Court highlights autonomy of letters of credit under English law

Letters of credit lie at the heart of trade across international borders. The principle of autonomy of a letter of credit ie its independence from the underlying sale transaction, is expressly stated in the ICC’s Uniform Customs and Practice for Documentary Credits 600 (UCP 600), and the extent to which English law gives effect to the autonomous nature of a documentary credit, and the status of such instruments as ‘akin to cash’, is one of the principal reasons why it is often chosen as the governing law of such instruments. 

In this case, the English Court dismissed a challenge to its jurisdiction over a dispute arising under standby letters of credit that were subject to UCP 600 and governed by English law, notwithstanding related Swiss civil and criminal proceedings. 

In the English Court’s view, it was the most appropriate forum for resolution of the dispute because it was best placed to give effect to the substantive characteristics of the standby letters of credit under English law as their applicable law.

Specifically, the English Court emphasised the high threshold for successfully relying on the fraud exception to the autonomy principle and the importance to international trade of honouring letters of credit. 

The background facts

The claimant was an international bank incorporated in Australia and the defendant a Swiss bank. By three advance payment and supply agreements concluded between November 2019 and January 2020, the claimant agreed to purchase three consignments of coal from a UAE company, Phoenix Global DMCC (Phoenix). 

The agreements required the claimant to make advance payments to Phoenix, which it did. Those advance payments were secured by standby letters of credit (SBLCs) issued by the defendant bank. The SBLCs were subject to UCP 600 and were governed by English law. 

The claimant contended that Phoenix failed to deliver the cargo under the first agreement and that this constituted an event of default under the other agreements also. It issued default notices in respect of all three agreements to Phoenix and also called for repayment of the advance payments it had made. The amounts claimed were significant; over US$13 million. However, Phoenix failed to make any payments and subsequently went into liquidation. The claimant demanded payment under the SBLCs. The defendant exchanged SWIFT messages with the claimant regarding additional information in relation to the shipment of goods under the agreement with Phoenix. However, the defendant did not identify any discrepancies in the payment requests nor did it notify the claimant that it was refusing to honour the SBLCs.

The claimant commenced Swiss civil court proceedings against the defendant. The defendant then made a criminal complaint to the Central Public Prosecutor’s office in the Canton of Vaud against ‘an unknown person’ for fraud and forgery, alleging that Phoenix had presented it with fictitious/falsified contracts in order to obtain the SBLCs. The defendant contended that had it known the true position, it would not have issued the SBLCs. 

No claim of fraud or dishonesty had yet been made against the claimant, and the claimant denied any involvement in any dishonest actions. Nonetheless, the defendant sought and obtained a stay of the Swiss civil proceedings pending the outcome of the criminal proceedings. The claimant’s attempts to have the stay lifted were unsuccessful, with the Swiss Supreme Court dismissing the claimant’s appeal and upholding the stay. While expert evidence as to the applicable principles of English law relating to payment under letters of credit was placed before the Swiss courts, the Swiss courts based their decisions exclusively by reference to Swiss law.

The claimant then commenced English Court proceedings against the defendant. The defendant contested the English Court’s jurisdiction.

The Commercial Court decision

The English Court confirmed that the legal effects of an LC governed by English law are clear. Where a bank has issued and confirmed an LC, it must pay under the LC if the documents presented are in order and the terms of the LC are satisfied. Any dispute between buyer and seller with regard to the underlying sale contract is separate and should be settled between themselves. The exception to this rule is where there is established or obvious fraud to the knowledge of the bank. 

The English Court added that, even where the courts of the bank’s domicile granted an injunction to seek to prevent a bank from paying out under an LC, that would not provide the bank with a basis for doing so. It was part of the law of international trade that LCs should be honoured and not nullified by an attachment order. Otherwise, no foreign seller would supply goods to buyers in that country on the basis of payment by LC.

The substantive characteristics of an LC had important procedural implications that were intended to prevent the payee’s substantive rights being circumvented by procedural means. 

Firstly, when a party sought to prevent a bank paying on grounds of the beneficiary’s fraud, or the bank itself sought to resist payment on that basis, a heightened evidential requirement applied: there must be obvious or established fraud. In this case, the defendant had prevented the claimant from enforcing the SBLCs while third party investigations were taking place into a potential fraud. The defendant was not yet in a position to present an arguable case of fraud against the claimant, nor was there clear evidence of the claimant’s knowledge of any fraud.

Secondly, the English Court would not stay the enforcement of a judgment under an LC pursuant to its procedural stay jurisdiction. Yet the defendant had used Swiss procedural law as a basis for not performing its substantive obligations under the SBLCs.

The English Court concluded that it was the most appropriate forum to give effect to the applicable law of the SBLCs, with its procedural consequences. On the evidence before the English Court, there was a very real risk that the Swiss civil proceedings would remain suspended for several years. Beyond pure delay, however, the English Court thought that the Swiss civil court would be unlikely to give effect to the claimant’s substantive rights under the SBLCs under the English governing law or the procedural consequences of enforcing those substantive rights.

If the defendant had a valid defence to enforcement of the SBLCs as a matter of English law, the English Court would give effect to that defence. If there was no such defence, then the English proceedings would proceed in a manner consistent with the substantive characteristics of the SBLCs under English law as instruments ‘akin to cash’, with judgment being given in a matter of months. 

These factors outweighed the links with Switzerland as the domicile of the defendant and as the place of the SBLCs’ expiry, payment and where presentation would take place. 

As to the vexatious nature of a party bringing two sets of proceedings in two different jurisdictions in respect of the same claim, the claimant had undertaken to seek to discontinue the Swiss civil proceedings if the defendant’s jurisdictional challenge was dismissed.

Comment

Under English law, the fraud exception will only be successfully invoked in relatively rare circumstances because it requires both evidence of an obvious fraud and for the bank to be aware of the fraud. 

Here, while investigations were ongoing to determine what, if any, fraud had taken place and whether the claimant buyer was implicated, the bank had as yet no arguable case of fraud or evidence against the claimant. 

Nonetheless, while some civil law jurisdictions apply similar legal principles to those under English law, there are some jurisdictions whose courts may be more willing to grant injunctions to prevent payment under letters of credit.