Article

Factual Summary:

Applicant procured letters of credit issued by two NY banks to cover the $1,076,243.70 purchase price of bed linen. To ensure that the linen would pass US customs, the contract required that the linen be of Bangladesh origin and the letters of credit required the presentation of invoices bearing the official Bangladesh Government export visa stamp attesting to the origin of the goods as Bangladesh.

A conforming presentation was made on a partial shipment to one of the issuers and drafts issued under the LC were accepted by the issuers. When the goods arrived, however, they did not pass US customs because they were of Pakistani origin. Additionally, the goods were not of the required quality. Accordingly, the applicant brought suit to enjoin payment under the accepted drafts and also filed suit against the beneficiary. The court granted a Temporary Restraining Order (TRO) preventing payment. Subsequently, the holder of the accepted drafts joined in the action.

In support of its motion for summary judgment, the applicant submitted an affidavit from the beneficiary's president. According to the affidavit, the beneficiary knew that its shipment and the visa stamp attesting to Bangladesh origin were fraudulent. The beneficiary testified that it was under severe pressure from the holder bank to ship the goods regardless of their state in order to generate income to pay off it. Subsequently, the holder bank foreclosed on the beneficiary's mortgage and sold all of the beneficiary's assets to satisfy the debt.

As holder of the drafts presented under the letters of credit, the bank brought counter-claims against the issuers and the applicant. The applicant moved for summary judgment against the advising bank. The court granted the applicant's Motion as to liability and gave the holder bank leave to file cross claims against the issuers which had accepted the drafts prior to the TRO.

Legal Analysis:

1. Fraud: The court first noted that fraud had clearly been proven by the applicant based on the beneficiary's affidavit.

2. Fraud: Holder in Due Course: The court observed that the fraud exception would not work against a holder in due course of negotiable drafts, which the applicant claimed it was.

3. Draft: Negotiable: The court observed that"[w]here there has been fraud in the transaction, the burden is shifted to the holder of the draft to prove that it is a holder in due course. ..." It examined the requirements for negotiability under UCC Article 3 and noted that, to be negotiable, the drafts in question must be payable at a definite time ascertainable from the face of the instruments. In this case, the drafts stated that they were payable a specified number of days from the date of the bill of lading. As the time of payment could not be ascertained without looking at the bills of lading, and as the bills of lading were not a readily available resource (such as a calendar), the court ruled that the drafts were not negotiable. As such, the bank holder was not a holder in due course but a mere transferee.

4. Acceptance: Injunction against Acceptors:The court also granted the bank holder's motion to amend its answer to assert claims against the issuers of the letters of credit under the theory that they had accepted the drafts prior to the injunction preventing honor being issued.

Comment:

1. This opinion is a useful reminder to those who have yielded to pressure to issue acceptance credits whose maturity is linked to the date of the bill of lading. An acceptance of such a draft does not, strictly speaking to a lawyer, yield a bankers' acceptance. What one has is a deferred payment undertaking. Whether it does to a banker depends on what a banker regards as a negotiable instrument. There is considerable evidence that under standard international banking practice the criteria of negotiability is reduce to a signed writing payable to order. Nonetheless, a draft whose maturity is pegged to something external is problematic.

2. The real difficulty with the opinion, however, is its assumption that a bank which had purchased the documents in good faith and for value was not entitled to payment simply because the draft did not meet the requirements of UCC Article 3. This result is absurd. To be sure, the bank's good faith and the value given are essential to recovery by a third person where there is egregious fraud. That the third person be a holder of a negotiable draft is not. This concept is an anachronism from an era where all LCs were accompanied by drafts. That time has long passed and decisions such as this one are further indications that the innocent purchase doctrine of UCC Article 5 should be divorced from UCC Article 3 theory. The same good faith purchase doctrine should and does apply to deferred payment undertakings. The court should have gone beyond its superficial view of the case and examined the substantive issue of good faith.

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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.