Letters of Credit cases concerning the autonomy principle
by Charles Williams & Clare Hammersley
The current position in relation to the autonomy of credit principle has been confirmed in two cases handed down from the Court of Appeal earlier this year.
In January 2017, the Court of Appeal handed down its judgment in National Infrastructure Development Company Limited v Banco Santander S.A.  EWCA Civ 27 and Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco S.A. & Others  EWCA Civ 9.
National Infrastructure Development Company Limited (“NIDCO”)
NIDCO, a state owned company of Trinidad and Tobago, contracted Construtora OAS Ltd (“OAS”) to build a new road in Trinidad and Tobago. Five banks issued standby letters of credit (“SBLC”), including Banco Santander S.A. (“Santander”), who issued both performance and retention security.
NIDCO terminated the construction contract on 21 June 2016 on the basis that OAS had abandoned the project. On 6 July 2016, NIDCO sent a letter to OAS which divided up the sums that OAS allegedly owed to NIDCO as being either due or requiring quantification in due course. Subsequently, NIDCO issued Letters of Demand under the SBLCs. As specified in the SBLCs, the wording of the Letters of Demand provided:
“We refer to the above Letter of credit in our favour. We hereby notify you that the amount of US$ [state amount] is due and owing to us by the contractor and demand immediate payment under the Letter of credit of that amount.”
Santander refused to pay out under the SBLCs on the basis that the demands had been made fraudulently / recklessly. NIDCO therefore commenced High Court proceedings against Santander and applied for summary judgment. Mr Justice Knowles, at first instance, found in favour of NIDCO and summary judgment was awarded. Santander was granted permission to appeal and appealed the first instance decision to the Court of Appeal.
The basis of NIDCO’s claim against Santander was that a valid demand had been presented and, as such, payment should be made under the SBLCs.
In its defence, Santander argued inter alia:
- No sums were “due and owing” under the Performance Security;
- NIDCO had overclaimed approximately US$4 million under the Retention Security. They had claimed around US$35m in retention security when the certified retention security was only around US$31m;
- The Demands were thus fraudulent / reckless.
The doctrine of autonomy is one of the fundamental principles in the law of letters of credit. It provides that, in the absence of fraud or illegality, the issuing bank’s obligation is to make payment under the letter of credit upon presentation of a conforming demand. The letter of credit contract is independent from the underlying contract (in this case between NIDCO and OAS) and the bank therefore should not have any regard for disputes arising in that contract.
So what constitutes fraud? It was held by Lord Herschell in Derry v Peek  UKHL 1 that: “fraud is proved when it is shown that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false.”
The Court’s findings
The Court of Appeal held that NIDCO’s claim was successful on all grounds. Namely:
- Unquantified damages can be said to be “due and owing”.
- NIDCO should be able to use the full value of the issued retention security of around US$35m as security for any claim. The retention security did not operate to limit the beneficiary’s claim to the amount of the retention monies certified. In making this finding, the Court commented that the different forms of security (performance or retention) were provided only because the underlying contract so required.
- The Demands were therefore not fraudulent / reckless.
Petrosaudi Oil Services (Venezuela) Ltd (“Petrosaudi”) entered into a seven year drilling contract to supply services to PDVSA. This contract was governed by Venezuelan law and contained a UNCITRAL arbitration clause. Several arbitrations had in fact taken place at the date of the appeal; the seat of which was Paris.
The deal was contingent on a bank guarantee which was provided by means of a SBLC. A dispute arose regarding payment rates and, following arbitration, the bank was restrained from paying out when presented with a demand under the SBLC. This was because the sum was found not to be due and owing under Venezuelan law.
The judge at first instance ruled in favour of the bank relying on the fraud exception mentioned above on the basis that there could not have been an honest belief that the sums were in fact ‘due and owing’ with consideration to the arbitrator’s previous decision. The judge went on to state that as the sums were not due and owing for the purposes of the underlying contract they could not be so deemed when presenting a demand for payment under the SBLC. This decision was appealed and that appeal was upheld meaning payment was ordered to be made under the SBLC and, furthermore, Mr Timothy Buckland, POS’s General Counsel, was expressly exonerated against any claim of fraudulent behaviour in making the demand for payment on POS’s behalf.
Reasons for the Judgment
The Court of Appeal focused on whether PDVSA was ‘obligated to pay’ the invoices claimed for in the SBLC.
It was considered that the phrase ‘obligated to pay’ had to be interpreted in its specific context, that is in the contract pertaining to the SBLC, not the underlying contract between the parties. The fact that the two contracts are separate was emphasised by the judge who made specific reference to the fact that they have different parties, different governing law and on that basis are fundamentally separate to the underlying contract relating to drilling. Specific facts of the case considered, it was found that the meaning of the phrase in this context means that the obligation to pay has accrued notwithstanding any different outcome that may arise with Venezuelan law.
Therefore, as the requirements for presenting the correct documents were met the SBLC had to be honoured pending any exceptions, of which fraud is one.
The Court of Appeal also specifically overturned the first instance decision in relation to fraud by finding that POS’s General Counsel was entitled to believe that payments were due in the circumstances and noting that different minds take different views regarding points of construction and therefore the requirements for fraud, as laid out above, could not have been met.
There has been a lot written about these judgments and they have been signalled by commentators as a victory for autonomy. What has become clear from this decision is that, due to the doctrine of autonomy, a bank has very little real chance of challenging payment.
In relation to the NIDCO case and commenting on Santander’s primary defences in turn, as regards the “due and owing” point, to most people this wording would mean a quantified sum. Regardless of the question of liquidated damages, it might be thought that “due and owing” can include an unquantified figure. Turning to consider the retention security, the Court appeared to interpret the SBLCs in the context of the underlying contract and not in the context of the wording of the retention security itself. This, of course, goes against the conventional view of the doctrine of autonomy.
However, the NIDCO and Petrosaudi cases make clear the Court’s view at this time. In the latter case, whilst at first instance there was a finding that the fraud exception had been invoked, the Court of Appeal overturned this decision and held that the signing of a certificate of demand when questions had arisen as to whether the sums were “due” or not in the underlying contract was not fraudulent.
These decisions indicate the rigidity of English law. Santander argued at first instance in the NIDCO case that the doctrine of unconscionability should apply. The doctrine of unconscionability allows a Court to prevent a bank from being forced to pay out under an SBLC in the absence of fraud, where the claim under the SBLC is affected by bad faith. This argument was rejected at first instance, and leave to appeal on this ground was, in practical terms, also rejected. English law appears to be out of kilter with a number of other Common law jurisdictions. The USA has taken a less rigid approach to the doctrine of autonomy, with the case of Sztejn v J Henry Schroder Banking Corp 31 NYS 2d 631 (1941) being said to have had a significant effect on the erosion of the doctrine of autonomy. Taking an even less rigid view, Singaporean and Australian law both now actively recognise the doctrine of unconscionability, albeit in different ways.
It is clear that preventing payment under SBLCs is almost impossible under English law. When issuing SBLCs, banks must therefore exercise caution when choosing the wording to trigger payment and even then, the hold of the doctrine of autonomy may mean that even carefully considered wording is not enough. Additionally, whilst these cases may have made clear the theoretical, legal position; they have also demonstrated the reality that, in practice, it is almost impossible to separate issues arising in connection with the underlying contract and the interpretation of the terms of the SBLC. Banks should therefore ensure that they have a watertight indemnity in place in the event that they have to pay out under the SBLCs. Moreover, the importance of SBLCs as a tool for promoting certainty in business transactions has been recognised by the Court of Appeal – it is likely that following this commercial approach the principle will not be applied flexibly.