Article

Type of Lawsuit: Claimant (as the assignee of the rights of action of a bank that had provided an advance payment guarantee) sued the beneficiary of the advanced payment guarantee for damages on the ground that the demand it had made under that guarantee was fraudulent as to its amount. Alternative claims were made in conversion and constructive trust.

Parties: Claimant/Seller/Assignee of Rights of Bank Issuing Advance Payment Guarantee- Uzinterimpex JSC (formerly known as FBC Innovatsia)1

Defendant/Financing Bank/Beneficiary of Advance Payment Guarantee- Standard Bank Plc (SBL)

Issuer of Advance Payment Guarantee- National Bank of Uzbekistan (NBU)

Purchaser- A. Meredith Jones & Co Ltd (AMJ)

Underlying Transaction: Contract for the sale of 50,000 mt of cotton to be shipped in a series of consignments on FOB terms under which buyer was to make an advance payment in respect of 90% of the value with the balance to be made by letter of credit. The contract required the purchaser to arrange for an advance payment guarantee to be issued in favour of SBL for the total value of the advance payment.

Financing: SBL, as the agent and issuing bank for a syndicate of banks (including itself), provided a pre-export facility comprising a US$70million loan and a $4.0million working capital line to AMJ. As security for its performance of this facility, AMJ assigned to SBL all its rights under the sales contract and in the cotton. AMJ was to be free, however, to deal with and sell the cotton in the ordinary course of its business provided there was no default under the facility.

Instrument: Advance Payment Guarantee (APG) for $65,674,688.40 issued by NBU in favour of SBL. The guarantee was subject to URDG458 and was to be construed in accordance with English law. It also contained a provision that the amount of the APG to be automatically reduced by 90% of the value of each consignment of cotton delivered to AMJ on the basis of tested telexes sent by SBL to the NBU. Delivery to be proved by the presentation by the NBU or by AMJ of the shipping documents and commercial invoices as required by the LC (Because of a fall in the cotton market, the 90% figure was subsequently amended to 100%).

LC: On instruction from AMJ, SBL opened an irrevocable LC in favour of the claimant requiring certain documents to be presented at the counters of SBL.

Operation of the APG and LC: The two were to operate in conjunction. Initially, when conforming documents were tendered under the LC, 10% of the price was paid under that letter with the balance being "paid" by the reduction of the APG. Although the parties did subsequently agree that the 10% would no longer be paid under the LC, that letter remained an essential vehicle for the presentation of documents. Reduction in the amount of the APG was to be made by the value of each consignment "delivered" to AMJ but such delivery remained to be proved by the presentation of shipping documents and invoices at the counters of SBL as required by the LC. Documents continued, therefore, to be presented under the LC. If they conformed, SBL was bound to accept them and reduce the APG accordingly. The transaction was to work in this way: SBL would release the documents to AMJ but retain a pledge over them; AMJ would sell the cotton and remit the proceeds to SBL to reduce the pre-export facility.2

Operations in Practice: During the first year certain consignments were duly delivered, documents were presented and the amount of the APG was automatically reduced. Disputes then arose between the claimant and AMJ as to late delivery and failure to correct presentation at SBL's counters of documentation not in conformity with the terms of the APG and the LC. A demand made under the APG and payment of $37.77m was made to SBL by the NBU. However, significant amounts of cotton in respect of which that demand was made had already been delivered to, and in some cases on-sold by, AMJ without there being a commensurate reduction in the amount of the APG ("the received cotton").

This was achieved in a number of ways, some of which involved the representatives of SBL. In some cases they had issued (or countersigned) letters of indemnity (LOIs)3 to ship-owners for goods in respect of which a second set of bills of lading had been issued, whilst in others they had executed releases in AMJ's favour for goods that had been warehoused. Even though such documents as were in due course presented at SBL's counters were not accepted, SBL had informed the NBU that they had been rejected.

Arbitration and Partial Settlement: Arbitration proceeding ensued and an award of $8.12m was issued in favour of the claimant. However, it was unable to enforce this award due to the insolvency of AMJ. By deed of assignment, all of the NBU's rights and interest in any rights of action it might have against SBL were assigned to the claimant. The parties then entered into settlement negotiations and in respect of SBL's potential liability for the part of the claim attributable to the LOIs and the releases. This resulted in SBL agreeing to pay the claimant a total of $3.28m.

