Bank of Nova Scotia v. Angelica-Whitewear Ltd.

Bank of Nova Scotia v. Angelica-Whitewear Ltd.
Collection
Supreme Court Judgments
Date
1987-03-05
Report
[1987] 1 SCR 59
Case number
17632
Judges
Beetz, Jean; Estey, Willard Zebedee; Chouinard, Julien; Le Dain, Gerald Eric; La Forest, Gérard V.
On appeal from
Quebec
Subjects
Financial institutions
Notes
SCC Case Information: 17632
Decision Content
Bank of Nova Scotia v. Angelica‑Whitewear Ltd., [1987] 1 S.C.R. 59
Bank of Nova Scotia Appellant
v.
Angelica‑Whitewear Ltd. and Angelica Corporation Respondents
indexed as: bank of nova scotia v. angelica‑whitewear ltd.
File No.: 17632.
1985: March 11; 1987: March 5.
Present: Beetz, Estey, Chouinard*, Le Dain and La Forest JJ.
*Chouinard J. took no part in the judgment.
on appeal from the court of appeal for quebec
Banks and banking operations ‑‑ Letters of credit ‑‑ Bank's obligation to pay on presentation of draft ‑‑ Fraud exception ‑‑ Scope and availability of exception ‑‑ Proof of the fraud required to relieve a bank of its obligation ‑‑ Whether fraud sufficiently established to require the bank to refuse payment.
Banks and banking operations ‑‑ Letters of credit ‑‑ Bank's obligation to pay on presentation of draft ‑‑ Rule of documentary compliance ‑‑ Discrepancies on the face of documents accompanying the draft ‑‑ Whether draft improperly paid by the bank.
At the request of the predecessor of the respondent Angelica‑Whitewear Ltd. ("Whitewear"), the appellant opened an irrevocable letter of credit in favour of a foreign supplier, Protective Clothing Co. ("Protective"), to cover the full invoice cost of men's industrial uniforms sold by Protective to Whitewear C.I.F. Montreal. The documents to accompany a draft under the letter of credit included an inspection certificate signed by one of the partners of Protective. The letter of credit was a negotiation credit that included an undertaking to honour drafts presented with conforming documents by a negotiating bank. The agreement between the appellant and Whitewear respecting the letter of credit incorporated the Uniform Customs and Practice for Documentary Credits (1962 Revision).
Whitewear took issue with the payment of two drafts which were presented for payment under the letter of credit by the negotiating bank, Shanghai Commercial Bank Ltd. ("Shanghai Commercial"), Protective's bank in Hong Kong. The first draft for Protective invoice SS/3 was paid by the appellant on July 26, 1974 and charged to Whitewear's account. On August 2, 1974, upon receipt of the documents that had been tendered with the draft, Whitewear informed the appellant that the signature on the inspection certificate accompanying the draft had been forged. A few days later, Whitewear drew the appellant's attention to certain "discrepancies" on the face of the documents accompanying the second draft for Protective invoice 0014, which had been negotiated by Shanghai Commercial on July 30. The discrepancies, which, according to Whitewear, constituted documentary non‑compliance with the terms and conditions of the letter of credit requiring the appellant to refuse payment of the draft for invoice 0014, were the following: (a) the inspection certificate referred to a letter of credit of Shanghai Commercial instead of the appellant's letter of credit; (b) the quantity of merchandise shown in the inspection certificate (1149‑11/12 dozen) did not correspond to the quantity shown in invoice 0014 (1144‑11/12 dozen); and (c) the bills of lading accompanying the draft for invoice 0014 called for freight prepaid delivery to Vancouver, whereas the letter of credit stipulated that shipment was to be C.I.F. Montreal. Whitewear also alleged that the appellant was informed before payment of the second draft that the prices in invoice 0014 had been fraudulently inflated. Despite being called on by Whitewear to refuse payment of the draft for invoice 0014, the appellant, after repeated demands for payment from Shanghai Commercial, paid the draft on October 30, 1974 and debited Whitewear's account.
In October 1975, the appellant instituted an action against both respondents (Angelica Corporation had guaranteed Whitewear's liabilities to the appellant) for the balance owing on a promissory note representing Whitewear's outstanding indebtedness to the appellant. In defence, Whitewear contended that the drafts had been improperly paid by the appellant and made a cross‑demand in damages. The damages consisted of the amount of the first draft and the amount by which the prices in invoice 0014 were allegedly inflated. The Superior Court maintained appellant's action and dismissed Whitewear's cross‑demand. Respondents then only appealed the portion of the judgment in respect of the alleged inflated price in invoice 0014. The Court of Appeal allowed the appeal. The Court upheld respondents' contention based on fraud, but did not deal with the contention based on documentary non‑compliance with the terms and conditions of the letter of credit.
