August 2020

BG: Restraining Payments under Letters of Credit: Fake Trades & Forged Documents-Who Bears the Risks?

Letters of credit (“LC”) are the lifeblood of international trade. They work in a world of strict documentary compliance which does not always fit in the fast and loose world of trading where sets of documents required under an LC can exchange hands without due regard to their representations contained in them. With a raft of high-profile cases revealing an alarming incidence of fictitious trades and fake BLs, banks are revisiting the old maxim that they only deal with documents and not the underlying trades. If a bank only deals with documents, can it refuse or claw back payment under a LC if documents, compliant on its face but fabricated to support a fictitious trade? If a buyer becomes insolvent, does the bank or the beneficiary bear the risk of forged documents? We provide English, Singapore & Swiss law perspectives.</P

Despite the general application of the UCP 600 Rules, the jurisprudence in national countries have nuanced differences and so the governing law of the LC itself may be critical. As a general principle, the proper law of an LC is that of the place stipulated in the LC for payment against documents, which at times may not be straightforward to ascertain as there are different types of LCs.

The Common Law Fraud Exception

LCs are described as autonomous and independent payment obligations which can only be withheld in cases of fraud. But important considerations arise such as whose fraud and what evidence is needed to establish this? The laws in England as there are in Singapore are unequivocal in that regard – fraud arises when the seller presents to the bank documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue. There can be numerous material misrepresentations in the documents, e.g., a backdated BL or an inaccurate certificate but the key inquiry is whether the seller (as beneficiary under the LC) can be said to be aware of these misrepresentations. Backdating of BLs by third parties without the knowledge of the seller isn’t enough to establish the fraud exception. But the case against the seller is certainly stronger when for example, it presents a certificate of origin listing it as an exporter or shipper under the BL, when it knows it is neither. In the paper shuffling game of international trade, such misrepresentations involving sellers who are passed these documents in a chain for a margin, may possibly trigger the fraud exception to payment under LCs

Then, there is a question of evidence, i.e., proving the knowledge of the seller/beneficiary. It is simply not enough to allege a fraud, even if there are admissions of double financing in the chain. Even a duplicate BL may be insufficient to demonstrate that a seller knew its BL was fake at the time of presentation. At its extreme, English case law has decided that a bank is obliged to pay even if there is a third-party fraud involved (e.g., forged third party certificates) if the beneficiary did not have knowledge of the fraud. Policy considerations dictate that the wheels of international trade must move in favour of a seller who is not guilty of fraud. While an LC is understandably sought to protect the beneficiary against certain risks such as the buyer’s default/insolvency, should that transfer the risk of third-party forgery to the bank?

Nullity – Another Exception?

Establishing a seller’s knowledge to fraud, is a notoriously difficult task so what can be done when forged or invalid documents are involved?  Singapore case law has shown that air waybills produced by fictitious entities or forged certificates produced by an incorrect party may be deemed a nullity, entitling non-payment. Some commentators deem this a “nullity exception” but it is strictly speaking not an exception to payment but instead a basic requirement of complying documents – that they are genuine.

The analysis by the Singapore courts in Beam Technology (Manufacturing) Pte Ltd v Standard Chartered Bank in 2013 is particularly instructive on this topical issue:

    While the underlying principle is that the negotiating/confirming bank need not investigate the documents tendered, it is altogether a different proposition to say that the bank should ignore what is clearly a null and void document and proceed nevertheless to pay. Implicit in the requirement of a conforming document is the assumption that the document is true and genuine although under the UCP 500 and common law, and in the interest of international trade, the bank is not required to look beyond what appears on the surface of the documents. But to say that a bank, in the face of a forged null and void document (even though the beneficiary is not privy to that forgery), must still pay on the credit, defies reason and good sense.

The position is entirely sensible but once again relates to a very unique set of facts (e.g., an airway bill issued by a fictitious company). In such cases, a nullity may appear as dressing the limited fraud exception in a different package.

The Swiss Position – Abuse of Right

Swiss law also allows restraint of payment under an LC in the event of fraud. But it appears that the Swiss courts have a greater latitude when examining the fraud exception to ensure payment under an LC is not deemed an abuse of right. The concept of abuse of right (which is the flip side of the general principle of “good faith” applicable under Swiss law) allows Swiss courts to rectify or prevent a result which, although correct from a purely formalistic legal or contractual point of view, would be ethically and morally questionable. As you can imagine, such a concept may not be easily to apply in practice with precision. The beneficiary would for instance commit an abuse of right if, while presenting formally valid documents to the bank in relation to a sale of goods, it knew or had reasons to believe that the goods did not exist, or that their value was significantly lower than the stipulated price, or, as well, if the buyer had already performed its obligations and paid the purchase price by other means (e.g. a valid set-off). In such circumstances, the principle of independence and autonomy of documentary credits would be set aside to protect the legitimate interests of the bank and its client.In a 2005 judgment, the Swiss Federal Tribunal ruled that even if the forgery is not detectable or very difficult to detect, the bank does not become the debtor of the beneficiary in such a case, given that the documents play an essential role in the functioning of any documentary credit and that their authenticity must be considered as a prerequisite for the validity of the obligations assumed by the bank. Naturally, a case of such nature would turn significantly on the evidence – but there appears greater appetite by the Swiss courts to depart from the independent payment obligations if there is a likelihood of forged documents.

There is an inherent tension for a bank between performing an autonomous payment obligation and safeguarding against an invalid claim that will prejudice its position with its applicant (particularly if there is an insolvency risk with the applicant). Without a clear exception for forged or invalid certificates unrelated to the seller/beneficiary, banks and are now left scrambling whether on its own or in response to a buyer’s attempt to injunct payment, to investigate the authenticity of documents – the very concept the UCP was intended to obviate for these financial institutions.

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