The rationale behind letters of credit with emphasis on the fundamental principles underlying them, and the English approach to applying the fraud exception to letters of credit with the help of case law.
Introduction
A letter of credit refers to a letter from a bank assuring that payment made by a buyer to a seller to will be made on time and in the right total. In the case that the purchaser is incapable of making payment with regards to the purchase, the bank will be required to cover the whole or the balance of the purchase. Credit letters are used in cross border business transactions to make sure that payment will be received. The adoption of letters of credit has become extremely essential in cross border trade due to the nature of international dealings such as varying laws and difficulty in knowing each trade party personally. Additionally, the bank acts on buyer’s behalf by making sure that a seller will not receive payment pending the bank’s verification that goods have been dispatched. The parties to a letter of credit comprise of three or more persons. These are; the account party (importer/ applicant/ buyer), the issuing bank (the applicant bank) and the beneficiary (exporter/seller) (Gilles & Moens, 1998, p 395; DiMatteo, 2009, p 100).
There exist contractual associations while using letters of credit in global business among the most essential parties, that is the issuing bank (one making payment of the applicant’s behalf), to the beneficiary, and the paying bank (in situations where there is a correspondent), the advising bank, as well as the confirming bank. Ideally, they are same bank but given different terms. As such, several contractual relationships are distinguishable. One is the contract between the applicant and the beneficiary. Two is the relationship between the applicant and the issuing bank. The third relationship is between the issuing bank and the beneficiary termed as the letter of credit contract, and finally the contractual relationship between the issuing bank and the advising bank (Andrews, Andrews & Millett, 2012, p 601).
The rationale behind the working of letters of credit is that the issuing bank offers to pay the beneficiary upon presentation of certain documents. This is usually a letter drafted and signed by bank acting on the applicant’s behalf, addressed to the beneficiary. The applicant bank will agree to drafts under credit simply if the beneficially adheres to conditions set forth in the credit letter. The beneficiary is also requested to hand in certain deeds like commercial invoices and insurance papers in addition to the draft and other documents that may be specifically needed. The issuing banks acts on behalf of the buyer (applicant) in paying the beneficiary provided that all terms stipulated in the letter are adhered to (Ramlogan & Persadie, 2004, p 14).
Documentary credit letters can be classified into:
Transferable or non-transferable
A beneficiary in the credit letter often maintains on an express term in the contract clarifying that the credit is “transferable”. The main upshot of a transferable letter of credit is that the seller (beneficiary) may request the designated bank to transfer credit to the beneficiary’s supplier. However, the designated bank is under no legal obligation to transfer credit. The UCP affirms that a credit letter is transferable only if the contacts states so, the absence of which the beneficiary cannot insist that the designated bank to transfer credit (Moens & Jones, 2008, p 39).
Revocable and irrevocable
A revocable letter can be rescinded by the bank responsible for issuing at any time without preceding notice to the seller. The contract has to specifically state that a credit letter is revocable; otherwise it will be considered unalterable. A beneficiary seller in cross border transaction needs payment security, apparently not prepared to accept revocable letter of credit, since this would result in credit amendment or revocation risk after goods have been delivered by the seller, but before payment for the goods has been obtained (DiMatteo, 2009, p 102).
Negotiable or non negotiable
Only a named seller may rely on the credit as is the requirement by the issuing bank under a typical letter of credit. This implies that the credit is non-negotiable. Nevertheless, a seller may request the issuing bank to allow any person who becomes a bona fide holder of the documents to rely on the credit (negotiable credit) (Moens & Jones, 2008, p 42).
The issuance of a documentary credit letter has legal implications. A letter of credit implies that the bank resolves pay a beneficiary on the applicant’s behalf. Whether the bank will absolutely pay the beneficiary by extinguishing the initial debts depends on novation. Novation denotes the replacement and discharge of an earlier duty with a fresh one. The applicant, the issuing bank and the beneficiary have to smother the current debt and substitute it with a fresh one for novation to take place. The beneficiary also has an option of claiming payment from the applicant incase the issuing bank is unwilling to pay or is insolvent. The beneficiary is at liberty to claim from the applicant, unless there is a clear intent of novation apparent from express wording of the contract of sale and the credit letter (Seyoum, 2000, p 207).
