UK: Letters Of Credit: Privy Council Reaffirms Autonomy Principle

The autonomy principle is fundamental to the utility of letters of credit (LCs). Under this principle, a bank must pay against a presentation of documents that appear on their face to comply with the credit. This obligation is "autonomous" from the underlying transaction. In a recent case, the Privy Council rejected an argument that would have made it easier to invoke one of the few exceptions to the autonomy principle - namely the fraud exception.  David Williams explains.

The autonomy principle

Under the autonomy principle an issuing bank's duty to honour a compliant presentation of documents under an LC is independent of the underlying contract and despite any disputes between the parties to that contract. Banks should not concern themselves with goods, services and underlying transactions. Nor should they look beyond the documents presented under the credit. The English courts have summarised the autonomy principle by saying LCs should be treated as equivalent to cash.

Exceptions

There are very few exceptions to the autonomy principle. These include:

• where it is illegal under local law in the place of payment for the bank to pay under the credit; and
• the fraud exception.

The English courts are still working out the precise scope of the fraud exception. The mere fact of some fraud arising in connection with the LC or the underlying transaction does not of itself trigger the fraud exception. For example, if the beneficiary of a credit presents the bank with forged documents that appear to comply with the credit, the fraud exception will not apply unless the beneficiary knows of the forgery and the bank is aware of this. 

In Alternative Power Solution v. Central Electricity Board [2014] UKPC 31, the Privy Council was asked to consider whether the fraud exception applied in a dispute originally heard in the Mauritian courts.

Alternative Power Solution v. Central Electricity Board

Alternative Power Solution (APS) had sold light bulbs to Central Electricity Board (CEB). Payment would be by LC. Following delivery, CEB claimed the bulbs had not been made according to specification, and APS had not allowed it to inspect the bulbs before shipping. In an earlier Mauritian court hearing, an officer of APS had stated that the goods would not be shipped until CEB had had an opportunity to inspect them. It later transpired that, when he made that statement, the goods were already on ship. CEB argued that the fraud exception applied. It sought an injunction to prevent the issuing bank paying APS under the credit.

The test applied in the Mauritian courts

The trial judge granted the injunction after finding "a serious prima facie arguable case that there might be an attempt to defraud". The Mauritius Court of Appeal affirmed this ruling.

The Privy Council's significantly more stringent test

APS appealed to the Privy Council arguing it had not acted fraudulently and that the Mauritian courts had applied too low a test for the fraud exception. The Privy Council agreed, and allowed the appeal. It characterised the dispute as a contractual one between APS and CEB, which did not affect the bank's obligations under the credit. The factors the Privy Council cited in deciding that the fraud exception did not apply included:

• there was no evidence the bank knew APS was acting fraudulently; and
• to the extent there was any fraud on the part of APS (on which the Privy Council did not opine), there was no suggestion it related to its presentation of documents to the bank.

It also clarified that the correct, and "significantly more stringent", test for the award of a pre-trial injunction to prevent payment on the basis of the fraud exception is that:

"... it must be clearly established at the interlocutory stage that the only realistic inference is (a) that the beneficiary could not honestly have believed in the validity of its demands under the letter of credit and (b) that the bank was aware of the fraud."

Even where this is established the court will consider further if, on the balance of convenience, an injunction directing the bank not to pay under the credit is justified. The Privy Council agreed with APS that the balance of convenience "will almost always militate against the grant of an injunction".

Conclusion

This should be reassuring for banks as well as applicants and beneficiaries of LCs. The commercial utility of documentary credits depends on there being certainty in English law on the autonomy principle and on the tests for invoking the exceptions to that principle.

Law stated as at 11 December 2014.

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.