Of Fraud In Bankers Documentary Credits

One of the essential features of the system of financing international sales by means of bankers’ documentary credits is that there is autonomy of the credit. In the case of Edward Owen Engineering Ltd v Barclays Bank International [1978] QB 159,171 Lord Denning MR said, “The only exception is when there is a clear fraud of which the bank has had notice.”

Critically discuss the way in which the courts have dealt with the question of fraud in relation to bankers’ documentary credits.

One of the essential features of the system of financing international sales by means of bankers’ documentary credits is that there is autonomy of the credit. In the case of Edward Owen Engineering Ltd v Barclays Bank International [1978] QB 159,171 Lord Denning MR said, “The only exception is when there is a clear fraud of which the bank has had notice.”

Critically discuss the way in which the courts have dealt with the question of fraud in relation to bankers’ documentary credits.

INTRODUCTION

The letters of credit (or otherwise called “documentary credits” or commercial credits”) do play an important role for the international trade. Several factors made their function essential. Because of the international factor of the nowadays trade, the transportation of goods may take several days or months. The payment cannot take place hand by hand. Especially while transporting goods by sea, the insecurity of the arrival of the goods or the payment for them is arising and the seller needs to secure himself before taking any such risk. A way to do so is through the letters of credit.

DOCUMENTARY CREDITS

The payment of goods as far as international trade in concerned can be made: 1. by an open account, 2. by a bill of exchange, 3. by a documentary bill and 4. by a letter of credit [1] . The seller, in order to agree to a way of payment, will need to take into account certain factor, as “the risks involved in the transaction, the duration of the payment term, the strength of the currency involved, the competition in product or geographic market and the goodwill and loyalty of the customer” [2] . It is necessary, before we proceed to an extensive analysis of the letters of credit, to make a brief mention of the three other ways of payment mentioned above.

By an open account the parties agree to pay in cash, before delivery of the goods, or on sight of sale documents. This way of payment is not that common, since it gives no guarantee to the buyer about the delivery of the goods. The bills of exchange (or otherwise called “draft”) are negotiable documents which are considered as cash. They are separate contracts and are not by any breach of the main contract [3] . The documentary bills are bills attached to the Bill of Lading, but this way of payments has a great disadvantage, i.e. “the buyer may not honour the bill of exchange, in which case, the party to whom the seller discounted the bill of exchange, would have recourse to him” [4] , and makes it not preferable for the parties. Other ways of payment are the buyer’s own cheque, the international money orders, the mail or telegraphic transfer, the swift transfers and the international direct debit [5] .

The Letters of Credit

The letters of credit work as a security, as a reassurance for the seller, who cannot trust the buyer that the last one will pay on delivery of the goods. In such a case, the bank (acting on behalf of the Buyer) reassures the seller, that he will definitely get paid and the bak actually pays the seller as soon as delivery takes place and all the relevant procedure is completed successfully. There are different types of Documentary Credits, which, all, are governed by the Uniform Customs and Practice for Documentary Credits (UCP), which though has not been incorporated in England. That means that it does not have the force of law in United Kingdom, but shall apply where there is no express term. According to UCP “Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation” [6] . The commercial credits provide the seller with security that he will be paid, in particular by a bank, and the buyer is discharged from the burden of having enough funds to pay for the delivered goods.

How do Letters of Credit work

After the parties agree to enter into a documentary credit, then the buyer opens a credit through his bank in favour of the seller. The bank needs then to contact a bank at the seller’s country to notify them of the opening of the relevant credit. The local bank will, thereafter, notify the seller about the credit, opened in his favour. After the shipment of the goods, according to what the Letter of Credit dictates, the seller will obtain all the sale documents and advise accordingly the local bank. The issuing bank pass the documents to the buyer and then get remunerated.