UCP uniform customs and practice
Following the wide usage of documentary credits and the impact in cross border trade, the significance of embracing a uniform international code for governing international trade comes at hand. The International Chamber of Commerce and Industry (ICC) have formulated a standardization document referred to as UCP 600 for use by credit letter users worldwide (DiMatteo, 2009, P 107).
Fundamental principles
Letters of credit are founded on two fundamental doctrines: the autonomy of credit and the principle of strict observance. Pursuant to the autonomy rule, credit letter is an independent transaction from the contract of sale or other transaction it may be founded. A bank is at liberty to refuse documents that do not strictly conform to the rules of the credit under the principles of strict conformity.
Principle of strict compliance
The doctrine of strict compliance necessitates that the prescribed documents that are tendered by the beneficiary strictly match the stipulations of the credit. The bank is under no obligation to honor non-conforming documents. This principle is also ingrained in the UCP article 4 that provides that in transactions involving letter of credit transactions, all parties concerned should deal with documents and not the merchandise, services and other piece to which the documents relate. This is demonstrated in the case of Institute National De Commercializacion Agricola v Continental Illinois National Bank And Trust Co. the court decided that a purchaser had no cause of action for neglectful misrepresentation against confirming bank that carelessly confirmed that documents submitted by the seller in the letter of credit complied with its conditions and terms. The court set out that a credit letter operation is not even agreeable to the tort of negligent misrepresentation and that in any event, the confirming bank has no duty of care to the customer, but only to the bank issuing (Seyoum, 2000, p 219; Campbell, 2007, p 469).
The issuing bank purely relies on what appears on the documents’ face presented to it by the beneficiary to establish whether the terms set in the credit letters have been observed. Banks handling finance aspects and not the merchandise are unaware of all trade customs and usages and thus, the skills stretch as far as handling the documents is concerned and not getting involved with the practices of a particular trade. In the case of Equitable Trust Co of New York V Dawson Partners Ltd: Lord Sumner stated “there was no room for documents that are almost similar, or which will do just as well. Business could not continue safely on any other lines” (Gilles & Moens, 1998, p 397; Campbell, 2007, p 478). In that case, the defendants purchased beans from a vendor in Batavia in respect of which they ordered the claimant bank to open a confirmed credit letter in support of the vendor. The documents required to be tendered in the credit letter comprised of a quality certificate to be given “by experts who are sworn brokers”. The advising bank erroneously informed the vendor that the obligatory certificate was to be given “by expert who is sworn broker”. The mistake happened because of an improper interpretation of the message sent through clandestine and secret telegraphic code of the advising bank, which utilized similar symbols for both singular and plural of words. The vendor falsely dispatched refuse (that had only 1percent of vanilla beans) and managed to extort a certificate from a sworn broker. Having approved to tender the documents and having observed the credit letter, the claimant bank sought to be refunded by the purchaser who declined to accept the documents. The claimant bank was triumphant at first instance, though lost on appeal in the House of Lords. The rule was that the plaintiff bank was not entitled to be refunded by the buyer since, in making available finance on the certificate of one expert instead of at least two experts, the claimant bank had acted contrary to the customer’s instructions.
The severity of principle of strict compliance is further illustrated by the case of SH Rayner and Co v Hambros Bank Ltd. In that case, a bank got instructions from a buyer/customer to open a confirmed credit letter in support of the claimant seller in respect of a cargo of “coromandel groundnuts”. The bank opened the credit the credit and notified the claimant that it was available against invoice and bill of lading of “coromandel groundnuts”. The petitioner presented bill of lading document for “machine-shelled groundnut kernels” along with an invoice for “coromandel groundnuts”. The bank turned down payment on the ground of non-conformity and the claimant sued the bank on credit. It was evidenced “machine-shelled groundnut kernels” were generally understood in the business to be similar to “coromandel groundnuts” (Gilles & Moens, 1998, p 398). The trial judge gave a ruling in support of the petitioner that the bank ought to be affected with the knowledge prevailing in the relevant trade that the two expressions meant the same thing. However, the ruling was rescinded on appeal. MacKinnon LJ asserted “it is quite impractical to imply that a banker is to be affected with facts of the mores and the traditional expressions of every one of the thousands of trades for whose transactions he can issue credit letters” (Ramlogan & Persadie, 2004, p 419). The ruling was further enforced by Goddard LJ, who stated that even if the bank had facts of the traditional term, it was bound to adhere stringently and factually with the rules of its mandate.
