Экзамен зачет учебный год 2023 / The-independence-principle-of-letters-of-credit-and-demand-guarantees-150-373

III. Application o f the Exception

payment on the ground of illegality. However, it appeared to have been common ground that there was an illegality exception to the principle of independence of letters of credit. The question was whether the same principle applied in the case of card payments.

III. APPLICATION OF THE EXCEPTIO N

An illegality exception with a very wide scope will threaten the independence of letters of 8.22 credit and demand guarantees in a way that might render these most valuable commercial instruments unattractive to businessmen. However, the exception can be confined within a

very limited scope. Indeed, it is submitted that the scope of the exception as conceived in

Mahonia is so narrow that in most cases a letter of credit or a demand guarantee will be enforced even though there is illegality in the underlying transaction. The reason for this is that the party seeking to rely on the exception will have to overcome a number of high hurdles before it will be applied. The first is that there must be evidence of the alleged illegality and the standard of proof is likely to be high. Secondly, it is not enough to establish illegality; the illegality must be sufficiently serious. Thirdly, even where a suffi­ ciently serious illegality is established, the exception will not apply unless the beneficiary.was involved in the illegality. Fourthly, even if the beneficiary is involved in illegality that is suf­ ficiently serious, the exception will only apply where the illegality in the underlying contract is sufficiently connected to the letter ofcredit or performance bond.42 It may be helpful to examine each of these requirements.

1. Evidence of Illegality

A. Standard of proof

The standard of proof that is likely to be required at trial is the same as that required for 8.23 fraud,43 namely, that of clearly established’44 illegality. The mere suspicion of illegality is not enough. If all that can be shown is that the underlying contract is arguably illegal the court

will not grant an injunction restraining payment.45 The standard of clearly established ille­ gality is a high one with the consequence that in practice illegality, like fraud, will be success­ fully established only in a few cases.46 Thus the practical difficulty of establishing any alleged

42in the case where the application is for an interim injunction the claimant will have to overcome the further hurdle of the balance of convenience test. See discussion at paras 10.24 to 10.32 below.

43See discussion at para 5.65.

44GroupJosi Re v. Walbrook Insurance Co Ltd [1996| 1 Lloyds Rep. 345, 362, per Staughton L.J.

45ibid., at 357 (per Clarke j.) and 362 (per Staughton L.J. saying that ‘[ijf the legality of the payment is merely doubtful, it may be that the bank would not be restrained’).

46Indeed the scope of the fraud exception has been so limited by the standard ofproof that in United Trading Corp SM v. Allied Arab Bank Ltd [1985] 2 Lloyds Rep. 554, 561, Ackner L.J. considered it necessary to warn against the dangers of too high a standard ofproof. He said that it would be ‘an unsatisfactory position if, having established an important exception to what has previously been thought an absolute rule, the Courts in practice were to adopt so restrictive an approach to the evidence required as to prevent themselves from intervening. Were this to be the case, impressive and high-sounding phrases such as “fraud unravels all" would become meaningless.’

1 9 3

The Illegality Exception

illegality will ensure that the exception does not become an easy excuse for banks to refuse to honour their obligations under a letter of credit.47

8 .2 4 Where the beneficiary has applied for summary judgment under CPR Pt 24 and the bank seeks to resist the application with a defence based on the illegality exception, it is likely that the same test o f‘real prospect of success’ as applied in the fraud exception cases48 would be applicable.49 Thus, the question would be whether on the evidence available the bank can show that it has a real prospect of succeeding at trial on the illegality exception, bearing in mind the standard of proof required at trial.

8.25 In the case of an application by the account party for an injunction against the beneficiary, the testshould be similar to that adopted for the fraud exception in United Trading Corporation SA v. AlliedArab Bank Ltd,50 On this basis the test should be whether the claimant has estab­ lished that on the evidence available there is a seriously arguable case that there is illegality in the underlying contract which makes the letter of credit or performance bond unenforceable by the beneficiary. This is not a low standard. On this test, it is not enough for the claimant to establish that there is a seriously arguable case that there is a good reason for suspecting that the underlying contract is illegal.

