Article

Factual Summary: In the context of a long term business relationship between Rionda, "an old established and internationally known sugar trader", and the Dine Group (Grupo Dine), a Brazilian group which owned three sugar mills in Brazil, Rionda agreed to finance the import of sugar into Brazil. The buyer and seller were both members of the group and payment was by means of letters of credit issued by Rionda's banks with terms of 390 days from sight. The buyer obtained the sugar from suppliers arranging payment by means of back to back LCs issued by banks nominated as confirmers in the Rionda LCs. When documents were presented to the issuer of the first LC, discrepancies were waived and the issuers of the back to back LCs discounted the payments due under the first LCs and apparently applied them to the amounts due on the back to back LCs. The documents were then turned over to the Brazilian buyer.

Subsequently, Rionda learned that it had been induced to apply for the LCs as a result of a massive fraud on the part of the Dine Group and its principal. The cane sugar that was pledged to it had also been pledged several times and, in fact, did not exist, and in addition the alcohol that had been pledged was water. The fraud rendered Rionda insolvent.

To protect itself, Rionda informed its banks and undertook various measures including application ex parte for orders restraining the issuer from paying on the LCs and a world wide Mareva injunction restraining any member of the Dine Group from disposing of or dealing with their assets up to US$50 million. Based on representations as to the established position of Rionda, no security was required. In subsequent proceedings, Rionda sought to maintain the pre-trial injunctions. The Queens Bench Division, Commercial Court, discharged the injunction.

Legal Analysis:

1. Availability of Relief for Fraud in the UK: The court noted that "on the whole" the authorities "strongly support" the position that "a claim for interlocutory injunction against a bank which has issued a letter of credit must always fail" on the question of balance of convenience even if there is "a case of clear fraud". Rionda urged that:

[I]n recent years two matters have become clear, or at any rate clearer: first, that the real jurisdictional basis of the fraud exception whereby a bank is not obliged to comply with what would otherwise be its letter of credit (or performance guarantee) obligation is not so much (or as Rionda would prefer to say, not merely) a substantive right of action against the bank, but the interest of the law in not allowing a fraud to succeed; and secondly, that where a cause of action against one party can be shown in fraud, an injunction against another party may proceed merely on the ground that the first party is mixed up in the fraud. That, it is said, breaks the iron grip of Mr Justice Kerr's logic [in another English case] that either a letter of credit applicant has a substantive cause of action against a bank, in which case he does not need the protection of an injunction, or he does not have such a cause of action against the bank, in which case he is not entitled to an injunction.

The court undertook a detailed analysis of the history of the fraud exception in English jurisprudence. It concluded that in the case before it:

[E]ven if I assume for the sake of argument that Rionda has otherwise brought itself within the fraud exception, its claim against [the issuer] for a pre-trial injunction must fail on the balance of convenience alone. I would seek to put the matter in the following way.

(1) The interest in the integrity of banking contracts under which banks made themselves liable on their letters of credit or their guarantees is so great that not even fraud can be allowed to intervene unless the fraud comes to the notice of the bank (a) in time, ie in any event before the beneficiary is paid, and (b) in such a way that it can be said that the bank had knowledge of the fraud. Whether that interest is viewed in terms of the importance that must be attached to the honouring of banking commitments, or in terms of the lifeblood of commerce and in particular international commerce, it has been amply recognized in case after case. Unless the banking commitment can be insulated from disputes between merchants, international trade would become impossible.

(2) If it were simply a matter of claim between two merchants who are in contractual relations with one another, let us say a buyer and a seller, no special rules would be necessary. A good arguable claim for relief by a buyer, alleging fraud, against a seller, could be dealt with on normal principles. Once, however, a letter of credit arrangement has been set up, the special rule that only the fraud exception permits interference comes into play.