The bank has a duty to examine the documents with reasonable care to establish whether they appear on their face to be in agreement with the rules of credit letter, both under article 13(a) of the UCP and at common law. The bank is only concerned with determining that the documents appear on their face to match to the credit letter rules. The bank is compelled to treat as non-conforming documents that appear on their face to be unclear.
Doctrine of independence
The notion of autonomy is significant in the letter of credit, since the bank’s duty on it is entirely separate from any of the contractual duties of the underlying transaction, either the duty of the applicant to pay the beneficiary under general principles that govern sales transactions, or any duty that the applicant may have under common law to refund the bank for disbursements made on its behalf in the credit letter. While the parties to the credit are related, failure by one undertaking to fulfill its role does not render the others unenforceable. UCP’s article 3 states that letters of credit are by nature autonomous from other contract that they may be founded on. The bank issuing is not mandated with what the parties had promised to do or ought to do under their contract. The issuing bank is only concerned with the presentation of documents, and not with merchandise, services or pieces to which the documentation may relate (Gao, 2002, p24; Mann, 2000, p 413).
The case of Maurice O’Meara Co. v. National Park Bank of New York illustrates the independence principle, which entailed the sale of newsprint paper of a precise tensile length. When the petitioner presented facially common documents and required payment against the credit, a defendant bank (the issuer) refused to pay the drafts, asserting “there has risen a reasonable doubt with regards to the quality of the newspaper”. The petitioner; who was the beneficiary bought the action against the issuer for damages suffered by its assignor from the issuer’s dishonor. The issuer protected against the seller’s acts on the basis that the quality of the tensile did not meet the requirements. During the appeal, majority judgment ruled against the issuing bank’s claim. It was held that when sight drafts are accompanied by the proper documents during presentation, the bank is entirely bound to make payment under the letter, regardless of whether it knew or had reasons to believe that the goods bought under the letter are not of the quality stipulated in the contract” (Blond & Petrillo, 396; Caprio, 589). UCP further ensures separation of credit letters from other dealings by providing that the beneficiary may in no case avail himself of the contractual relations that exist between the banks, or among the buyer and bank issuing (Gao, 2002, p 24; Schaffer, Agusti & Earle, 2008, p 237)
Independence principle emphasizes the nature of credit letter in cross border transactions as an autonomous responsibility by the bank to make payment the beneficiary. The independence principle acts as a restraint in circumstances where the applicant wishes to sue as a result of the beneficiary contravening the contract. It also restraints the applicant from interfering with the issuing banks payment to the beneficiary, even when all terms in the letter have been complied with. In the case of Ex Parte Sapan Trading (Pty) Ltd, the applicant sought to halt payment of an irrevocable letter to the seller by acquiring an attachment of the seller’s claim against the issuing bank so as to find authority. The effect of the attachment would have been for the issuer to pay the money to a sheriff who would have held the funds on behalf of the beneficiary for its claim. The court based its ruling on the effects implied by the irrevocable credit letter. Given that the applicant arranged for an irreversible letter, it impliedly mean that he would not attempt to attach proceeds from the letter of credit (Mugasha, 2003; 170; Caprio, 2012, p 589).
The English approach to applying the fraud exception to letters of credit
The strict duty on banks on the doctrine of independence of credit that banks must pay is subject to some exceptions, where the bank has the right to right to refuse payment, where the documents tendered in favor of an application for payment under credit is not stringently in conformity with credit requirements. However, the bank has a duty to pay of the documents are in conformity on their face value. In the doctrine of strict conformity, notwithstanding the verity that document tendered matches the face value in strict conformity with conditions of the credit, payments can be refused under the fraud exception. Fraud exception arises where there is clear proof of fraud, the bank has a clear notice of this proof, as well as, the bank’s awareness of the fraud was timely. The most likely approach to be used is injunction where fraud is alleged, but the balance of convenience may be involved, where pre-trial injunction is sought for. The English courts will only award an interlocutory injunction if among other things; the balance of convenience is in favor of awarding an injunction limiting payment. The exception operates to stop payment strictly in exceptional circumstances (Lulu, 2009, p 153; Warne & Elliott, 2005, p 231).