Features of the Letters of Credit

Autonomy principle

In Hamzeh Malas and Sons v British Imex Industries Ltd [7] Jenkins LJ said “… the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon the banker an absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to contract or not…That system of financing these operations would break down completely if a dispute as between the vendor and the purchaser was to have the effect of ‘freezing’ the sum in respect of which the letter of credit was opened…”. According to Jenkins LJ a letter of credit has autonomy and does not affect the obligations of the bank in respect of such letter. If an issue arises as to the description of the delivered goods, than the buyer can sue the seller, not stop payment by the bank (Discount Records v Barclays Bank Ltd [8] ). The buyer, on that specific case sought an ‘injunction’ in order to stop the bank from paying the seller, since he discovered that there were on his cargo empty boxes. The court decided not to allow such an injunction on the ground that the contract of sale was a separate contract from the documentary credit. The bank did need to pay under the letter of credit without that obligation being influenced by the performance of the transportation of the goods and the compliance of the seller to the contract of sale. The bank assures the buyer for the payment and does not guarantee for the good’s situation in which they will be delivered [9] . Those two leader cases demonstrate the autonomy that the letters of credit do have. Furthermore, Article 4 of UCP600 states: “ A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfill any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank.” where we can distinguish the contract from the letter of credit.

Principle of strict compliance

Apart from that important feature, the documentary credits must strictly comply with the terms of the credit [10] . According to article 14 of the UCP600: a. A nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation … h. If a credit contains a condition without stipulating the document to indicate compliance with the condition, banks will deem such condition as not stated and will disregard it.” Article 15 of the same act says: a. When an issuing bank determines that a presentation is complying, it must honour”. Moreover, in Article 17 of the UCP600 it is established that: “a. At least one original of each document stipulated in the credit must be presented. b. A bank shall treat as an original any document bearing an apparently original signature, mark, stamp, or label of the issuer of the document, unless the document itself indicates that it is not an original. c. Unless a document indicates otherwise, a bank will also accept a document as original if it: i. appears to be written, typed, perforated or stamped by the document issuer’s hand; or ii. appears to be on the document issuer’s original stationery; or iii. states that it is original, unless the statement appears not to apply to the document presented. d. If a credit requires presentation of copies of documents, presentation of either originals or copies is permitted. e. If a credit requires presentation of multiple documents by using terms such as “in duplicate”, “in two fold” or “in two copies”, this will be satisfied by the presentation of at least one original and the remaining number in copies, except when the document itself indicates otherwise. Those articles imposes the compliance rule of the letters of credit to the terms of the credit in order for those letters to be accepted by the Bank. That doctrine is well illustrated in numerous cases, such as Glencore International AG v Bank of China [11] and Kredietbank Antwerp v Midland Bank plc. [12] .

D. Fraudulent presentation of documents – The fraud (nullity) exception

In UCP there is no definition of fraud. Though articles 9,13 and 14 refer to fraud in trade:

“Article 9: a. A credit and any amendment may be advised to a beneficiary through an advising bank. An advising bank that is not a confirming bank advises the credit and any amendment without any undertaking to honour or negotiate. b. By advising the credit or amendment, the advising bank signifies that it has satisfied itself as to the apparent authenticity of the credit or amendment and that the advice accurately reflects the terms and conditions of the credit or amendment received. c. An advising bank may utilize the services of another bank (“second advising bank”) to advise the credit and any amendment to the beneficiary. By advising the credit or amendment, the second advising bank signifies that it has satisfied itself as to the apparent authenticity of the advice it has received and that the advice accurately reflects the terms and conditions of the credit or amendment received. d. A bank utilizing the services of an advising bank or second advising bank to advise a credit must use the same bank to advise any amendment thereto. e. If a bank is requested to advise a credit or amendment but elects not to do so, it must so inform, without delay, the bank from which the credit, amendment or advice has been received. If a bank is requested to advise a credit or amendment but cannot satisfy itself as to the apparent authenticity of the credit, the amendment or the advice, it must so inform, without delay, the bank from which the instructions appear to have been received. If the advising bank or second advising bank elects nonetheless to advise the credit or amendment, it must inform the beneficiary or second advising bank that it has not been able to satisfy itself as to the apparent authenticity of the credit, the amendment or the advice.”