B. Time of evidence

8.26 The relevant time for the bank to have clear evidence of illegality is the time of the hearing. In keeping with the approach adopted in the fraud cases, the bank may refuse to pay on the ground of illegality even if it does not have evidence of clear illegality at the time, provided that it will be able to provide such evidence at any hearing in a claim against it brought by the beneficiary for breach of contract in refusing to pay. In Mahonia, at the date of payment the bank did not have evidence of the alleged illegality. However, by the time of the hearing of the application for summary judgment the bank claimed to have obtained information amounting to clear evidence that the underlying transaction was illegal under United States law. Colman J. held, by analogy with the position relating to the fraud exception, that the bank was entitled to rely on the evidence of illegality available at the date of the trial even though it did not have that evidence at the date when payment should have been made.51 When the matter went to a full trial Cooke J. also held that the bank was entitled to rely on the defence of illegality even though it did not have evidence of the alleged illegality at the time it refused to pay. He mentioned the position relating to the fraud exception and said that ‘the position is stronger in relation to arguments on unlawfulness because of the public policy considerations which come into play’.52

47In Mahonia the illegality defence failed because the alleged illegality was not clearly established.

48See discussion in paras 5.82 to 5.86.

49However, inMahonia Ltd v.JP Morgan ChaseBank [2003] EWHC 1938 (Comm); [2003] 2 Lloyd’s Rep.

911 at [6], the parties agreed that for the purposes of the applications the facts alleged by the bankas constitut­ ing the relevant illegality or unenforceability should be assumed to be true.

50[1985] 2 Lloyd’s Rep. 554.

51[2003] 2 Lloyds Rep. 911 at [(59i.

52[2004] EWHC 1938 (Comm) at [433].

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III. Application o fthe Exception

2. Seriousness of the Illegality

ment was to be by letter of credit, upon presentation of a bill of lading for one thousand kalashnikov rifles to the port of Basra, the English court would not enforce the beneficiary’s claim under the credit.57 In Mahonia,58 Colman J. agreed with that example, saying that a beneficiary who was a party to such an illegal arms transaction would not be permitted to enforce a letter of credit which was an integral part of that transaction even if the relevant legislation did not on its proper construction render the letter of credit contract illegal. He then went on to mention an underlying contract for the sale and purchase of heroin as another example of illegality that would be sufficiently serious for this purpose. These exam­ ples offer an indication of the degree of seriousness of the illegality required to bring the

53 e.g. StJohn Shipping Corporation v.Joseph Rank Ltd [1957J 1 Q B 267, 288-289.

54 e.g. Beresford v. RoyalInsurance Co Ltd (1937] 2 K B 197, 219; Maries v. Philip Trant & Sons Ltd [1954] 1 Q B 29, 39; Geismar v. Sun Alliance and London Insurance Ltd[ 1978] Q B 383, 395; Fitzgerald v. F.J. Leonards

(1997) 71 A L JR 653, 673.

55At [430].

56At [430] and [432].

57[1996] 1 Lloyds Rep. 345, 362.

58[2003] 2 Lloyd’s Rep. 911 at [68].

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The Illegality Exception

exception into operation. Therefore, application of the exception to this limited extent will not constitute a threat to the lifeblood of international commerce.

3. Beneficiary’s Involvement

8.30 The illegality exception applies only where the beneficiary is a party to the illegality in the underlying contract or had knowledge of it. Under general principles, where an agreement is illegal because it was entered into for an illegal purpose59 a claimant who had no knowledge of the illegal purpose is not barred by the illegality defence.60 If a person borrows money to fund an illegal transaction, the lender’s claim under the loan agreement is not defeated by the illegality of the transaction funded with the loan money if the lender did not have knowledge of the borrower’s illegal purpose.61 In the context of letters of credit or performance bonds, illegality in the underlying contract will not defeat the beneficiary’s claim under the instru­ ment if the beneficiary was not aware of the illegality. Thus, in Mahonia, even if illegality in the underlying transaction was established, the illegality exception would not have been available if the beneficiary of the letter of credit had no knowledge of the illegal purpose.