In Harbottle v National Westminster Bank case, the English plaintiffs entered into contract for sale with Egyptian applicants. Every contract presented that the petitioners should supply a guarantee confirmed by bank. The guarantees covered five percent of the buying price in favor of the applicants (buyers). The petitioners said that the buyers insisted payment under the guarantees without explanation. Justice Kerr stated that petitioners “now even go so far as to say that the buyers’ demands were sham”. The contention was rejected on the bases that only in exceptional cases would courts interfere with the irrevocable obligations taken by banks. In the case of Edward Owen Engineering v Barclays Bank, the appeal court endorsed the verdict of justice Kerr in the case of Harbottle. Lord Denning held “that case shows that there is this exemption to the strict principle: the bank should not to pay under the credit if it ascertains that the documents are falsified or that the call for payment is made deceptively in situations where there is no right to payment” (Connerty, nd. p 4: Andrews, Andrews & Millett, 2012, p 617)
Where fraud is discovered before payment by the bank, an applicant can seek a court interdiction to stop disbursement. The bank is permitted to refuse payment even without a court injunction where falsification and forgery appear on the documents’ face. Where fraud is discovered after the bank has made payments with its funds, it may recover the funds from the applicant. However, the applicant does not have a claim against the bank where payment has been effected from his own money. This risk is inferred on the beneficiary by the nature of documentary letters of credit (Jeffery, nd, p 6)
Conclusion
Letters of credit are essential tools for conducting cross border trade as they help ease the challenges brought about by geographical distance, varying laws in different countries and risks associated from fraud on parties to the transactions. The fundamental principles of strict compliance and independence give assurance to authenticity ingrained in the letter. Fraud may arise in spite of the two fundamental principles governing the working of credit letters, and this calls for parties (especially the applicant) to be well versed with the risks associated with letters of credit before adopting them.
Introduction
A letter of credit refers to a letter from a bank assuring that payment made by a buyer to a seller to will be made on time and in the right total. In the case that the purchaser is incapable of making payment with regards to the purchase, the bank will be required to cover the whole or the balance of the purchase. Credit letters are used in cross border business transactions to make sure that payment will be received. The adoption of letters of credit has become extremely essential in cross border trade due to the nature of international dealings such as varying laws and difficulty in knowing each trade party personally. Additionally, the bank acts on buyer’s behalf by making sure that a seller will not receive payment pending the bank’s verification that goods have been dispatched. The parties to a letter of credit comprise of three or more persons. These are; the account party (importer/ applicant/ buyer), the issuing bank (the applicant bank) and the beneficiary (exporter/seller) (Gilles & Moens, 1998, p 395; DiMatteo, 2009, p 100).
There exist contractual associations while using letters of credit in global business among the most essential parties, that is the issuing bank (one making payment of the applicant’s behalf), to the beneficiary, and the paying bank (in situations where there is a correspondent), the advising bank, as well as the confirming bank. Ideally, they are same bank but given different terms. As such, several contractual relationships are distinguishable. One is the contract between the applicant and the beneficiary. Two is the relationship between the applicant and the issuing bank. The third relationship is between the issuing bank and the beneficiary termed as the letter of credit contract, and finally the contractual relationship between the issuing bank and the advising bank (Andrews, Andrews & Millett, 2012, p 601).
The rationale behind the working of letters of credit is that the issuing bank offers to pay the beneficiary upon presentation of certain documents. This is usually a letter drafted and signed by bank acting on the applicant’s behalf, addressed to the beneficiary. The applicant bank will agree to drafts under credit simply if the beneficially adheres to conditions set forth in the credit letter. The beneficiary is also requested to hand in certain deeds like commercial invoices and insurance papers in addition to the draft and other documents that may be specifically needed. The issuing banks acts on behalf of the buyer (applicant) in paying the beneficiary provided that all terms stipulated in the letter are adhered to (Ramlogan & Persadie, 2004, p 14).