“Article 13: a. If a credit states that reimbursement is to be obtained by a nominated bank (“claiming bank”) claiming on another party (“reimbursing bank”), the credit must state if the reimbursement is subject to the ICC rules for bank-to-bank reimbursements in effect on the date of issuance of the credit. b. If a credit does not state that reimbursement is subject to the ICC rules for bank-to-bank reimbursements, the following apply: i. An issuing bank must provide a reimbursing bank with a reimbursement authorization that conforms with the availability stated in the credit. The reimbursement authorization should not be subject to an expiry date. ii. A claiming bank shall not be required to supply a reimbursing bank with a certificate of compliance with the terms and conditions of the credit. iii. An issuing bank will be responsible for any loss of interest, together with any expenses incurred, if reimbursement is not provided on first demand by a reimbursing bank in accordance with the terms and conditions of the credit. iv. A reimbursing bank’s charges are for the account of the issuing bank. However, if the charges are for the account of the beneficiary, it is the responsibility of an issuing bank to so indicate in the credit and in the reimbursement authorization. If a reimbursing bank’s charges are for the account of the beneficiary, they shall be deducted from the amount due to a claiming bank when reimbursement is made. If no reimbursement is made, the reimbursing bank’s charges remain the obligation of the issuing bank. c. An issuing bank is not relieved of any of its obligations to provide reimbursement if reimbursement is not made by a reimbursing bank on first demand.”

“Article 14:a. A nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation. b. A nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank shall each have a maximum of five banking days following the day of presentation to determine if a presentation is complying. This period is not curtailed or otherwise affected by the occurrence on or after the date of presentation of any expiry date or last day for presentation. c. A presentation including one or more original transport documents subject to articles 19, 20, 21, 22, 23, 24 or 25 must be made by or on behalf of the beneficiary not later than 21 calendar days after the date of shipment as described in these rules, but in any event not later than the expiry date of the credit. d. Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit. e. In documents other than the commercial invoice, the description of the goods, services or performance, if stated, may be in general terms not conflicting with their description in the credit. f. If a credit requires presentation of a document other than a transport document, insurance document or commercial invoice, without stipulating by whom the document is to be issued or its data content, banks will accept the document as presented if its content appears to fulfil the function of the required document and otherwise complies with sub-article 14 (d). g. A document presented but not required by the credit will be disregarded and may be returned to the presenter. h. If a credit contains a condition without stipulating the document to indicate compliance with the condition, banks will deem such condition as not stated and will disregard it. i. A document may be dated prior to the issuance date of the credit, but must not be dated later than its date of presentation. j. When the addresses of the beneficiary and the applicant appear in any stipulated document, they need not be the same as those stated in the credit or in any other stipulated document, but must be within the same country as the respective addresses mentioned in the credit. Contact details (telefax, telephone, email and the like) stated as part of the beneficiary’s and the applicant’s address will be disregarded. However, when the address and contact details of the applicant appear as part of the consignee or notify party details on a transport document subject to articles 19, 20, 21, 22, 23, 24 or 25, they must be as stated in the credit. k. The shipper or consignor of the goods indicated on any document need not be the beneficiary of the credit. l. A transport document may be issued by any party other than a carrier, owner, master or charterer provided that the transport document meets the requirements of articles 19, 20, 21, 22, 23 or 24 of these rules.

It is not enough for the buyer to be suspicious of the seller’s attitude. From all the cases, even those are not many, it is established that fraud involves dishonesty, forgery, fundamental mistake, deceit, breach of contract, illegality and recently even money laundering. Fraud needs to be in relation to the credit or in relation to the transaction. It shall not be attributed to a third party, but only to the seller himself or his agent. It is on the ………. to prove that fraud was used in order to obtain payment and that party must prove that actual fraud was committed and not just to show evidence which would make a reasonable bank to think that the beneficiary has committed fraud [13] . According to UCC two types of fraud shall not be paid: the first one is forged or fraudulent documents and the second id fraud in the transaction. Fraud international transactions has been described as “the cancer in international trade”.

As we mentioned above, the letters of credit are characterised by the principle of autonomy. An exception to that principle is fraud. Discount Records v Barclays Bank Ltd [14] is the first case which dealt with fraud regarding the commercial credits. The buyers failed to restrain the confirming bank from paying under the credit. It was alleged, but could not be proved, that the sellers were fraudulent. It is difficult to prove the existence of fraud. Megarry J. mentioned: “In such a situation, where the seller’s fraud has been called to the bank’s attention before the drafts and documents have been presented for payment, the principle of the independence of the bank’s obligation under the letter of credit should not be extended to protect the unscrupulous seller.” [15]

In Mallas and Another v British Imex Industries Ltd [16] case it was noted that the bank has the obligation to pay without regard to any dispute concerning the seller and the buyer.