8.31 In many cases the beneficiary will not be aware of the illegal purpose of the account party. Titus, if the underlying contract is one for the sale of goods F.O.B. an English port, the fact that the overseas buyer intended to and in fact committed an illegal act by importing the goods into his own country without paying the required duties does not prevent the English seller from claiming payment.62 And it appears that the English courts will not be quick to find that the seller/beneficiary of a letter credit had knowledge of the buyer’s illegal purpose even where the seller took some steps to facilitate the overseas buyer’s illegal act. In Fielding & Platt Ltd v. Najjar,63 for example, there was a contract for the sale of an aluminium extru­ sion press. lire Lebanese buyer had no import licence for an extrusion press but he had a licence to import a rolling-mill. In order to deceive the authorities of his country by import­ ing the extrusion press without a licence, he requested the English seller to invoice the press as ‘parts of a rolling-mill’. The explanation given to the seller is that this was required ‘for local consumption’. It was held that the seller’s claim under the contract was not defeated by the illegality defence because the seller had no knowledge of the buyer’s illegal purpose.64 It follows that if payment under the contract was by means of a letter of credit for the benefit of the seller, his claim under the credit would have succeeded in spite of the buyer’s illegal purpose.

8.32 This requirement of knowledge on the part of the beneficiary therefore has a limiting effect on the scope of the illegality exception. A similar limitation on the fraud exception, by which fraud does not defeat the beneficiary’s claim unless he had knowledge of the fraud before presentation of documents,65 has helped to restrict the scope of that exception.

59That is to say, where the making of the agreement itself is not prohibited.

60Mason v. Clarke[ 1955] AC 778,794. See generally, N. Enonchong, IlkgalTransactions (Lloyds ofLondon Press, London, 1998) eh. 15.

61e.g. Basse v. Mdstercraft (1995) 123 DLR (4,b) 161 (Ont. CA); Canadian Im perial Bank o f Commerce v. Drutz (1996) ACWS (3d) 258.

62Catlin v. B ell{ 1815) 4 Camp. 183.

63[1969] 1 WI.R357.

64Ibid., at 362.

65M ontrodLtdv. Grundkotter Fleischvertriebs-GmbH [2001 ] EWCACiv 1954; [2002] 1 WLR 1975.

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III. Application o fthe Exception

4. Degree of Connection

test is uncertain. It is not entirely clear whether the claimant is not allowed to rely on his own illegality or on the illegal transaction. In the GroupJosi case, for example, Staughton L.J. at one point refers to the rule as prohibiting a party from relying on his own ‘illegality’72 and at

66.Mahonia x [428] and [429].

67[1945] KB 65.

63 [1994] 1 AC 340. See Enonchong, Illegal Transactions (Lloyds of London Press, London, 1998) 181 etseq.

69Ibid., at366,perLordJauncey of Tullichettle.

70Ibid., at 376, per Lord Browne-Wilkinson.

71e.g. Stowe, ‘The “Unruly Horse” has Bolted’ (1994) 57 MLR 441, 446; Enonchong, ‘Illegality: The Fading Flame of Public Policy’ (1994) 14 OJLS 295, 299; Buckley, ‘Law’s Boundaries and the Challenge of Illegality’ in Buckley (ed), LegalStructures (1996) 233-234.

72Ibid., at 360.

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The Illegality Exception

another point as prohibiting a party from relying on the ‘illegal contract’.73 The two are clearly not the same. The former is narrower in scope and so would make it easier for a claim­ ant to succeed in spite of the fact that the contract is tainted with illegality.74