Held: The appeal should be dismissed.
An issuing bank is obliged to honour a draft under a documentary letter of credit when it is accompanied by documents which appear on their face to be regular and in accordance with the terms and conditions of the credit. This obligation is independent of the performance of the underlying contract for which the credit was issued. The issuing bank agrees to pay upon presentation of documents, not goods. There is an exception to this rule: a bank should not pay where a fraud by the beneficiary of the credit has been sufficiently brought to its knowledge before payment of the draft or demonstrated to a court called on by the customer of the bank to issue an interlocutory injunction to restrain the bank from honouring the draft.
(1) The Fraud Exception
The fraud exception to the autonomy of documentary letters of credit should not be confined to cases of fraud in the tendered documents but should include fraud in the underlying transaction of such a character as to make the demand for payment under the credit a fraudulent one. The exception, however, should be limited to fraud by the beneficiary of a credit and should not extend to fraud by a third party of which the beneficiary is innocent. It should also not be opposable to the holder in due course of a draft on a letter of credit. Finally, a strong prima facie case of fraud would be a sufficient test on an application for an interlocutory injunction to restraint payment under a letter of credit on the ground of fraud by the beneficiary of the credit. But where, in a case like this one, no such application was made and the issuing bank has had to exercise its own judgment as to whether or not to honour a draft, it must be shown, to demonstrate that a draft was improperly paid by the issuing bank after notice of alleged fraud by the beneficiary, that the fraud was sufficiently established to the knowledge of the issuing bank before payment of the draft as to make the fraud clear or obvious to the bank.
In the present case, the respondents' contention based on the fraud exception to the autonomy of a documentary credit must fail. The evidence did not support a finding that the alleged fraud with respect to the prices in invoice 0014 was sufficiently established to the knowledge of the appellant before payment of the draft. The evidence adduced referred mainly to the discrepancies appearing on the face of the documents tendered with the draft and there was no specific reference to the alleged inflation of price in invoice 0014.
Appellant's knowledge of the fraud with respect to the prices or quality of the goods covered by invoice SS/3, as well as the forgery of the signature on the inspection certificate accompanying that invoice, had no bearing on the question whether it had knowledge of the alleged fraud with respect to invoice 0014. Whitewear had ample opportunity to inform the appellant of the alleged irregularities with respect to invoice 0014 and it took steps to do so. There was therefore no reason for appellant to make any inquiry or to act on any assumptions concerning the shipment covered by invoice 0014 by reason of what it had been informed concerning the prior shipment covered by invoice SS/3. It was entitled to assume that it had been fully informed of all the alleged irregularities with respect to invoice 0014.
(2) The Rule of Documentary Compliance
The rule of strict documentary compliance requires not only that the tendered documents appear on their face, upon reasonably careful examination, to conform to the terms and conditions of the letter of credit but that they also appear to be consistent with one another, particularly in the sense that they refer to the same shipment of goods. The rule of strict documentary compliance does not extend to minor variations or discrepancies that are not sufficiently material to justify a refusal of payment.
In the case at bar, the two discrepancies on the face of the inspection certificate were not grounds for concluding that the draft was improperly paid by the appellant. First, there was a sufficient indication on the face of the inspection certificate that it related to the same parcel or shipment of goods as that referred to in invoice 0014. Second, the inconsistency in respect of quantity between the inspection certificate and the invoice was not of sufficient materiality to justify a refusal of payment since the quantity specified in the invoice was the one for which the buyer was being charged.
The appellant, however, was not obliged and was not authorized to accept the documents and pay the draft for invoice 0014 because of the discrepancy with respect to prepaid freight and continuous documentary cover to destination on the face of the bills of lading. This was a documentary non‑compliance with the terms and conditions of the letter of credit that required the appellant to refuse acceptance of the documents and payment of the draft at the time they were tendered. The appellant was not relieved of this obligation by the fact that the goods may have been transported to destination at no additional charge to Whitewear. A documentary non‑compliance cannot be cured by the actual performance of the underlying contract.
The fact that Whitewear was not prejudiced by the discrepancy, in the sense that its loss in respect of the goods was not directly attributable to it, is immaterial. It is not necessary for the applicant for a documentary credit to show that he is prejudiced by a particular documentary non‑compliance with the terms and conditions of the credit, just as it is not for an issuing bank or the courts to question the necessity or reasonableness of a particular documentary requirement stipulated by the buyer.
