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Note:Komercni Banka, a Czech bank, agreed to finance the import/export business of BCL Trading GmbH. It issued deferred payment LCs with maturity dates varying from 180 to 360 days for the account of BCL as Applicant in favor of Stone and Rolls, Ltd, a UK company, for the purchase of large quantities of agricultural products from Russian and the Ukraine. The scheme involved 51 LCs issued between 1997 and 1999.

As a condition to issuing the LCs, Issuer required that the LC would not become operative until a prepayment was made into a BCL dollar account with Issuer and, on a drawing, would transfer the funds from the account with Applicant being liable for any balance. The prepayment varied from 100% to 25%.

The 30 LCs involved in this action required the presentation of a commercial invoice, confirmation of insurance, and a warehouse "warrant list". Typical terms were:

Commercial invoice in 1 original duly stamped and signed.

Confirmation of Insurance indicating that goods are fully insured and that insurance is vinculated in favour of Komercni Banka,a.s. Prague

Original of Warrant List, duly signed, indicating LC number, total quantity of goods, unit price and total amount, stating that the goods under consignment of LC are lying in the warehouse and are held only in favour of Komercni Banka, a.s, indicating that goods will be released to final consignee only upon authorisation of Komercni Banka, a.s.

Furthermore confirming that all charges accrued from storage will not be calculated to Komercni Banka,a.s. The grain warrants provided that:

We, as the sellers warehouse holder, herewith confirm and state that goods under consignment LC number 9822590007003 are lying in our warehouse and are held only in favour of 57 Komercni Banka,a.s., Prague. We irrevocably confirm that respective goods will be released to final consignee only upon authorisation of Komercni Banka, a.s, Prague. We also confirm that all charges accrued from storage will not be calculated to Komercni Banka, a.s, Prague.

Beneficiary "[procured] the presentation of documents to the bank, via an intermediary bank. The documents presented were accepted by [Issuer]. The LCs were then assigned by [Beneficiary] to a discounting bank or in some cases forfeited by [Issuer] itself." Beneficiary cycled the bulk of the payments back to Applicant, characterizing them as "advance loans", retaining for itself a "commission". Portions of these funds were used to provide the prepayments for further LCs.

When a new manager of Issuer became aware from newspaper reports that a steel plant which held steel for Applicant in an unrelated transaction was experiencing financial difficulties, inquiries were made and it was discovered that there was no steel warehoused for the bank. This revelation led to inquiries about the warehoused grain which, after many delays taking five months, revealed that there was no grain and that the grain warrants were regarded as having no binding legal effect and merely indicated a willingness to provide grain should it be paid.

It was also discovered that "there were no longer sufficient funds both to repay maturing LCs and to maintain blocked pre-payments for LCs which had not yet matured." The reason for this situation was that the branch had used the same funds as cover for both the LCs and for foreign exchange transactions for which there was also a blocking of funds. In addition, it was discovered that of the 30 LCs, the funds for eight did not remain blocked and for the other 22 LCs there was no prepayment whatsoever.

Issuer sued Beneficiary and its principal for deceit in England on 30 LCs which resulted in a loss of US$ 94,720.382.80. It asserted that there were never any genuine underlying sales of the grain located in Russian warehouses; that the invoices and warrant lists presented to it were a "sham"; and that Beneficiary acted as a "puppet" to obtain money by false pretenses. The court noted that there were separate proceedings against Applicant in Austria and the Czech Republic and that criminal charges had been brought against bank employees.

The High Court of Justice, Queen's Bench Division, Commercial Court, Toulson, J., granted judgment in favor of Issuer against both Beneficiary and its principal.

The court noted that "[b]ecause the action is brought in deceit, the [Issuer] has to establish not only that there was misrepresentation on a comparison between the objective meaning of the documents presented to it and the true facts, but that the [Beneficiary] either intended to deceive it or were indifferent, i.e. reckless, whether it was deceived."

For this purpose, the focus shifts from the objective meaning of the documents to what was in the mind of [Beneficiary's principal]." The court relied on Spencer Bower, Turner and Hadley on Actionable Misrepresentation, 4th ed. (2000) where the principle is stated "'[i]n deciding whether the representation was fraudulent, the questions is not whether the representor honestly believed it to be true in the sense assigned to it by the court, or on any objective consideration of its truth or falsity, but whether he honestly believed it to be true in the sense in which he understood it when it was made.'"

In considering the background of the Russian grain trade, the court gave credence to the statements of an expert who opined that:

"The Russian grain trade is conducted with a ripoff mentality. Traders exploit producers wherever possible. It is difficult for producers to gain access to reliable price information. Contracts are treated with cursory regard. A warehouse warrant is a dubious document."