The Action against SBL: The claimant's principal claim4 was that the demand made by SBL upon the NBU was fraudulent as to its amount. It alleged that the demand was excessive to the knowledge of SBL or, alternatively, that the representatives of SBL were reckless as to whether or not the demand was excessive. This arose from the fact that those representatives knew that some of the received cotton had been delivered to, accepted by and on-sold by AMJ, such that AMJ was not entitled to reject those consignments or the documents relating to them. Further, the claimant alleged that the NBU was induced by SBL's false representations to make payment under the APG, such that (as assignee of the NBU) it had a claim in deceit.

Decision: The Commercial Court, Steel J., held that the claim in deceit failed.

The Law: The claim depended upon the allegations constituting the tort of deceit.5 The court summarised the elements of this as follows: (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 states. This involves conscious knowledge of the falsity of the statement; (e) The statement must have been intended to be relied upon; (f) It must have in fact been relied upon. In addition, all these elements had to be established by reference to the heightened burden of proof required in cases of fraud.

The court made two further observations with regard to fraud in the context of an APG. First, a demand that the maker does not honestly believe to be correct as to its amount is a fraudulent demand. Secondly, questions of reliance do not really arise. If a beneficiary under an APG makes a demand that to his knowledge is 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 it is likely to induce the representee to act in the manner desired by the representor and the representee does so act, it will be presumed that the representee was influenced by the statement. Here, the demand was a call upon the NBU and the NBU had no reason to believe that that demand represented anything other than SBL's honest assessment of what was due.

Additional Background Facts: Fraud has always to be judged in its context and in this respect the claimant relied on certain other matters that arose in the operation of the contract and its financing.

First, there were the unusual circumstances surrounding the issue of a second set of bills of lading and of LOIs whereby the release of the cotton was obtained. In short, under this second set of bills AMJ was named as the shipper, the consignee being to the order of a sub-buyer's bank with the sub-buyers themselves as the notified party. By virtue of the LOIs (which were usually counter-signed by SBL), AMJ requested the ship-owners to deliver the cotton to the sub-buyers on production of this second set (or, in some cases, LOIs issued by the sub-buyer's bank).

As the court observed, there was no question, and SBL did not contend otherwise, that this whole scheme was dependent upon the issue of false bills of lading. They gave rise to a potential fraud on the claimant, the third party buyer and the third party buyer's bank.

The Claimant's Arguments: At this point it is necessary to examine the basis of the claim in deceit. The court commented that as pleaded this was not entirely straightforward. The underlying case was that in making its demand SBL impliedly represented that "so far as it was aware" the demand was "valid and was not excessive". The requisite knowledge of SBL as to the falsity of this representation, however, was first pleaded and then argued in rather different ways.

First, it was said to be that of its representatives in that they knew some of the consignments comprising the value of the demand had in fact been delivered to AMJ, sold on to third parties and the proceeds of these sales received by SBL. In these circumstances the representatives had "reason to believe" that AMJ was not entitled to reject the documents relating to those consignments.

A rather different case was advanced in a final written submission. The argument here was that the reason why SBL knew that it was calling for more than it was entitled to was because its representatives knew they were making a demand in respect of cotton that had been on-sold by AMJ and where the proceeds of that sale had been received by the bank. They must have known that AMJ was rejecting the documents dishonestly because AMJ had on-sold the goods (often with the essential assistance of the bank's own LOIs) and paid those proceeds to the bank. SBL was prepared to go along with this to suit its own purposes (the sub-sale proceeds reduced AMJ's facility). Knowing it had received those proceeds by way of reduction of its syndicated loan, it was dishonest for SBL not to reduce the APG.

This was broadened in submissions made during oral argument. It was said that SBL was "institutionally corrupt" (demonstrated by its willingness to execute LOIs where a second set of bills of lading was issued) and that, given this propensity for dishonesty, SBL was dishonest in the way that it switched certain cotton delivered under the contract to secure repayment of its working capital facility.

