Commercial Contract Law

Does UK law over-emphasize commercial certainty and neglect justice in relation to the operation of the principle of the autonomy of the letter of credit and the fraud exception?

The following exploration
will consider the role of justice in UK commercial contract law, focusing on
the autonomy of the letter of credit and the fraud exception. In order to do
this the discussion will consider the courts adherence to contracts especially
ones between competent businessmen. This will illustrate the reasoning why any
contract is upheld. It will then consider whether this adherence to precedent
and upholding of contracts that may override principles of justice is isolated
to the UK or do other nations uphold the certainty of contracts between
companies; in order to do this a case study of a UK decision and a USA decision
will be made. Then this discussion will consider the exception of fraud to the
certainty of upholding a contract, because as the basics of contract law hold
is that if there is no intention to uphold the contract then there is no
contract, because there is no good faith present. It will do this by
considering insurance law as these contracts have a higher standard of good
faith and illustrate that the absence of good faith voids the contract and the
principles of justice, i.e. equity step into ensure there is a remedy to any
fraudulent intention however small. The discussion will then apply theses
principles to the case law surrounding the autonomy of the letter of credit and
the fraud exception and determine whether the basics are upholding contracts
outweigh justice. This section will also consider cases from the USA and
discuss whether the outcome is isolated to UK law or prevalent in liberal
democratic legal systems. The first chapter aims to set the stage for the
second chapter and discuss the differences in the case of the autonomy of the
letter of credit as opposed to basic contract law. The discussion surrounding
insurance law illustrates the principles of justice at there strongest, hence
adding a different dimension into the discussion.

Chapter One – Equity & Contract Principles:

Certainty of Contracts:

Contracts
are usually upheld by courts as they represent the freedoms between individuals
concerning business dealings. Also the elements of a valid contract are so
tightly defined that to override them would make a mockery of an individual’s
right to deal. In order to determine if there is a valid contract there has to
be three elements which are; agreement; consideration; and intention. The first
element that will be dealt with is the notion of agreement between the two
parties. This element contains the ingredients of offer and acceptance. A valid
offer must be clearly communicated by writing, mouth or act in order to allow
the other person or group of persons to decline or accept. In
relation to sales of goods there is no requirement for the agreement and offer
to be in writing, as with the sale of property; however the offer has to be
certain in its terminology and must be clearly distinguishable from an
invitation to treat. In respect to certainty of terms both parties must make
their intentions clear, as the courts will not enforce a vague agreement
or an incomplete agreement; in addition it has to be
more than a wish to enter negotiations, which the individual does not want to
be bound.

The second element of a valid contract is consideration,
which is defined as an indication that the promisor intended to be bound, and
has the capacity to be bound. Consideration must be of some value,
where there is a right, interest, profit or benefit to one party and a
detriment to the other. There must be sufficient detriment to one party to be
valid consideration. Consideration must come
from the promisee, i.e. the person who has provided consideration can only
enforce the promise; however the consideration does not need to be adequate,
i.e. the consideration of the individual but does not need to be equal to the
consideration of the other party. The law leaves it to the two parties to
determine the amount of consideration, it may be very little;
however there is no consideration if the terms are vague;
and there is no consideration if it is not sufficient.
Insufficient consideration includes performing a duty imposed by law or a duty
owed to a contract of another’s. Therefore consideration is an important part of
a valid contract, however in relation to sales of goods it is usually executed
consideration – a price paid for a promise, i.e. a price paid for the goods
received.

Intention is the final element of a valid contract, which is the
intention to be legally bound by the contract. In relation to the sales of
goods it is not a complex scenario because once the money is received and the
individual had the intention to sell the item, then the goods must be delivered
to the buyer. The only way that intention can be omitted if it is proved that
the party did not seek to be included to enter legal relations; however the
passing of money and retaining it equates to a legal contract, the only way not
to enter a contract is to reject the offer of the buyer and return the price of
the goods.

If all these elements are in the contract along with
good faith then the contract is complete and must be honored or a breach of
contract law may be present. Good faith is present within all types of
contracts whereby it refers to the honest intent to act without taking an
unfair advantage over the other person within the contract. Therefore the only
method to discharge a contract is through actions in breach, frustration, fraud
etc. In respect to business dealings between companies these principles are
stricter because it is assumed that the bargaining power is equal as they are
both knowledgeable in the workings of contracts.

The Adherence to Contracts – UK v USA Perspective:

The aim of this section is to discuss whether UK law
adheres too strictly to contracts without considering whether the bargaining
power and basic principles of justice that govern equity are adhered too. It
will consider the USA as a comparison.