Documentary credit letters can be classified into:
Transferable or non-transferable
A beneficiary in the credit letter often maintains on an express term in the contract clarifying that the credit is “transferable”. The main upshot of a transferable letter of credit is that the seller (beneficiary) may request the designated bank to transfer credit to the beneficiary’s supplier. However, the designated bank is under no legal obligation to transfer credit. The UCP affirms that a credit letter is transferable only if the contacts states so, the absence of which the beneficiary cannot insist that the designated bank to transfer credit (Moens & Jones, 2008, p 39).
Revocable and irrevocable
A revocable letter can be rescinded by the bank responsible for issuing at any time without preceding notice to the seller. The contract has to specifically state that a credit letter is revocable; otherwise it will be considered unalterable. A beneficiary seller in cross border transaction needs payment security, apparently not prepared to accept revocable letter of credit, since this would result in credit amendment or revocation risk after goods have been delivered by the seller, but before payment for the goods has been obtained (DiMatteo, 2009, p 102).
Negotiable or non negotiable
Only a named seller may rely on the credit as is the requirement by the issuing bank under a typical letter of credit. This implies that the credit is non-negotiable. Nevertheless, a seller may request the issuing bank to allow any person who becomes a bona fide holder of the documents to rely on the credit (negotiable credit) (Moens & Jones, 2008, p 42).
The issuance of a documentary credit letter has legal implications. A letter of credit implies that the bank resolves pay a beneficiary on the applicant’s behalf. Whether the bank will absolutely pay the beneficiary by extinguishing the initial debts depends on novation. Novation denotes the replacement and discharge of an earlier duty with a fresh one. The applicant, the issuing bank and the beneficiary have to smother the current debt and substitute it with a fresh one for novation to take place. The beneficiary also has an option of claiming payment from the applicant incase the issuing bank is unwilling to pay or is insolvent. The beneficiary is at liberty to claim from the applicant, unless there is a clear intent of novation apparent from express wording of the contract of sale and the credit letter (Seyoum, 2000, p 207).
UCP uniform customs and practice
Following the wide usage of documentary credits and the impact in cross border trade, the significance of embracing a uniform international code for governing international trade comes at hand. The International Chamber of Commerce and Industry (ICC) have formulated a standardization document referred to as UCP 600 for use by credit letter users worldwide (DiMatteo, 2009, P 107).
Fundamental principles
Letters of credit are founded on two fundamental doctrines: the autonomy of credit and the principle of strict observance. Pursuant to the autonomy rule, credit letter is an independent transaction from the contract of sale or other transaction it may be founded. A bank is at liberty to refuse documents that do not strictly conform to the rules of the credit under the principles of strict conformity.
Principle of strict compliance
The doctrine of strict compliance necessitates that the prescribed documents that are tendered by the beneficiary strictly match the stipulations of the credit. The bank is under no obligation to honor non-conforming documents. This principle is also ingrained in the UCP article 4 that provides that in transactions involving letter of credit transactions, all parties concerned should deal with documents and not the merchandise, services and other piece to which the documents relate. This is demonstrated in the case of Institute National De Commercializacion Agricola v Continental Illinois National Bank And Trust Co. the court decided that a purchaser had no cause of action for neglectful misrepresentation against confirming bank that carelessly confirmed that documents submitted by the seller in the letter of credit complied with its conditions and terms. The court set out that a credit letter operation is not even agreeable to the tort of negligent misrepresentation and that in any event, the confirming bank has no duty of care to the customer, but only to the bank issuing (Seyoum, 2000, p 219; Campbell, 2007, p 469).
