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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.
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.
J G Barnes & J E Byrne, 2001, 'Letters of Credit: 2000 Cases', 56 Business LR 4
Gao and Buckley, 2003, A Comparative Analysis of the Standard of Fraud Required Under the Fraud Rule in Letter of Credit Law, Oxford University Comparative Law Forum 3
Charlesworth and Morse, 1999, Company Law, Sweet & Maxwell
Farrar et al, 1998, Farrar's Company Law 4th 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 1(6)
Pillans and Bourne, 1999, Scottish Company Law, Cavendish
Sealy, 2001, Cases and Materials in Company Law, LexisNexis UK
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