Legal Analysis:

The use of the bogus bills of lading and the subsequent issue of the LOIs, the Judge thought, did not of itself form the basis of the claim in deceit. They showed a propensity for improper conduct, yes. They showed, too, a lack of appreciation of the inconsistency between the realisation of sale proceeds on the part of AMJ and the rejection of documents presented by the sellers. But the claimant's case had to go beyond mere administrative carelessness and establish that there could have been no honest belief in the call.

False Statement: At the basis of any claim in deceit is the representation in question. Here it was the demand. This read:

In accordance with the above guarantee we hereby give you notice that we are demanding US$37,773,636.04 ... in respect of the said guarantee. We hereby state that FBC Innovatsia have failed to fulfil their contractual delivery obligations under contract ....

It was common ground that the claimant was indeed in breach of its delivery obligations at the material time, but did the demand contain a false statement in assessing that it was, as regards its quantum, "in accordance with the guarantee"? The Judge dealt with this by saying that no submission was as such made by the claimant that the demand was excessive in accordance with the terms of the APG itself, that is, there was no submission that SBL was not contractually entitled to demand the sum it did.

He also rejected the submission that SBL was "institutionally corrupt" on the basis that it had participated in the LOI system. This had been introduced at a time when there was no conceivable motive for any attempt to defraud the claimant. Furthermore, its initiation had been preceded by consultation within the bank and with legal advice and no one had taken the view that it was intrinsically unsound let alone dishonest. He concluded:

It strikes me that the SBL representatives might have perhaps hoisted in theinappropriateness of the LOI/release system but it is clear that the penny had not dropped even after the demand. In any event, I am not remotely surprisedthat, when focusing on the proper call, they concentrated on the terms of the APG.

Honest Belief: After listening to the evidence given during the hearing, the Judge concluded that the claimant had "fallen well short" of proving to the necessary standard that the representatives of SBL had no honest belief in the legitimacy of the figure demanded.

Foremost among the considerations leading the Judge to form this view was the fact that the SBL staff involved had at the very outset expressed a clear understanding of the potential disparity between the sale process and the documentary process. None of the documentary evidence disclosed contained any reservation or hesitation about the manner in which the demand was to be calculated. There was an awareness of the odd consequence of sub-sales being achieved without a commensurate reduction in the APG. The representatives were quite open about this and the members of the syndicate expressed no reservations about it. Furthermore the Judge concluded, nothing in SBL's monitoring or operation of the facility nor in its liaising with the syndicate supported a conclusion that SBL "went along" with some dishonest plan.

Other Matters: The judgment dealt briefly with a few other points.

Quantum of the Fraud Claim: Although his conclusion as to the fraud claim made this unnecessary, the Judge expressed his view that the assessment of the claim (had it been successful) would have been made on the basis of the amount by which SBL knew the demand was excessive. The settlement figure of $3.77m would have constituted the loss sustained by the NBU in responding to the (excessive) demand by reason of SBL's provision of the LOIs and releases.

Implied Term: An alternative argument raised by the claimant was that the APG was subject to an implied term relating to repayment of any part of a demand that later was found to be excessive. There is authority for there being an implied term in a contract of sale that the buyer will account to the seller for any amount that has been paid under a bond to the extent that the amount paid exceeds the true amount of the buyer's loss.6 However, the Judge rejected the claimant's submission that an equivalent term must be implied into the APG. The various formulations of the term itself that were suggested by the claimant somewhat undermined its existence, and more particularly so when it was sought to be implied into a bond, an instrument the very nature of which required clarity and certainty. The Judge considered that the suggested implied term would subvert the principle of autonomy of the APG; it would convert it into a guarantee of losses under the sale contract.

Conversion: This part of the claim related to the unsold received cotton in warehouses at the time of the demand. If, contrary to its primary case, AMJ and/or SBL had validly rejected the documents submitted in respect of that cotton, then it still belonged to the claimant.

