The law on letters of credit has been upheld in two cases; banks cannot refuse to pay a demand meeting the requirements of a letter of credit unless it would involve fraud.

The strict approach of English law in enforcing payment under standby letters of credit has been reinforced in two judgments (National Infrastructure Development Company Limited (NIDCO) vs BNP Paribas and NIDCO vs Banco Santander SA). Once a demand has been made in accordance with the requirements of a letter of credit, a bank can only refuse to pay is if it is on notice of fraud at the time of the call or where payment would be fraudulent.

Letters of credit are used internationally as performance securities for major construction contracts and the law on demands made in respect of them is essentially the same as for on-demand bonds.

In both cases, Fenwick Elliott acted for NIDCO, a company set up by the government in Trinidad and Tobago to deliver infrastructure projects. BNP Paribas (BNP) and Santander both provided securities at the request of a Brazilian contractor (Construtora) for the construction of a highway project. The letters of credit were subject to English law and the jurisdiction of the English courts.

Disputes arose, and a termination notice was served in June 2016. By then, Construtora had gone into the Brazilian equivalent of administration. A London Court of International Arbitration process was started and is ongoing. NIDCO served demands in respect of the letters of credit. The letters of credit had been provided by banks in Europe. However, their Brazilian subsidiaries (which had given counter-guarantees to their European counterparts) were injuncted by the Brazilian courts from paying NIDCO and these courts extended the injunction to cover the European banks. Both banks declined to pay, noting that a substantial fine would be payable if they did.

It would be wrong in principle to use a stay of execution to subvert the principles of law that provide very limited defences to claims to enforce letters of credit

NIDCO applied for summary judgment over about $58m (£47m) against BNP and $38m (£31m) against Santander. The BNP case came before the Commercial Court on 26 September, and the Santander hearing in November.

At the BNP hearing, the issue was whether the Brazilian injunction gave BNP Paribas any grounds not to pay under English law. The judge emphasised that letters of credit have a status equivalent to cash and should be paid out unless very limited exceptions apply.

The judget noted:

"Whilst it is said that the facts of the present case are extraordinary, I suspect they would become commonplace if a party who had opened a letter of credit could defeat the bank's payment obligation to pay by obtaining an injunction against the bank in its home jurisdiction."

The judge granted summary judgment and added it would be

"wrong in principle to use a stay of execution to subvert the principles of substantive law which provide very limited defences indeed to claims to enforce letters of credit"

Santander argued the fraud exception applied. This was mainly because the amounts due had not been determined by the arbitration, so NIDCO could not have an honest belief in its demands. It also argued that English law should be extended to include a doctrine of "unconscionability", as in other jurisdictions. Santander said that, given the Brazilian injunction and NIDCO's alleged financial status, it would be unconscionable to order payment.

Making an employer wait until a claim is determined before calling on on-demand securities after a termination would undermine the purpose of on-demand securities

Its arguments were rejected. Mr Justice Knowles noted the case of J Murphy and Sons vs Beckton Energy Ltd in which Mrs Justice Carr held:

"The trigger for a performance bond is a belief on the part of the drawing party in its entitlement, not such entitlement having been subject to a final determination."

There was no serious case that NIDCO did not believe its demands were valid so payment had to be made. The parties had chosen English law, which did not recognise unconscionability.

Permission was denied for a stay pending the release of the Brazilian injunction, the arbitral decision or any application to appeal; letters of credit must work within their terms, including those on time.

While Santander may appeal, the decision protects the securities system. Making an employer wait until a claim is determined before calling on on-demand securities after a termination would undermine the purpose of on-demand securities. To start with, the security may have expired by the time a dispute is resolved.

If an employer is facing a hefty bill to complete works, on-demand securities provide the monies to do so pending resolution. If the parties expressly say they cannot be called until a determination has been made, that is different.

The courts have upheld one of the greatest achievements of uniformity in international law relating to letters of credit and the importance of treating them like cash unless there is fraud.

This article was co-written with Claire King,Partner, Fenwick Elliott and first appeared in Building Magazine 2 December 2016.

International Quarterly is produced quartely by Fenwick Elliott LLP, the leading specialist construction law firm in the UK, working with clients in the building, engineering and energy sectors throughout the world.

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