{"id":280260,"date":"2022-12-23T11:00:26","date_gmt":"2022-12-23T05:30:26","guid":{"rendered":"https:\/\/www.scconline.com\/blog\/?p=280260"},"modified":"2022-12-26T10:40:29","modified_gmt":"2022-12-26T05:10:29","slug":"documentary-credits-and-performance-bonds-in-international-trade-two-sides-of-the-same-coin","status":"publish","type":"post","link":"https:\/\/www.scconline.com\/blog\/post\/2022\/12\/23\/documentary-credits-and-performance-bonds-in-international-trade-two-sides-of-the-same-coin\/","title":{"rendered":"Documentary Credits and Performance Bonds in International Trade: Two Sides of the Same Coin?"},"content":{"rendered":"
\n

Introduction<\/h4>\n

International trade may not only involve higher profits but also, high financial risks. Usually, traders part with the goods prior to receiving payments or payments may have been made for goods that are non-conforming. Among other modes of payments, documentary letters of credit facilitate international trade transactions. The fundamental aspects of documentary credits are \u2014 principle of strict compliance and autonomy. Strict compliance, as it applies in the English letter of credit law mandates the banks to examine whether the documents tendered by the beneficiary strictly comply with the letters of credit.1<\/sup><\/a> The autonomy principle is the factor insulating the seller\u2019s rights from the obligation of the bank from the underlying sale contract.2<\/sup><\/a> A similar approach is followed for payment undertakings by means of first demand guarantees and stand-by letters of credit. The disquisition of this article is that like letters of credit, performance bonds (in-principle) are autonomous subject to the exceptions of fraud3<\/sup><\/a> and illegality.4<\/sup><\/a><\/p>\n

Principle of autonomy: In documentary credits and performance bonds<\/h4>\n

By means of a documentary credit, a bank may be substituted with the buyer as the party to guarantee payment to the seller or beneficiary.5<\/sup><\/a> The payment by the bank is for documents tendered as shipment sales do not guarantee delivery of goods.6<\/sup><\/a> While documents represent goods in transit, documentary credits ensure adherence to documentary requirements as security for shipped goods. Banks exercise \u201cautonomy\u201d when making payments for compliant documents. Autonomy under English letter of credit law is \u201c\u2026 independence of the underlying contract from the credit\u201d7<\/sup><\/a> and restricts the obligation to the examination of documents tendered for payment rather than the \u201c\u2026 subject-matter of the underlying contract\u201d. Independence is to the extent that payment against documents is necessary even if goods do not arrive.8<\/sup><\/a> The credit is construed to be autonomous and banks issuing credits assume \u201cabsolute obligation to honour them without investigating the underlying contract\u201d.9<\/sup><\/a> This not only ensures prompt payment to the beneficiary making documentary credits financially attractive and effective. Uniform Customs and Practices for Documentary Credits (UCP) are the standard practices applicable and codified by the International Chamber of Commerce (ICC) of which Articles 4 and 5 enshrine the autonomy principle. It stipulates that \u201ccredits are separate from the underlying contract\u201d. Banks examine only documents \u201con their face\u201d, as per Article 14(a<\/i>), for documents that \u201clook or appear genuine\u201d are compliant by the standard of the bank. Simply put, documents presented to the bank that undertakes to make a payment are required to be \u201cin conformity\u201d with the documents as per the documentary credit. From Article 34, it is understood that banks do not assume liability or responsibility for the genuineness of the documents. While actual genuineness of the documents cannot be tested, this provision ensures documents remain in circulation after all, documents are of commercial value.<\/p>\n

