Courts and Fraud Exception

Fraud Bank Court

Some decided cases of English courts relating to fraud exception

The development of English case law in relation to the fraud exception is based on an American case: Sztejn v. Henry Schroder Banking Corporation, this was a decision of Judge Shientag. In this case the applicant of the letter of credit sought an injunction against the issuing bank to stop the bank from paying on documents, presented by the seller. The beneficiary was a merchant in India. Applicant's allegation was that the shipped goods were not the goods he had contracted for.

In the New York Court of Appeal, Judge Shientag stated that a Letter of Credit is “independent of the primary contract of sale between a buyer and a seller. The issuing bank agrees to pay upon presentation of documents not goods. This rule is necessary to preserve the efficiency of the Letter of Credit as an instrument for the financing of trade”.

But the Judge further said that due to the facts of the case the situation is different because: “on the present motion, it must be assumed that the seller has intentionally failed to ship any goods ordered by the buyer. 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 principal of the independence of the bank's obligation under a Letter of Credit should not be extended to protect the unscrupulous seller.”

This decision of an American Court had been given about sixty years ago but has been quoted many time in the English Courts. Indeed, Lord Diplock in the United City Merchants case referred to Sztejn as “the landmark American case”.

Discount Records v Barclays Bank [1975]

In this case, buyers claimed that the cartons shipped by the sellers contained only a small amount of the goods, which the buyers had contracted for ordered, and the remaining cartons were filled with rubbish. The buyers sought an injunction against the bank to stop the payment to the sellers, under letters of credit. It was held that the fraud had been alleged but was not yet proved, so an injunction would not be granted, as in such circumstances, the grant of an injunction would prevent the bank from performing its obligations.

Harbottle v National Westminster Bank [1978]

In this case, English plaintiffs entered into contracts for sale with Egyptian buyers. Each of the contracts provided that the plaintiffs would provide a guarantee confirmed by a bank and the guarantees covered five percent of the purchase price in favour of the buyers. The plaintiffs claimed that the buyer's demand of guarantees was without any justification. Mr Justice Kerr stated in his judgement that it was only in “exceptional cases” that courts would interfere with the irrevocable obligations assumed by banks.

Edward Owen Engineering v Barclays Bank [1978]

In this case, Court of Appeal approved the decision of Sir Michael Kerr in the Harbottle case. Lord Denning described the fraud exception the following words:

“that case (the Sztejn case) shows that there is this exception to the strict rule: 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 where there is no right to payment” (page 982).

In the same case, Lord Justice Brown, said about the fraud exception:

“that exception is that where the documents under the credit are presented by the beneficiary himself and the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled to refuse payment”(page 984).

Lord Justice Geoffrey Lane also said at page 986:

“the only circumstances which would justify the bank not complying with the demand …… this, if it had been clear and obvious to the bank that the buyer had been guilty of fraud”.

United City Merchants v Royal Bank of Canada [1982]

In this case, documents presented to the confirming bank, contained a misstatement, i.e. the bill of lading showed the shipment date as 15th December 1976 which was the last date for payment, while in fact shipment was on 16th December. So the Defendant bank refused to pay.

In the House of Lords, Lord Diplock described the autonomous nature of the letters of credit, that the goods are irrelevant to the seller's right to payment from the bank. However, he said:

“to this general statement of principle as to the contractual obligations of the confirming bank and 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.”

Lord Diplock further referred to the Sztejn case and said:

“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.”

Deutsche Ruckversicherung v. Walbrook Insurance [1996]

In this case, Lord Justice Staughton emphasised on the distinction between preventing a seller from getting payment from the issuer or preventing a bank from making a payment under a letter of credit transaction. He said:

“the effect on the lifeblood of commerce would be precisely the same whether the bank is restrained from paying or the beneficiary is restrained from asking for payment.”

Standard Chartered Bank v. Pakistan National Shipping Corporation [2000]

This is an important case in relation to the liability of a bank in case of contributory negligence, where false documents are delivered by the beneficiary in support of an application to get payment under a letter of credit.

In the proceedings before the English Court, Standard Chartered Bank had established a good cause of action against the defendant, Pakistan National Shipping Corporation. Pakistan Shipping Corporation issued a Bill of lading which to its knowledge contained a false shipment date. The Bill of Lading was presented to Standard Chartered Bank under a letter of credit which was issued by Incobank of Vietnam and was confirmed by the Standard Chartered Bank. In fact the shipping documents were presented to Standard Chartered Bank late. However Standard Chartered Bank made the payment without the authority of Incobank, and hence claimed reimbursement on the basis of a false statement that the documents had been presented on time. Incobank refused to make payment because of discrepancies. Pakistan Shipping Corporation argued that the damages caused due to Standard Chartered Bank's negligence in failing to find out the discrepancies in the documents presented before the bank, and the Court should reduce the amount payable under the provisions of Section 1 of the Law Reform (Contributory Negligence) Act 1945.

The Court of Appeal held that under section 4 of the 1945 Act, for a defence of contributory negligence, negligence should be actionable. In this case Pakistan Shipping Corporation's claim for reduction of the damages payable depends upon its establishing that the act of Standard Chartered Bank has given rise to an action for contributory negligence. However, it was unbelievable that the deceitful conduct of Standard Chartered Bank would have afforded Pakistan Shipping a defence, as in any event, a Defendant, liable in a deceit could not establish a defence based upon the contributory fault of a Claimant. Therefore, there were no grounds for reducing the damages recoverable on the basis of contributory negligence.

The Court of Appeal criticised the role played by Standard Chartered Bank in this case. Lord Justice Ward referred to Standard Chartered Bank, “scandalous attempts to deceive the issuing bank on the basis of a false statement that the documents were presented to them in time.” (page 948). Later he referred to his “…..distaste for the bank's conduct. They have brought dishonour upon themselves and upon the City. It is quite another question whether the dishonest ship owners can benefit from the attempted fraud”. (page 958).