Article

Factual Summary:

The issuer provided a standby LC to the applicant in the course of an international sales transaction between the applicant and the beneficiary providing for the shipment goods from Miami to Brazil. It required a beneficiary statement that all of its obligations regarding the shipment of goods had been met. When conforming documents were presented, the issuer honored.

Only part of the goods reached Brazil, however, and those that were received were returned as nonconforming, even though the beneficiary's statement had warranted that the goods were shipped in accordance with the terms of the LC and that the applicant owed it $160,000. The court characterized this statement as "fraudulent". The beneficiary also forwarded shipping receipts that the court indicated were later determined to be false.

When the issuer discovered the fraud in the documents presented, it demanded that the funds be returned by the beneficiary. The beneficiary refused and the issuer brought suit against the beneficiary to recover the funds. On the beneficiary's motion, the trial court dismissed for failure to state a cause of action. On appeal, affirmed.

Legal Analysis:

1. Warranty: No Beneficiary's Warrant for False Statement:Recognizing that there is a split in the authority in both state and federal courts regarding beneficiary warranties under prior UCC Section 5- 111, the court ruled that, absent language expressly making veracity a condition of the LC, there is no breach of warranty or presentation by the beneficiary for false statements as long as the documents conformed on their face with the LC. The court based its decision on the independent nature of the issuer's duty to the beneficiary that is unrelated to the underlying contract between the beneficiary and the applicant. The issuer is required to examine documents presented for compliance with the LC. Describing the bank's role as ministerial, the court noted that it has no duty to investigate the validity or effectiveness of the documents.

The court found that prior Section 5-111 did not create a cause of action for the issuer against the beneficiary because the "warranty" of compliance with the conditions of the LC meant that the beneficiary warranted only that the documents presented are in compliance with the conditions of the LC. Here, there was no warranty as to the veracity or conditions of compliance with the underlying contract, and such a warranty would conflict with the independence principle that is vital to LCs.

The court noted that an applicant may seek to enjoin payment on an LC prior to its honor if it discovers fraud in the presentation, but that there was no such injunction sought in this case.

Comment:

1. Proponents of a beneficiary warranty against fraud in revised UCC Article 5 argued that such a provision was needed to enable the issuer or confirmer to recover in the event that it paid against forged or fraudulent documents. While the issuer or confirmer is not required to determine the genuineness of documents and is entitled to be reimbursed even if it pays against documents that are fraudulent or forged or if there was fraud in the underlying transaction, it was urged that the provision provided an important auxiliary action to issuers or confirmers whose applicants were insolvent. What eventually became Rev. UCC Section 5-110 (Warranties) encountered strenuous opposition on several related grounds. It was warned that such a provision would be confused with the discredited "warranty of truthfulness" which several cases read into the previous Section 5-111 warranty. Under this approach, the applicant was able to recover on an LC theory against the beneficiary even though it had no course of action on the underlying transaction. The creation of a "warranty" against fraud was opposed because it was deemed to be unnecessary since courts have a panoply of common law remedies against fraud.

2. This decision suggests that the proponents may have been correct. Since the appeal is from a motion to dismiss, any conclusions regarding what is alleged depend on the initial pleading. Nonetheless, the opinion seemed to assume that the beneficiary had engaged in fraud and that its statement was false.

3. Here is the nub of the problem with this decision: what level of fraud? If the fraud was egregious, or so vitiated the transaction as to render it a nullity (letter of credit fraud) that it would warrant injunctive relief or constitute a defense to an action for wrongful dishonor, the issuer is entitled to relief under common law principles. Neither letter of credit law nor Prior UCC Article 5 mandate any different result. The existence of egregious fraud itself renders the independence principle inapplicable to such a situation and the issuer is entitled to obtain relief from the fraudster. If the fraud did not rise to the level of LC fraud (e.g., a non-material false statement), no relief is warranted.

4. The difficulty with this decision is that it appears to have foreclosed relief even if the issuer had proven LC fraud. Such a result is wrong. While the court correctly suggested that a different result would ob tain under Rev. UCC Section 5-110, it failed to understand the issues or their impact on prior Section 5-111.

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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.