The claim of Whitewear is for recovery of part of the amount debited to its account pursuant to the improper payment of the draft for invoice 0014. In the circumstances, it was not precluded from such recovery by its acceptance of the goods under protest and the disposal of them in order to minimize the loss. Nor was it obliged to reimburse the appellant for the payment of the draft by reason of an exemption clause in the agreement respecting the letter of credit.
Cases Cited
Considered: Edward Owen Engineering Ltd. v. Barclays Bank International Ltd., [1978] 1 All E.R. 976; United City Merchants (Investments) Ltd. v. Royal Bank of Canada, [1983] 1 A.C. 168; Sztejn v. J. Henry Schroder Banking Corp., 31 N.Y.S.2d 631 (1941); Guaranty Trust of New York v. Van den Berghs, Ltd. (1925), 22 Ll. L. Rep. 447; referred to: Intraworld Industries, Inc. v. Girard Trust Bank, 336 A.2d 316 (1975); New York Life Insurance Co. v. Hartford National Bank & Trust Co., 378 A.2d 562 (1977); First Arlington National Bank v. Stathis, 413 N.E.2d 1288 (1980); Foreign Venture Ltd. Partnership v. Chemical Bank, 399 N.Y.S.2d 114 (1977); Dynamics Corp. of America v. Citizens & Southern National Bank, 356 F. Supp. 991 (1973); NMC Enterprises, Inc. v. Columbia Broadcasting System, Inc., 14 UCC Rep. 1427 (1974); United Bank Ltd. v. Cambridge Sporting Goods Corp., 360 N.E.2d 943 (1976); Itek Corp. v. First National Bank of Boston, 511 F. Supp. 1341 (1981); Rockwell International Systems, Inc. v. Citibank, N.A., 719 F.2d 583 (1983); Malas v. British Imex Industries, Ltd., [1958] 1 All E.R. 262; Discount Records Ltd. v. Barclays Bank Ltd., [1975] 1 All E.R. 1071; R. D. Harbottle (Mercantile) Ltd. v. National Westminster Bank Ltd., [1977] 2 All E.R. 862; European Asian Bank A.G. v. Punjab and Sind Bank, [1983] 1 Lloyd's Rep. 611; Lumcorp Ltd. v. Canadian Imperial Bank of Commerce, [1977] C.S. 993; Aspen Planners Ltd. v. Commerce Masonry & Forming Ltd. (1979), 100 D.L.R. (3d) 546; C.D.N. Research & Developments Ltd. v. Bank of Nova Scotia (1980), 18 C.P.C. 62; Henderson v. Canadian Imperial Bank of Commerce (1982), 40 B.C.L.R. 318; Rosen v. Pullen (1981), 126 D.L.R. (3d) 62; Canadian Pioneer Petroleums Inc. v. Federal Deposit Insurance Corp. (1984), 30 Sask. R. 315; Phoenix Conveyer and Belting Systems Inc. v. Speed King Manufacturing Co. (1985), 37 Man. R. (2d) 84; Etablissement Esefka International Anstalt v. Central Bank of Nigeria, [1979] 1 Lloyd's Rep. 445; Urquhart Lindsay & Co. v. Eastern Bank, Ld., [1922] 1 K.B. 318; English, Scottish and Australian Bank Ltd. v. Bank of South Africa (1922), 13 Ll. L. Rep. 21; Equitable Trust Co. of New York v. Dawson Partners, Ltd. (1926), 27 Ll. L. Rep. 49; Gian Singh & Co. v. Banque de l'Indochine, [1974] 2 All E.R. 754; J. H. Rayner & Co. v. Hambro's Bank, Ld., [1943] K.B. 37; Davis O'Brien Lumber Co. v. Bank of Montreal, [1951] 3 D.L.R. 536; Bank of America Nat. Trust & Savings Ass'n v. Liberty Nat. Bank & Trust Co. of Oklahoma City, 116 F. Supp. 233 (1953); Moralice (London), Ltd. v. E. D. & F. Man., [1954] 2 Lloyd's Rep. 526; Soproma S.p.A. v. Marine & Animal By‑Products Corp., [1966] 1 Lloyd's Rep. 367; Margaronis Navigation Agency Ltd. v. Henry W. Peabody & Co. of London Ltd., [1965] 2 Q.B. 430; Midland Bank, Ltd. v. Seymour, [1955] 2 Lloyd's Rep. 147; Banque de l'Indochine et de Suez S.A. v. J. H. Rayner (Mincing Lane) Ltd., [1982] 2 Lloyd's Rep. 476, aff'd [1983] 2 Lloyd's Rep. 228; Bank of Montreal v. Recknagel, 109 N.Y. 482 (1888); Camp v. Corn Exchange Nat. Bank, 132 A. 189 (1926); Orient Co. v. Brekke & Howlid, [1913] 1 K.B. 531; Michael Doyle & Associates Ltd. v. Bank of Montreal (1982), 140 D.L.R. (3d) 596; Hansson v. Hamel & Horley, Ld., [1922] 2 A.C. 36; Holland Colombo Trading Society, Ltd. v. Segu Mohamed Khaja Alawdeen, [1954] 2 Lloyd's Rep. 45.