The American Accord [17] is another important case which deals with fraud in commercial credits. The issue of a fraudulent bill of lading regarding the shipping period was not know to the sellers and the confirming bank refused to pay, as she had information that the shipment hadn’t take place as per the bill. Lord Diplock supported a narrow formulation [18] of the exception and said: “To this general statement of principle as to the contractual obligations of the confirming bank to the seller, there is one established 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 the 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” case is Sztejn v. J. Henry Schroder Banking Corporation (1941) 31 N.Y.S. 2d 631. This judgment of the New York Court of Appeals was referred to with approval by the English Court of Appeal in Edward Owen Engineering Ltd v. Barclays Bank International Ltd [19] , though this was actually a case about a performance bond under which a bank assumes obligations to a buyer analogous to those assumed by a confirming bank to the seller under a documentary credit. The exception for fraud on the part of the beneficiary seeking to avail himself of the credit is a clear application of the maxim ex turpi causa non oritur actio or, if plain English is to be preferred, “fraud unravels all.” The courts will not allow their process to be used by a dishonest person to carry out a fraud.” [20] The concept of applying an exception to the principle of autonomy, i.e. fraud, was created so as to maintain the letters of credit as a safe way for international trade (RD Harbottle (Mercantile) Ltd v National Westminster Bank [21] ). Kerr J illustrated the importance of the independence of transactions and that courts should interfere only in very exceptional cases. Trade of goods internationally requires trust and loyalty between the seller and the buyer. As for the case Edward Owen Engineering Ltd v. Barclays Bank International Ltd [22] it was said that: “The bank ought not to pay under the credit if it knows that the documents are forged or that the request for payment is made fraudulently in circumstances when there is no right to payment.”

Czarnikow Rionda Sugar Co v Standard Bank London Ltd [23] Rix J accepted that the re is an implied term in the letters of credit contracts that the bank shall not pay in case on documents being clearly fraudulently made (that case though has not being accepted by the English courts) This implied terms is well set out in article 34 of the UCP600: “A bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document, or for the general or particular conditions stipulated in a document or superimposed thereon; nor does it assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods, services or other performance represented by any document, or for the good faith or acts or omissions, solvency, performance or standing of the consignor, the carrier, the forwarder, the consignee or the insurer of the goods or any other person.”

In Montrod Ltd v Grundkotter Fleischvertriebs GmbH, Fifti Bank (UK) plc and Standard Chartered Bank [24] judge Raymond Jack Q.C. held that it is not dishonest to seek payment based o documents which are correct but at the time of payments it is known that they were dishonest. It was said characteristically that: “The fraud exception to the autonomy principle recognised in English law…should remain based upon, the fraud or knowledge of fraud on the part of the beneficiary or other party seeking payment…”, rejecting accordingly the implied term of Czarnikow Rionda Sugar Co v Standard Bank London Ltd [25] set out above.

It is on the ………. to prove that fraud was used in order to obtain payment and that party must prove that actual fraud was committed and not just to show evidence which would make a reasonable bank to think that the beneficiary has committed fraud [26] . According to the case United Trading Corp. SA and Murray Clayton Ltd v Allied Arab Bank Ltd [27] the court must be given clear evidence on a high standard [28] that the beneficiary demanded payment according to fraudulent documents and that the bank had knowledge about that fact [29] .

E. The United States

In United States, fraud relating to documentary credits is governed by the Uniform Commercial Code (UCC), and more particularly by articles 5-109 of UCC. In US the fraud exception was limited to cases where there existed false documents and where fraud was established on the issuer (Sztejn v. J. Henry Schroder Banking Corporation (1941) 31 N.Y.S. 2d 631). In NMC Enterprises Inc v Columbia Broadcasting System Inc. [30] “the court took the view that the fraud exception as set out in Sztejn was relatively wide and encompassed fraud in the underlying transaction” [31] . Moreover, in the case Shaffer v Brooklyn Park Garden Apartments [32] the court decided that in order to protect a party against fraud and dishonesty payment can be prevented and an injunction may be granted. United State Courts comprehend in the meaning of fraud exception the fraud in the underlying transaction.