Performance bonds fall within the category of first demand guarantees to secure the seller\u2019s performance, particularly in shipment sales. The seller procures the performance bonds to be provided to the buyer for protection in the event of seller\u2019s non-performance. Simply put, it is an incentive for the seller to discharge the contractual obligations in a sale contract otherwise the buyer may claim payments at the cost of the seller. The distinguishing aspect between an ordinary letter of credit and performance bond is that the buyer (beneficiary) can \u201ccall-in\u201d the guarantee immediately in case the seller fails to perform. Unlike a documentary credit which functions on presentation of documents and strict compliance criteria as a standard of examination by the bank, a performance bond can \u201ctriggered at the simple demand of a buyer\u201d subject to the terms of opening the performance bond.10<\/sup><\/a> This induces a high risk of being left with forged documents. Various academic views such as of Professor C. DeBattista departs from the traditional view of autonomy of the performance bond. He comments that \u201cperformance bonds are default undertakings and essentially, perform a security function rather than that of a primary payment mechanism\u201d11<\/sup><\/a>, suggesting that the comparison with letters of credit is flawed. However, in a more general understanding, performance bonds function on the principles of autonomy and separation in the manner similar to documentary credits. It is noteworthy that operating on \u201csimple demand\u201d without verification or furnishing proof of the seller\u2019s default exposes to abuse from the beneficiary. However, the mechanism of \u201cfirst demand\u201d is premised on immediate payment. The courts interpret the terms of the performance bonds in the literal sense.12<\/sup><\/a> This is the autonomy of the bank\u2019s undertaking to make payment provided the demand by the beneficiary is made as per the terms of the guarantee, even in an event of objection by the seller to the request of the beneficiary.13<\/sup><\/a> The bank\u2019s undertaking for payment upon request is absolute and autonomous, separate from the underlying contract.<\/p>\n

In Edward Own Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>, a fraud allegation was on a performance guarantee which was taken \u201con a similar footing to a letter of credit\u201d.14<\/sup><\/a> It was held that the bank must honour the guarantee irrespective of any dispute between the buyer and the seller, except where \u201cobvious fraud to the knowledge of the bank\u201d. Though the buyer was found to be in breach of the sale contract for failing to open a conforming letter of credit, buyer could receive payment under the bank guarantee and no fraud was established. The threshold for establishing fraud was set very high. Therefore, upholding that performance guarantees are separate from the underlying sale contract.<\/p>\n

The fraud exception<\/h4>\n

The principle of autonomy is subject to the fraud exception where \u201cdocuments on their face complying with the terms and conditions of the credit are presented in furtherance of fraud\u201d.15<\/sup><\/a> Applicable according to the national law, fraud exception to documentary and autonomous guarantees functions alike.16<\/sup><\/a><\/p>\n

Lord Diplock referred to Hamzeh Malas & Sons<\/i> v. British Imex Industries Ltd.<\/i>17<\/sup><\/a> and was of the view that \u201c\u2026\u2026 fraud exception on the part of the beneficiary seeking to avail himself of the credit is a clear application of the maxim ex turpi causa non oritur actio, <\/i>or in plain English, \u2018fraud unravels all\u2019. The courts will not allow their process to be used by a dishonest person to carry out a fraud\u201d.<\/p>\n

The American Accord<\/i> is a seminal decision on fraud as an exception to the bank\u2019s duty for payment against documents compliant \u201con their face\u201d.18<\/sup><\/a> It provides the exception relating to fraudulent documents presented to the bank, within the seller\u2019s knowledge. Excluding fraud on account of a third party, it was held that the exception applied to a beneficiary or to which the beneficiary was a party. Therefore, the extent of the fraud exception was limited to the conduct of the beneficiary only. This does not apply to fraud in the underlying transaction. The court cautioned that the decision is based on public policy, merely as a deterrent to a dishonest person having no implications on the exercise of autonomy in documentary credits, clarifying Lord Diplock\u2019s view that \u201cfraud unravels all\u201d. Not limited to the fraud of the beneficiary, the fraud exception demands the bank (on its own motion) to decline payment to an apparently compliant presentation where the bank has knowledge of the fraud, as per Edward Owen Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>19<\/sup><\/a> Rightly held that the fraud exception to autonomy operates through an implied limitation upon the mandate to the bank under the credit.20<\/sup><\/a><\/p>\n

Proving fraud requires \u201cestablished or obvious fraud\u201d, established very clearly.21<\/sup><\/a> Laid down in Turkiye Is Bankasi AS<\/i> v. Bank of China<\/i>, the test of \u201cseriously arguable fraud\u201d is \u201csignificantly more stringent than a good arguable case\u201d.22<\/sup><\/a> It is most likely that evident forgery will not go unnoticed to a beneficiary when tendering documents as if \u201cgenuine\u201d. It is unfair for the beneficiary to expect the bank to examine whether the allegations it makes on fraud are unfounded or not.23<\/sup><\/a><\/p>\n