Statutes and Regulations Cited
Civil Code, art. 1073, 1074, 1075, 1140.
Uniform Commercial Code, s. 5‑114(2).
Authors Cited
Chitty on Contracts, vol. II, 25th ed. London: Sweet & Maxwell, 1983.
Davis, Arthur Geoffrey. The Law Relating to Commercial Letters of Credit, 2nd ed. London: Isaac Pitman & Sons, Ltd., 1954.
Ellinger, E. P. Documentary Letters of Credit. Singapore: University of Singapore Press, 1970.
Ellinger, E. P. "Fraud in Documentary Credit Transactions," [1981] J.B.L. 258.
Ellinger, E. P. "The Tender of Fraudulent Documents Under Documentary Letters of Credit" (1965), 7 Malaya L. Rev. 24.
Encyclopédie juridique Dalloz: Répertoire de droit commercial, t. II, 2e éd. Rubrique "Crédit documentaire". Paris: Dalloz, 1972.
Gutteridge, Harold Cooke and Maurice Megrah. The Law of Bankers' Commercial Credits, 7th ed. London: Europa Publications Ltd., 1984.
Harfield, Henry. Bank Credits and Acceptances, 5th ed. New York: Ronald Press Co., 1974.
Harfield, Henry. Letters of Credit. Philadelphia: American Law Institute‑‑American Bar Association, Committee on Continuing Professional Education, 1979.
Kozolchyk, Boris. Commercial Letters of Credit in the Americas. New York: Matthew Bender & Co., 1966.
Note. "Fraud in the Transaction": Enjoining Letters of Credit During the Iranian Revolution" (1980), 93 Harv. L. Rev. 992.
Pomerleau, Manon. "La fraude du bénéficiaire du crédit documentaire irrévocable‑‑étude comparative en droit commercial international" (1984), 44 R. du B. 113.
Sarna, Lazar. Letters of Credit: The Law and Current Practice, 2nd ed. Toronto: Carswells, 1986.
Stoufflet, Jean. Le crédit documentaire. Paris: Librairies Techniques, 1957.
Uniform Customs and Practice for Documentary Credits (1962 Revision), art. 3, 7, 8, 9.
Uniform Customs and Practice for Documentary Credits (1974 Revision), art. 7.
Uniform Customs and Practice for Documentary Credits (1983 Revision), art. 15.
Van Houten, Stephen H. "Letters of Credit and Fraud: A Revisionist View" (1984), 62 Can. Bar Rev. 371.
APPEAL from a judgment of the Quebec Court of Appeal, [1985] C.A. 718, 31 B.L.R. 155, allowing respondents' appeal from a judgment of Nolan J., allowing appellant's action and dismissing Angelica‑Whitewear Ltd.'s cross‑demand. Appeal dismissed.
Allan R. Hilton, for the appellant.
Mitchell Klein and Josée Gravel, for the respondents.
The judgment of the Court was delivered by
1. Le Dain J.‑‑This appeal involves a claim by a customer against a bank to recover an amount debited to the customer's account for the payment of a draft under a documentary letter of credit. The customer contends that the bank was not entitled to debit its account because the bank was not obliged to pay the draft, and should not have paid it, for two reasons: (a) the bank had notice prior to payment of the draft that the beneficiary of the credit had fraudulently inflated the prices in the invoice accompanying the draft; and (b) the documents tendered with the draft were not on their face in accordance with the terms and conditions of the credit. The issues raised by the appeal thus involve consideration of the fraud exception to the autonomy of documentary credits and the requirement of strict documentary compliance with the terms and conditions of a credit.
2. The appeal is by leave of this Court from the judgment of the Quebec Court of Appeal on March 3, 1983, [1985] C.A. 718, 31 B.L.R. 155, allowing an appeal from the judgment of the Superior Court for the District of Montreal on February 28, 1978 and maintaining, in an action on a promissory note by the appellant bank against the respondents, the cross‑demand of the respondent Angelica‑Whitewear Ltd. for damages in the amount of $19,045.57.