Beneficiary denied any dishonesty. Instead, it blamed its trading partner as being "unreliable". It also asserted that the underlying transactions were genuine, denying any deceit or dishonesty. It claimed that the US$ 121,000,000 advanced to Applicant constituted loans conducted in the ordinary course of business for which it had security in the form of its ability to withhold delivery of the goods.

In this regard, the court assessed the evidence of Beneficiary's principal:

"However, at the same time as it was being represented to the bank that goods as described in the warrant list were being held only in favour of the bank, [Beneficiary's principal] on his own evidence knew that he intended to pass all or most of the discounted proceeds of the LC to [Applicant], and that he intended not to permit delivery under the contract of sale between [Beneficiary] and [Applicant], for which payment was to be by the LC, until after repayment by [Applicant] of the re-cycled proceeds of the LC. As he made clear in the passages from his third witness statement set out above, he regarded the ability of [Beneficiary] to withhold delivery of the goods sold to [Applicant] as a form of security for [Applicant's] debt created by [Beneficiary] passing to [Applicant] the proceeds of the LC by which payment for those goods had been made. How could that be squared honestly with the making of representations to the bank that the goods were held only in its favour (assuming for this purpose that [Beneficiary's principal] believed that the goods were being held in the warehouse)? At the end of his evidence I asked [Beneficiary's principal] about this [reference omitted]."

"[Beneficiary's principal] gave a lengthy answer containing two parts. The first part was that he was confident from the prepayments made by [Beneficiary] to FIG Don that [Beneficiary] had the ability to fulfil its contractual obligation to [Applicant]. Whether true or not, this was not an answer to the point. The second part involved drawing a chronological distinction between the presentation of documents to the bank and the subsequent loan of discounted LC proceeds to [Applicant], and treating the two stages as unconnected. I regard this as disingenuous. The plan to recycle the proceeds of the LC to [Applicant], and to withhold delivery of goods under the contract of sale financed by the bank, was in existence at the time of the presentation of documents to the bank; it was not a later independent idea. [The signatory of the Warrants] on his own evidence intended all along that the goods should not be held 'only' in favour of the bank, but rather that they would not be released to the supposed buyer, [Applicant], until it had repaid the re-cycled proceeds of the discounted LC."

"I reject also [Beneficiary's principal's] suggestion that he believed that the statement in the first sentence of the warrant list that the goods 'are being held only in favour of' the bank was narrowed by the irrevocable confirmation in the next sentence that the goods would be released to the final consignee only upon the bank's authorisation. On that argument it would not have mattered what rights anybody else might have to prevent delivery of the goods. That would make no commercial sense from the bank's viewpoint and would be contrary to the requirement of the LC that the warrant list should state that the goods were held only in its favour."

Furthermore, Beneficiary argued that there were "grave internal irregularities and shortcomings on the part of the [Issuer]" and that Issuer had failed to protect itself by obtaining and maintaining prepayments.

The court noted that there were "An astonishing catalogue of deficiencies from the board of directors downwards..." some of which had resulted in criminal charges in the Czech Republic but also that there were no allegations of fraud by any bank officer or employee. In particular, the court noted that "J-1" The court noted that when a new risk assessment unit was established, their inquiries were regarded "as an unwelcome form of interference". When recommendations about the adequacy of monitoring bank risk were made, they were not followed.

Nonetheless the court stated that it did not agree with Beneficiary's argument that Issuer's own negligence was responsible for the loss. "When the bank accepted the documents presented to it, as a result of the defendants' fraud, it incurred an apparent liability to the beneficiary (or its assignee) for the face value of the LC. The defendants' fraud was therefore an operative cause of the loss sustained by the bank in paying that amount (or a discounted proportion). Its own negligence in failing to obtain or retain the pre-payment specified in the LC was a concurrent partial cause of its loss. However, the bank breached no duty to the beneficiary in that regard and its own contributory negligence is not available as a defence to a fraudster."

The court noted that "[f]rom the defendants' viewpoint there is certainly an element of fortuity in that if the proceeds of payments by [Beneficiary] to [Applicant] were used to repay earlier LCs issued in favour of [Beneficiary], [Beneficiary] would cease to owe a liability to the bank in respect of those earlier LCs; but if they were used to repay other LCs, [Beneficiary] would gain no benefit. However, that is not something about which [Beneficiary] is entitled to complain. A fraudster who pays proceeds of his fraud to an accomplice takes his chance what happens to them."

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