8.36Thirdly, application of the test in the context of the illegality exception is likely to lead to unsatisfactory results because it will reduce the scope of the exception to such an extent as to make it almost illusory. In other words, in most cases the beneficiary’s claim will succeed in spite of his illegal conduct because he will not need to rely on the illegality in the underlying transaction in order to make out his claim for payment under the letter of credit or perfor­ mance bond.75 It is true that in GroupJosi Staughton L.J. expressed the view that the benefi­ ciaries would not have been able to make out their claim without relying on the underlying illegal transactions. However, the facts of that case were exceptional. The claimants were a reinsurance company. The claim was for an injunction to restrain the defendants, who were the reinsured companies, from presenting documents for payment under two letters ofcredit. The claim was concerned with reinsurance contracts concluded between the parties. Under the original arrangement the reinsured retained part of the premium due on the reinsurance contracts as a reserve against claims. After a while, the reinsurers argued that the money should be in their hands until such time as the claim materialized. It was then agreed that the money would be paid to the reinsurers who would open letters of credit for the benefit of the reinsured. The letters of credit provided for payment upon presentation by the beneficiary of debit notes covering the liability for outstanding loss reserves under your umbrella quota share facilities’. In seeking an injunction against the beneficiaries, the reinsurers argued that the underlying reinsurance contracts were illegal and that the illegality tainted the letters of credit so that the beneficiaries should not be allowed to enforce the letter of credit contracts. On the question whether the beneficiaries in presenting documents for payment under the letter of credit would be relying on the underlying illegal contracts, Staughton L.J. took the view that since the beneficiaries were bound to present debit notes covering liability for out­ standing loss reserves, they would be relying on the underlying illegal contracts to make out their case,76 because the liability could only arise from those contracts.

8.37However, in most letter of credit cases the beneficiary is not required to present any document asserting any liability under the underlying contract.77 In many cases where letters of credit are used to finance the international sale of goods, the credit would normally require the beneficiary, the seller, only to present the shipping and other documents relating to the goods. These will not normally involve the assertion of any liability arising from the underlying contract. The position is similar in other transactions. In Mahonia, where the

73Ibid., at 363.

74On the ground that although the claimant may need to rely on the (illegal) contract, he does not need to

rely on the illegality itself: cf. American Home Assurance Co v. Hong Lam M arine Pte Ltd [1999] 3 SLR 682 at [68] holding that, assuming there was illegality in backdating the date ofconclusion of a shipbuilding contract, that illegality did not affect a party’s right to call on a performance bond issued in respect of the illegal contract.

75cf. Fortune Hong KongTrading Ltd v. Cosco-Feoso (Singapore) Pte Ltd [2002] EWHC 79 (Comm) at [43], where, however, the alleged illegality (illegal moneylending) was in a transaction between the buyer and a third party rather than in the underlying dale of goods transaction between the buyer and the seller/beneficiary.

76[1996] 1 Lloyd’s Rep. 345, 363.

77The mere fact that the claimant is obliged to give evidence of the underlying illegal contract does not

necessarily mean that he is relying on that contract to make out his case: Euro-Diam Ltd v. Bathurst [1990] 1 QB I, 18.

198

v. Milligan [1994] 1 AC 340,370.

80 [2004] EWHC 1938 (Comm) at [426Н427].

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The Illegality Exception

letter of credit was ‘opened in consideration of obligations’ contained in the underlying illegal transaction,81 that the letter of credit was ‘brought into existence for the very purpose of being part o f’ the unlawful scheme,82 that ‘without it [the letter of credit] the [underlying] transaction would not have gone ahead’,83 and that the letter of credit ‘shared the same unlawful purpose’ as the underlying transactions.84

8.40 Some of these formulations are, with respect, open to doubt. For example, the idea that the degree of connection between the letter of credit and the underlying transaction should be measured by whether the letter of credit was opened in consideration of obligations’ in the underlying contract serves little purpose because in virtually all cases the letter of credit would be opened in consideration of such obligations. If this test is applied almost every letter of credit will be tainted by the illegality of the underlying transaction in respect of which it was issued. Similarly, the idea that the letter of credit is sufficiently connected with the underlying transaction because without it the underlying transaction would not have gone ahead is also open to question. Would a court find that a letter of credit is not suffi­ ciently connected to the illegality of the underlying transaction because it is established that without it the transaction would still have gone ahead? The mere fact that the parties to the illegal venture decided to carry it out using a letter of credit when they could still have gone ahead with the venture without the letter of credit is not a sound basis for holding that there­ fore the letter of credit is not sufficiently connected to the illegality.

