Letters of Credit and the Fraud Exception

(by Alex Monk, assisted by Jamie Cawthorn)

The autonomy of the credit

The principle of the autonomy of the credit means the payment obligation created in a letter of credit is independent from the underlying contract between buyer and seller and can be enforced by the seller irrespective of disputes. However, in cases involving fraud, there can be an exception to this principle.

Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2016].

The facts of the case

POS supplied oil rig drilling services to PDV, a Venezuelan state entity. The supply contract provided that PDV would pay POS invoiced amounts regardless of whether it had approved them or not. A letter of credit was issued in favour of POS by the First Defendant, Novo Banco.

The invoice amounts were disputed and PDV refused to pay. On referral to arbitration, the arbitrators found that, as a state entity, PDV was bound under Venezuelan law to submit all invoices to a prescribed approval process. The “pay now, argue later clause” in the supply contract was inconsistent with national law, was unenforceable and therefore payment of the invoices was not yet due.

In spite of the decision, POS presented the letter of credit to Novo Banco certifying that PDV was “obligated” to pay under the terms of the supply contract. The court held that for the bank to pay out under the letter of credit the sums demanded had to be due for payment immediately which, under Venezuelan law, they were not. The fraud exception was also held to apply.

The fraud exception applied

Mr Buckland, a director of POS and the signatory of the demand for payment under the letter of credit, claimed that despite the arbitrators’ findings, he had honestly believed the invoices were “due” once issued. He also claimed he had not considered whether “obligated” meant “obligated now”, as opposed to at a future date.

Rejecting his argument, the court held that Mr Buckland (a qualified solicitor) did not honestly believe this to be the real meaning of the certificate but in fact knew that the certificate was false or was reckless as to its falsity. His actions were therefore fraudulent and the fraud exception applied.

Accordingly, the bank was restrained from making payment under the letter of credit.

Cautionary note

The reluctance of the courts to contravene the principle of autonomy of the credit is well known. However, this case serves as a caution to sellers who underestimate, intentionally or otherwise, the importance of whether a debt is due before certifying a presentation under a letter of credit.

For further information or to discuss this this news item further, please contact Alex Monk on the contact details below.

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About the contributor

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    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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