The basis of Hansen Bancorp Inc et al v US is that the Court of Federal Claims had erred in its judgement and the breach
of contract by the US government was total therefore the appellants of the
Hanson Company were entitled to restitution on all counts. This decision stems
around the question whether there has been a total breach of contract, if there
has been a total breach of contract restitution is available; however without
total breach this remedy is not available. The court decided there was a total
breach because the US government had come to a contract and Hanson had
committed its resources by fulfilling its duties; however the US government had
failed to complete its obligations therefore fulfilling the criteria of a total
breach of contractual obligation. This decision is primarily an exercise in the
power of the contract and its adherence, which cannot be avoided even if the
breaching party is the government.

Stocznia Gdanska SA v Latvian Shipping Co is another case that deals with an appeal dealing with the validity of
restitution; however this case’s argument is based upon an argument that there
was a total failure of consideration. However consideration the House of Lords
argued was defined from the actions of the shipbuilders, i.e. had they acted on
the contract and were funds expended? The contract was for design, construction
and delivery and as the shipbuilders had acted on this has consideration been
fulfilled? In this case the House of Lords argued yes because it is was not just
a contract of the mere sale of a ship, but the design and construction; whereby
once this design and construction has been initiated then there can be no total
failure of consideration.

Both these cases have similarities in the fact that they
deal with the point when a one party commits their resources to fulfilling the
contractual obligation; whereas the other party fails to meet their obligations
therefore breaching the contract. The US court discusses whether there has been
a total breach of contract; whereas the UK court explores whether there has
been a total failure of consideration. Therefore illustrating the similarities
of the cases, in addition to the decision that there had been a total failure
and remedies were to be awarded to the individual who maintained and upheld their
portion of the contract. The case of Hansen Bancorp heavily
relies on the adherence of the contract and contract law; whereby once the
parties started to act on the contract then it is only fair that the other
party follows through with their contractual obligations. This case does not
fudge along the lines of what may not constitute total breach of the contract.
Rather the courts take a very logical and straightforward approach considering
each part of the dealing to ensure that a total breach has occurred. The court
identifies that a breach is an act or failure to act that impedes the fulfillment
of the contract by one of the parties, where the other party has fulfilled
their obligations or all the obligations they are able to prior to action by
the other party. This approach ensures that the original contract is the most
important factor in determining a breach and if the actions of a party are
obviously impeding the contract then there is a breach of contract, i.e. by not
fulfilling their contractual obligations there is a total breach.

The Court of Federal Claims also decided against
restitution on the ground that state law already imposed a duty to exchange
shares as part of the merger. The argument is that by contributing their
Raritan holdings, the Hansens were actually performing under New Jersey law a
pre-existing legal duty, rather than a true “condition” of the
Assistance Agreement. Landmark bars compensation for strategic business
decisions not fairly attributable to the agreement with the government. That
was not the case here. The exchange of stock constituted the performance of a
clear and explicit condition of the contract between the parties. The fact
that it also happened to be required under New Jersey law does not negate the
fact that the stock exchange was an explicit term of the Hansens’ contract with
the government.

The rationale in these cases unusually purports the true concerns of
the court; however in the case of Hansen Bancorp there is the
added dimension that more powerful parties, such as the government, cannot use
loopholes in the law to try and wriggle out of their contractual obligations.
The Hansen Bancorp case does this by considering the whole
contract and ensures that all factors of the contract, even if a law
automatically binds a party to follow the actions. In this case this added
dimension is to equalize the power of the parties and ensures once a contract
is signed and one party has acted on it then the other party has totally
breached the contract if they do not fulfill their contractual obligations. In
short although both cases uphold the contract the UK court was more concerned
with the fulfilling of contract basics; whereas as the USA was concerned with
the principles of justice and equality of bargaining power, i.e. if the case
was the opposite way round in all likelihood the USA court would have held that
there was no contract.

Fraud & Insurance Contract Law – The Notion of Utmost Good Faith:

This section will expand on the basic principle of
equity, i.e. good faith, in the UK concerning contracts and reveal a set of
cases that illustrate that justice can outweigh the certainty of upholding
contracts. This is the case study of insurance law, however it must be noted
that this has backing from statutory provisions and may be an exception to the
certainty of upholding contracts rule. This scenario one could argue represents
the USA approach and is the fairer approach to ensuring justice within contract
law and deterring fraudulent actions or proving whether there was initial
intention not to uphold the contract, i.e. indirect fraud.

Utmost
good faith refers specifically to insurance law; whereby the insured must
disclose all the material facts otherwise the insured can vitiate the contract.
The concept of good faith is present within all types of contracts whereby it
refers to the honest intent to act without taking an unfair advantage over the
other person within the contract. In the area of insurance law it is essential
for the insuree to notify the insurer of all applicable information because
this will effect if the policy can be made and the amount of the policy. This
is because the insuree is in the position of power as they know all the
information and their duty is to disclose it. If one looks at the relevant
notion of a valid contract, if the elements of a valid contract are not present
then the contract is void. In addition if the intention of the insuree is
fraudulent and information is not disclosed then the contract is void. The
notion of good faith goes straight back to the four elements of a valid
contract. Section 17 was included in the Marine Insurance Act 1906 to ensure
that the duty surrounding intention was properly qualified, as well as to give
a higher duty to the insuree. However in reference o utmost good faith this is
not a wholly statutory notion and has been developed through common law
principles and can be seen to be a valid defence to voiding a contract on the
basis of intention at the time prior to and up to making the contract; however
is there more to the making of Section 17?

