Legal basis for the fraud exception in letters of credit under English law
Name: Zaid Aladwan
Qualifications: Doctorate in law
Address: 50 Plymouth Avenue, Brighton, UK BN2 4JB
Affiliation: University of Sussex
As it is stand in the law, the fraud exception rule is the only recognised exception under letters of credits. Nonetheless, in order to apply such exception some conditions must be met. Among these conditions; the bank’s knowledge and a requirement of a clear evidence. Notably, the bank’s knowledge is crucial, meaning that the establishment of the sole exception will depend upon the status of the knowledge by the said bank. That is to say, if the bank is aware of existing fraud, it is under a duty to refuse presentation. Otherwise, it should not. In turn, the establishment of a clear evidence by the English courts is somewhat hard to achieve, consequently, such condition criticised often. From these two facts, this paper will try to analysis the status of the bank’s knowledge and the hardship related to the clear evidence requirement.
It is clear in the law that a bank’s obligation is to honor the credit against confirming documents. Nonetheless, in the case of fraud, there are times when the bank might be obliged to dishonor the credit based on its own decision. That is to say, if the bank is aware of existing fraud, it is under a duty to refuse presentation. Conversely, in connection with the fraud exception rule in English law, the claimant must gain an injunction, which will force the bank to postpone payment under the credit until the end of the hearings. In order to gain such an injunction, the claimant must provide clear evidence of fraud. Based on these points, this section will focus on a bank’s knowledge and clear evidence.
1. Bank’s knowledge
Despite the fact that a bank’s obligation is to pay against confirming documents, it is believed that the bank must dishonour the credit if it learns of fraud prior to honouring the credit. Accordingly, the fraud defence cannot be established if the bank is not aware of the fraud. In Czarnikow-Rionda Sugar Trading Inc. v Standard Bank London Ltd, the court was against the issuing of an injunction to stop the payment because the bank was not aware of the fraud. Even if there is suspicion of fraud and the bank is aware of it, they must refuse to pay. Thus, to fall within the ambit of the bank’s knowledge, the fraud must come to light before releasing the payment. However, if the bank becomes aware of the fraud and disregards it and instead honours the credit, they will be liable in front of the applicant, meaning the payment was honoured wrongfully and thus, the bank must recover that payment from the beneficiary. In such cases, the bank can be seen as a participant in the fraudulent act.
However, if the bank was not aware of the fraud while examining and honouring the credit, but the fraud came to light after payment, the applicant will be under a duty to reimburse the bank. If the bank was not aware of the fraud and agreed to honour the credit, the applicant is still bound to re-imbursee the bank when the fraud comes to light. In Gian Singh & Co Ltd v Banque de l’Indochine, the documents were fraudulent; in particular, the signature was forged. The bank honoured the credit as it was unaware of the fraud, and the court ruled in favour of the bank. If the bank had rejected the presented documents on the ground of discrepancies and the fraud was discovered later, in this respect bank is already in a safe position.
In any case, the question is whether the bank can rely on this defence if it becomes aware of the fraud prior to examining the documents. Although there are no cases in this regard, in my judgment, the bank must examine the presented documents and decide whether it should honour the credit or not unless fraud comes to light during the examination. This suggestion is based on the duty of good faith upon the bank. In one case, the court held that the bank is under a duty of good faith to the beneficiary. Even though this occasion is not clear in the law, from both the good faith principle and the autonomy principle, the bank is under a duty to honour the credit if the presentation is compliant regardless of knowing of the fraud prior to examination. Bearing in mind that banks deal with documents and not facts, unless the presentation itself indicates a possibility of fraud, the bank must honour the credit if the documents are compliant.
What can be drawn from the proceeding discussion is that a bank’s knowledge of the fraud must emerge from the bank itself and not from any other party. If another party, particularly the applicant, becomes aware of fraud, they must ask for an injunction from the court to stop the payment, providing a clear evidence of the fraud, as is explained in the following section. This ‘bank’s knowledge’ must emerge from the presented documents and from the apparent data in particular, not from any external source. This is justified because a bank deals only with documents and, more importantly, by virtue of the autonomy principle. Further, the bank should be aware of the fraud during examination and before it decides to honour the credit.
