The High Court recently applied the 'fraud
exception' to prevent payment under a standby letter of credit
where the signatory who certified a presentation thereunder was
aware that requirements being certified as true were in fact
The judgment in Petrosaudi Oil Services (Venezuela) Ltd
v. Novo Banco SA and others acts as a cautionary reminder to
those certifying presentations under a letter of credit to
carefully consider whether the requirements of the credit being
certified have been satisfied.
Autonomy of Credit and the Fraud Exception
A letter of credit is aimed at enabling a seller to substitute
the creditworthiness of its buyer with that of a creditworthy bank.
It is a fundamental principle underlying the operation of a letter
of credit that the obligations of the parties to the credit are
totally independent of the terms of the underlying commercial
transaction – the 'autonomy principle'.
Fraud and illegality are the key exceptions to the autonomy
principle of letters of credit, and allow an issuing bank to
withhold payment even where the presented documents appear on their
face to comply with the credit. The courts have effectively shown
over time that they are reluctant to apply such exceptions, save in
clear and exceptional circumstances, in order to uphold the
sanctity of letters of credit as a key risk mitigation tool in
The claimant, Petrosaudi Oil Services (POS),
supplied oil rig drilling services to Venezuelan state entity PDVSA
Servicios SA (PDV). The underlying contract was
governed by Venezuelan law and a standby letter of credit (the
L/C) was issued in favour of POS. The contract
provided that PDV would pay POS invoiced amounts, regardless of any
disputes, i.e. 'pay now, argue later'. Subsequently, POS
issued an invoice for nearly US$130 million, which PDV challenged,
invoking the contract's arbitration clause. The arbitral
tribunal found that the 'pay now, argue later' clause was
null and void under Venezuelan law, as it directly contradicted
Article 141 of the Venezuelan Public Contracting Law. This article
prohibits state entities from making payment without verification
and approval of invoices.
Nevertheless, POS contended that it was entitled to make a
presentation under the L/C and receive full payment regardless of
the arbitration having been instigated due to the 'pay now,
argue later' clause. Accordingly, POS made a presentation to
the issuing bank, certifying that PDV was "obligated" to
pay POS under the contract (as the L/C required such
certification). The issuing bank confirmed compliant presentation
and its intention to pay and PDV consequently sought injunctive
The High Court held that, under the L/C and at the time of
presentation, the sums demanded had to be due for immediate payment
and "not at some defined or undefined point in the
future". Judge Waksman QC considered it clear that whether the
sum was immediately payable should have been obvious in light of
the arbitrators' ruling. The court did not accept that the
signatory, a POS director (also POS's general counsel),
honestly believed that the sum was due and owing at the time of
certification. The certification under the L/C was, therefore, held
to be fraudulent and the bank was restrained from making
Despite the courts' general reluctance to undermine the
autonomy principle of letters of credit, and stringent thresholds
that need to be satisfied to rely on the fraud exception, the
Petrosaudi case illustrates that the fraud exception is a tool the
courts are willing to use to uphold the balance of risk between the
various parties to a documentary credit.
The key thing for parties to avoid such difficult situations,
when presenting and seeking payment, is to give due consideration
to the types and content of documents to be presented under a
letter of credit.
The following tips are suggested as good practice when reviewing
letters of credit:
Tailor the requirements of the credit
to the underlying sale contract requirements and ensure no
inconsistencies between the two.
Draft presentation requirements
clearly and try to keep these simple.
Avoid certification requirements if
the subject matter of such certification requires the person
certifying to interpret the underlying contract in order to
determine the validity of that subject matter.
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.
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