The English Court of Appeal has recently re-affirmed, in National Infrastructure Development Co Ltd v Banco Santander, that the fraud exception to the autonomy principle in letters of credit will be narrowly applied in circumstances where the beneficiary holds an honest belief that the amounts are due and owing.
A Standby Letter of Credit ("SBLC") is a written undertaking issued by a bank ("the issuing bank") which guarantees payment to a party to a contract ("the beneficiary") in the event that the other party fails to fulfil an obligation under the underlying contract. SBLCs are very common in large commercial transactions, including cross-border transactions, as sellers are exposed to a risk that the buyer will not pay on time.
There is an absolute obligation on the issuing bank to pay out to the beneficiary. This is the principle of autonomy and it is one of the foundations of the laws of letters of credit. The SBLC creates standalone rights and obligations, entirely separate to the performance of the underlying contract. It is an undertaking by the issuing bank to pay against the presentation of proper documents regardless of any dispute between the parties to the underlying contract.
Fraud exception to autonomy of SBLCs
Fraud is an exception to the principle of autonomy. If the beneficiary makes a fraudulent demand, the issuing bank is entitled to refuse to pay out under the SBLC. However, it is clear from recent UK decisions that the exception is limited and the courts will not depart lightly from the principal of autonomy. A high standard of proof is required both as to the fact of the fraud and as to the issuing bank's knowledge of such fraud.
Banco Santander issued an SBLC to National Infrastructure Development Co (NIDC) in relation to a construction contract. The contract was subsequently abandoned and NDIC issued a demand to the issuing bank. It certified in its demands that the sums were "due and owing" from the contractor. The issuing bank argued that the demands were made recklessly as to what was due and owing. It argued that the fraud exception should apply in this case as NIDC had certified that the sums were "due and owing" but this was not the case.
English High Court decision
The English High Court held that, in certifying that amounts are due and owing, what mattered was NIDC's honest belief that amounts were due and owing. NIDC did not have to state that a tribunal had determined the amounts to be due and owing, or that it had been advised that the amounts were due and owing as a matter of law.
Summary judgment was granted and the issuing bank was ordered to pay NIDC. The High Court decision was appealed but it was upheld by the English Court of Appeal.
This case is an example of the narrow approach the English courts have taken when applying the fraud exception to the autonomy principle. The English Court of Appeal's decision confirms that its courts are reluctant to broaden the scope of the fraud exception and recognises the importance of treating standby letters of credit as equivalent to cash. The autonomy principle stands strong.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.