I
3. At the request of Whitewear Manufacturing Co. Ltd., the predecessor of the respondent Angelica‑Whitewear Ltd. (both of which will hereinafter be referred to as "Whitewear"), the branch of the appellant Bank of Nova Scotia ("the Bank") at St. Catherine and Peel Streets, Montreal, opened an irrevocable letter of credit No. 1/50021 dated November 13, 1973 in favour of Protective Clothing Company ("Protective"), a Hong Kong company owned in equal partnership by a Mr. Jack Davis and a Mr. Elmer Wong. The letter of credit was for a total amount of US $350,000 to cover the full invoice cost of men's industrial uniforms sold by Protective to Whitewear C.I.F. Montreal. Shipment was to be from Taiwan to Montreal. Third party shipment, partial shipments and transhipment were to be permitted. Drafts under the letter of credit were to be accompanied by the following documents:
1. Full set clean on board Ocean Bills of Lading to order of The Bank of Nova Scotia marked notify Whitewear Mfg. Co. Ltd., 1421 Montcalm St., Montreal 132, Quebec.
2. Commercial Invoice in three copies.
3. Canadian Customs Invoice in six copies, showing fair market value at the time and place of shipment in the currency of the country of export.
4. Insurance Policy or certificate in negotiable form in duplicate.
5. Inspection Certificate in triplicate signed by Jack Davis, B31 form with every shipment in excess of $10,000.
The letter of credit was a negotiation credit that included an undertaking to honour drafts presented with conforming documents by a negotiating bank. The agreement between Whitewear and the Bank respecting the letter of credit provided that the Uniform Customs and Practice for Documentary Credits (1962 Revision) (hereinafter referred to as the "Uniform Customs (1962)") were to be incorporated as part of the agreement and to apply to the credit.
4. Whitewear's claim arose out of the payment of two drafts which were presented for payment under the letter of credit by the negotiating bank, Shanghai Commercial Bank Ltd. ("Shanghai Commercial"), Protective's bank in Hong Kong: a draft in the amount of US $107,061.60 for Protective invoice SS/3 dated July 17, 1974 and a draft in the amount of US $67,480.85 for Protective invoice 0014 dated July 27, 1974. Shanghai Commercial had financed the purchase by Protective from its Taiwan supplier of the goods for sale to Whitewear, taking the Bank's letter of credit as security. In the case of the goods covered by invoice 0014 Shanghai Commercial had opened a back‑to‑back letter of credit D‑72519 in favour of the supplier. Upon receipt of the documents required by the Bank's letter of credit Shanghai Commercial credited Protective with the amount of its invoice to Whitewear and presented the draft for that amount, with the accompanying documents, to the New York agency of the Bank for payment.
5. Shanghai Commercial paid Protective the amount of US $107,061.60 for invoice SS/3 on July 18, 1974. The draft for that amount was paid by the New York agency of the Bank on July 26, and Whitewear's account was debited for that amount on July 29. Whitewear received the debit memo with the documents that had been tendered with the draft on August 2. On that day Mrs. Marion Stern, an officer of Whitewear, learned from Mr. Jack Davis of Protective that his signature on the inspection certificate accompanying invoice SS/3 had been forged, and she immediately informed Mrs. Carol Pichette, the assistant accountant at the St. Catherine and Peel Streets branch of the Bank. By cable the same day the Bank advised Shanghai Commercial with reference to the draft for US $107,061.60 as follows: ''SHIPMENT FRAUDULENT SIGNATURE FORGED ON CERTIFICATE OF INSPECTION PLEASE WITHHOLD FURTHER PAYMENTS....'' By telex on August 8, 1974 Shanghai Commercial advised the Bank that the draft for US $67,480.85 in respect of invoice 0014 had been negotiated on July 30. Shanghai Commercial further advised that it had been unable to contact Mr. Elmer Wong, the other partner of Protective.
6. In telephone conversations in early August with Mrs. Pichette and Mr. Fernand Montpellier, the manager of the St. Catherine and Peel Streets branch of the Bank, and in a meeting with the Bank's solicitor, Mrs. Stern drew the Bank's attention to certain "discrepancies" on the face of the documents accompanying the draft for US $67,480.85. Whitewear also alleges that the Bank was informed before payment of the draft that the prices in invoice 0014 had been fraudulently inflated by the amount of $19,045.57, but this allegation is denied by the Bank. The discrepancies on the face of the documents tendered with the draft for invoice 0014 which are said to be in breach of the requirement of documentary compliance with the terms and conditions of the letter of credit are the following: (a) the inspection certificate refers to the letter of credit D‑72519 of Shanghai Commercial instead of the Bank's letter of credit; (b) the quantity of merchandise shown in the inspection certificate (1149‑11/12 dozen) does not correspond to the quantity shown in invoice 0014 (1144‑11/12 dozen); and (c) the bills of lading accompanying the draft for invoice 0014 call for freight prepaid delivery at Vancouver, whereas the letter of credit stipulates that shipment is to be C.I.F. Montreal.