(3) Thus, in the absence of the fraud exception, a buyer can no more seek to prevent his seller from drawing on the letter of credit for which the seller has stipulated than the buyer can seek to prevent his bank from making payment under it. The reason is that otherwise the special rule could be subverted, and the integrity and insulation of banking contracts could be overthrown, simply by the device of injuncting the beneficiary rather than the bank. The formulation of the fraud exception, to the extent that it requires the timely knowledge of the bank and not merely that of the beneficiary (who, ex hypothesis knows of his own fraud), emphasizes the distinctiveness of this rule. In this connection, Themehelp v West represents either a genuine distinction, based on the fact that the claim against the beneficiary alone was brought at an early stage, well before the question of enforcement of the guarantee arose; or the decision must be regarded as undermined by the concession there that a claim against a beneficiary, as distinct from a claim against a bank, was not covered by prior authority. In any event, the present case, although it involves a claim against the beneficiary, USR, also involves a claim against a bank, Standard, and does not come at an early stage, but long after negotiation of documents and transfer of the goods, and is therefore not within any Theme help exception.

(4) An additional dimension of complexity is superimposed by the fact that a final decision on the beneficiary's alleged fraud cannot be reached at a merely pre-trial hearing. Of course, the fraud exception is framed in such terms, requiring the fraud to be clear and to come to the timely knowledge of the bank, that in one sense there ought not to be a difference between a pre-trial application and the final trial. But life and the law are not perhaps as simple as that, and the difference between the tests formulated for the pre-trial stage and for final trial emphasize the difficulty. However, the fact that the claimant gets the benefit of a lower standard of proof for the purposes of a pre-trial hearing, places on the Court, as I believe the cases demonstrate, an additional requirement to be careful in its discretion not to upset what is in effect a strong presumption in favour of the fulfillment of the independent banking commitments.

(5) It is in this context that one comes to Mr Justice Kerr's "insuperable difficulty". The same considerations that compel the narrowness of the exception which the Courts have allowed to the fulfilment of the banking commitments continue to operate at the level of balance of convenience. A short answer to the submission of Rionda and [the issuer] before me is, therefore, that the approach of Mr Justice Kerr in Harbottle has not only his own authoritative guidance but is, I believe, binding on me in the form of its express application by the Court of Appeal in both United Trading Corporation v Allied Arab Bank and GKN v Lloyd's. It was also applied by Mr Justice Hirst in Tukan v Barclays. Moreover, Harbottle was in general approved by the Court of Appeal in Edward Owen v Barclays.

(6) As for Mr Strauss' [counsel for the issuer] attack on the premise that an applicant either has a valuable remedy for breach of contract against a bank or no cause of action for an injunction at all, Mr Strauss would prefer to say that there was no remedy in contract at all, whereas Mr Philipson [counsel for Rionda] would prefer to say that there was. I am inclined to think that Mr Philipson is right about this, for I do not see how payment in the face of fraud can be a mere matter of discretion by a bank: it must be either within its mandate or not, and either a matter of obligation or not. It seems to me that the passage from Harbottle supports that view, as does its adoption in United Trading Corporation v Allied Arab Bank and GKN v Lloyd's , and the reference in Tukan v Barclays by Mr Justice Hirst to a "cast-iron claim" is particularly in point. Mr Justice Megarry in Discount Records v Barclays also seems to have been of the view that the claim is based in contract. Moreover, if it is not a matter of contract, why should the claimant be entitled to any injunction? Mr Strauss and Mr Philipson say, because no cause of action is needed, the defrauded claimant is entitled to the Court's protection in any event. But it seems to me that there is ultimately nothing in the authorities to require such a view. It is prima facie contrary to The Siskina doctrine and has been treated as such in the cases (not least in United Trading Corporation v Allied Arab Bank). The fact that the rationale of the fraud exception is the law's prohibition on the use of its process to carry out fraud (per Lord Diplock in United City Merchants (Investments) Ltd v Royal Bank of Canada ) may appropriately be viewed as an authorative expression of the source in law of the implied limitation on a bank's mandate. I accept that in Deutsche v Walbrook Mr Justice Phillips raised the question whether it is necessary for the claimant to have any cause of action, and sought to answer it in the negative by reference to the acceptance of his propositions in Bolivinter: but I have already ventured to suggest that Sir John Donaldson's judgment in Bolivinter does not support that view of the matter. If the source of the power to injunct were purely the law's interest in preventing the beneficiary from benefiting from his own fraud, I do not see why there should be the added requirement that the fraud be patent to the bank.

