Article

Factual Summary: Membership of an underwriting syndicate at Lloyds requires the member (known as a 'Name') to enter into a Security and Trust Deed under which he has to procure guarantees in favor of Lloyds for the due payment of sums which the Name may from time to time become liable to pay to Lloyds. Peter Holmes became a Name and at his request, the guarantor granted three guarantees in favor of Lloyds. The principal, in turn, granted indemnities in favor of the guarantor undertaking to pay the guarantor any sums which the bank may become liable to pay to Lloyds under the guarantees. In due course, Lloyds did make certain claims under the guarantees. The first two such demands (for £22,681) were met by the guarantor and the principal met his corresponding obligation to the guarantor under the indemnities. Three subsequent demands totaling £39,318 were met by the guarantor, but the principal refused to make payment under the indemnities. The guarantor issued proceedings for the sum, together with interest from the date it had made payment to Lloyds under the guarantees.


Legal Analysis:

1. Fraud Exception; Application in Scotland: The court accepted that the fraud exception applied in appropriate circumstances in Scotland, as had been decided in the earlier Scots case of Centri-Force Engineering Ltd. v. Bank of Scotland[1993] SLT 190. Lord MacFadyen cited with approval the authorities which had established the exception in England, includingRD Harbottle (Mercantile) Ltd. v.National Westminster Bank[1978] QB 146,United City Merchants (Investments) Ltd. v. Royal Bank of Canada[1983] 1 AC 168 andUnited Trading Corp. SA v. Allied Arab Bank Ltd.[1985] 2 Lloyds Rep 554.

2. Alleged Fraud: The fraud of which the principal argued the guarantor had notice was alleged fraud on the part of Lloyds in connection with the terms upon which he had been invited to become, and had become, a Name. The contention was that such fraud undermined the validity of his underlying contract with Lloyds and thus undermined Lloyds' entitlement to make demand for payment upon the guarantor under the guarantees.

Thus the fraud alleged was more remote from the demand for payment under the guarantees than was the case in any of the authorities mentioned above. The alleged fraud was not fraud in making the demand, but fraud inducing the principal to enter into the underlying contract with Lloyds, i.e., to become a member of a Lloyds syndicate at all. On this unprecedented issue, Lord MacFadyen reserved his opinion, since he considered he could dispose of the case on a broader ground. He did, however, say that although his initial impression had been that fraud at this earlier stage would not support the fraud exception, on reflection it seemed to him that it might do so.

3. The Defendant's Pleadings: The broader ground upon which the principal failed was that he had not pleaded the fraud alleged with sufficient specification. Neither in his defense nor in the material purported to be incorporated in that pleading had he given adequate specification either of the fraud alleged to have been committed by Lloyds or of the notice of that fraud given to the guarantor before it met Lloyds' demands under the guarantees. In short, the principal failed to meet the rigorous standards required with regard to the pleading of fraud.

Comment:

1. This decision adds practical substance to many of the earlier authorities. The dilemma faced by a bank meeting demands under guarantees is well-known: if it has notice of matters which might amount to evidence of fraud, then it must make up its mind whether or not the material is sufficient to justify a plea of fraud - see the passage in the judgment of Saville, J. inLloyds v. Canadian Imperial Bank of Commerce[1993] 2 Lloyds Rep. 579 at p. 582, set out inDocumentary Credit World(July 1999) at page 33. In reimbursement action, whereex hypothesisthe bank has decided that the material presented to it by its customer before paymentis insufficientto support the fraud exception, it is to be welcomed that in such subsequent proceedings the customer will have to satisfy the most rigorous standards of pleading what the fraud was, who committed it and when, and that the bank was furnished with adequate material of the fraud before it met the beneficiary's demand.

2. The case is interesting for raising, although in the event not deciding, the complex point of whether fraud inducing conduct (e.g. Holmes becoming a 'Name') will "infect" the claim for payment by the beneficiary and thereby enable the customer to resist its bank's claim for reimbursement on the ground of that fraud, provided of course that the bank was furnished with adequate material evidencing that fraud before it met the beneficiary's demand. In essence, this is the same question as to whether a broad or a narrow view is to be taken of theSztejncase as codified in the phrase "fraud in the transaction".

3. This decision, although not binding upon the courts in England, will be of high persuasive authority.

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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.