Letters of Credit and the fraud exception

by Alex Monk and Rachel Turner

The highly limited availability of fraud as a defence against payment under letters of credit has been re-emphasised by the Privy Council (“PC”) in an appeal case from the Mauritius Court of Appeal. In Alternative Power Solution v Central Electricity Board, CEB accepted a tender by APS to supply light bulbs. Payment was to be effected by way of an irrevocable letter of credit (“LC”) issued by Standard Bank. The sale contract provided CEB with a right of inspection prior to shipment, although the list of documents required for a complying presentation to the bank for payment under the LC did not include any confirmation that the goods had been accepted by the CEB. No inspection was carried out before the goods were shipped and the CEB applied for an injunction restraining the Bank from paying out under the LC, making several allegations of fraudulent conduct against APS.

The judgment delivered in September 2014 overruled the lower court’s decision to uphold an injunction granted at first instance. The PC’s ruling concluded that for CEB to have been successful with the fraud argument it must seriously argue and clearly establish that the only realistic inference is (i) that the beneficiary could not honestly have believed in the validity of its demands under the LC and (ii) that the bank was aware of the fraud. The judgment noted that the test in the context of an LC is intended to be “significantly more stringent” than there being a good arguable case, and not just simply a serious issue to be tried (the established test for injunctions in the ordinary case). Furthermore, the PC criticised the reliance in part on the performance of the underlying sale contract which conflicted with the fundamental principle that the LC should be regarded as a wholly independent obligation. The PC also made it clear that the balance of convenience in favour a remedy of injunctive relief would almost always be “hopelessly outweighted” against the injunction because the claimant will usually have an adequate remedy against a bank in damages if it pays out in breach of the LC.

The case serves as a strong reminder of the reluctance of the courts to break the independent contract principle which is a fundamental tenet of letters of credit in trade finance transactions. The fraud exception will only be successfully invoked on very strong and particular facts concerning the existence of a fraud by a beneficiary and the knowledge of the relevant bank. The Judicial Committee of the Privy Council is not an English court, and so, technically speaking, its decisions are not binding on the English courts but are regarded as persuasive precedent. Nonetheless, the Privy Council and the English Supreme Court share the same judges and so in practice the Privy Council decisions are treated with great respect.

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About the contributor

  • Alex Monk Partner

    Alex has a wide finance transaction experience with a particular focus on trade and commodity finance transactions acting for banks, financial institutions and corporates.

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