(7) Let me suppose, however, that I am wrong about that and Mr Strauss is right to say that a pre-trial injunction in aid of the fraud exception is, jurisdictionally speaking, itself an exception to the Siskina principle and reflects the concern of the law to protect a defrauded claimant even against a defendant bank which is merely mixed up in a third party's wrongdoing, as in Norwich Pharmacal or Mercantile Group v Aiyela . Even on that hypothesis, however, the balance of convenience would seem to me to come down firmly in favour of the bank. Ex hypothesis, the bank would be entitled, in the absence of an injunction, to pay the beneficiary and would not be in breach of contract to the claimant in doing so. Why, therefore, should the interests of the claimant overtop the public and general interests in the maintenance of banking commitments and in the autonomy of such commitments? The preference of concern about the private loss of the defrauded claimant to the general weal might arguably in a particular case fall in favour of the former, if the claimant could be in no other way protected. But it seems to me that the presence of the Mareva injunction or freezing order, which the Courts can grant in a case of fraud even on a worldwide basis and even as merely ancillary relief to litigation abroad, militates very strongly against that argument.

(8) Thus in Bolivinter Sir John Donaldson drew attention to the possibility and relevance of such relief, and in Themehelp in his dissenting judgment Lord Justice Evans returned to that thought in greater detail. In the present case the Dine Group defendants, including Vivalet, are all subject to a Mareva injunction. Therefore, they cannot enjoy or dispose of the fruits of the alleged fraud, even if it were the case that they have not already obtained such fruits in the form of the discounted payments to them and to their suppliers. It is true that a Mareva injunction is not a complete solution to all the problems of a claimant in such circumstances: thus it does not give security or priority over competing claims, and in a situation where, as here, the allegedly fraudulent beneficiary is bankrupt, that may be a serious drawback. But then it is not clear to me that the claimant should be entitled to any priority, a point that Lord Justice Evans made in Themehelp. I accept that a claimant would not, perhaps I should say might not, suffer from such drawbacks where he can prevent the proceeds of a credit or guarantee ever getting into the hands of or being credited to the beneficiary. Nevertheless, where the balance of convenience is being considered, it seems to me that the availability of the protection of Mareva relief to a claimant must be a highly important consideration and goes very far to undermine his complaint about the difficulties of his position if the credit is drawn upon.

(9) In other words, the competing interests become the importance to international trade of the integrity and autonomy of banking commitments on the one hand, and the demands of the allegedly defrauded claimant, e a good claim within the fraud exception was accepted by the Court at a pre-trial stage. I do not regard Mr Justice Kerr and the other Courts which have approved or applied the logic of his "insuperable difficulty" as necessarily saying that it could never be done. It is perhaps wise to expect the unexpected, even the presently unforeseeable. All that can be said is that the circumstances in which it should be done have not so far presented themselves, and that it would of necessity take extraordinary facts to surmount this difficulty. This is to be contrasted with Mr Strauss' candid acceptance that, if his submission were accepted, it would not be the unique or rare case which merited an injunction against performance by the bank, but in nearly every case the balance of convenience would be in favour of the claimant. That illustrates to my mind how radical his submission is, and how far it would change the law and practice which has hitherto been recognized.

The court also made the following additional points:

First, it is in any event clear that Vivalet in particular, the beneficiary under the three letters of credit, and the Dine Group in general have already received the benefit of the credit arrangements. This is because Vivalet has received the benefit of the credits in its favour in part directly, by payment to it of discounted sums which represent its profit, and in part indirectly by using the letters of credit opened on the application of Rionda as collateral for the opening of further credits to finance the contracts under which the alcohol was to come through it into the hands of the Dine Group. Those contracts have been performed. Rionda must have known, although Mr Barg disputes it (see below), that the credits for which it applied would be used in this way to obtain the alcohol. Thus the maintenance of an injunction would not now prevent Vivalet and the Dine Group from obtaining the fruits of the fraud: they have already done so. Indeed, this is a case where, unusually, not only the seller beneficiary (Vivalet) but the buyer as well (USR) has already received the benefit of the transactions in question.

