United States: Part III: When Findings Of Fraud Can Undo The Guarantee In A Letter Of Credit

Raymond Patella and Michael Viscount write:

This is the final installment in a three-part series on letters of credit by attorneys in Fox Rothschild's Financial Restructuring & Bankruptcy Practice. Part I focused on the advantages of letters of credit as a credit enhancement tool. Part II explored the use of letters of credit as collateral in bankruptcy proceedings. Here, in Part III, we conclude the series with an outline of important fraud exceptions.  

Ordinarily a letter of credit, or LC, is a reliable guarantee of payment that enhances a party's credit by shifting the credit risk from the customer to the financial institution and is unlikely to be affected by a bankruptcy. However, a finding of fraud can change the picture dramatically.

Under the Uniform Commercial Code, courts have at times permitted the issuer to refuse to pay, notwithstanding the beneficiary's proper document presentation, if the LC document "is forged or materially fraudulent," or if "honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant." Note that the issuer has no obligation to dishonor the beneficiary's payment demand; the issuer may honor, despite the fraud, as long as it does so in good faith.

The UCC and courts fashioned the fraud exception carefully. For example, the First Circuit has held that a court may enjoin payment when it "concerns 'fraud' so serious as to make it obviously pointless and unjust to permit the beneficiary to obtain the money. [Such circumstances include:] where the circumstances 'plainly' show that the underlying contract forbids the beneficiary to call a letter of credit, where they show that the contract deprives the beneficiary of even a 'colorable' right to do so, where the contract and circumstances reveal that the beneficiary's demand or payment has "absolutely no basis in fact", [or] where the beneficiary's conduct has so vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served." (Ground Air Transfer, Inc. v. Westates Airlines, Inc., 899 F.2d 1269 1272-73 (1st Cir. 1990) (emphasis in original) (citations omitted).

Fraud in Underlying Transaction

Courts and legal commentators have long been divided as to whether fraud in a transaction should include only fraud in the LC transaction or should also include fraud in the underlying transaction. UCC § 5-109 provides that fraud in the transaction includes both fraud in the LC transaction and one in the underlying transaction. Therefore, if the beneficiary committed fraud in the underlying transaction, the applicant may prevent the beneficiary's draw by requesting so of the issuer, although the issuer is under no obligation to accept that request. Also, the applicant may ask a court to enjoin the beneficiary's draw based upon the beneficiary's fraud in its underlying transaction with the applicant.

In Mid-America Tire, Inc. v. Ptz Trading Ltd., 768 N.E.2d 619 (Ohio 2002), the court held that the beneficiary's fraud in the underlying transaction justified an injunction against the issuers honoring the LC, where foreign buyers promised American buyers they could sell certain goods, many of which the buyer-applicants could not legally import or sell in the United States. The court issued an injunction because honoring the LC would facilitate the seller-beneficiary's fraud in the underlying transaction, which was to sell the illegal goods.

Fraud in the Draw

Many cases prompt courts to issue an injunction against payment — or to justify the issuer's refusal to honor the beneficiary's payment demand — as a result of a beneficiary's fraud in the draw. In a New York case, Sztejn v. J. Henry Schroder Banking Corp., the beneficiary presented invoices and bills of lading describing the merchandise as "bristles," as the LC required. The beneficiary, however, had shipped cow hair and other worthless rubbish instead of bristles. The Sztejn court held that the beneficiary was practicing fraud on the issuer by supplying the issuer with fraudulent documents, instead of the fraud merely involving the beneficiary's breach of the underlying contract.

The Second Circuit, in Brenntag International Chemicals, Inc. v. Bank of India, 175 F.3d 245 (2nd Cir. 1999), issued an injunction against the issuer-bank from making payments to the beneficiary. The beneficiary could draw upon the stand-by LC only when the applicant failed to perform its obligations and only after the beneficiary submitted certain documents, including a default letter stating that the beneficiary did not receive payment due from the applicant. The beneficiary submitted a default letter to the issuer, and the Second Circuit affirmed an injunction against payment because the default letter was facially fraudulent; the default letter on its face was "not true and could not have been true" when the letter was written.

Parties involved with LCs are well advised to seek the advice of counsel if they suspect fraud in any aspect of the LC relationship.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.