The English Court of Appeal has recently re-affirmed, in National Infrastructure Development Co Ltd v Banco Santander, that the fraud exception to the autonomy principle in letters of credit will be narrowly applied in circumstances where the beneficiary holds an honest belief that the amounts are due and owing.
A Standby Letter of Credit ("SBLC") is a written undertaking issued by a bank ("the issuing bank") which guarantees payment to a party to a contract ("the beneficiary") in the event that the other party fails to fulfil an obligation under the underlying contract. SBLCs are very common in large commercial transactions, including cross-border transactions, as sellers are exposed to a risk that the buyer will not pay on time.
There is an absolute obligation on the issuing bank to pay out to the beneficiary. This is the principle of autonomy and it is one of the foundations of the laws of letters of credit. The SBLC creates standalone rights and obligations, entirely separate to the performance of the underlying contract. It is an undertaking by the issuing bank to pay against the presentation of proper documents regardless of any dispute between the parties to the underlying contract.
Fraud exception to autonomy of SBLCs
Fraud is an exception to the principle of autonomy. If the beneficiary makes a fraudulent demand, the issuing bank is entitled to refuse to pay out under the SBLC. However, it is clear from recent UK decisions that the exception is limited and the courts will not depart lightly from the principal of autonomy. A high standard of proof is required both as to the fact of the fraud and as to the issuing bank's knowledge of such fraud.
Banco Santander issued an SBLC to National Infrastructure Development Co (NIDC) in relation to a construction contract. The contract was subsequently abandoned...