Secondly, in as much as Rionda stands behind USR or the Dine Group, it too has received the alcohol for which the credits were opened. This is not the usual case where the alleged fraud in question goes to the very goods in question (or the documents) which are the subject-matter of the credit. Thus in the Sztejn case it was alleged that rubbish had been shipped in place of the goods. In this case, however, the alcohol was shipped and received by USR (for whom Rionda acted) and there is no claim in respect of the sale contracts themselves. What is said, rather, is that if Rionda had not been deceived by Mr Cury, and if it had known the true state of affairs in the Dine Group, it would never have lent its name and credit to these transactions in the first place. Thus its attack on the performance of the credits is at one stage further removed than the normal case. Indeed, Rionda pleads that it sold the alcohol under contracts 003 and 004 in mitigation of its loss. It is only in the case of contract 005 that Rionda has not managed to get hold of the alcohol itself, because no import licence had been obtained. But that was a risk which Rionda took under that contract.

Thirdly, [the confirming banks] have given full value for the documents which they have accepted and passed to [the issuer] and are the parties which are in effect out of pocket. Of course, they face the submission from Rionda ([the issuer] takes a neutral position) that by discounting their deferred obligations, or as in the case of L/C 260, by entering into a back to back credit but on a much shorter seven-day payment basis, they face the risk, which they have taken upon themselves, of paying in advance of the time for payment and therefore outside their mandate. The fact remains that they have given full value in respect of the credits' deferred payment obligations, even if they were to have acted outside their mandate. If, therefore, [the issuer] is prevented from reimbursing them, then the parties who will bear the effect of the Court's injunction will be primarily [the confirming banks], who acted in total ignorance of even any suggestion of any fraud at the time when they gave value to Vivalet in the manner described.

Fourthly, even though it is not a matter that I propose to decide on this occasion, it seems to me to be strongly arguable that [the confirming banks] did not act outside their mandate when they discounted future obligations or entered into other arrangements with a shorter maturity date. They were described in the three letters of credit as negotiating banks, and it is my provisional view that the credits were available "by negotiation" for the purposes of UCP art 10. It would follow that by virtue of art 10(b)(ii), which defines "negotiation" as the giving of value for documents by the bank authorized to negotiate, they had negotiated the documents in question because they had given value for them. If that is so, then [the issuer's] obligation to reimburse them under art 10(d) took effect long before any question of fraud arose, and in my provisional view could not be affected by any subsequent invocation of the fraud exception, however justified the complaint of fraud might be. For much the same reasons, I do not think that Rionda or [the issuer] are in time to invoke against the Swiss banks, qua confirming banks, a fraud exception which in any event was not known when, in reliance on Standard's obligation to reimburse, they negotiated the documents and entered into personal commitments on the strength of [the issuer's] credits. If, on the other hand, I am wrong in those views, and the banks were acting outside their mandate in giving value for the documents in advance of the maturity date, then the position might be, I suppose, that [the issuer] could seek to invoke the fraud exception against them: but it has not done so.

On the contrary, the formal position before me is that [the issuer] has served points of defence in which it denies Rionda's alleged implied term in support of the fraud exception, denies the prayer for a declaration that it is not entitled to pay out under the three letters of credit and otherwise makes no admissions as to the history of events which Rionda alleges against the Dine Group defendants. Similarly, although it has, shortly before the hearing, informally served third party notices on [the confirming banks], the only relief which it seeks under those notices is the determination of the issue whether it is liable to pay out under the credits and if so whether to [the confirming banks] respectively or to Vivalet's liquidator. It makes no positive alternative case against the Swiss banks, and in particular claims no remedy against them by way of injunction.