To deny the right of reimbursement to a bank, it must be proved that the bank had knowledge of the fraud \u201cat the latest at the time it paid\u201d with clear evidence on the fact of fraud and \u201cestablished or obvious fraud\u201d in the knowledge of the bank.24<\/sup><\/a> However, the bank must pay against apparently complying presentation, in absence of the knowledge of fraud.25<\/sup><\/a><\/p>\n

Banks may refuse payment where the buyer may obtain an injunction.26<\/sup><\/a> American Cyanamid Co.<\/i> v. Ethicon Ltd.<\/i> laid the three-stage test proposing \u2014 evidence of merits, adequacy of damages as alternative remedy and overall, balance of convenience.27<\/sup><\/a> It is trite law that a mere allegation of fraud is not sufficient, and neither should it be vexatious or frivolous. In Alternative Power Solution Ltd.<\/i> v. Central Electricity Board<\/i>, it was held that it must be established clearly that the beneficiary could not have honestly believed in the validity of its demands and the bank was aware of the fraud or the fact.28<\/sup><\/a> This approach establishes that where conforming documents are presented, the bank has an obligation to pay the beneficiary. However, the exception is where documents presented are \u201cclearly fraudulent\u201d.29<\/sup><\/a> Prevention of payments under the autonomous instruments do not find the usual difference in evidential burden between interim proceedings and final trial.30<\/sup><\/a> Therefore, the crucial aspect is how fraud is determined. Amongst all defences, fraud is likely to succeed based upon a high standard of proof.31<\/sup><\/a><\/p>\n

To conclude, Benjamin rightly comments that autonomous undertakings are vital to financing international trade and that a wide basis to the fraud exception can become \u201cthrombosis of the lifeblood of international commerce (credits)\u201d. The objective should be to prevent profit or benefit from one\u2019s own wrongdoing.32<\/sup><\/a> Following Lord Toulson\u2019s view, law should be applied consistently to serve in the interest of justice.33<\/sup><\/a> The equitable remedy of injunctions must be subject to a high standard of proof where there is compelling evidence of fraud for the principle of autonomy must be upheld and protected from excessive court intervention. Wrongdoers often perceive documentary credits as soft or vulnerable targets. Failure to consider that permitting the \u201cfraud exception\u201d, thereby, setting aside the principle of autonomy, makes it an easy target which may be used as a shield. Therefore, the basis of the fraud exception should be public policy.<\/p>\n<\/div>\n

\n

\u2020 Lawyer, BA LLB (Hons.), LLM (Litigation and Dispute Resolution) (University College London). Author can be reached at nigam.tanvi@gmail.com<\/a>.<\/span><\/strong><\/p>\n

1.<\/a> Equitable Trust Co. of New York<\/i> v. Dawson Partners Ltd.<\/i>, 1927 Lloyd\u2019s Rep 49.<\/p>\n

2.<\/a> Power Curber International Ltd.<\/i> v. National Bank of Kuwait SAK<\/i>, (1981) 1 WLR 1233 : (1981) 2 Lloyd\u2019s Rep 394<\/a>.<\/p>\n

3.<\/a> Edward Owen Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>, 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

4.<\/a> Mahonia Ltd.<\/i> v. JP Morgan Chase Bank<\/i>, (2003) 2 Lloyd\u2019s Rep 911.<\/p>\n

5.<\/a> Ali Malek, David Quest et al., Jack: Documentary Credits: The Law and Practice of Documentary Credits including Standby Credits and Demand Guarantees<\/i>, Tottel Pub. (2009).<\/p>\n

6.<\/a> Michael G Bridge<\/a>, Benjamin\u2019s Sale of Goods<\/i>, (Sweet & Maxwell 11th Edn., 2021).<\/p>\n

7.<\/a> Power Curber International Ltd.<\/i> v. National Bank of Kuwait SAK<\/i>, (1981) 1 WLR 1233 : (1981) 2 Lloyd\u2019s Rep 394<\/a>.<\/p>\n

8.<\/a> Gill & Duffus SA<\/i> v. Berger & Co. Inc. (No. 2)<\/i>, (1982) 1 Llyod\u2019s Rep 101.<\/p>\n

9.<\/a> Hamzeh Malas & Sons<\/i> v. British Imex Industries Ltd.<\/i>, (1958) 2 QB 127<\/a> : (1958) 2 WLR 100<\/a>.<\/p>\n