7. By letter dated August 8, 1974 the solicitors of Whitewear informed the Bank that Whitewear intended to hold the Bank liable for payment of the draft in the amount of US $107,061.60 for Protective invoice SS/3 and that it would hold the Bank liable if it honoured the draft in the amount of US $67,480.85 for invoice 0014. After repeated demands by Shanghai Commercial for payment of the draft for US $67,480.85, the Bank, acting on the advice of its own solicitors, instructed its New York agency on October 29, 1974 to pay the draft. It was paid on October 30, and Whitewear's account was debited for the amount of the draft on November 6.
8. On October 2, 1975 the Bank instituted an action against Whitewear and the other respondent, Angelica Corporation (which had guaranteed payment of Whitewear's liabilities to the Bank), for the balance owing on a promissory note representing the outstanding indebtedness of Whitewear to the Bank. In its plea to the action Whitewear contended that it had been improperly charged by the Bank for a total of $126,106.17 in respect of the drafts for invoices SS/3 and 0014, and it made a cross‑demand in damages for this amount. The total of $126,106.17 was made up of $107,061.60, the amount of the draft in respect of invoice SS/3, and the amount by which the prices in invoice 0014 were allegedly inflated, shown in the plea as $19,044.57, but in fact $19,045.57.
9. In the Superior Court Nolan J. (as he then was) maintained the Bank's action and dismissed Whitewear's cross‑demand with costs. He rejected both the contention based on fraud and the contention based on documentary non‑compliance with the terms and conditions of the letter of credit. Whitewear did not appeal from the judgment in respect of the amount of $107,061.60 for invoice SS/3, but only in respect of the amount of $19,045.57 for the alleged inflation of price in invoice 0014. The Court of Appeal (Turgeon, Kaufman and Monet JJ.A.) allowed Whitewear's appeal for this amount, or to be exact, for the amount of $19,045.50. Monet J.A., who delivered the unanimous judgment of the Court of Appeal, upheld Whitewear's contention based on fraud, but did not deal with the contention based on documentary non‑compliance with the terms and conditions of the letter of credit.
II
10. The fundamental principle governing documentary letters of credit and the characteristic which gives them their international commercial utility and efficacy is that the obligation of the issuing bank to honour a draft on a credit when it is accompanied by documents which appear on their face to be in accordance with the terms and conditions of the credit is independent of the performance of the underlying contract for which the credit was issued. Disputes between the parties to the underlying contract concerning its performance cannot as a general rule justify a refusal by an issuing bank to honour a draft which is accompanied by apparently conforming documents. This principle is referred to as the autonomy of documentary credits. It is reflected in general provision c. of the Uniform Customs (1962), which states: "Credits, by their nature, are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts." It is further reflected in Article 8 of the Uniform Customs (1962), which reads: "In documentary credit operations all parties concerned deal in documents and not in goods." Article 3 of the Uniform Customs (1962) defines the obligation of the issuing bank to the beneficiary of the credit as follows: "An irrevocable credit is a definite undertaking on the part of an issuing bank and constitutes the engagement of that bank to the beneficiary or, as the case may be, to the beneficiary and bona fide holders of drafts drawn and/or documents presented thereunder, that the provisions for payment, acceptance or negotiation contained in the credit will be duly fulfilled, provided that all the terms and conditions of the credit are complied with." A bank's duty of verification with respect to documentary compliance is defined by Article 7 of the Uniform Customs (1962) as follows: "Banks must examine all documents with reasonable care to ascertain that they appear on their face to be in accordance with the terms and conditions of the credit." The general rule with respect to fraud is that a bank is not responsible for payment against forged or false documents which appear on their face to be regular, as indicated in Article 9 of the Uniform Customs (1962), which provides in part: ``Banks assume no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any documents, or for the general and/or particular conditions stipulated in the documents....'' The same principles are embodied in the 1974 and 1983 revisions of the Uniform Customs and Practice for Documentary Credits.