The mechanics of the sale contract involved that until payment the seller retained the right of disposal. The price was not in effect paid by a reduction in the APG and so, although AMJ may have obtained possession and control of the cotton by virtue of the warehousing procedure, it did not thereby obtain title. The Judge accepted that SBL, by asserting title to or retaining the documents of title relating to that cotton, was liable in conversion.7

Constructive Trust: This claim was advanced against the proceeds of the received cotton paid by SBL (in contrast to the conversion claim directed at the cotton that was not sold by AMJ).

The case advanced was as follows: (1) AMJ held these proceeds as constructive trustee for Innovatsia until the APG was reduced; (2) This trust arose because AMJ had sold the cotton and received the proceeds without accepting the shipping documents and without reducing the APG; (3) SBL knew these matters and accordingly was liable to account to Innovatsia since it would be unconscionable to retain the proceeds of sale and the proceeds of the demand. In support of the allegations as to SBL's 'knowledge' and the 'unconscionability' of its retaining the proceeds, the claimant relied upon the same matters as were said to form the claim in deceit.

The submission was rejected. The Judge considered that SBL would only be affected by a constructive trust if it had acted dishonestly. But having already rejected the claimant's case in deceit, he was not persuaded that even objectively viewed SBL's conduct was contrary to acceptable standards of honest conduct.

Conclusion: In the result, the Judge ordered that the sum of $355,771 be added to the amount agreed by the parties in their settlement.

Comments:

1. The multi-role played by SBL is noteworthy. Agent for a syndicate of banks providing an export facility; provider of a working capital line; beneficiary of an APG (expressed as being the security in the event that the delivery obligations were not fulfilled); issuer or counter-signatory of LOIs and operator of the LC. This almost inevitably created a situation for some sort of conflict of interest to arise.

The Judge alluded to the consequences of this in his judgment. After describing the bank's conduct (to 'oil' the wheels of commerce) as being in one sense laudable but nevertheless without justification, he commented that:

[T]he process was hardly unselfish since the outcome was for the sub-sale proceeds to be used to reduce AMJ's facility but by the same token to allow any reduction of the APG to await the provision of a compliant set of documents (which themselves would include the original bills of lading).

And in another passage, he observed:

It is true that the LOIs represented an unsatisfactory backdrop to the demand. But they had emerged early on in the performance of the sale contract in circumstances which attracted no criticism ... . Indeed from the outset, SBL staff were expressing a clear understanding of the potential disparity between the sale process and the documentary process.

2. The Judge accepted the evidence given by the bank's representatives as to their acquiescing in the issue of the second set of bills of lading and their adoption of and motives for operating the LOI/release system. In his approach to this he followed the observations made in an earlier case:

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.8

3. Having heard the evidence, the Judge rejected the claim. There are two aspects to this. The first is that in cases of deceit the authorities stress the need for dishonesty. There must be conscious knowledge of falsity. "When Judges say, therefore, that wickedness and dishonesty must be present, they are not requiring a new ingredient for the tort of deceit so much as describing the sort of knowledge which is necessary." 9

The second aspect, whether in identifying the relevant misstatement or in the finding of a dishonest mind, is that it is necessary to bear in mind the heightened burden of proof that bears on the claimant. However:

[T]his does not mean that where a serious allegation is in issue the standard of proof required is higher. It means only that the inherent probability or improbability of an event is itself a matter to be taken into account when weighing the probabilities and deciding whether, on balance, the event occurred ... . [T]he more serious the allegation the more cogent is the evidence required to overcome the unlikelihood of what is alleged and thus to prove it.10

The Judge identified several features in the context of the transaction and in the conduct and attitude of the representatives concerned that heightened the improbability of dishonest conduct and rebutted an inference of fraud.

4. The judgment can be contrasted with the decision in Brown Jenkinson11 where commercial and legal standards had also come into conflict. The Judge referred to this decision in relation to the LOI scheme. Describing what the bank's representatives did as laudable though unjustifiable, his conclusion differed from that in the earlier case where the court had said of the ship-owners: "Theirs was a slipshod and unthinking extension of a known commercial practice to a point where it constituted fraud in law". Steel J, on the other hand, concluded that what the SBL representatives did as respects the bills and the LOIs had no bearing on the demand subsequently made under the APG and, presumably, was not the cause of the loss suffered.12

In contrast also is the more recent decision in Standard Chartered Bank v Pakistan National Shipping Corporation13. Shawn of its rather complex facts, in this case a confirming bank knowingly made a false representation (that shipping documents had been presented in time) to an issuing bank in order to induce that bank to reimburse it. There was copious evidence as to the reasons why the document checkers of the confirming bank had caused or permitted the false statement to be made (a concern to "facilitate trade"). The trial Judge had found the checkers undoubtedly negligent but not fraudulent or dishonest.

