of the on-sale contract between itself and TOTSA.₁ As Issuer would discover, however, the on-sale contract supporting LC issuance was not genuine. The LC value reflected the actual purchase price of the sales contract between Applicant/Fraudster and Seller/Beneficiary as being the unit price of the “average of the mean quotations published in Platt's crude oil marketwire” plus a premium of USD 3.24 per barrel (para.5(b)). The purported on-sale contract between Applicant/Fraudster and TOTSA reflected a purchase price of Platt's plus USD 3.60. Thus, as the trial judgment noted, were this to be the true on-sale price, the proceeds assigned to Issuer from TOTSA would cover the purchase price Applicant/Fraudster would owe Seller/Beneficiary and, accordingly, the exposure of Issuer under the LC.

The LC was issued on 3 April 2020. Because the original B/Ls were unavailable, Seller/Beneficiary made the alternate presentation, through Bank of China (Presenting Bank), of a signed LOI and signed invoice to Issuer on 16 April 2020. It was undisputed that this presentation complied with the LC terms and conditions. Issuer, however, became concerned about the underlying realities when it received an email from TOTSA on 23 April 2020 making several allegations: (1) that TOTSA received a competing notice from ING Bank NV (ING) regarding its assignment of proceeds from the on-sale contract with Applicant/Fraudster; (2) that Applicant/Fraudster requested TOTSA to approve the ING assignment (although TOTSA never countersigned that document); (3) Applicant/Fraudster subsequently requested TOTSA not to approve the ING assignment claiming an internal “mistake” by Applicant/Fraudster caused the assignment to go to Issuer; (4) TOTSA countersigned the assignment to Issuer; and (5) that TOTSA acknowledged it would pay the legitimate holder of its receivable. Following this email, Issuer informed TOTSA of the contract Applicant/Fraudster provided to support issuance of the LC. On 28 April 2020, TOTSA tendered Issuer with the actual on- sale contract. That contract showed a purchase price of Platt's minus USD 3.60 per barrel. As the appellate Judgment noted, Applicant/Fraudster, then nearly insolvent, “had decided to defraud [Issuer] by introducing a small circle of over-priced contracts which [Issuer] would be induced to support by [Applicant/Fraudster]'s production of the doctored copy of its contract for on-sale to TOTSA.” (para.9).

Suspicious of the underlying fraud, Issuer chose to dishonour Seller/Beneficiary's presentation; the maturity date for payment, as reflected in the underlying contract, was 5 June 2020. Critically, however, Issuer did not send Seller/Beneficiary a notice of refusal stating its basis for dishonour within the timeframe prescribed by UCP600. Issuer 's decision to dishonour became clear when on 28 May 2020 it applied for and obtained an ex parte interim injunction from the High Court of Singapore restraining payment. Seller/Beneficiary received notice of this injunction (although Applicant/ Fraudster did not). Before the injunction was lifted, the relevant parties engaged Mayer Brown (Singapore) Pte. Ltd. (Escrow Agent) to serve as escrow for the TOTSA sale proceeds pending resolution of the dispute. TOTSA tendered Escrow Agent USD 16,517,003.06; thereafter, interpleader proceedings initiated resulting in Issuer recovering USD 6,197,532.75. Applicant/Fraudster ultimately became insolvent.

The interim injunction was discharged by the High Court on 13 November 2020 after the parties executed an accommodation whereby Issuer paid the LC value into a blocked account under Seller/ Beneficiary's name. In turn, Seller/Beneficiary caused Presenting Bank to issue a bank guarantee which would serve to protect Issuer were its claims ultimately successful.