8.41The different formulations adopted by Cooke J. only point to the difficulty of finding a single expression that can capture the degree ofcloseness required in the wide range of possible trans­ actions. It is suggested that the sole factor that should be used to determine whether the letter ofcredit or demand guarantee is sufficiently connected to the illegality of the underlying trans­ action should be the beneficiary’s complicity in it. If the beneficiary was aware of the illegal purpose of the underlying contract then that should be enough to establish a sufficient connec­ tion between the illegality and the letter of credit issued in respect of the transaction. But if the beneficiary was not aware of the illegality in the underlying transaction it cannot be sufficiently connected with and so taint his claim under the letter of credit or demand guarantee. If this test for close connection is adopted it would in effect mean that there is no need to articulate a sepa­ rate requirement that the letter of credit must be closely connected to the illegality, since the beneficiary’s knowledge of the illegality is already a condition for the application of the illegal­ ity exception. The merit of this approach is that it will maintain certainty in this area of the law which, as Cooke J .’s formulations indicate, is in danger of becoming too uncertain.

IV. CAN TH E EXCEPTIO N BE EXCLUDED

BY AGREEMENT?

8.42 The scope of the illegality exception is also affected by the question whether a clause in the letter of credit can limit the normal effect of illegality in the underlying contract. In other

81Ibid., at [4291.

82Ibid., at [4271.

83Ibid., at [429].

84Ibid., at [432].

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IV. Can the Exception be Excluded by Agreement?

words, the question is this: what is the effect of a provision in the letter of credit stating that the banks obligation to pay is not to be affected by the illegality of the underlying contract? There is no clear authority on this point. In relation to performance bonds, some commenta­ tors have said that the autonomous nature of the bond should mean that the beneficiary of the bond is not affected by the invalidity or illegality of the underlying contract even in the absence o fsuch a clause ,85 However, this view is open to doubt. It has been demonstrated above that with respect to letters of credit there is a clear line of judicial opinion in England to the effect that in the absence of such a clause, the beneficiary of the credit may be affected by the illegality of the underlying transaction. There seems no reason why the position should be different with regards to a performance bond. It is widely accepted that, with respect to the autonomy principle, letters of credits are analogous to performance bonds or demand guarantees.86 The question here is whether the existence of a clause exclud­ ing the normal effects of illegality makes a difference. It is submitted that the answer should be different depending on whether the claim under the instrument is by the original beneficiary or an innocent third party such as an assignee without notice.

1. Claim by the Original Beneficiary

If the illegality is sufficiently serious and if the beneficiary had knowledge of it then he should 8.43 not be allowed by contract to exclude the normal consequences of his involvement in the illegality. Where, pursuant to an illegal contract of sale, the buyer requests a bank to issue a

letter of credit with such an exclusion clause for the benefit of the seller (who is involved in the illegality of the underlying contract), the seller should not be allowed by the use of such a clause in the letter of credit to evade the normal consequences of his participation in the illegality of the underlying contract. It would be perverse for the law to allow a person who participates in the violation of the law to protect himself, by contract, from the normal consequences prescribed by law.

2. Claim by an Assignee

The position may be different, however, where the beneficiary is not a party to the illegality 8.44 in the underlying contract. This may occur where the original beneficiary who participated

in the illegality has assigned the benefit of the letter of credit to an innocent third party who takes without notice of the illegality. How should the law deal with such a case? The general principle is that a third party to whom the benefit of the credit has been assigned is in no better position than the original beneficiary, since assignments normally take effect subject to equities.87

85 J. O ’Donovan and J. Phillips, 1he Modern Contracto fGuarantee (London, 2003) 804. Emphasis added.

86 United City Merchants v. RoyalBank o f Canada [1983] A C 168, 183: R. D. Harbottle (Mercantile) Ltdv. National Westminster Bank Ltd [1978] Q B 146; Howe Richardson Scale Co Ltd v. Polimex-Cekop and National Westminster Bank Ltd [1978] 1 Lloyds Rep. 161; Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] Q B 159; Intraco Ltd v. Nottis-Shipping Corp [1981] 2 Lloyd’s Rep. 256; Solo Industries UK Ltd v. Canara Bank [2001] 1 W I.R1800, 1804.