The
notion of utmost good faith has been lately used to expand the protection for
the insurer from pre-contractual fraud to include post-contractual fraud as
well. However in the Sea Star Case it was
determined that this section of the Marine Insurance Act can only apply up to
the signing of the contract, as it refers to the elements of a valid contract.
Fraudulent acts after the signing or non-disclosure is not provided by Section
17, as a valid contract is apparent. Therefore the insurer has to use equitable
remedies or other defences provided within insurance law. The Sea Star Case ensured that the duty of full disclosure is tied to the intention contained
within a valid contract; hence not muddying the elements of valid contract as
this may put the insurer at an unfair advantage. This would defeat the purpose
of Section 17 which is to ensure that both parties are in an equal position of
knowledge (i.e. arms) in creating a contract. The notion of full disclosure in
insurance law is similar to the American and Canadian version of full
disclosure in land sales; whereby a contract can be voided if the seller does
not disclose all relevant information. This duty cannot be conceivably be
extended from what the seller knows at the time of the sale to post-sale as
this would mean that the property sale could be voided by all past buyers until
the original seller who had the information, i.e. the buyer that did not
perform full disclosure. Hence this would illustrate the unfair advantage of
the buyer over the seller, as at the time of the contract the intention of both
parties was made in utmost good faith. However if Section 17 was just
reaffirming the duty of utmost good faith does this mean that there is not more
to this duty other than full disclosure pre-contractually? It has been argued
that Section 17 is the key defence to protecting the insurer from fraudulent
intention, which is reaffirmed in the following sections. Section 19 refers to
the scenario whereby agents are affecting the insurance for the insuree, i.e.
middle-man/insurance brokers. This section provides that this duty moves to the
insurance brokers, as they are setting the contract with the insured and the
insuree. There is no duty for the insurer to investigate the circumstances as
this is the role of the agents and if they fail in their duty not only does the
contract become void, but there are other possible avenues that the insurer can
take because of the negligence of the insurance broker. Therefore Section 19
provides that the broker must disclose all material circumstances as provided
in Section 18 unless waived by the insurer. The higher duty of care that the
insurance broker holds is due to their further knowledge in the area, i.e. it
is no longer a circumstance of a company and an individual rather it is the
circumstance of two companies or competent businessmen. Therefore this section
further lends itself that this Act is a contract of utmost good faith and
supports the principle laid out in Section 17.

Chapter Two – Commercial Certainty v Justice:

Autonomy of the Letter of Credit:

Letters of Credit are basically agreements for one party
to pay a repayable to sum to another, once the letter of credit has been
properly completed then it is binding for the party to pay this sum of money,
i.e. extend credit to the other party. In other words, as with a contract to
exchange goods etc once it has been completed and has all valid elements the
court will uphold the validity of the contract and its performance; therefore
to have a letter of credit presupposes that a valid contract is in place, which
is at the heart of this discussion. There is one exception, other than the lack
of a valid contract, which is the presence of fraudulent information being
forwarded to the creditor. This means that if the information that the creditor
is given wrong and the person who is lending the money knows this then it is
fraud and will fulfill the fraud exception to stop the credit note being held
valid. UK law does not provide any specific statute to confirm this but is
enshrined within common-law principles. This exception is very similar to the
notion of utmost good faith in insurance law in principle the use of it is very
limited therefore limiting the working of justice, i.e. if there is a legal
principle that is rarely or never used makes it null and void. This may seem to
be counterproductive to the other approaches to fraudulent contracts; however
it seems to be indicative of the UK’s approach of upholding valid contracts
over the invoking justice.

The given approach to fraud exception was defined by
Lord Denning in United City Merchants v Royal Bank of Canada as that defined in the US Case Sztejn v Henry Schroder Banking Corp:

To this general statement of
principle [of independence], … there is one exception: that is, where the
seller, for the purpose of drawing on the credit, fraudulently presents to the
confirming bank documents that contain, expressly or by implication, material
representations of fact that to his knowledge are untrue. Although there does
not appear among English authorities any case in which this exception has been
applied, it is well established in the American cases of which the leading or
landmark is Sztejn v J Henry Schroder Banking Corp (1941) 31 N.Y.S. 2d 631.