Subsequently, the High Court transferred the case to the Singapore International Commercial Court. The action involved two competing claims. Issuer sought a declaration that Seller/Beneficiary was not entitled to the LC proceeds as it was a participant in the underlying fraud and an order that Seller/Beneficiary return the payment made pursuant to the accommodation plus interest; alternatively, even if Issuer were found to have improperly dishonoured, Issuer sought a declaration that Seller/Beneficiary breached the warranties made in the LOI and, consequently, Seller/ Beneficiary was liable for damages equal to the LC sum paid under the accommodation. In its counterclaim, Seller/Beneficiary sought a declaration that it was entitled to retain the proceeds paid under the accommodation plus the costs of obtaining the bank guarantee. The trial court denied each of Issuer's requests and ruled in favour of Seller/Beneficiary. In a subsequent 30 March 2022 judgment, Beneficiary obtained favourable rulings on damages, interest and costs. Issuer appealed both judgments. The Singapore Court of Appeal, Judith Prakash, Jonathan H. Mance and Bernard Rix, JJ., affirmed in part and reversed in part.

After concisely reviewing the factual matrix, the appellate court expressed that “remarkable as was [Beneficiary]'s ignorance of even the general level of market prices and its disinterest in what was going on, that is the factual basis on which these appeals proceed. There has been no attempt to disturb the Judge's findings on these points.” (para.14). Issuer also declined to appeal the ruling that, having given no notice of refusal under UCP600 Article 16, it was precluded from arguing that the documents did not comply.

Issuer's principal argument was that it should be entitled to rely on the fraud of Applicant/ Fraudster “to set aside and avoid liability to pay under the letter of credit issued in favor of [Beneficiary].” (para.17). Essentially, Issuer sought to bring the facts of the instant case within the ambit of the LC fraud exception. Accordingly, the appellate court began by reviewing general LC law and practice, and cited text from UCP600 Article 4(a) (Credits v. Contracts) to highlight the autonomy (independence) of letters of credit from the underlying contracts that they support. The court also reviewed case law dealing with LCs₂ and the fraud exception as explored under English common law.₃ In this context, the appellate court noted that “the proposition that a fraud by a third party to the letter of credit could affect its enforceability is worth noting in relation to the issue currently before this court.” There were no facts to (1) support a collusion theory between Beneficiary and Applicant/Fraudster; (2) that Beneficiary also fraudulently induced Issuer to makes its undertaking; or (3) that Beneficiary had knowledge that the LC its received had been fraudulently issued. See paras.20-30. In ultimately rejecting Issuer 's fraud exception argument, the appellate court stated:

The fundamental problem with [Issuer]'s case on the letter of credit is that it would, if accepted, significantly undermine the whole system of documentary credits. The effect would be that no seller-beneficiary could be assured of payment under a letter of credit, without investigating the integrity of the issuing bank's customer in its relationship with the issuing bank, which is a practical impossibility, or without seeking some further contractual protection or insurance against the risk that the issuing bank's customer may have misled the issuing bank. [para.31].

The appellate court turned to Issuer 's arguments concerning the presented LOI. At trial, the court entered judgment in favour of Beneficiary as, by the terms of the LOI, the stated warranty and indemnity were unenforceable absent payment by Issuer on the due date stated in the underlying sales contract between Beneficiary and Applicant/Fraudster (originally 5 June 2020). The appellate court delineated the LOI representations into two components: (1) the “warranty”, i.e. “at the time property passed under the contract [Beneficiary] had marketable title to such shipment, free and clear of any lien or encumbrance”; and (2) the “indemnity”, i.e. to “protect, indemnify and save [Issuer] harmless from and against any and all damages, costs and expenses … which [Issuer] may suffer or incur by reason of the original bills of lading remaining outstanding or breach of warranties given above”.

Issuer primarily argued that the trial court misconstrued its terms such that enforceability of the stated warranty was extended beyond payment of the original due date by operation of the interim injunction it obtained. While the trial court rejected that argument, finding the LOI to be a “unilateral contract” only accepted by timely payment, the appellate court disagreed; instead, “the LOI was in its context effective from the moment of its issue.” (para.51). Thus, the inquiry turned to whether “payment of the letter of credit on its due date, or, if it matter[ed], the payment of the amount due under the sale contract on its due date, was a condition precedent of [Beneficiary]'s obligation to indemnify [Issuer].” The appellate court was unpersuaded by the unilateral contract approach. Rather, once it was issued and signed, the LOI was effective as against Beneficiary since it was a required document to receive LC payment (in lieu of original B/Ls) just as it triggered Issuer 's undertaking to honour. In any event, Beneficiary could not withdraw the LOI once presented, particularly after Issuer gave its advice of receipt of documents and indication of acceptance. See paras. 52-54.

