Article

Factual Summary:

After being issued its standby letter of credit in favor of seller of non-alcoholic beer,issuing bank received a letter from applicant claiming that there were disputes regarding quality and alleging serious fraud in the underlying transaction and accompanied by a letter from the beneficiary to its counsel regarding options that could be used against the applicant. Applicant also informed the issuer that the beneficiary owed it more than the amount of invoice, so that the drawing was improper. Notwithstanding these communications, issuer paid and sought reimbursement from applicant. When applicant refused to pay, issuer brought an action on applicant's promissory note which was endorsed in accommodation by its president individually. Applicant responded with various defenses regarding the note and the LC obligation. After a trial on the issues, the trial court entered judgment for the issuer.

Legal Analysis:

1. Wrongful Honor: Burden of Proof of Non- Compliance: Applicant alleged that the documents failed to comply with the terms and conditions of the standby. Noting that the applicant failed to introduce the standby or documents, the court assumed that the documents complied. It concluded that "the applicant has the burden of proving that the letter of credit was wrongfully paid because the necessary documents as set forth in the letter of credit were not tendered or were improper ... ."

2. Fraud in the Transaction: Applicant alleged that beneficiary's conduct in indicating that it intended to destroy the applicant and in doing so and in drawing more than it owed applicant on the underlying transaction constituted fraud in the transaction. The court stated that "only in rare situations of egregious fraud would the issuer be justified...in going behind apparently regular, conforming documents; such fraud must be narrowly limited to situations...in which the wrongdoing of the beneficiary has not vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served", quoting from New York Life Ins. Co. v. Hartford National Bank and Trust Co., 173 Conn. 492, 378 A.2d 562 (1977). Based on this standard, the court stated that it was "not convinced that there was 'egregious fraud'".

3. Fraud: Allegations of Fraud Prior to Payment: Prior UCC § 5-109; Good Faith: Applicant alleged that it had notified the issuer prior to payment that the beneficiary had the fraudulent intention to destroy the applicant as evidenced by a letter from beneficiary to its counsel. It also alleged that an employee of the issuer stated that "invoices would not be honored" and that the invoices were less than the amount owed by beneficiary to applicant. The applicant claimed that the issuer's payment despite notice was a failure to exercise good faith. The court concluded that "despite the notification from the applicant of debt issues regarding the underlying contract between the applicant and the beneficiary, the issuer was obliged to pay on these accounts when presented with the proper documents that conformed with the conditions of the letter of credit and were not defective on their face."

4. Reimbursement: The court ruled that an issuer which has duly honored a demand for payment is entitled to immediate reimbursement of any payment made under the letter of credit, quoting from New York Life Ins. Co. v. Hartford National Bank and Trust Co., 173 Conn. 492, 378 A.2d 562 (1977).

Comment

This decision reiterates the general rule that an issuer that pays is entitled to reimbursement regardless of applicant claims of fraud in the underlying transaction unless the issuer acts in bad faith in honoring. At points in the opinion it is unclear whether the court recognizes that the presence of fraud is irrelevant except tangentially with respect to the claim of fraud. The applicant bears the risk of fraud. The only issue is whether the issuer acted in good faith in paying. As the court recognizes, the failure of the applicant to prove bad faith entitled the issuer to reimbursement.

© 2000 INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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.