Article

Factual Summary: Santander (London) advised and confirmed a letter of credit issued by Paribas (Paris) and available with Santander by deferred payment 180 days from bill of lading date. The confirmer received facially complying documents, took them up, and thereby incurred a deferred payment obligation. A few days later, The confirmer paid to the beneficiary the discounted value of its deferred payment obligation after deducting its fees and taking an assignment of the beneficiary's rights under the letter of credit. A week later the applicant notified the issuer, who notified the confirmer, that the documents were false.The issuer refused to reimburse based on beneficiary fraud made known to the banks before payment was authorized under the letter of credit.

The banks requested the court to rule on the legal effect of beneficiary fraud on the confirmer's right to reimbursement. The court was requested to assume that the confirmer was not aware of fraud when it discounted its deferred payment obligation but that there was fraud and the fraud was known to both banks before that obligation matured.

Legal Analysis:

1. Discounting of Deferred Payment: The court interpreted UCP 500 Articles 9, 10, and 14 as authorizing the confirmer to pay at maturity, but not to prepay or discount the deferred obligation that it was obligated to incur and did incur against presentation of facially complying discounts. An expert witness testified that banks in London discount deferred payment obligations incurred under letters of credit without considering the integrity of the beneficiary and without taking an assignment of the beneficiary's rights. The court found this expert testimony to be a reflection of banker expectation but not a sufficient basis for implying authorization to discount under letters of credit available by deferred payment or for finding a custom to that effect.

The court noted that if the letter of credit had authorized Santander to accept a time draft, then Santander could have discounted it and avoided the effect of subsequently discovered fraud by the drawer-beneficiary under the statutory law applicable to accepted time drafts. From this the court concluded that a letter of credit authorizing acceptance necessarily authorized discounting, but that the law applicable to acceptances did not extend to deferred payment obligations incurred under a letter of credit.

2. Assignment of Beneficiary's Rights: The court considered the confirmer's rights as the assignee of the beneficiary's rights under the letter of credit. The court concluded that the beneficiary had undischarged rights to assign, but that Santander, as an innocent assignee for value, could not avoid fraud by its assignor under English case law applicable to the assignment of contractual rights.

3. Fraud: English Law: The court was requested to assume that the banks had knowledge of beneficiary fraud at the time of maturity, but not discounting, of Santander's obligation. Applying English law to those assumed facts, the court held that if the beneficiary had sought payment at maturity instead of discounted prepayment, then Santander would have been obligated to refuse to pay the beneficiary at maturity.

Comment:

The issues raised in this case concern the scope of the fraud exception and involve ascertainment of applicable law, not interpretation of UCP 500. UCP 500 Article 14 treats the decision of an issuer or confirmer to take up the documents as final. Moreover, UCP 500 Article 15 clearly states that banks are not responsible for beneficiary fraud. The notion that an issuing or confirming bank should act or refuse to act because facially complying documents may later prove to be forged or fraudulent is foreign to UCP 500.

The fraud exception is imposed by law as an extraordinary exception to the independence principle which otherwise dominates letter of credit law and practice. It has been argued that there should be no fraud exception, but most jurisdictions allow for some legal interference in the use of letters of credit to deter or undo fraud. Different jurisdictions have developed different reputations for protecting - sometimes too much or too little - against fraud. English law and court practice have developed the reputation for rarely finding actual fraud by a beneficiary but easily shifting the risk of potential fraud from the applicant onto the banks.

The issues raised in this case would be differently analyzed and answered under U.S. law. Section 5-109(a) of revised UCC Article 5 reads:

(a) If a presentation is made that appears on its face strictly to comply with the terms and conditions of the letter of credit, but a required document is forged or materially fraudulent, or honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant:

(1) the issuer shall honor the presentation, if honor is demanded by (i) a nominated person who has given value in good faith and without notice of forgery or material fraud, (ii) a confirmer who has honored its confirmation in good faith, (iii) a holder in due course of a draft drawn under the letter of credit which was taken after acceptance by the issuer or nominated person, or (iv) an assignee of the issuer's or nominated person's deferred obligation that was taken for value and without notice of forgery or material fraud after the obligation was incurred by the issuer or nominated person; and

(2) the issuer, acting in good faith, may honor or dishonor the presentation in any other case.

U.S. law generally forces an applicant claiming beneficiary fraud to try to persuade a judge to enjoin honor rather than to try to make fraud known to an issuer or confirmer so as to induce dishonor. Revised UCC § 5-109(a)(1) expressly protects issuers and confirmers that discount deferred payment obligations incurred under a letter of credit. U.S. law thus views acceptances and deferred payment obligations incurred under a letter of credit as letter of credit obligations and equates them so as to facilitate market practice.

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