Factual Summary: The applicant and broker agreed to the sale and purchase of fabric consisting of 65% rayon and 35% wool. Although the LC required documents indicating this ratio, the broker and beneficiary agreed to sell fabric which was 70% rayon and 30% wool. At the insistence of the broker, and in order to ensure payment, the beneficiary presented documents which falsely indicated that the fabric shipped contained 35% wool. Payment was made and neither the issuer nor the applicant were aware of the true nature of the goods shipped until the applicant ceased to receive payment under its underlying contract with the ultimate purchaser due to the wool content. The issuer had honored several draws made by the beneficiary in reliance on the false documents, and the applicant subsequently reimbursed the issuer.

On learning of the false nature of the documents presented, the applicant brought an action against the beneficiary for fraud and sought to enjoin the issuer from further payment under the credit.

In a previous opinion, the court had granted the beneficiary/defendant's motions for summary judgement on the nine claims made against it. On appeal, the appellate court upheld the dismissal of eight the plaintiff's claims, but reversed on the claim of fraud and remanded for trial. After a trial on the fraud claim, the trial court found for the applicant.

Legal Analysis:

1. Fraud Claim Precluded by Contractual Relationship:The beneficiary claims that the applicant does not state a course of action for fraud because the alleged misrepresentations do not amount to common law fraud but are related to performance of the underlying contract. The court rejected this argument, stating that this principle of common law fraud did not apply because the action related to misrepresentations made in the LC drawing, a matter which is independent of the contract.

2. Elements of Common Law Fraud:The court indicated that "[u]nder New York law, 'the essential elements of a common law fraud claim include material, false misrepresentation, and intent to defraud thereby, and reasonable reliance on the representation, causing damage to the plaintiff."

a. Intent to Defraud: The beneficiary admitted that it did not believe that the goods shipped had a fiber content which matched the description of the goods in the documents which it presented. The court noted that "[the beneficiary] was cognizant of the need for exact conformity between the description of goods in the letters of credit and the description in the documents submitted to the Bank, and thus intentionally mismarked these documents for the purpose of collecting payment". The court also found that the beneficiary "knew [the applicant] would be liable on the letters of credit". As such, the court found that the beneficiary had acted to intentionally defraud the applicant.

b. Third Party Reliance:The court concluded that the issuer would not have paid out on the letters of credit if the beneficiary had not falsified the documents which it presented. It went on to address the issue of whether a misrepresentation relied on by the issuer could be raised by the applicant in an action of fraud against the beneficiary. The court regarded the issuer as the applicant's "financial intermediary" and noted that the applicant was the party at risk in the LC transaction. Furthermore, when it applied for the credit, the applicant was aware that the issuer would make payment based on representations made to it. Thus, the court ruled that the applicant "anticipatorily relied on [the beneficiary's] submissions to the Bank" satisfying the reliance element of fraud.

c. Fraud Exception to the Requirement to Honor:Applicant's Ability to Seek Injunction: The court noted that the fraud exception to the requirement to honor "provides that an applicant may enjoin an issuing bank from paying on the letter of credit if the beneficiary has submitted false documents or if there is fraud in the underlying sales transaction, unless the demand for payment is made by a holder in due course". This would allow an applicant to "enjoin a bank's payment on a letter of credit ... [making it] anomalous to prevent an applicant from asserting a fraud claim against the beneficiary after the letters of credit had been drawn down". The court therefore reasoned that "in order to recover for fraud, [the applicant] need not prove that it, rather than [the issuer] received [the beneficiary's] misrepresentations."

d. Access to Information:The beneficiary argued that the applicant could not claim that it was defrauded since it should have known that the goods shipped were not of 35% wool content. The beneficiary claimed that the exact nature of the goods would have been evident if the applicant had "reviewed the correspondence between [the broker] and [the beneficiary]" or if the applicant had either "required ... inspection certificates" or "inspected the fabric itself". The court refused to accept this argument stating that "[w]here, as here, the parties are engaged in a commonplace commercial transaction, [the applicant's] failure to review readily accessible information will not defeat its fraud claim unless it was "placed on guard or practically faced with the facts'".

e. Materiality:The court found that the beneficiary's "misrepresentations concerning the fabric's fiber content were material" since it had already concluded that the issuer would not have paid on the letter of credit if the presented documents had not been fraudulent.



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.