The issuing bank purely relies on what appears on the documents’ face presented to it by the beneficiary to establish whether the terms set in the credit letters have been observed. Banks handling finance aspects and not the merchandise are unaware of all trade customs and usages and thus, the skills stretch as far as handling the documents is concerned and not getting involved with the practices of a particular trade. In the case of Equitable Trust Co of New York V Dawson Partners Ltd: Lord Sumner stated “there was no room for documents that are almost similar, or which will do just as well. Business could not continue safely on any other lines” (Gilles & Moens, 1998, p 397; Campbell, 2007, p 478). In that case, the defendants purchased beans from a vendor in Batavia in respect of which they ordered the claimant bank to open a confirmed credit letter in support of the vendor. The documents required to be tendered in the credit letter comprised of a quality certificate to be given “by experts who are sworn brokers”. The advising bank erroneously informed the vendor that the obligatory certificate was to be given “by expert who is sworn broker”. The mistake happened because of an improper interpretation of the message sent through clandestine and secret telegraphic code of the advising bank, which utilized similar symbols for both singular and plural of words. The vendor falsely dispatched refuse (that had only 1percent of vanilla beans) and managed to extort a certificate from a sworn broker. Having approved to tender the documents and having observed the credit letter, the claimant bank sought to be refunded by the purchaser who declined to accept the documents. The claimant bank was triumphant at first instance, though lost on appeal in the House of Lords. The rule was that the plaintiff bank was not entitled to be refunded by the buyer since, in making available finance on the certificate of one expert instead of at least two experts, the claimant bank had acted contrary to the customer’s instructions.
The severity of principle of strict compliance is further illustrated by the case of SH Rayner and Co v Hambros Bank Ltd. In that case, a bank got instructions from a buyer/customer to open a confirmed credit letter in support of the claimant seller in respect of a cargo of “coromandel groundnuts”. The bank opened the credit the credit and notified the claimant that it was available against invoice and bill of lading of “coromandel groundnuts”. The petitioner presented bill of lading document for “machine-shelled groundnut kernels” along with an invoice for “coromandel groundnuts”. The bank turned down payment on the ground of non-conformity and the claimant sued the bank on credit. It was evidenced “machine-shelled groundnut kernels” were generally understood in the business to be similar to “coromandel groundnuts” (Gilles & Moens, 1998, p 398). The trial judge gave a ruling in support of the petitioner that the bank ought to be affected with the knowledge prevailing in the relevant trade that the two expressions meant the same thing. However, the ruling was rescinded on appeal. MacKinnon LJ asserted “it is quite impractical to imply that a banker is to be affected with facts of the mores and the traditional expressions of every one of the thousands of trades for whose transactions he can issue credit letters” (Ramlogan & Persadie, 2004, p 419). The ruling was further enforced by Goddard LJ, who stated that even if the bank had facts of the traditional term, it was bound to adhere stringently and factually with the rules of its mandate.
The bank has a duty to examine the documents with reasonable care to establish whether they appear on their face to be in agreement with the rules of credit letter, both under article 13(a) of the UCP and at common law. The bank is only concerned with determining that the documents appear on their face to match to the credit letter rules. The bank is compelled to treat as non-conforming documents that appear on their face to be unclear.
Doctrine of independence
The notion of autonomy is significant in the letter of credit, since the bank’s duty on it is entirely separate from any of the contractual duties of the underlying transaction, either the duty of the applicant to pay the beneficiary under general principles that govern sales transactions, or any duty that the applicant may have under common law to refund the bank for disbursements made on its behalf in the credit letter. While the parties to the credit are related, failure by one undertaking to fulfill its role does not render the others unenforceable. UCP’s article 3 states that letters of credit are by nature autonomous from other contract that they may be founded on. The bank issuing is not mandated with what the parties had promised to do or ought to do under their contract. The issuing bank is only concerned with the presentation of documents, and not with merchandise, services or pieces to which the documentation may relate (Gao, 2002, p24; Mann, 2000, p 413).