11. An exception to the general rule that an issuing bank is obliged to honour a draft under a documentary credit when the tendered documents appear on their face to be regular and in conformity with the terms and conditions of the credit has been recognized for the case of fraud by the beneficiary of the credit which has been sufficiently brought to the knowledge of the bank before payment of the draft or demonstrated to a court called on by the customer of the bank to issue an interlocutory injunction to restrain the bank from honouring the draft. The scope and availability in practice of the fraud exception to the autonomy of documentary credits have turned on several questions, of which the most important would appear to be the following: (a) the kinds of fraud that should be recognized as falling within the fraud exception, or more specifically, whether the exception should be confined to cases of forged or false documents or whether it should extend to fraud in the underlying transaction; (b) the related question of the proof or demonstration of fraud that should be required to relieve an issuing bank of its obligation to honour a draft or to warrant the issue of an interlocutory injunction to enjoin it from doing so; (c) whether the fraud exception should be opposable to a holder in due course of a draft, that is, one who took the draft for value and without notice of the fraud; and (d) whether the fraud exception should be confined to fraud by the beneficiary of a credit, or whether it should include fraud by a third party which affects the letter of credit transaction but of which the beneficiary of the credit is innocent. Differences of view or emphasis with respect to these issues, particularly the kind of fraud and proof required, reflect the tension between the two principal policy considerations: the importance to international commerce of maintaining the principle of the autonomy of documentary credits and the limited role of an issuing bank in the application of that principle; and the importance of discouraging or suppressing fraud in letter of credit transactions. The potential scope of the fraud exception must not be a means of creating serious uncertainty and lack of confidence in the operation of letter of credit transactions; at the same time the application of the principle of autonomy must not serve to encourage or facilitate fraud in such transactions. The relative emphasis on the one or other of these two considerations tends to explain what have been characterized as the strict and more liberal approaches to the availability of the fraud exception, each of which has had its judicial and academic adherents. For an interesting analysis of the issues, reflecting an apparent change of view over a period of some fifteen years, see E. P. Ellinger, "The Tender of Fraudulent Documents Under Documentary Letters of Credit" (1965), 7 Malaya L. Rev. 24, and "Fraud in Documentary Credit Transactions," [1981] J.B.L. 258. I propose to make brief reference to American, English and Canadian cases which have considered these issues. Most of the cases have involved an application for a preliminary or interlocutory injunction to restrain an issuing bank from paying under a letter of credit or guarantee. Few, if any, have had to address the precise issue raised by this appeal: what the customer or applicant for the credit must show, where there has not been an application for injunction, to justify a conclusion that an issuing bank was not obliged to pay a draft under a letter of credit because of its prior knowledge of fraud by the beneficiary, and that its payment of the draft was therefore an improper or unauthorized one for which the customer was not obliged to reimburse the bank.
12. It is generally acknowledged that the fraud exception to the autonomy of documentary credits was first recognized by American courts and that the leading case is Sztejn v. J. Henry Schroder Banking Corp., 31 N.Y.S.2d 631 (S.C. 1941). There the question arose on a motion to dismiss a complaint to enjoin the issuing bank from paying a draft under a letter of credit on the ground that the complaint did not set forth a cause of action. The allegations of the complaint had therefore to be taken as established for purposes of the motion to dismiss. The fraud alleged was that instead of the goods ordered and described in the bill of lading and invoices accompanying the draft the seller beneficiary of the credit had shipped worthless material and rubbish. Shientag J. stated the principle of autonomy as follows at p. 633:
It is well established that a letter of credit is independent of the primary contract of sale between the buyer and the seller. The issuing bank agrees to pay upon presentation of documents, not goods. This rule is necessary to preserve the efficiency of the letter of credit as an instrument for the financing of trade. One of the chief purposes of the letter of credit is to furnish the seller with a ready means of obtaining prompt payment for his merchandise. It would be a most unfortunate interference with business transactions if a bank before honoring drafts drawn upon it was obliged or even allowed to go behind the documents, at the request of the buyer and enter into controversies between the buyer and the seller regarding the quality of the merchandise shipped.
He distinguished the case before him as one involving fraud by the beneficiary of the credit as follows at p. 634:
This is not a controversy between the buyer and seller concerning a mere breach of warranty regarding the quality of the merchandise; on the present motion, it must be assumed that the seller has intentionally failed to ship any goods ordered by the buyer. In such a situation, where the seller's fraud has been called to the bank's attention before the drafts and documents have been presented for payment, the principle of the independence of the bank's obligation under the letter of credit should not be extended to protect the unscrupulous seller.