F. Remedy against fraud regarding the documentary credits

In case of fraud, the applicant may apply to court for an injunction (called “pre-trial injunction”) so as to preclude the banks from paying under the letters of credit. RD Harbottle (Mercantile) Ltd v National Westminster Bank [33] imposes the two conditions which must be met for such an injunction to be applied: “ 1. an injunction will only be available if the Issuing Bank is threatening to make a payment in breach of its contract with the applicant, and 2. the balance of convenience is in favour of the applicant” [34] .

III. CONCLUSION

Documentary credits is the most common way of payment in international trade. According to R.D Harbottle (mercantile) Ltd v. National Westminster Bank Ltd [35] commercial credits are “ the life blood of international trade”. The difficulty in payment in international sales has contributed in augmenting the problem of fraud in transactions and in particular in the banker’s documentary credits. Both parties, seller and buyer need to trust each other that delivery of goods will be as per contract and that payment will in deed take place. In order for parties to secure payment, they resort to fraud. The fraud exception was established in order to keep balance between the interests of the sellers. The nullity exception in still weak under English law. The courts impose that there must be “a clear case of established fraud to prevent payment under a credit”.

A way which could help the reduction of fraud in international trade is for the buyer to try to find details about the credibility of the seller. Moreover, it is essential to check the details of the sale contract regarding the vessel and its delivery date so as to ensure that the vessel will indeed arrive as per contract. The use of independent surveyors could help the buyer to have an independent opinion on the quality and quantity of goods. Finally, the system surrounding the letters of credit needs to be improved in order for international transactions to take place without any element of fraud.

CASES

Hamzeh Malas and Sons v British Imex Industries Ltd [1958] 2 QB 127

Discount Records v Barclays Bank Ltd [1975] 1 Lloyd’s Rep 444

Glencore International AG v Bank of China [1996] 1Lloyd’s Rep 135

Kredietbank Antwerp v Midland Bank plc [1998] Lloyd’s Rep Bank 173; [1999] Lloyd’s Rep Bank 219 (CA)

Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] QB 159,171

RD Harbottle (Mercantile) Ltd v National Westminster Bank [1977] 2ALL ER 862, [1978] Q.B. 146

Society of Lloyd’s v Canadian Imperial Bank of Commerce [1993] 2 Lloyd’s Rep. 579

Bolivinter Oil v Manhattan Bank [1984] 1 Lloyd’s Rep. 251

United City Merchants (Investments) Ltd v Royal Bank of Canada (The American Accord) [1983] 1 AC 168, p. 184

United Trading Corp. SA and Murray Clayton Ltd v Allied Arab Bank Ltd [1985] 2 Lloyd’s Rep. 554n

Rafsanjani Producers Co-operative Co v Bank Lenmi (UK) Plc [1992] 1 Lloyd’s Rep 513

Sztejn v. J. Henry Schroder Banking Corporation (1941) 31 N.Y.S. 2d 631

The Bhoja Trader [1981] 2 Lloyd’s Rep. 256

Montrod Ltd v Grundkotter Fleischvertreibs-GmbH [2001] 1 AII ER (Comm) 368

Safa v Banque Du Caire [2000] 2 AII ER (Comm) 567

I.E. Contractors Ltd v Lloyd’s Bank plc [1989] 2 Lloyd’s Rep. 205

Frans Maas (UK) Ltd v Haibib Bank AG zURICH [2001] CLC 89

BOOKS

“Benjamin’s Sale of goods”, Judah Philip Benjamin, 7th edition, Sweet & Maxwell, 2006

“International Trade Law”, Indira Carr, 3rd edition, Cavendish publishing, 2005

“Law of International Trade”, Jason Chuah, Sweet & Maxwell, 2005

“The Sale OF Goods”, P.S. Atiyah, John N. Adams, Hector Macqueen, 11th edition, Pearson Longman, 2005

“International