Factual Summary: Pursuant to a sales contract, the applicant opened an usance LC in favor of the beneficiary. The beneficiary, in conjunction with the second defendant, presented a set of forged documents to the issuer. The bill of lading stated that it was issued by the second defendant, on behalf of the third defendant. In reality, the third defendant never authorized the second defendant to issue the bill of lading on its behalf. After the issuer accepted the draft drawn by the beneficiary, the applicant then obtained all documents from the issuer. The beneficiary then discounted the accepted draft to a bank in London. On the arrival of the vessel at the designated port, the applicant discovered that the goods were not on board. The applicant then sued the beneficiary, requesting that the court declare the sales contract invalid, void the LC, stop payment, and hold the defendants jointly liable for its losses. The court entered a default judgment against the beneficiary and the second defendant (who failed to Jin Saibo is a Partner at Beijing Yiwen Law Firm, PRC. Zhou Feng is an Associate at Beijing Yiwen Law Firm, PRC. 2001 LC CASE SUMMARIES enter a reply or appear in court), holding them jointly liable, but dismissed the charges against the third defendant.

Legal Analysis

1. Fraud; Injunction; Forged B/L: The court stated that: "The lawful rights and interests of the applicant should be protected in signing a sales contract to buy steel sheets and later applying to the issuer to open the LC in accordance with the sales contract. The beneficiary has not delivered the goods to the applicant as agreed in the sales contract. It even conspired with the second defendant to forge the clean on board B/L and presented the forged documents to the negotiating bank, for purpose of obtaining the payment by fraud. The above facts are sufficient to prove that the beneficiary and the second defendant intentionally defrauded the plaintiff. Therefore, the sales contract and relevant documents, including the B/L, should be invalid. The payment under the LC should be stopped. The beneficiary and the second defendant should be jointly liable for the losses of the applicant. The third defendant had no part in the fraud and should not assume any liability. Comment by Jin Saibo: Letter of credit transactions are based on the independence principle whereby claims between the parties with respect to the underlying contract shall not affect the rights and obligations of the banks and other parties under the letter of credit. However, fraud is an exception to the independence principle. Like courts in other jurisdictions, the PRC Supreme People's Court allows courts to freeze payment under the LC where there is fraud. On the other hand, the Supreme Court of China has clearly stated that the issuing bank must make payment, even where there is fraud, if the issuing bank has accepted the draft under the LC and, as a result, the issuing bank's obligation under the LC is converted into a duty of unconditional payment. In practice, beneficiaries who commit fraud will invariably discount the draft once it is accepted. The holder, who often will have acquired the draft in good faith for the fair market value, then applies to the issuing bank for payment. The issuing bank cannot rely on fraud as an excuse to refuse payment to a holder in due course. The Xiamen Court's decision in this case clearly is at odds with the Supreme Court's previous rulings. The Xiamen Court's decision determined the rights and obligations of the issuing bank and holder in due course, even though neither was a party to the suit. The decision was not only unfair to the good faith purchaser of the discounted draft, but it also harmed the reputation and interests of the issuing bank and the reputation of the Chinese banking industry at large. Because the issuing bank was not a party to the suit, it cannot appeal the court's judgment or its order to freeze payment. However, if the holder in due course sues the issuing bank abroad, the issuing bank will be held liable for not only the original amount owned but for interest as well. In addition, the issuing bank will incur litigation costs. Unfortunately, the issuing bank cannot obtain reimbursement from the applicant. Moreover, as the judgment was made without the joining of the issuing bank and the holder in due course, it should not bind the two parties. The Xiamen Maritime Court in this case obviously did not consider the issue of the payment finality of an accepted draft. Neither did the court consider whether the holder of the accepted draft is in due course or not. The court did not consider that at the same time it is protecting the rights and interests of the domestic applicant, it is depriving the property, the rights and interests of other parties. In this case, the holder in due course has been deprived without the opportunity to defend its interests.


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.