10.<\/a> I.E. Contractors Ltd.<\/i> v. Llyods Bank Plc<\/i>, (1989) 2 Lloyd\u2019s Rep 205.<\/p>\n

11.<\/a> Charles DeBattista, \u201cPerformance Bonds and Letters of Credit: A Cracked Mirror Image\u201d, (1997) 7 Journal of Business Law 289.<\/p>\n

12.<\/a> I.E. Contractors Ltd.<\/i> v. Llyods Bank Plc<\/i>, (1989) 2 Lloyd\u2019s Rep 205.<\/p>\n

13.<\/a> Edward Owen Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>, 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

14.<\/a> 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

15.<\/a> Michael G Bridge<\/a>, Benjamin\u2019s Sale of Goods<\/i>, (Sweet & Maxwell 11th Edn., 2021).<\/p>\n

16.<\/a> Turkiye Is Bankasi AS<\/i> v. Bank of China<\/i>, (1993) 1 Lloyd\u2019s Rep 132.<\/p>\n

17.<\/a> (1958) 2 QB 127<\/a> : (1958) 2 WLR 100<\/a>.<\/p>\n

18.<\/a> United City Merchants (Investments) Ltd.<\/i> v. Royal Bank of Canada (The American Accord)<\/i>, 1982 QB 208<\/a> : (1981) 3 WLR 242<\/a>.<\/p>\n

19.<\/a> 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

20.<\/a> Czarnikow-Rionda Sugar Trading Inc.<\/i> v. Standard Bank London Ltd.<\/i>, 1999 CLC 1148.<\/p>\n

21.<\/a> Edward Owen Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>, 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

22.<\/a> (1993) 1 Lloyd\u2019s Rep 132.<\/p>\n

23.<\/a> Turkiye Is Bankasi AS <\/i> v. Bank of China<\/i>, (1993) 1 Lloyd\u2019s Rep 132.<\/p>\n

24.<\/a> Edward Owen Engg. Ltd.<\/i> v. Barclays Bank International Ltd.<\/i>, 1978 QB 159<\/a> : (1977) 3 WLR 764<\/a>.<\/p>\n

25.<\/a> European Asian Bank AG<\/i> v. Punjab & Sind Bank (No. 2)<\/i>, (1983) 1 WLR 642 : (1983) 1 Llyod\u2019s Rep 611<\/a>.<\/p>\n

26.<\/a> Czarnikow-Rionda Sugar Trading Inc.<\/i> v. Standard Bank London Ltd.<\/i>, 1999 CLC 1148.<\/p>\n

27.<\/a> (1975) 2 WLR 316<\/a>.<\/p>\n

28.<\/a> (2015) 1 WLR 697 : 2014 UKPC 31<\/a>.<\/p>\n

29.<\/a> Czarnikow-Rionda Sugar Trading Inc.<\/i> v. Standard Bank London Ltd.<\/i>, 1999 CLC 1148.<\/p>\n

30.<\/a> Alternative Power Solution Ltd.<\/i> v. Central Electricity Board<\/i>, (2015) 1 WLR 697 : 2014 UKPC 31<\/a>.<\/p>\n

31.<\/a> Roy Goode, \u201cAbstract Payment Undertakings and the Rules of the International Chamber of Commerce\u201d, 39 St. Louis ULJ 725 (1994-1995).<\/p>\n

32.<\/a> Patel<\/i> v. Mirza<\/i>, (2016) 3 WLR 399<\/a>.<\/p>\n

33.<\/a> Patel<\/i> v. Mirza<\/i>, (2016) 3 WLR 399<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"

by Tanvi Nigam†<\/p>\n","protected":false},"author":8808,"featured_media":280294,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[42503,1191],"tags":[53794,53796,53791,53792,53797,53795,53793],"class_list":["post-280260","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-legal-analysis","category-op-ed","tag-absolute-and-autonomous","tag-beneficiary-seeking","tag-credits-and-performance","tag-documentary-letters","tag-fraud-exception","tag-fraud-unravels-all","tag-primary-payment-mechanism"],"yoast_head":"\nDocumentary Credits and Performance Bonds in International Trade: Two Sides of the Same Coin? | SCC Times<\/title>\n<meta name=\"description\" content=\"International trade may not only involve higher profits but also, high financial risks. 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