The next issue was proper interpretation of the LOI, specifically whether the eventual late payment by Issuer extinguished the warranty made effective at the time the document was issued. After consideration of the commercial realities (see paras. 55-57), the appellate court accepted the trial court's view that the interim injunction Issuer obtained did not extend the time for payment under the LC nor the sales contract.

This has also been the conventional way of dealing with such letter of credit disputes. In our judgment, the [trial] Judge was right about this. The due date under the terms of the sale contract could not be affected by the court's order without making [Applicant/Fraudster] a party to the proceedings, which did not occur. As it was, even the due date for payment under the letter of credit was not changed, for interest was paid for late payment. [para.57].

Thus, against an effective LOI, although payment was late, the same did not defeat the warranty made therein, i.e. there was no strict condition “which made time of the essence.”

The appellate court then turned to whether Beneficiary breached the LOI warranty, i.e. whether Beneficiary had “marketable title” or whether the goods were “free and clear of any lien or encumbrance.” At trial, a ruling on this issue was unnecessary as the Judge deemed the LOI ineffective in light of late payment, although the Judge mentioned in passing that Beneficiary had marketable title since the goods “did pass at the vessel's flange at the loadport.” (para.63). The Judge also declined to distinguish the marketable title warranty from that regarding encumbrances. The appellate court, however, rejected this approach. In the court's view, the question of marketable title was separate and required resolution.

It was undisputed that Applicant/Fraudster was “not acting in the ordinary course of business in its fraudulent endeavours”. The appellate court then adopted many of the findings of the trial court to hold that Beneficiary was “hardly a bona fide purchaser” of the goods. These findings included that Beneficiary was aware of the round-tripping contracts, aware that Applicant/Fraudster had been both seller and buyer in the chain, and the transactions were structured such that any financing bank would “not reveal” the presence of Applicant/Fraudster in more than one position in the chain. See paras.65-66. In reviewing the trial transcript, the appellate court noted that Beneficiary witnesses' attempts “to deny any knowledge of such round-tripping were unbecoming and redolent of [Beneficiary]'s lack of good faith. Though the [trial] Judge eventually accepted that [Beneficiary] did not know that the round-tripping prices were well above market price”, the witnesses were deemed to have been evasive on the matter. There were other concerns regarding witness credibility and, while not found to have participated in the fraud, the trial court concluded that Beneficiary was not “an innocent bystander”. Even though these findings were insufficient to establish LC fraud, the appellate court deemed them relevant on the issue of the warranty of marketable title found in the LOI. As the court expressed:

Neither Shandong nor [Beneficiary] were bona fide purchasers for value, since value entails actual payment and no payment was made by Shandong or [Beneficiary] until 16 April 2020, whereas the question in issue related to title as of shipment on 6 April 2020 … we conclude under this issue that there was a breach of the Warranty in that [Beneficiary] lacked a marketable title. [paras.65, 69].

What remained was a determination of damages. Although Issuer originally claimed USD 23,662,732.50, the sum paid on the LC, Issuer revised its claim in light of the sums recovered via interpleader proceedings. The appellate court accepted this revision, i.e. “the net difference between the price payable by TOTSA to [Applicant/Fraudster] and caught by the interpleader proceedings, namely US$16,517,532.06, and the recovery of US$6,197,532.75 achieved by [Issuer] in the settlement of those proceedings.” (para.74). In conclusion, the appellate court “allow[ed] [Issuer]'s appeals solely on the ground that [Beneficiary] had breached its Warranty under the LOI that it had marketable title at the time that property passed and [gave] judgment in favour of [Issuer] in the sum of US$10,319,470.81.” The prior trial orders were set aside and the parties were to file submissions regarding interest and costs.

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