It is not clear whether Sztejn was, or should have been, regarded by the court as a case of false documents or a case of fraud in the underlying transaction, although the latter is probably the better view. The bill of lading and invoices correctly described the goods called for by the contract of sale, but the fraud consisted of the failure to ship any goods of that kind. The bill of lading and invoices could, however, be regarded as false documents in that they misrepresented the goods that were in fact shipped. With respect to another issue bearing on the scope or availability of the fraud exception, Shientag J. held that despite conflicting opinion he preferred the view that the fraud exception could not be raised against a holder in due course of a draft on a letter of credit. On the allegations of the complaint, however, which had to be taken as true, the bank presenting the draft for payment was a mere agent for collection and not a holder in due course.
13. The fraud exception is now governed in the United States by § 5‑114(2) of the Uniform Commercial Code, which has been adopted, in some cases in a modified form, in almost every state. It applies to both "forged or fraudulent" documents and "fraud in the transaction". The issuer of a credit must honour a draft, despite notification of fraud, when it is presented with apparently conforming documents by one who is in the position of a holder in due course. In other cases of fraud of which the issuer has notice, the issuer has an option, which must be exercised in good faith, as to whether or not to honour the draft, but a court may enjoin it from doing so. There have been various characterizations of the nature of the fraud required to justify an issuing bank in refusing payment of a draft or a court in granting an injunction to restrain such payment. The exception for forged, and generally for false, documents is clear enough. The main area of uncertainty lies in the scope to be given to the exception for "fraud in the transaction". See H. Harfield, Bank Credits and Acceptances (5th ed. 1974), pp. 82‑83, and Letters of Credit (1979), pp. 84‑85, for the view that "fraud in the transaction" should be confined to fraud in the letter of credit transaction or a transaction so intimately related to the letter of credit transaction as to be an implied term of it; and the Note, " ‘Fraud in the Transaction.’: Enjoining Letters of Credit During the Iranian Revolution " (1980), 93 Harv. L. Rev. 992 for a critical evaluation of this view. The required fraud has been described in somewhat vague terms as fraud of sufficient seriousness to destroy the foundation of the letter of credit transaction. Thus in Intraworld Industries, Inc. v. Girard Trust Bank, 336 A.2d 316 (Pa. S.C. 1975), it was said at p. 324: "In light of the basic rule of the independence of the issuer's engagement and the importance of this rule to the effectuation of the purposes of the letter of credit, we think that the circumstances which will justify an injunction against honor must be narrowly limited to situations of fraud in which the wrongdoing of the beneficiary has so vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served." In New York Life Insurance Co. v. Hartford National Bank & Trust Co., 378 A.2d 562 (Conn. S.C. 1977), at p. 567, it was said, quoting this passage from Intraworld Industries, that it would be only in "rare situations of egregious fraud" that the issuer of a credit would be justified in going behind "apparently regular, conforming documents". See also First Arlington National Bank v. Stathis, 413 N.E.2d 1288 (Ill. App. 1980), at p. 1295, where, in addition to quoting the above statements from the Intraworld Industries and New York Life Insurance cases, the court referred to the characterization, in Foreign Venture Ltd. Partnership v. Chemical Bank, 399 N.Y.S.2d 114 (App. Div. 1977), of the exception for "fraud in the transaction" as "a narrow exception". Dynamics Corp. of America v. Citizens & Southern National Bank, 356 F. Supp. 991 (N.D. Ga. 1973); NMC Enterprises, Inc. v. Columbia Broadcasting System, Inc., 14 UCC Rep. 1427 (N.Y.S.C. 1974), and United Bank Ltd. v. Cambridge Sporting Goods Corp., 360 N.E.2d 943 (N.Y.C.A. 1976), in which preliminary injunctions were granted to restrain an issuing bank from paying under a letter of credit on the ground of fraud by the beneficiary, are thought to reflect a less strict view of the fraud exception under § 5‑114. Cf. S. H. Van Houten, "Letters of Credit and Fraud: A Revisionist View" (1984), 62 Can. Bar Rev. 371 at pp. 380‑81. In granting a preliminary injunction to preserve the status quo in Dynamics Corp., the court acknowledged that the issue of fraud would be a difficult one to resolve at trial and said at p. 1000: "It appears to the court that plaintiff has at least a decent chance of winning this suit, and there is as much public interest in discouraging fraud as in encouraging the use of letters of credit." In NMC Enterprises, a preliminary injunction was granted to restrain an issuing bank from honouring a draft under a letter of credit on a prima facie showing of fraud in the "underlying transaction" of sale, which was said to be "tainted with fraud in its inducement." The buyer was induced to enter into the cont