3.4. The nullity exception
4.2.3. Distinguishing between both categories
A letter of credit is a “multi-transaction arrangement”.18
In fact, a letter of credit transaction involves at least three transactions: (a) the underlying contract between the applicant and the beneficiary through which these parties agree to issue a letter of credit, (b) the applicant’s application to his bank in order to open a letter of credit, (c) the letter of credit transaction between the bank and the beneficiary which usually stipulates for some documents to be submitted by the latter in order to obtain the amount named in the letter of credit.19
15 Goode, R. “Commercial Law” (Butterworths, 3rd ed., 2004) at pp. 990-991
16 Gao, X. “The Fraud Rule in the Law of Letters of Credit: A Comparative Study” (London, 2002), at
p. 107
17 Mugasha, A. “The Law of Letters of Credit and Bank Guarantees” (The Federation Press, Sydney
2003) at p. 144. In Mugasha’s words: “the issue has been whether ‘transaction’ means the letter of credit transaction or includes the underlying transaction”.
18 Gao, X. “The Fraud Rule in the Law of Letters of Credit: A Comparative Study” (London, 2002) at p.
101
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The beneficiary’s fraud on the applicant can be envisaged only in transactions (a) and (c).20 Transaction (c) is the letter of credit transaction which usually stipulates for the documents presentation. In this sense, if the documents are fraudulent this would mean that there is fraud in the letter of credit transaction.21 By the same token, if there is fraud in the letter of credit transaction this would be directly reflected in the documents stipulated for in such a credit. Examples provided above to illustrate fraud in the documents can be said to constitute equally fraud in the letter of credit transaction.22 Hence, it could be understood that fraud in the documents is the same as that described as fraud in the letter of credit transaction (or even that called ‘fraud in the credit’). Both cover the different fraudulent actions happening in the same transaction. The Sztejn case is an example of such fraud.23 Worthless cow hair was sent instead of the contracted for bristles and, accordingly, although apparently conforming, the documents were fraudulent. As one commentator suggests “This fraud will usually relate to the documents themselves. They may be forged or untrue in relation to the goods to which they refer.”24
In order to determine whether the presented documents are fraudulent or not, scrutinizing the documents merely would not be sufficient. Examining the letter of credit transaction which the documents cover would be necessary to reveal such a
20 Indeed, in transaction (b) the two parties involved are the bank and the applicant. Fraud by the
applicant upon the bank in his application to open the letter of credit cannot constitute a defence of fraud against the beneficiary. A beneficiary’s fraud could not be envisaged in such an arrangement unless there is a conspiracy between the applicant and the beneficiary to defraud the bank. An example where the applicant and beneficiary conspired to defraud the bank is Rafsanjan Pistachio Producer v. Bank Leumi [1992] 1 Lloyd’s Rep. 513. Irrespective of the difficulty arising from such a distinction between the two concepts “fraud in the documents” and fraud in the underlying transaction”, a bank could stop the letter of credit payment process when it has the knowledge of such a fraudulent conspiracy. For more discussion in this point, see: Gao, X. at p.117.