Yet, as previously mentioned the courts take a non-interference
approach to letters of credit, in order to interfere the fraud must reach a
specified burden of proof and must actually involve beneficiary fraud. The
standard of proof is very high where there must be clear and unequivocal proof
that fraud has been committed. The case of RD Harbottle v Natwest defines this burden of proof as:

Except possibly in clear cases of fraud of which the banks
have notice, courts will leave the merchants to settle their disputes under the
contracts by litigation or arbitration as available to them or stipulated in
the contracts. … Otherwise, trust in international commerce could be
irreparably damaged.

Therefore as with the exploration of the
UK’s approach to upholding the certainty of contracts the courts take a very
enlightened principle and hinder it with such a high burden of proof that it
basically makes it unusable. In addition the courts have added the actual
necessity for there to be beneficiary fraud, which means that the fraud has to
be committed by the beneficiary of the credit note, therefore if some fraud was
involved by at the hands of a third party the creditor has to bear the weight
of this fraud even if the fraud would have met the high standard of proof. This
has been upheld in the United
City Merchants Case.
Therefore this seems to prove that the UK’s adherence to contract certainty far
outweighs the basic principles of justice, which leads one to believe that
notion of utmost good faith is an exception to the rule of upholding
the certainty of contract, especially in respect to contracts that are made by
companies. This was stresses in the judgment of the RD Harbottle Case when the decision of imposing a high burden of proof
was being justified in the nature of commercial certainty:

Otherwise, trust in international commerce could be
irreparably damaged.

UK v USA Approach:

The USA, on the other hand, champions the fraud
exception rule as to uphold fraudulent acts breaches the basic precepts of
justice of a valid contract. The USA has enshrined this rule in statute, as
well as has extended to types of fraud. The Sztejn Case as in the UK is
the key case dealing with fraud exception; however it is not limited by a high
burden of proof. It also is not limited to intentional and unequivocal fraud,
i.e. it includes constructive fraud and egregarious fraud, but most
interestingly the USA approach has a flexible standard that is indicative of
the USA’s adherence to justice in contracts whether on party is a company or
not. This flexible standard is confirmed in the case of United Bank Ltd v
Cambridge Sporting Goods Corp:

It should be noted that the
drafters of section 5-114, in their attempt to codify the Sztejn case and in
utilizing the term fraud in the transaction, have eschewed a dogmatic
approach and adopted a flexible standard to be applied as the circumstances of
a particular situation mandate. It can be difficult to draw a precise line
between cases involving breach of warranty (or a difference of opinion as to
the quality of goods) and outright fraudulent practice on the part of the
seller.

Therefore this leads on to the conclusion that the approach of the
UK is too entrenched in the belief that certainty in commercial contracts
outweighs justice, which has created a lopsided and unfair system concerning
letters of credit; especially when the fraud exception is based upon principles
that promote justice as in the USA.

Conclusion:

Justice seems in many cases
to be contrary to the basic precept of upholding contracts, especially those
between companies; however in the case of fraudulent actions justice comes to
the forefront as it can be directly linked to the lack of intention. The
problem with fraud is that the lack of initial intention, i.e. the lack of good
faith, to uphold the contract is difficult prove without a paper trail,
therefore a higher standard of good faith needs to be present as with insurance
law’s utmost good faith or the USA’s determination of the particular case’s
position in justice. The second chapter has shown that the UK has failed
explore what type of justice is to be applied to the autonomy of the letter of
credit and the fraud exception principle, especially when the principle is
based upon a very flexible standard as shown in the USA cases. It has also
shown that the UK with insurance law’s utmost good faith, which is enshrined in
statute, that such a flexible approach is available with respect to commercial
contracts; however it has failed to take up this approach in respect to
commercial certainty, which seems to be contrary to the basic rule in contract
law which determines a contract void if fraud is present because there
requisite intention of both parties is not present. As Gao and Buckley argue:

If a comparison has to be made, the difference
between the two appears to be that the US position is enshrined in a statute,
but English position is embodied in the common law. This may mean that courts
in the US will look more on the severity of the effect of the fraud on the
transaction rather than the state of fraud of the beneficiary,whilst English courts, at
least if Jack be correct, will require proof of the state of the mind of the
fraudster.

Bibliography:

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of Credit: 2000 Cases’, 56 Business LR 4

Gao and
Buckley, 2003, A Comparative Analysis of the
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Charlesworth
and Morse, 1999, Company Law, Sweet & Maxwell

Farrar et
al, 1998, Farrar’s Company Law 4^th Edition, Butterworths

Jones &
Sufrin, 2004, EC Competition Law, Oxford University Press

Keenan and
Bisacre, 1999, Company Law (with Scottish supplement), Prentice Hall

K L
Macintosh, 1986, ‘Letters of Credit: Dishonour When a Required Document
Fails to Conform to the Section 7-507(b) Warranty’, 6 J L & Commerce
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Bourne, 1999, Scottish Company Law, Cavendish

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