The justification for this condition is twofold. Firstly, this payment method secures the bank and not the parties, especially the applicant. Therefore, any dispute regarding the transaction will not result in the bank’s involvement in litigation. Secondly, in case a seller is untraceable, the only remedy for the bank will be the buyer. Therefore, insisting on the bank’s knowledge can be seen as an ‘opt out’ from fraud litigation.
While this approach no doubt will ensure the ultimate aim of letters of credit in international transactions and will secure the bank, nonetheless, it will harm the applicant. In a case where the applicant becomes aware of the fraud, there is no other option for the applicant except to ask for an injunction from the court, which is not easy to gain under English courts. In addition, it is unclear how the court will prove that the bank is aware if there is fraud in the presented documents. In addition, the question arises as to whether the same strict standard will be required by both the applicant and the party who notified the fraud.
2. Clear evidence
A mere allegation of fraud will not be sufficient for courts in England to dishonour the credit. Once the fraud is established by strong evidence, an injunction from the court will be forthcoming. In Discount Records Ltd v Barclays Bank Ltd, although only 275 of the 8,625 records ordered were delivered in accordance with the order, the court refused to apply the fraud exception rule, alleging that there was no strong evidence. Despite the claimant providing the court with an inspection certificate, the document was not considered sufficient enough to convince the court and they refused to issue the injunction. However, the dispute in the Discount Record case falls within breach of contract scope and not fraud. Therefore, in my judgment, the court was correct in not issuing an injunction. Similarly, in Tukan Timber Ltd v Barclays Bank plc, the documents were forged but the court refused to issue an injunction because the claimant failed to provide clear evidence. Nonetheless, injunctions have been upheld in some English cases, including Themehelp Ltd v West and Other and Kvaerner John Brown Ltd v Midland Bank plc.
In the Themehelp case, the evidence was that the beneficiary, deliberately and recklessly, failed to inform the applicant of the falling-off of future demand from the defendant; ‘Sony’, which they were aware of by the date of the contract. The failure to provide the contracted goods in the future was strong established evidence that the beneficiary was aware that it would, indeed, cause dishonest demand for payment under the credit. Therefore, an injunction was granted.
On appeal, the court held that ‘the December correspondence showed that the sellers knew that the loss of the Sony trade was possible and that this loss could have a very damaging effect on Shinecrest’s [The appellant defendants] future prospects. There was evidence that these forecasts had been sent to Shinecrest [The appellant defendants], and no explanation why a pattern of monthly forecasts hitherto regularly received from Sony should have suddenly been altered’. Therefore, this evidence was quite sufficient to entitle the court to issue the injunction.
In contrast, in the case of Kvaerner John Brown Ltd v Midland Bank plc, the subject matter of the contract was a standby letter of credit. The plaintiff Kvaerner John Brown (KJB) failed to fulfil his obligation and, as a result, Polyprima issued a notice, wrongfully, demanding the payment under the credit due to such failure. In this respect, the court held that:
‘In the wholly exceptional case where a demand under a performance bond or standby credit purports to certify that a written notice has been given as required by the underlying agreement when it plainly has not been given, the court will, in the exercise of its discretion, grant an injunction to restrain the beneficiary from maintaining the demand accompanied by what is in fact a false certificate. To grant an injunction in such a case is not inconsistent with the general principles set out above. It is, in my view, clearly arguable in the present case that the only realistic inference is that the demand was made fraudulently and it is, in my view, further arguable that it is, in the circumstances, dishonest to maintain the demand’. That is to say, issuing the required notice was fraudulent as it was issued wrongly and contrary to a nominated clause in their agreement. Therefore, the court was correct in issuing the injunction.
