Article

Factual Summary:To pay for the purchase of goods, bank confirmed a commercial LC in favor of Seller/Beneficiary requiring presentation of "Full clean set air way bill marked freight collect made out to order of [Issuer]."

Two banking days after the banking day of presentation, Confirmer refused the documents, claiming discrepancies. Two days later, Confirmer discovered that the air waybill was issued by a phantom company, informed the Beneficiary, and returned the documents.

When Beneficiary informed Confirmer that it would re-present the documents, Confirmer refused due to the fictitious air waybill. Beneficiary then sued Confirmer for wrongful dishonor. After a trial, the court ruled in favor of Confirmer. On appeal, affirmed.

Legal Analysis:

1. Fictitious Document:Noting that the parties had stipulated that the air waybill was a "forgery," the appellate court distinguished between a false document, a forgery, and a fictitious document. While accepting the parties' characterization, it noted that the document was fictitiously created by a nonexistent company. "I pause to mention that a document may be false without being a forgery although every forgery must necessarily be false in so far as that is taken to mean that it is not the true document. There is also a distinction, in my view, between a fictitious document created by an existing entity and a document purportedly created by a nonexisting entity. In the case of the former, the fictitious document may in certain circumstances be given legal effect; for instance, where a case is made out on estoppel. In the later case, a document 'created' by a non-existing entity is every bit a ghost as its 'creator' with neither substance nor shadow."

2. Duty of Confirmer:The court noted that a confirmer's obligation is "to effect payment when the requisite documents are presented. The law does not require the bank to verify the authenticity of the documents themselves, for they need only look at the face value of the documents."

3. Can a Bank Raise Forgery as a Defense After It is Obligated to Honor: The court and the parties were constrained by a series of decisions of English and Singapore courts which they accepted and attempted to adjust to the circumstances of their case, including the decision in Montrod (2001 Q.B. Commercial Court (England); 2002 Annual Survey of Letter of Credit Law and Practice 270), which was cited extensively. Under these decisions, it was accepted that a bank could not raise a defense based on fraud or forgery after a period of seven days from the date of presentation.

4. Innocence of Beneficiary: The beneficiary argued that it was entitled to honor where it was innocent of knowledge that a document was forged. For purposes of its decision, the court assumed that the beneficiary was innocent. Nonetheless, it concluded that a bank could properly refuse documents due to their forgery even though the beneficiary was innocent provided that it did so within the time available to it for examination.

5. Knowledge of Fraud Before a Bank Takes Up the Documents:The beneficiary argued that because there was a forgery, an innocent beneficiary was entitled to recover. The court, however, noted that the facts before it were more narrow. The court noted that a bank could in the first instance base its refusal on the ground that the documents were forged. The court stated "[t]he circumstances of the case before me is therefore different from that of Montrod's which concerns situations arising after the seven-day period for the bank to decide whether to accept or reject documents presented. If the bank knows or believes at that stage, that is, during the seven-day period that a document in their hands is not a requisite document - for whatever reason, be it forgery or something else - it will not be right to expect the bank to act on it as if it was a true document. Ordinarily, from the moment the iniquity of forgery is discovered time and motion are frozen so far as the law is concerned. Nothing more must be done to give effect to that forgery. It becomes utterly inert. The rights of the innocent are preserved but only in so far as they do not require an act to be done on the basis of any entitlement that is premised on the validity of the document in question. I cannot see how, in those circumstances, a court can justify a direction to the bank to ignore the forgery and accept it as if it were a true and proper document; thereby giving weight to an otherwise weightless paper, and value to an otherwise valueless paper."

6. When Can a Bank Not Raise the Fraud Defense?: In considering "[w]hen is it too late to 11 2002 LC CASE SUMMARIES sound the alarm? I am of the view that in the context of UCP 500 the end of the seven-day period under art 13b marks that point." The court noted that although the moment fraud is discovered nothing more must be done to give it any effect." It observed, though, "[i]n certain circumstances, however, parties may, by contract, agree that the obligations as between themselves should not be affected by a fraud (which neither is a party to)."

7. Notice of Refusal and Defense of Fraud: The beneficiary argued that the issuer had already stated its grounds for refusal, failed to mention fraud, and was precluded from raising it subsequently. The court rejected this argument, stating that the confirmer did not have notice of the forgery at the time of refusal. Since the documents were returned for correction and never taken up, the court concluded that "until that has been done and the documents returned to the defendants the documents cannot be regarded as having been accepted."

Comments:

1.This case is well reasoned, given the case law precedent on which it is based and with which it had to contend, and the result is sound. From the perspective of letter of credit policy, however, it is another case in a long line of English-inspired LC fraud jurisprudence that leaves one aghast, not to mention twisted in circles. It is a situation that could only be created by common law courts seeking to achieve a sound result in each case without the benefit of an overarching statute. The result is absolute unpredictability.

2. This comment, however, is not intended to criticize this court which cleverly manoeuvred through the shoals and rocks of the applicable case law. It is intended to highlight once again the inherent difficulties that the series of English fraud decisions have created.

3. The problem itself is knotty and it is one that is complicated by the UCP rather than helped. The question is what to do about LC fraud.