Fifthly, even if I assume, what is certainly not common ground before me, that there was a "clear fraud" within the meaning of the fraud exception, and that clear knowledge of such fraud was available to [the issuer] before the maturity dates, at any rate so far as that need be shown at this pre-trial stage, it remains very unclear whether Rionda would be entitled to rely on such fraud to rescind the 003/004/005 contracts into which it has entered. After all, the goods to be supplied under the contracts were supplied, even if in the case of contract 005 alone there has not been permission as yet to import the alcohol into Brazil; and Rionda has dealt with the alcohol imported under contracts 003 and 004. It was only in its points of claim that it first sought to rescind the contracts, alternatively claimed damages in lieu. In such circumstances, even though it may well have good claims in fraud against the Dine Group, it is not obvious to me that it has made out a sufficiently good case that it was entitled to rescind the contracts so as to make it a fraud on the part of Vivalet to draw on the letters of credit at the time when it received discounted payment under them or used them to arrange the back to back facilities in favour of [the ultimate suppliers]. At that time, the sale contracts still stood. That was the ground on which Mr Justice Phillips in Deutsche v Walbrook rejected the claim for an injunction, and it seems to me to be a sufficient ground in itself for doing so here.

The position therefore comes to this. Rionda claims no relief against the Swiss banks. [The issuer] claims no injunction against them. The Swiss banks have in fact in one way or another given full value for the reimbursement that they say they are entitled to under the letters of credit as confirming and/or negotiating banks and did so long before any question of fraud arose. It is not clear whether Rionda would be entitled to a rescission of the underlying contracts. If the injunction is maintained, the effective loser by it would be the Swiss banks. It is in any event too late to prevent Vivalet and the Dine Group benefiting from their fraud. These, in my judgment, are very far indeed from being the sort of exceptional circumstances which would be needed to take this case out of the general pattern of cases so as to make the balance of convenience come down in Rionda's favour, even if it did not face Mr Justice Kerr's insuperable difficulty.

Rionda's injunction must therefore be discharged.

2. Abuse of Process: The court also indicated that the failure to make full disclosure of Rionda's financial situation in the ex parte proceedings and the "absence of a real issue" between the issuer and the applicant constituted an abuse of process, constituting additional factors which supported the discharge of the injunction. Noting that the real effect of the proceedings was on the confirming banks located in Switzerland, the court stated:

In my judgment it would be an abuse of process to seek to obtain effective relief against foreign persons outside the jurisdiction by a collusive action against a defendant who can be served within the jurisdiction, if in truth there was no real issue between the colluding parties.

While not expressing a "definitive view", the court indicated that the independence of the parties was "seriously in question" although the issuer had officially taken a neutral position. The court, however, voiced its suspicion that the issuer wanted injunctive relief to be granted to prevent it from paying on the LCs.

As to the financial situation of Rionda, the court stated:

In my view Rionda's financial situation was misrepresented to Mr Justice Tuckey. Given the serious implications and unusual nature of the injunction sought, and the importance of the undertaking in damages in such circumstances, I regard the failure of Rionda to make a full and candid statement of its financial situation as a matter for concern, and as rendering the injunction obtained against [the issuer] as one that ought to be discharged on that ground alone. The irony is, that now that the true position has emerged, the uncertainty of Rionda's financial situation has itself been relied on as a factor in its favour on the balance of convenience. In my judgment, however, the Court would be doing a disservice to the international trading and financial community if it were not to uphold in such a case the rigour with which it demands proper candour at the ex parte stage. Although [the issuer], against whom the injunction is on the face of things sought, does not complain about this non-disclosure and probably could not complain about it, since it is privy to Rionda's financial affairs, the absence of complaint merely serves to illustrate my serious concerns that [the issuer] and Rionda are playing on the same side. The effect of the injunction, however, and in my view the intended effect of it, was not merely to place a formal embargo on [the issuer's] payment, but to prevent the non-parties [the confirming banks] from claiming reimbursement under the three credits concerned. Therefore in my judgment the Swiss banks are entitled to complain.

º 2000 INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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