So far, under the English law the majority of the cases refused to issue an injunction to stop the payment because of the absence of clear evidence. One justification for such rejection is that English courts require a high standard of proof of fraud. It was argued by Professor Ellinger that this excessive requirement with respect to proof of fraud makes it completely impossible for the courts to apply the fraud exception. Due to the high standard of proof required, it is difficult to bring an action against the banks in England.
However, requiring a high standard is convincible. This rigid approach can be seen as important to affirm the autonomy principle in letters of credit and to ensure that ‘the claim is not frivolous or vexatious’, meaning that that there is a serious issue. However, none of the courts specified what type of evidence was required, or what would be considered convincing evidence for the courts to apply the fraud exception. In this regard, the standard was settled merely on the basis of intentional, rather than material fraud.
Goode argued that the standard of proof in England depends on the stage of the proceedings. In proceedings, mere allegation is not sufficient to estop a bank from honouring a credit. Instead, it is necessary to establish clearly that the beneficiary is not honest and that the bank is aware of fraud. In this regard, the evidence must be clear, both as to the fact of fraud and as to the bank’s knowledge. In contrast, the standard of fraud embraced by the US courts is when the demand for payment has absolutely no basis in fact or the conduct of the beneficiary has vitiated the entire transaction.
However, it should be noted that justification for a high standard of evidence for fraud required by the courts is to affirm the autonomy principle and secure the parties, yet this is not always the case. Apparently, granting an injunction in order to postpone the demand for payment under performance bond, demand guarantee, or standby letter of credit, is not a difficult task in England compared to such a demand under a ‘commercial’ letter of credit. Generally speaking, the right of payment under these three instruments (performance bond, demand guarantee or standby letter of credit) is based on the applicant failing to fulfil the obligations under them. In contrast, under a commercial letter of credit it is legitimate once the beneficiary has fulfilled their obligation successfully. Therefore, proving that the demand for payment by the beneficiary in a fraudulent way under commercial letters of credit is not an easy task. This difficulty emerged due to a two involved context here, namely; goods and documents, although presenting documents is also a compulsory in the other three instruments. Consequently, in my judgment, sometimes requiring clear evidence might not be possible with regard to a commercial letter of credit, especially when the fraud rule in England is restricted only to fraud in documents. Therefore, it is difficult to see how the applicant can prove, on the face of the documents alone and within a short period of five banking days, that the beneficiary is not honest. In this regard, it is not clear that the requirement for clear evidence will be fulfilled through providing, for example, a formal document indicating that there is no vessel existing with the name (X). It is doubtful that such a document would prove that the beneficiary has no right for payment under the credit. If the applicant provides evidence that the documents are forged due to the fact that a beneficiary is no longer trading for (x) reason/s (e.g. liquidation) and, as a result will not be able to provide the required goods, the question arises as to whether this evidence could be used to postpone payment. In my judgment, the court should ask for ‘sufficient’ or ‘convenient’ evidence instead of ‘clear’ evidence in order to issue the injunction. This convenient evidence is subject to the case’s facts.
Furthermore, by referring to the first condition (the bank’s knowledge), and bearing in mind that banks are not experts in such transactions nor required to go beyond the documents, it does not make any sense that the court is more convinced with the banker’s evidence and consider it as sufficient to prove that they are aware of the fraud while, in contrast, the applicant’s evidence is not. As the applicant is the main party in such transactions, they have more expertise in the status of the transaction than the banks.
From a purely civil law point of view, the party who claimed the existence of the fraud must, besides providing ‘sufficient’ or ‘convenient’ evidence, provide the court with a monetary fee that will be held by the court until the end of the trail. These fees can be imposed as compensation if the allegation is found to be invalid, which will guarantee the other parties’ interest. If the allegation was legitimate, the fees are released back to the owner. Otherwise, it will be given to the beneficiary – the defendant – as compensation for postponing their right of payment due to the false allegations. This suggestion will secure rights for both parties.
In conclusion, English courts focus more on evidence of the fraud rather than making unnecessary distinctions pertinent to the fraud exception scope. The absence of such evidence will not trigger the exception rule. Conversely, injunctions are not easily granted in England where the requirement for heavy evidence and proof of the bank’s knowledge will be obstacles. That is to say, banks are more protected in England simply because the courts want to uphold the integrity of the banking system when affirming the autonomy principle.
