Recently there have been growing concerns about trade finance fraud from banks perspectives all over the world. This issue is becoming more confusing in light of the fact that the Uniform Customs and Practice for Documentary Credits (the "UCP") does not deal with this issue, and the fact that national laws varies from country to country.

Article 34 of UCP 600 states that banks assume no liability or responsibility for the accuracy, genuineness or falsification of any document, nor do they assume any liability or responsibility for the good faith of the consignor, the carrier, the consignee or any other person.

This means that if a Letter of Credit (LC) calls for, among other documents, three original Bills of Lading (B/L) signed and stamped by the Carrier and the nominated bank has reasonably examined the credit documents and honors payment based on what it seemed like a complying presentation, such bank will not be responsible if it turns out on a later stage that the presented Bs/L were found to be forged. The Applicant will remain liable to cover the finance and may not default or reject payment as per Article 34 mentioned above.

This exclusion of liability given to banks seems logical considering the bank's obligation to honour payment if the documents appeared complying on their face. Article 5 of UCP 600 provides that banks deal with documents and not with goods, services or performance to which the documents may relate. In addition, Article 14 states that banks must examine the presentation of documents on their face to determine whether or not such documents are complying.

The aforesaid rules are related to what is known as the "principle of independence" which is considered the cornerstone of the law relating to letters of credit. It is understood under this principle that the LC is independent of and separate from the underlying contract or arrangement between the Applicant and the Beneficiary, and also from the contract between the Applicant and the Issuing Bank.

Article (4/a) of UCP 600 provides that the LC is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any form of reference is included in the credit.

This principle of independence was also recognised under the UAE Commercial Transaction Law (the "Law"). Article 436 of the said Law reads as follows (quoted translation):

"The bank shall only be liable to assure that the documents are as they appear, conform with the documents required in the letter of credit; and it shall not be bound to check if the goods conform to the documents which represent them."

Accordingly, if the presented documents appear on their face to be in compliance with the terms and conditions of the credit, the bank must honour payment according to Article 15/a of UCP 600 regardless of any disputes or challenges between the beneficiary and the applicant.

On the other hand, if the presented documents do not comply with the terms and conditions of the credit or are inconsistent with each other, the bank may refuse to honour payment.

In addition, the beneficiary might present a B/L which seems to be on its face complaint, but it is actually forged. In such incident, the bank might effect payment after reasonable banking examination of documents which will result in the unjust enrichment of the Beneficiary. In this event, the bank will assume no responsibility according to Article 34 of the UCP mentioned above.

However, the main uncertainty arises under a third scenario in which the bank notices the forged B/L before honouring payment. Should the Bank honour payment or not? The uncertainty will increase when the credit is confirmed through different banks in different jurisdictions.

Obviously, banks should not promote fraud under any circumstances.

The UCP does not address the fraud issue and accordingly this issue was left to the local national applicable laws.

There are precedents and case law in many jurisdictions confirming that when an LC is affected by fraud, the courts have the authority to interfere with banks' obligation to honour or not.

Although there is no similar precedent on the Fraud Exception in the UAE, yet there is also no contrary ruling which says banks should honor payment based on forged documents which appears complying on their face.

In addition, UAE courts in many matters (not related to LCs) upheld the saying "Fraud repeal all". This rule will certainly support the banks position if it decides not to honour payment under the LC.

Moreover, there is a UAE court law in relation to LC, in which the court has interfered in the bank's decision to what is considered a complying presentation or not, and whether documents are consistent or inconsistent as per Article 435/2 of the Law. The said Article reads as follows (quoted translation):

"2- The bank must examine
whether the documents required are available, that their contents are in full conformity with the conditions of the letter of credit and that they fully consistent with each other."

Accordingly, it can be argued that banks are entitled not to honour payment in cases of suspicion of fraud under LC, but obviously will be requested to provide evidence of such fraud.

Nevertheless, it should be noted that the approach of national legal systems on this issue may differ from country to country, and also from court to court, especially in a country like the UAE in which this issue has never been experienced.

There is no doubt that the issuing bank facing such incident will be exposed either way, whether payment under the suspicious B/L was honoured or not.

In its country, the issuing bank will be exposed to the Applicant if payment was honoured. It is likely that the Applicant will either refuse to cover the finance or will take legal action to claim a refund if the issuing bank has debited the applicant's account.

The Applicant may argue that the issuing bank honoured payment while it was aware of the forged B/L and this resulted in the unjust enrichment of the beneficiary on account of the applicant.
In contrast, the issuing bank will be exposed abroad to the confirming bank (if any) and the Beneficiary if it refuses to honour payment based on the suspicious that the B/L presented was forged.

If the presented B/L was actually forged, it is likely that the Beneficiary will attempt to disappear and will not take any legal action against the nominated bank as he will be exposed to criminal proceedings.

However, the issuing bank will remain exposed to the confirming bank, especially if such bank has honoured payment to the Beneficiary. The confirming bank will argue that it did not notice the forged B/L and acted in good faith, and will certainly argue that the issuing Banks obligation towards the confirming bank is independent and separate from the confirming Bank's obligation towards the Beneficiary. Thus, the issuing bank must honour its reimbursement claim.

Banks must take certain procedures to minimise its exposure and deal with this issue on a case by case basis. These procedures should include swift communication under legal advice with the applicant and all other banks involved in the transaction to determine the best approach.

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.