Article

Factual Summary:Prior to Applicant's liquidation, Issuer advanced two sums in the form of "local" letters of credit for US$ 2,786,000 for goods and US$ 1,092,795.14 engine parts. Both LC applications required a Beneficiary's draft drawn on Issuer to be presented. However, when the LCs were issued, the Beneficiaries' drafts were omitted from the required list of documents necessary for presentation.

Issuer advised Applicant that it had received the drawings for both LCs. For each LC presented, the documents appeared to conform with the documents explicitly required by the LC issued. On both occasions, Issuer gave Applicant the option of either debiting its current account or its trust account. Applicant chose its trust receipt account.

Prior to the two LCs being paid, Applicant entered liquidation on October 12, 1998. During this liquidation process none of the actual goods subject of the two LCs were found. The Liquidators refused to accept the proof of debt for the two LCs. Subsequently, Issuer sought an order that the rejection of the claims on the two LCs be overturned by an Originating Summons filed May 30, 2001. A discovery list was agreed to and the Issuer list of documents was surrendered in mid-December 2001. The Originating Summons was scheduled to be heard in mid-April 2002.

In February 2002, the Liquidators petitioned for a more comprehensive list of documents, alleging that these documents were necessary to determine whether Issuer was reckless or had "'turned a blind eye'" in making payments under the two LCs. Issuer disclosed worksheets from its Bill Checker and Officer that showed no discrepancies. Issuer objected to turning over any additional requested documents primarily based on the independence principle where fraud is not established at the time of payment. Instead, Issuer argued that the Liquidators failed to produce any evidence showing that the Issuer had knowledge or was a party to any fraud at the time of payment. Issuer alleged that further document production was a "'fishing' exercise" on the part of the liquidators.

Legal Analysis:

1. UCP500 Articles 3 and 15: The court examined UCP500 Articles 3 (Credits v. Contracts) and 15 (Disclaimer on Effectiveness of Documents). The court concluded that an issuer that has issued an LC must pay against the presentation of conforming documents, unless there was clear evidence of fraud and of Issuer's knowledge of that fraud at the time of payment.

2. Fraud; Recklessness: The court considered whether the issue of fraud had been raised in the proceeding by particular allegations. The Liquidator agreed that no such particular allegations had been made in the affidavit of evidence that Issuer had "'positive knowledge'" of fraud. However, Liquidator argued that Issuer was "reckless" or turned a blind eye to the following matters: (1) no advising bank was involved, Beneficiaries' offices were located near Applicant, and only a few documents were required, (2) the LCs were physically collected by Beneficiaries from Issuer, (3) in the documents presented for LC number 80356, Beneficiary's invoice referred to the LC number before the LC was even issued and the cargo receipt was dated after the invoice and LC were issued. Similarly, LC 80374 the cargo receipt was issued on the same day as the invoice, (4) with respect to the goods, the cargo receipts failed to indicate that the goods were received in trust for Issuer, and Issuer did not require a certification from Beneficiaries that the goods were delivered to Applicant as Issuer's agent.

The court noted, that Applicant was a governmental subsidiary "that engaged in a wide variety of business activities. The letters of credit in question were for amounts which were within approved or authorised credit limits for [Applicant]. Since these were purportedly for goods sold and delivered locally, the absence of requirements for shipping documents, air way bills, insurance documents and other paraphernalia of international trade would not have been surprising. Similarly, the absence of an advising bank would not have been surprising. As for the fact that the offices of the beneficiaries were within a few hundred metres (in the case of one) and a few kilometres (in the case of the other) of [Applicant], I fail to see how that could have caused a banker to have notice that fraud was clear and obvious."

"In relation to the point made on the letters of credit themselves, again I fail to see the relevance of the fact that the letters of credit were physically collected from the Bank by the beneficiaries."

As to the points regarding the documents, the court concluded that they would not give the issuer notice of fraud.

Finally, Liquidators argued that Beneficiary drafts listed in the LC application were not included in the LCs issued. The court applied the following "wellestablished" test: "whether standing in the shoes of the paying bank at the time of payment, the fraud was clear and obvious to it." The court rejected the recklessness argument stating it could not be substituted for a fraud allegation. When fraud is clear and obvious then Issuer risks non-reimbursement paying the beneficiary at its own risk. However, when the fraud was not obvious or clear, then "it is not for the banker to question why the businessman involved in the underlying transaction had chosen to conduct their business in any particular way."

The court held that there was no issue of fraud and rejected the recklessness arguments on each point raised by Liquidators' counsel as not giving raise to any clear and obvious notice of fraud. The court concluded its opinions stating that "[i]t is established principle that it is not fair and just to permit a party to raise a vague unparticularised case in the hope of making good after discovery."

Comment:

While the court is correct in stating that recklessness does not constitute LC fraud, LC fraud is not the only defense available to an applicant. It may also defend where there has been a material discrepancy between the terms of the LC and the documents presented. Perhaps this decision should be understood as also concluding that the petty differences raised on behalf of the applicant would not excuse its obligation to reimburse the issuer.

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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.