What can be drawn from the preceding discussion in this paper is that, to trigger such an exception in England, two conditions, bank’s knowledge and clear evidence, must be met to establish the fraud rule, which will be applied only if it appears in documents. The bank’s knowledge condition, which means that the bank should be aware of the fraud before the payment, was explained in most of the English cases. However, if the bank is not aware of the fraud, they must honour the credit if the documents are compliant, meaning the paying bank is protected if the documents against which it made payment are tainted with fraud, even if it is not aware of the fraud. Moreover, it is not a bank’s responsibility to investigate allegations of fraud. Nonetheless, there are some reservations regarding the bank’s knowledge and clear evidence conditions, as explained above. In short, such an approach does not lead to fairness and justice for the applicant.
 see Bank Russo-Iran v Gordon Woodroffe & Co  116 Sol. Jo. 921; see also Esefka International Anstalt v. Central Bank of Nigeria  1 Lloyd’s Rep. 447, see also United Trading Corporation S.A & Murray Clayton Ltd v. Allied Arab Bank Ltd  2 Lloyd’s Rep. 554
 Andrew Burrows, Principles of English Commercial Law (OUP Oxford 2015) para 6.122, see also Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) para 24-027, see also Agasha Mugasha, The Law of Letters of Credit and Bank Guarantees (Federation Press 2003) 150
 see Discount Records Ltd v Barclays Bank Ltd  1 Lloyd’s Rep. 444 see also Alternative Power Solution Ltd v Central Electricity Board  UKPC 31;  1 W.L.R. 697, see also Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) para 24-027-029
 United Trading Corporation S.A & Murray Clayton Ltd v. Allied Arab Bank Ltd  2 Lloyd’s Rep. 554, see also Bank Russo-Iran v Gordon Woodroffe & Co  116 Sol. Jo. 921, see also Mallis v. Bankers Trust Co., 615 F.2d 68 (2d Cir. 1980), see also Ewan McKendrick, Sale of Goods (Informa Law from Routledge 2000) 741, see also Matti Kurkela, Letters of Credit and Bank Guarantees Under International Trade Law (2nd edition, Oxford University Press 2007) 176, see also Agasha Mugasha, The Law of Letters of Credit and Bank Guarantees (Federation Press 2003) 137
  C.L.C. 1148
 Czarnikow-Rionda Sugar Trading Inc. v. Standard Bank London Ltd  C.L.C. 1148 at 1153
Arab Banking Corp (BSC) v Boustead Singapore Ltd  SGCA 26;  3 S.L.R. 557, see also GKN Contractors v Lloyds Bank plc  30 B.L.R. 48 at 63
 Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) para 24-025
 see in general Banco Santander SA v Bayfern Ltd  1 All ER (Comm) 776 (CA), see also European Asian Bank AG v Punjab & Sind Bank (No.2)  1 W.L.R. 642 at 658, see also Andrew Burrows, Principles of English Commercial Law (OUP Oxford 2015) para 6-122, see also Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) para 24-029
  1 W.L.R. 1234 (Privy Council (Singapore))
 Gian Singh & Co Ltd v Banque de l’Indochine,  1 W.L.R. 1234 at 1238 (Privy Council (Singapore))
 Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce, 62 B.L.R 4th 1 (Ont. Ct. App. 2009). A duty of a good faith is recognized in the American courts. Such duty is stipulated in Section 5-109 (a) (2) of the U.C.C which states ‘the issuer, acting in good faith, may honour or dishonour the presentation in any other case’.