87 Ihe Law of Property Act 1925, s 136. Thus the assignee o f the benefit of a letter of credit is subject to the defence o f fraud which would have been available against the assignor: Banco Santander SA v. Bayfern Ltd [2000] Lloyd’s Rep. Bank 165; (2000) C L C 906; [2000] 1 A ll ER (Comm) 776.

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The Illegality Exception

8.45However, this general principle may be excluded by the parties 88 who may make provision by contract for the protection of the assignee.89 This is what happened in Standard Bank (London) Ltdv. Canara Bank,90 a case concerned with a performance bond. The buyer agreed to pay a certain sum as ‘pre-export advance’ to the seller. The advance was to be repaid by set-offagainst the price due in respect of goods delivered. The pre-export advance was funded by a loan made by the claimant bank (lender) to the buyer. As security for the seller’s perfor­ mance of its obligations under the contract of sale the defendant bank (guarantor) provided a demand guarantee to the buyer. The guarantor was aware that the guarantee was to be assigned to the lender as security for the loan to the buyer and indeed the guarantee was so assigned with notice to the guarantor who sent a written acknowledgement of the assignment. The guarantor refused to honour a call on the guarantee claiming that the underlying contract of sale was a sham and that the existence of a genuine and valid contract of sale was a condition precedent. It was held that the transaction was not a sham and there­ fore the beneficiary was entitled to payment under the guarantee. However, Moore-Bick J. went on to say that even if the underlying contract was a sham the guarantor would still have been liable to the assignee/beneficiary because the guarantee contained a clause excluding the consequences of invalidity. The clause stipulated that the guarantor’s liability shall not be affected ‘by any invalidity, illegality, unenforceability’ of the underlying contract of sale. It was held that if the underlying contract was a sham and therefore a fraudulent device used to induce the guarantor to issue the guarantee, then the buyer (the original beneficiary)

could not make a valid demand because it was itself a party to the fraud. But the lender, as assignee with no knowledge of the fraud, was in a different position. The circumstances of the case (including the exclusion clause) indicated that the parties intended that the lender should take the benefit of the assignment free of cross-claims of any kind, including any claim by the guarantor to avoid the guarantee on the ground of fraud on the part of the parties to the underlying contract.91

8.46Although this may be the position where the underlying contract is ineffective or invalid on the ground of fraud, it does not necessarily follow that the position should be the same where the underlying contract is ineffective because of illegality. There is a difference between a transaction that is voidable for fraud and one which is unenforceable or void for illegality. Where the issue of the letter of credit is induced by fraud in the underlying contract the letter of credit is only voidable at the option of the innocent party (the issuer). The issuer can there­ fore validly make provision for the protection of the assignee by, in effect, waiving its right to rely on the fraud. By contrast, where the defect in the underlying contract which taints the letter of credit is illegality the letter of credit is not merely voidable, at the option of one party, it is unenforceable by both. Transactions that are unenforceable for illegality are inef­ fective on grounds of public policy rather than for the benefit of one party. Neither party has the option to waive the illegality and, in effect, affirm the contract.92 That is why the court has the power to raise the issue of illegality of its own motion if the parties fail to do so.93

88The rule may also be excluded or modified by statute: e.g. Bills of Exchange Act 1882, s 38(2).

89Banco Santander SA v. Bayfern Ltd [2000] Lloyd’s Rep. Bank 165, 168-170, perWaller L.J.

90HC, May 22, 2002.

91Ibid., at [81].

92Statutory exceptions apart.

93Evans v. Richardson (1817) 3 Mer. 469; Societe des Hotels Riunis v. Hawker (1913) 29TLR578; Montefiore v, Monday Motor Components Co [1918] 2 KB 241.

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