Article

Factual Summary: Buyer and Seller entered into a contract for the purchase of LDPE made in Russia. It provided that the loading port could be any Russian city. At Applicant's request, Issuer issued a commercial LC in favor of Beneficiary/Seller. The arrangement was that Applicant would make a deposit amounting to 30% of the LC amount and the remaining 70% of the LC amount would be secured by the goods. The LC was to be freely negotiable by any bank in Amsterdam, Netherlands.

Subsequently, Issuer received a demand letter and a demand note from the Dutch Bank (Presenting Bank) requesting the payment under the LC. The demand letter stated "we hereby confirm that all documents comply with the terms and conditions of the LC and inform you that the reimbursement of the LC was hereby assigned to the undersigned ... who had accepted the above assignment." Issuer initially refused to pay on the ground that the presented documents did not comply with the terms and conditions of the LC. Two days later, Applicant discovered that no goods had arrived and that beneficiary had committed fraud. Issuer applied to Manzhouli Intermediate People's Court for an injunction against the payment under the LC. The Intermediate People's Court of Manzhouli gave an order to freeze the payment under the LC and ordered the issuing bank to withhold the payment under the LC. The Presenting Bank requested mediation and sent a letter to Issuer stating that "(i) Please transfer all the deposit of the LC made by [A]pplicant to us, which should be no less than 30% of the LC amount;(ii) Please confirm that your bank will cooperate with our bank to mitigate the loss suffered by us to the greatest extent and try our best to recover the contract price the beneficiary had assigned to us. After the payment of the deposit to our account at... and your confirmation of aforementioned (i) and (ii), you have the right to cancel and close your LC automatically."

Subsequently after the action had been brought, it was confirmed by relevant transportation institution that the railway bill presented by the beneficiary was forged.

Legal Analysis:

First Instance; Trial Decision:

1. Material Fraud: The trial court ruled that, since all documents of Beneficiary presented to Presenting Bank and Issuer were forged, which constituted material LC fraud, thus the purchase contract was void due to the material fraud committed by the Beneficiary. The principle of LC fraud exception should also apply to the case.

2. The Issuing Bank was Entitled to Apply for an Injunction: Although Applicant was aware of the fraud committed by Beneficiary, it did not bring an action against Beneficiary in time. This failure impaired Issuer's right. The view that only the Applicant should have the right to apply for a court order to withhold the payment under the LC or that it was only after Applicant had committed or involved in fraud that a court order would be made to withhold the payment under the LC at the request of the Issuer is a deviation from the fraud exception. Issuer is entitled to withhold the payment under the LC for fraud.

3. Difference between Assignment and Negotiation: "Assignment" and "negotiation" have been expressly provided for respectively in UCP500Articles 49 and 10. Issuer asserted that Presenting Bank was an assignee of the LC, as supported by its demand letter and the conciliation letter sent to Issuer by Presenting Bank which were introduced by Issuer in court and admitted by Presenting Bank. As the assignee of the LC, Presenting Bank was not entitled to payment under the LC due to the material fraud by the assignor, the Beneficiary

Second Instance; Trial Decision:

Presenting Bank appealed, alleging that (1)although Issuer did not claim that the underlying contract was void, the trial court ruled the contract as invalid, which was against the basic principle of civil litigation; (2) the trial court decision invalidating the LC lacked factual and legal basis; (3) it was incorrect for the trial court to disregard Presenting Bank as the negotiating bank; (4) it was against trade custom to consider Presenting Bank as an assignee based on the words in the demand letter and conciliation letter sent to Issuer; (5) the trial decision seriously violated the judicial practice of LC cases in China. Presenting Bank also sought to introduce new evidence but since the time limit for adducing evidence had elapsed, the appellate court disregarded the new evidence submitted by Presenting Bank during the second instance trial.

1. Status of Presenting Bank: According to the evidence rules, an admission by the parties can be made as proof. Therefore, with the evidence that Presenting Bank had referred to itself as the" Assignee" in the demand letter and conciliation letter sent to the issuing bank, it was correct for the first instance trial court to treat Presenting Bank as the "Assignee".

2. Fraud Exception: As Beneficiary committed material fraud by presenting the forged documents, there was no error for the trial court to apply fraud exception principle to this case.

3. Whether Issuing Bank Can Apply for an Injunction: The appellate court held the view that there were no rules and regulations that forbid Issuing Bank to apply for the injunction of the payment under the LC. Thus, Issuer was entitled to withhold the payment under the LC for fraud.

4. Validity of LC and Underlying Contract: As there was no sufficient evidence to prove that Applicant had been involved in the LC fraud, it was improper for the trial court to invalidate the LC. In addition, there was no legal basis for the trial court to consider the underlying contract as void due to the forged documents and non-delivery of goods.

Based on the above reasons, the appellate court noted there were some mistakes in the trial court's judgment. According to Clause 1, Article 153 of PRC Civil Procedure Law, the appellate court made the judgment as follows: (i) repeal the first part of the decision made by the trial court regarding the underlying transaction (ii) affirm the second part of the decision by the trial court regarding the injunction.

Comments by JIN Saibo:

1. There is sufficient evidence that Beneficiary committed fraud in the underlying contract. Applicant did not sue Beneficiary in time after applying for the court order to freeze the LC. It was quite clear that the applicant intended to shift the risk of LC fraud to the issuing bank. Under such circumstances, Issuer was entitled to bring an action to the court declaring the enjoinment of the payment under the LC.

2. The essential issue of the case is under a freely negotiable LC, how to distinguish and identify a qualified negotiation bank from an assignee and their respective status under PRC law.

3. Presenting Bank did not have sufficient evidence to support its assertion that it is a qualified negotiating bank under UCP500 Article 10. On the contrary, the cover letter and the conciliation letter contained what the court regarded as an admission that it was an assignee of the LC.

4. It is interesting that the court did not invalidate the LC, but permanently enjoined the Issuer's payment obligations under the LC.

* JIN Saibo is a partner with Zhonglun Law Firm (Beijing office) and YANG Wantao is a partner with Zhonglun Law Firm (Shanghai office).

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