One of the recognised, but limited, exceptions to the obligations of an Issuing Bank or a Confirming Bank to make payments under an irrevocable letter of credit is where the bank is aware that the beneficiary of the credit is acting fraudulently in presenting documents under it.
This "fraud exception" caused a problem for a bank which had accepted documents, discounted a deferred payment and paid the proceeds early to a beneficiary under a deferred payment letter of credit in the English case of Banco Santander SA v Bayfern Ltd (2000). A fraud was discovered between the acceptance of the documents and the date the deferred payment was actually due under the credit. The discounting bank was also the Confirming Bank under the credit. It sought reimbursement from the Issuing Bank, but the court held it was doing so as the assignee of the fraudulent beneficiary (which had assigned its rights to payment under the credit). As a result, the Issuing Bank was entitled to refuse to pay.
However, it was considered that the Issuing Bank could not have refused to pay if a negotiable instrument (a bill of exchange) had been required as the means of payment under the credit and the Confirming Bank had accepted it and held it until maturity when it would have been discharged under s61 of the English Bills of Exchange Act 1882. A French court has since taken a different view as far as French law is concerned in the case of Credit Lyonnais v Canara Bank International Division (2005). It held that, unless a draft (i.e. negotiable instrument) is presented by a third party holder in good faith who is not a party to the credit, then defences arising under the credit (such as notice of fraud) can be asserted against the holder.
Both cases referred to the terms of the ICC Uniform Customs and Practice for Documentary Credits (1993 Revision) – UCP 500, which were incorporated by reference in the relevant letters of credit but which did not assist the Confirming Bank’s position. Perhaps this problem will be dealt with when these rules are next revised.
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