Factual Summary: To assure performance of a US$69 million rice contract, U.S. Seller was required to post a 10% performance bond to be issued by a Local Bank in favor of Buyer. To obtain the bond, Seller obtained a US$6.9 million counter standby from Counter-Standby Issuer in favor of Local Bank, which in turn issued its Local Undertaking in favour of the Buyer.

The counter standby provided that, "[Funds are] . . . available against your authenticated Swift/Tested Telex that you have duly issued your Performance Bond as requested by ourselves and that you have received a claim in accordance with the terms of the performance bond." The Opinion stated that, "[t]he Letter of Credit also expressly incorporates the terms of the Performance Bond itself" which provided, "[a]ll claims made under this performance bond must be accompanied by a SGS original laboratory report specifically certifying that the quality of the purchased commodity does not meet the contractual specifications."

The goods were approved by the independent inspection agency at least 3 times during the journey. Subsequently, the Counter Standby Issuer received a complying demand on its Counter Standby from the Local Bank. However, the inspection agency in Iraq stated that it had never issued a report certifying that the quality was unsatisfactory as required for the Local Beneficiary to draw on the Local Bank. When Counter Standby Issuer indicated its intent to honor the presentation by the Local Bank, which complied on its face, Counter Standby Applicant sued for and obtained a preliminary injunction against payment by Counter Standby Issuer.

Legal Analysis:

LC Fraud or Abuse; Injunction; US Rev. UCC §5-109: The Judge noted that in drawing under the Counter Standby, Local Bank/Beneficiary indicated that it had honored a drawing on its Local Undertaking on the basis that the inspector had rejected the rice despite affirmative evidence that the inspector had not rejected it. The Judge made special note that Local Bank/Beneficiary of the Counter-Standby and Issuer of Local Undertaking were both entities of the government of Iraq. Because he could not perceive any other set of circumstances by which either the Buyer or Beneficiary could have determined that the goods were non-conforming, the Judge concluded that the most reasonable interpretation of the facts was that Beneficiary's request was an attempt to effectuate a fraud:

[A]bsent an adverse SGS quality report, it is difficult to perceive a set of circumstances by which [Buyer] or [Beneficiary of Counter Standby/Local Bank] could have otherwise determined that the Cargo did not meet the Contract's quality specifications, thereby warranting their demand for payment under the Letter of Credit. At the time [Bene of CS/Local Bank] made its request, on February 10, 2011, two-thirds of the Cargo had not even reached Iraqi shores, and the portion of the Cargo that had arrived, aboard the CAPTAIN HARRY, was still in the process of being unloaded. Moreover - over the course of the CAPTAIN HARRY's journey from Darrow, Louisiana to Umm Qasr, Iraq - [Inspector] sampled, analyzed, and inspected the Cargo several times, and issued at least three reports certifying its quality. None of the several [Inspector] reports issued with regard to the Cargo indicates any problem with the rice's quality, let alone a problem that would justify a full draw down on the Letter of Credit.

The Judge thus concluded that this case fit into the fraud exception of US Rev. UCC § 5-109 (Fraud & Forgery), which provides that an issuing bank may refuse to honor documents which "appear on [their] face strictly to comply with the terms and conditions of the letter of credit" but are "forged or materially fraudulent," or if "honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant."

Comment: While the Counter-Guarantee is independent from the Local Undertaking, uncontroverted evidence of material forgery in the drawing on the Local Guarantee taints the drawing on the Counter Guarantee when the Court concludes that a document presented is forged or fraudulent and the same governmental entity controls both the Local Bank and the Local Beneficiary.



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.