21 Kimball, G. & Sanders, B. ‘Preventing Wrongful Payment of Guarantee Letters of Credit-Lessons
from Iran’ (1984) 39 Bus. Law. 417 at p. 424
22 See section 4.2.1.
23 Sztejn v. Henry Schroder Banking Corp., 31 N.Y.S.2d 631 (Sup. Ct 1941) 24
Murray, C. Holloway D & Timpson-Hunt, D. “Schmitthoff’s Export Trade: The Law and Practice of International Trade” (Sweet & Maxwell, London, 11th ed., 2007) at p. 236
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fraud. It would be very difficult for the bank itself to verify fraud allegations which stem from such cases except in situations which the current author describes as technical documentary fraud (e.g. where the letter of credit beneficiary submits a fraudulently signed certificate of inspection which should be signed from one of the bank’s clients with whose signature the bank is familiar).25
It should be noted that, unlike independent guarantees, this kind of fraud (fraud in the documents/fraud in the letter of credit transaction) is more pertinent to documentary letters of credit contexts. In an independent guarantee context no documents are usually required but a mere demand by the guarantee’s beneficiary, without even stating that the applicant has defaulted, would be sufficient for obtaining its amount.26
Transaction (a) is the underlying contract through which the applicant for credit and the beneficiary agree to utilise a letter of credit in order to facilitate their intended business. Fraud in the underlying contract can be committed at the stage of formation of the contract. There is no case better than that of Themehelp Ltd v. West27 to provide an example of this kind of fraud. In the case of Themehelp, the plaintiff contracted with the defendant, West, to buy some shares by instalments. An independent guarantee had been opened by the plaintiff in the seller, West’s, favour to secure the third and largest instalment of the contract. Indeed, the parties negotiated their contract on the assumption that a major customer of the seller’s business would continue to deal and order from the new buyer. However, the seller, who knew that the major customer had ceased his dealings with the company engaged in
25 Such kind of fraud is of a technical nature including instances of fraudulent signatures, fraudulent
dates or even where documents are obtained from a non-existent company. United City Merchants (Investments) Ltd v Royal Bank of Canada [1983] 1 AC 168 and Montrod Ltd v Grundkotter Fleischvertriebs-GmbH [2002] 1 WLR 1975 are examples of such a kind of fraud. This technical nature of fraud is the core of the chapter three discussion.
26 McCormack v. Citibank NA [1997] 6 Bank. L.R. 381 at 385, Edward Owen Ltd. [1978] 1 Q.B. 169,
at 171
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misrepresentation in relation to this fact in order to facilitate the sale process.28 The plaintiff, alleging fraud in the underlying contract, acquired a court’s injunction to stop his bank from paying the seller, West. Indeed, this kind of fraud in the underlying contract is what Goode provided as an example of fraud in the underlying transaction in his second and third quotations cited above.29
In addition to fraud committed in its formation, fraud in the underlying contract can be carried out in the performance of such a contract. Shipping cowhair instead of the contracted for bristles is an example of fraud in performing the underlying contract.30 While one might think that this kind of fraud would constitute fraud in the documents, this is not the case always. An example of this fraud is where the underlying contract stipulates for the shipment of a number of cars produced in the year 2003 and the letter of credit only requires documents attesting the shipment of the cars without mentioning the production year. The seller fraudulently ships a 1999 set of cars, acquires the required documents which do not show the year when the cars were manufactured and obtains the letter of credit amount. Whilst fraud in such an example does not exist in the documents and the bank-beneficiary letter of credit transaction, fraud is pertinent to the underlying contract between the applicant and the beneficiary.31
In order to determine whether fraud in the underlying contract does exist or not it would be necessary to return and consider the beneficiary-applicant contract itself.32 Examining the documents and the letter of credit transaction only, which the
28
Themehelp Ltd v. West [1996] Q.B. 84
29 See section 3.2.2.
30 Sztejn v. Henry Schroder Banking Corp., 31 N.Y.S.2d 631 (Sup. Ct 1941)
31 Horowitz, D. “Letters of Credit and Demand Guarantees: Defences to Payment” (Oxford University
Press, 2010) at p. 26
32
Krimm, J. ‘U.C.C.-Letters of Credit & “Fraud in the Transaction”’ (1986) 60 Tul. L. Rev. 1088 at 1095
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documents represent, would not reveal such a kind of fraud.33 It would be very difficult for banks to verify allegations of this kind of fraud where there is no fraud in the documents which limits its relation with both the credit’s applicant and beneficiary.34 It should be noted that, unlike documentary letters of credit, this kind of fraud is more pertinent to the context of independent guarantees where no documents are usually required. Indeed, to discover if a demand is fraudulent or not in an independent guarantee context, returning to the underlying contract itself is usually inevitable.
Whilst fraud in the underlying contract, whether in its formation or performance, will sometimes constitute fraud in the documents,35 in some cases it does not.36 In order to make common sense and to denote something other than fraud in the documents, and though not being redundant, it is submitted that the concept of fraud in the underlying transaction connotes that fraud having been committed in the underlying contract. The letter of credit transaction and the documents fraud being two sides of the same coin, there would be no sense in distinguishing between them. Accordingly, fraud where a letter of credit is utilised should be divided (in terms of place) into: fraud in the documents (transaction c) and fraud in the underlying transaction (transaction a).37