The court of appeal saw things differently, however. Despite their being actuated by understandable intentions, the statement the checkers made was false to their knowledge and this exposed their bank to liability in deceit if acted upon by the issuing bank and it thereby suffered loss. This did not detract from the trial Judge's findings. He was using those words as they are used in the criminal law in a different sense from their relevance to the tort of deceit.

One other point of interest arising from the PNSC case was that the confirming bank had argued that the same rigorous standard as to the accuracy of statements made in the course of a LC transaction should not apply to those made by a bank as it applies to those made by a master and agents of a ship-owner. Evans LJ rejected this:

In my judgment, the same standard of commercial honesty is required by the law from other parties to a letter of credit transaction, including and perhaps especially from a bank. I find it surprising that a leading commercial bank is suggesting that some lower standard of honesty should be applied to it. 5. It is thought that consideration is being given to an appeal.

Comment by DCW: The court referred in its opinion to "UCP 458", stating that the advance payment guarantee was subject to it. Presumably, the court intended to refer to ICC Publication 458, the Uniform Rules for Demand Guarantees (URDG) and not UCP500 since independent guarantees are virtually never subject to the UCP. We have, accordingly, inserted reference to the URDG in Mr. Fayers' note.

* Roger D. Fayers, Barrister (UK), is a former legal advisor in the Department of Trade and Industry and a DCW Editorial Advisory Board member. Fayers served as the Chair of the UK delegation to the Working Group which drafted the UN Convention on Independent Guarantees and Stand-by Letters of Credit.

1. The claimant is referred to throughout the court judgment as being "Innovatsia". )

2. If the documents did not conform and the discrepancies were not waived by AMJ, they would be rejected. In consequence, 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 be able to obtain the sale proceeds for the cotton. On rejection of the documents the claimant would regain possession of the cotton.

3. In its simplest form an LOI is given by A to B to indemnify B against any loss or damage he may incur by reason of his doing something (which otherwise he would not do) as respects C. A classic example is found in the case of Brown Jenkinson & Co Ltd v Percy Dalton (London) Ltd [1957] 2 QB 621. A shipper who required a clean bill of lading for his goods requested the ship-owner, on the promise of an indemnity, to issue a clean bill in respect of the goods rather than one claused to reflect their damaged condition. Despite the well intentioned motive of the ship-owner and evidence that the practice of giving indemnities upon issuing clean bills of lading was not uncommon, the court held the indemnity unenforceable.

4. The alternative claims in conversion and constructive trust are dealt with briefly on page 6 below.

5. Established in the old case of Derry v Peek (1889) 14 App. Cas. 337.

6. See Cargill International SA v Bangladesh Sugar & Food Industries Corporation [1996] 2 Lloyds Rep 542, discussed in March 2000 DCW at page 30.

7. The basic features of the tort of conversion are (1) the defendant's conduct was inconsistent with the rights of the owner (or other person entitled to possession); (2) the conduct was deliberate; and (3) the conduct was so extensive an encroachment on the rights of the owner as to exclude him from use and possession of the goods.

8. The Ocean Frost per Goff LJ [1985] 1 Lloyds Rep at page 57.

9. Per Devlin J in Armstrong v Strain [1951] 1 TLR at page 871.

10. Per Lord Nicholls in In re H (Minors) [1996] AC at page 586.

11. See note 3 above.

12. It will be recollected that SBL sought to settle its potential liability for that part of the demand attributable to the LOI/releases. Because he rejected the wider claim in fraud, the Judge did not deal with causation. It may be noted that there is a different legal test for causation when fraud is proved than when the claim is for damages.

13. [2001] 1 Lloyds Rep 218; discussed in 'Banks are not always Shinning Innocents', June DCW 2001 at page 30.

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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.