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Standby Letter of Credit: stringent approach in establishing fraud exception

  • Hong Kong
  • Other

14-02-2017

In the recent case of Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017] EWCA Civ 9, the UK Court of Appeal considered the validity of a presentation under a standby letter of credit (“SBLC”) and the fraud exception.

Background

Petrosaudi Oil Services (Venezuela) Ltd (“POS”) provided certain services to PDV (a Venezuelan state entity) under a service contract which was governed by Venezuelan law. To secure receipt of payment under the service contract, a bank (“Issuing Bank”) was requested to issue a SBLC in favour of POS. The SBLC was governed by English law. The SBLC specifies the following wording which is required to be stated by POS in its demand to be presented under the SBLC:

“We certify that the applicant is obligated to the beneficiary….to pay the amount demanded under [the service contract].”

POS and PDV were later in dispute about the invoices issued by POS pursuant to the service contract and the payment obligation of PDV under those invoices. The parties went to arbitration and there were complicated arguments and arbitral decisions. In any event, no arbitral decision was given in favour of POS with the effect that PDV was ordered to pay POS immediately. POS then issued and presented a demand in the above wording under the SBLC. PDV applied for an injunction order restraining the Issuing Bank from making payment under the SBLC.

Fraud exception inapplicable

The special feature in this case is that under Venezuelan law there is certain legislation which (as accepted by the court) has the effect that no payment will be made under the service contract until certain procedure has been carried out. Based on that, it was submitted to the court that the issuance and presentation of the demand in such wording by POS was false/fraudulent and therefore no payment should be made under the SBLC.

The court took a practical approach to resolve this issue. The court considered the two status relating to a payment obligation: 1) a liability to pay; and 2) an immediate obligation to discharge that liability. The court was in favour of the view that “obligated to pay” refers to a liability to pay notwithstanding that there is no immediate obligation to discharge that liability by the obligor until certain procedure has been carried out, such as the procedure provided by the relevant Venezuelan law in this case. There was also no arbitral decision that PDV was not obligated to pay in the circumstances. In view of these, the court ruled that that the issuance of the demand by POS in such wording was not fraudulent in any sense.

Comment

While it is sensible to maintain the concept of fraud exception to prevent a fraudulent beneficiary from obtaining payment under a standby letter of credit, it should not be easily invoked in reality as the autonomy of a standby letter of credit is important for commercial transactions. This case is an illustration of the stringent approach adopted by UK courts if a paying party intends to rely on the fraud exception.

Read the full judgment here

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