A Comparative Analysis of the Standard of Fraud Required under the Fraud Rule in Letter of Credit Law

Article excerpt

National courts have required different standards of fraud to justify non-payment, or restraint of payment, under a letter of credit. The United Nations Commission on Trade Law (UNCITRAL) has adopted its own position. The issue is far from settled in any legal system. Based on an analysis of the law in the United States, United Kingdom, Canada and Australia, and under the Convention, this article proposes a standard that is a distinct improvement on the various standards applied around the world and suggests a means for its implementation.

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The fraud rule allows the issuer of a letter of credit or a court to disrupt the payment of a letter of credit when fraud is involved. The raison d'etre of letters of credit is to provide an absolute assurance of payment to a seller, provided the seller presents documents that comply with the terms of the credit. The fraud rule thus goes to the very heart of the letter of credit obligation. The fraud rule is necessary to limit the activities of fraudsters, but its scope must be carefully circumscribed so as not to deny commercial utility to an instrument that exists to serve as an assurance of payment. (1)

This article explores the kind of fraud required to invoke the fraud rule or, in other words, what does fraud mean under the fraud rule in the law governing letters of credit? This is a challenging question because fraud is an "inherently pliable concept." (2) Some argue that the fraud rule must be applied in a strict fashion, or in cases where only egregious fraud is involved. These commentators emphasize that the letter of credit is a unique commercial device that must be protected from simple contract disputes, which are often difficult to distinguish from certain fraud claims. (3) Others favor a more flexible approach to the concept. (4)

This article investigates how this question has been answered in the United States, United Kingdom, Canada and Australia, and under the United Nations Convention on Independent Guarantees and Standby Letters of Credit (the UNCITRAL Convention). (5)

I. THE POSITION IN THE UNITED STATES

A large number of letter of credit fraud cases have been decided in the United States. In addition, Article 5 of the Uniform Commercial Code (U.C.C.) contains state-of-the-art provisions with respect to the fraud rule. Therefore, the U.S. position deserves much attention. To facilitate the discussion, the U.S. position will be examined in three categories: the pre-U.C.C, position, the Prior U.C.C. Article 5 position, and the Revised U.C.C. Article 5 position. (6)

A. Pre-U.C.C. Position

1. Pre-Sztejn Cases. The seminal case on the fraud rule in letter of credit law was Sztejn v. J. Henry Schroder Banking Corp. (7) While a U.S. decision, Sztejn has influenced and shaped the fraud rule in virtually all jurisdictions worldwide. Before Sztejn was decided, a number of letter of credit cases in the United States touched on the issue of fraud, but none considered the fraud rule in detail. Little discussion appeared in those cases about what kind of fraud might invoke the fraud rule. One of the few passages mentioning the issue was the dissenting judgment of Justice Cardozo in Maurice O'Meara Co. v. National Park Bank, (8) which read, in part:

   We are to bear in mind that this controversy ... arises between the
   bank and a seller who has misrepresented the security upon which
   advances are demanded.... I cannot accept the statement of the
   majority opinion that the bank was not concerned with any question
   as to the character of the paper. If that is so, the bales tendered
   might have been rags instead of paper, and still the bank would
   have been helpless, though it had knowledge of the truth, if the
   documents tendered by the seller were sufficient on their face. (9)

This paragraph shows that, in the view of Justice Cardozo, fraud under the fraud rule in the law governing letters of credit means misrepresentation. …