 For general discussion see John F. Dolan, ‘Concerns Regarding the Ontario Court’s Judgment in the Nareerux Case’  128 Banking L.J. 116; see also Bradley Crawford, ‘Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce: A New Implied Duty of Good Faith for Banks Issuing Letters of Credit’  49 Can. Bus. L.J. 130; see also Deborah Holbrook, ‘Documentary Letters of Credit: Banks’ Obligation to Payee May Involve Duty of Good Faith’  127 Banking L.J. 857
 United Trading Corp SA v Allied Arab Bank Ltd  2 Lloyd’s Rep. 554, see also Andrew Burrows, Principles of English Commercial Law (OUP Oxford 2015) para 6.122
  1 Lloyd’s Rep. 444
 Discount Records Ltd v Barclays Bank Ltd  1 Lloyd’s Rep. 444 at 446,447
 Discount Records Ltd v Barclays Bank Ltd  1 Lloyd’s Rep. 444 at 447,448
  1 Lloyd’s Rep. 171
 Tukan Timber Ltd v. Barclays Bank Plc  1 Lloyd’s Rep. 171 at 177
 Andrew Burrows, Principles of English Commercial Law (OUP Oxford 2015) para 6.122, see also Stefano Ferrero, ‘Some Considerations on The Doctrine of Strict Compliance and The Autonomy Principle in Documentary Credit’  4 Business Jus 25, 28
  Q.B. 84
  C.L.C. 446
 Themehelp Ltd v West and Other  Q.B. 84 at 99
 Themehelp Ltd v West and Other  Q.B. 84 at 106
  C.L.C. 446
 Kvaerner John Brown Ltd v Midland Bank plc  C.L.C. 446 at 448, 449
 Kvaerner John Brown Ltd v Midland Bank plc  C.L.C. 446 at 450
 Agasha Mugasha, The Law of Letters of Credit and Bank Guarantees (Federation Press 2003) 148, see also Andrew Burrows, Principles of English Commercial Law (OUP Oxford 2015) para 6.122, see also Xiang Gao and Ross Buckley, ‘A Comparative Analysis of the Standard of Fraud Required under the Fraud Rule in Letter of Credit Law’  13 Duke Journal Comparative & International Law 293, 322
 E.P. Ellinger, ‘Fraud in Documentary Credit Transactions’  JBL 258,264-269
 American Cyanamid Co v Ethicon Ltd  A.C. 396 at 407, see also Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) para 24-027. However, in Themehelp Ltd v West and Other  Q.B. 84 at 102 EVANS L.J. did not support issuing an injunction as it will affect the banking system integrity. His Lordship commented ‘(8) Granting an injunction such as the present in these circumstances is also harmful, in my judgment, to the integrity of the banking system and to standards of commercial morality which the courts should uphold’.
 Roy Goode, Goode on Commercial Law (5th edition, Penguin 2017) para 35.109
 Alternative Power Solution Ltd. v. Central Electricity Board  UKPC 31,  4 ALL ER 882,  1 WLR 697 at 59
 Bolivinter Oil SA v Chase Manhattan Bank  1 Lloyd’s Rep. 251 at 257, see also Edward Owen Engineering Ltd v Barclays Bank International Ltd  Q.B. 159 at 173, see also Deutsche Ruckversicherung AG v. Walbrook Insurance Co Ltd  4 All ER 181
 3M Company v. HSBC Bank USA, N.A. No. 16 Civ. 5984, 24 (PGG) (S.D.N.Y. 2018), see also Intraworld Industries, INC v Girard Trust Bank, 336 A 2d 316, 324 (Pa. 1975)
 See in general Themehelp Ltd v West and Other  Q.B. 84; Kvaerner John Brown Ltd v Midland Bank plc  C.L.C. 446; Edward Owen Engineering Ltd v Barclays Bank International Ltd  Q.B. 159; see also Deborah Horowitz, Letters of Credit and Demand Guarantees ‘Defences to Payment’ (Oxford University Press 2010) chapter 5; Michael Bridge, Benjamin’s Sale of Goods (10th edition, Sweet & Maxwell 2017) chapter 24, see also Agasha Mugasha, The Law of Letters of Credit and Bank Guarantees (Federation Press 2003) chapter 1.
 This suggestion is emerged from Jordanian legislations practice, which is applied in most civil law litigations in Jordan.