4. The fundamental principle stated by the court at the close of its opinion is one that can be accepted generally, namely that a court will not lend its offices to the commission of fraud. Having stated this principle, however, does not resolve issues that relate to innocent third parties who may be caught up by the LC fraud. No one would doubt that a fraudster should not be rewarded, but the agreement seems to end when it comes to relatively innocent third parties.

5. As to nominated banks, UCP500 Articles 10, 14, and 15 reflect the opinion of the letter of credit community and most legal systems except that of England and those who follow it that a bank that acts pursuant to its nomination is entitled to be reimbursed if it honours without actual knowledge that the documents are forged or fraudulent. A corollary of this rule which the English appear to accept is that the nominated bank has no duty to investigate the existence of a fraud and may honour if it acts in good faith.

6. The problems appear to arise in two respects, one with regard to the conduct indicted and the other with respect to a beneficiary that is innocent of the fraud or forgery.

7. The court elaborated several distinctions between types of letter of credit fraud. It could be said to distinguish between false documents, forged documents, and fraudulent documents although at other points it distinguished only between forged and fraudulent documents, perhaps regarding both as "false". This typology is problematic for several reasons. In the first place, it is difficult to apply. Is a document that is falsely created by a legitimate company forged or fraudulent? If the signature is forged is not the document also fraudulent? The court suggests that there is a distinction in situations where the legitimate issuer of a document might be estopped to assert that it was forged or fraudulent. From the perspective of LC practice and law, however, these distinctions are irrelevant. Practically, it may help to distinguish between a document that is fraudulent or forged and a transaction that is fraudulent but in most cases where there is fraud in the transaction, there is also a fraudulent document unless the credit only calls for a draft and, even then, it could be argued that the document was fraudulent. Whatever the value of this distinction, it only is significant to LC law in that it requires different proof to show that a document is fraudulent than to show that a transaction is fraudulent and, given the availability of the evidence, may be harder to convince the court that the transaction is fraudulent than that the document is fraudulent which, after all, is a more narrow inquiry. Having concluded that there is fraud, however, the distinction is meaningless.

8. It is meaningless because no LC bank undertakes to pay against a document that is itself fraudulent or where the transaction that gave rise to the LC is fraudulent. The provisions of the UCP that provide that a bank is not liable for the genuineness of a document are a shield against claims that the bank should have investigated and should be denied reimbursement. They do not blunt the sword of the bank which can sever the transaction where there really is fraud and it is able to meet the rigorous burden of proof.

9. Because the English cases do not understand these principles or accept them, they are forced into a variety of end runs or fictions when faced with a case involving an innocent beneficiary. The instant case is a perfect example. Outside the world of English jurisprudence, no one believes that a bank that becomes aware of fraud (and can prove it) is obligated to pay, whether or not it has given notice of refusal or of when it became aware of the fraud. The time of awareness or the notice of refusal is irrelevant because fraud disrupts all regular obligations and arrangements. The court itself stated the proposition very well. The problem is that it limited its reasoning to the situation where the seven day period had not run.

10. What relevance the seven-day period has defies comprehension. It is simply a convenient excuse to frame an exception to the wrong-headed rule that suggests that the innocence of the beneficiary has some significance., The court, scrambling to avoid this result, suggests that where the fraud is discovered before the seven days have run but after the first notice of refusal is given can raise the defense. If the innocence of the beneficiary has significance, then why observe the seven day limit? What is magic about the seven days? Or, if the time matters, why can the bank not raise the defense in its refusal in the event of a re-presentation and, until that time, raise it in any action for wrongful refusal? The fact that the UCP establishes this period as an outer limit is not persuasive. The time frame is a reasonable time, not seven days and, in any event, it stops when the notice is actually given. The reality is that the UCP only imperfectly addresses fraud, hoping that the courts will get it right. Hoping in vain, in most cases it would seem, where it comes to the English courts although in many cases the result is right however messy the rationale.

11. The root cause of much of this distress is that the term "fraud" is used. Under common law, it is necessary that there be scienter or knowledge where fraud is involved. As a result, where the beneficiary is innocent, there can be no scienter as to it and, consequently, no fraud. The reality, however, is that cases involving LC are not cases that sound in common law fraud but in LC fraud, which is a different matter. The beneficiary is not being accused of fraud. It is seeking to establish itself as being entitled to qualify for an exception to the rule that fraud undoes all obligations. While nominated banks fall within that exception, as do transferee beneficiaries, the original beneficiary does not. It bears the responsibility for the forgery or fraudulent creation of documents that it presents whether or not it has committed the actions. If any documents are forged or fraudulent, the beneficiary or anyone who claims under it is not entitled to an exception regardless of whether or not it is innocent. In this respect, the English courts have started off on the wrong road and, with every passing decision, their jurisprudence becomes increasingly convoluted and confused.

12. It is sad to have to say that a decision by so eminent a jurist with such careful and thoughtful reasoning, that is correct as to its result, ultimately, when looked at from a distance is so obviously silly. The solution? Adoption of the UN Convention on Independent Guarantees and Stand-by Letters of Credit would be a useful starting point. It would . provide a statutory framework by which issues of LC fraud could be approached and provide the common law courts with a new start on this question that enabled them to circumvent prior case law.

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