The case of Maurice O’Meara Co. v. National Park Bank of New York illustrates the independence principle, which entailed the sale of newsprint paper of a precise tensile length. When the petitioner presented facially common documents and required payment against the credit, a defendant bank (the issuer) refused to pay the drafts, asserting “there has risen a reasonable doubt with regards to the quality of the newspaper”. The petitioner; who was the beneficiary bought the action against the issuer for damages suffered by its assignor from the issuer’s dishonor. The issuer protected against the seller’s acts on the basis that the quality of the tensile did not meet the requirements. During the appeal, majority judgment ruled against the issuing bank’s claim. It was held that when sight drafts are accompanied by the proper documents during presentation, the bank is entirely bound to make payment under the letter, regardless of whether it knew or had reasons to believe that the goods bought under the letter are not of the quality stipulated in the contract” (Blond & Petrillo, 396; Caprio, 589). UCP further ensures separation of credit letters from other dealings by providing that the beneficiary may in no case avail himself of the contractual relations that exist between the banks, or among the buyer and bank issuing (Gao, 2002, p 24; Schaffer, Agusti & Earle, 2008, p 237)
Independence principle emphasizes the nature of credit letter in cross border transactions as an autonomous responsibility by the bank to make payment the beneficiary. The independence principle acts as a restraint in circumstances where the applicant wishes to sue as a result of the beneficiary contravening the contract. It also restraints the applicant from interfering with the issuing banks payment to the beneficiary, even when all terms in the letter have been complied with. In the case of Ex Parte Sapan Trading (Pty) Ltd, the applicant sought to halt payment of an irrevocable letter to the seller by acquiring an attachment of the seller’s claim against the issuing bank so as to find authority. The effect of the attachment would have been for the issuer to pay the money to a sheriff who would have held the funds on behalf of the beneficiary for its claim. The court based its ruling on the effects implied by the irrevocable credit letter. Given that the applicant arranged for an irreversible letter, it impliedly mean that he would not attempt to attach proceeds from the letter of credit (Mugasha, 2003; 170; Caprio, 2012, p 589).
The English approach to applying the fraud exception to letters of credit
The strict duty on banks on the doctrine of independence of credit that banks must pay is subject to some exceptions, where the bank has the right to right to refuse payment, where the documents tendered in favor of an application for payment under credit is not stringently in conformity with credit requirements. However, the bank has a duty to pay of the documents are in conformity on their face value. In the doctrine of strict conformity, notwithstanding the verity that document tendered matches the face value in strict conformity with conditions of the credit, payments can be refused under the fraud exception. Fraud exception arises where there is clear proof of fraud, the bank has a clear notice of this proof, as well as, the bank’s awareness of the fraud was timely. The most likely approach to be used is injunction where fraud is alleged, but the balance of convenience may be involved, where pre-trial injunction is sought for. The English courts will only award an interlocutory injunction if among other things; the balance of convenience is in favor of awarding an injunction limiting payment. The exception operates to stop payment strictly in exceptional circumstances (Lulu, 2009, p 153; Warne & Elliott, 2005, p 231).
In Harbottle v National Westminster Bank case, the English plaintiffs entered into contract for sale with Egyptian applicants. Every contract presented that the petitioners should supply a guarantee confirmed by bank. The guarantees covered five percent of the buying price in favor of the applicants (buyers). The petitioners said that the buyers insisted payment under the guarantees without explanation. Justice Kerr stated that petitioners “now even go so far as to say that the buyers’ demands were sham”. The contention was rejected on the bases that only in exceptional cases would courts interfere with the irrevocable obligations taken by banks. In the case of Edward Owen Engineering v Barclays Bank, the appeal court endorsed the verdict of justice Kerr in the case of Harbottle. Lord Denning held “that case shows that there is this exemption to the strict principle: the bank should not to pay under the credit if it ascertains that the documents are falsified or that the call for payment is made deceptively in situations where there is no right to payment” (Connerty, nd. p 4: Andrews, Andrews & Millett, 2012, p 617)
Where fraud is discovered before payment by the bank, an applicant can seek a court interdiction to stop disbursement. The bank is permitted to refuse payment even without a court injunction where falsification and forgery appear on the documents’ face. Where fraud is discovered after the bank has made payments with its funds, it may recover the funds from the applicant. However, the applicant does not have a claim against the bank where payment has been effected from his own money. This risk is inferred on the beneficiary by the nature of documentary letters of credit (Jeffery, nd, p 6)
Conclusion
Letters of credit are essential tools for conducting cross border trade as they help ease the challenges brought about by geographical distance, varying laws in different countries and risks associated from fraud on parties to the transactions. The fundamental principles of strict compliance and independence give assurance to authenticity ingrained in the letter. Fraud may arise in spite of the two fundamental principles governing the working of credit letters, and this calls for parties (especially the applicant) to be well versed with the risks associated with letters of credit before adopting them.
