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

V. Authorities in OtherJurisdictions

This principle tends to suggest that if the letter of credit is unenforceable because of illegality in the underlying contract the parties are not free to make provision by contract for the protection of the assignee from that consequence.

However, other considerations militate in favour of allowing the parties to use an exclusion 8.47 clause to protect the assignee who takes without notice. 'There are two main considerations:

one moral, the other commercial. The moral consideration is that an assignee without notice is not implicated in any moral culpability. His cause does not arise ex turpi causa. His position is in truth comparable not to that of the guilty assignor but to an original beneficiary who has no knowledge of the illegal purpose of the underlying transaction. Since such a beneficiary is allowed to enforce the letter of credit, the assignee without notice should be in no worse position. The commercial consideration is that if an assignee who takes without notice cannot be protected by contract from the possible illegalities in the underlying transaction with which he is not concerned, financial institutions that finance international commerce on the security of assigned letters of credit or demand guarantees would be reluctant to con­ tinue to do so. If this were to happen, the vital commercial purpose served by such assign­ ments would be seriously damaged to the detriment of international commerce.94 It is submitted that on balance the strength of these two factors outweigh the arguments against enforcing an exclusion clause in the letter of credit for the protection of the assignee without knowledge. Restricted in this way, the illegality exception is unlikely to have any disruptive effect on the well-established arrangements by which banks accept to advance funding for international trade transactions on the security ofletters of credit and similar instruments.

V. AUTHORITIES IN O TH ER JURISDICTIONS

A look at the authorities in some other jurisdictions reveals that there is no uniformity in the 8.48 attitude o f the courts towards an illegality exception. Whereas in some jurisdictions, such as

the USA, the exception appears to have been firmly rejected, in others, such as Australia, there is a hint that the exception may be well received. In states where the UN Convention on Independent Guarantees and Standby Letters of Credit is in force, there appears to be scope within the Convention for the illegality exception to apply where the underlying con­ tract has been declared illegal and invalid by a court or arbitral tribunal. And in France,

94 An exclusion clause of the type discussed in the text is inserted for the protection of a third party (assignee bank). In some cases it is the issuing bank that will require protection against the possible illegality in the under­ lying transaction. In such acase the issuing bank will require the applicant to give an undertaking that all foreign and domestic laws applicable to the underlying transaction will be complied with. If the applicant gives such an undertaking and later brings an action against the issuing bank for breach of contract, for example, on the ground that the bank has paid against non-conforming documents, the question that arises is whether the bank can rely on illegality in the underlying transaction as a defence to the applicant’s claim. The answer is in the affirmative because in such a case illegality in the underlying transaction ofwhich the applicant had knowledge

is a breach of his contract with the issuing bank. If he claims against the bank for breach of contract, the bank will also be entitled to respond by claiming that the applicant breached the application contract and that that breach absolves it of its own liability: Rudy T. Oei v. Citibank, NA, 957 F.Supp. 492, 516(1997). In such a case, the principle of independence is not called into question and does not prevent the bank from raising its defence. A case of this type is different from a case where the bank is refusing to pay on the ground that the letter ofcredit is tainted by illegality in the underlying contract. It is also different from a case where the issuing bank seeks to argue that the application contract is illegal because it is tainted with the illegality of the underlying contract.

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The Illegality Exception

although the illegality exception is not a ground for the bank to refuse payment, the account party may rely on illegality as a restitutionary basis on which to recover the payment from the beneficiary.

1.USA

8.49In the USA the illegality exception is not recognized under Article 5 of the United States Uniform Commercial Code (UCC). The only exceptions to the autonomy of the letter of credit are fraud and forgery, as provided for in Article 5-109- One commentator has argued that despite the lack of an express statutory provision for an illegality exception, the UCC does not exclude an illegality exception and that a bank is entitled under the UCC to rely on illegality in the underlying contract to refuse to honour its payment obligations under the letter of credit.95 However, the conventional view in the USA is that illegality is not included in the exceptions in Article 5-109 of the U C C 96 and therefore a bank must pay even though the underlying contract is illegal. Even before the current 1995 revision of Article 5, judicial opinion was that ‘[tjhere is nothing in the U.C.C. . . . which excuses an issuing bank from paying a letter of credit because of supervening illegality’.97

2.Some Commonwealth Authorities

8.50In Australia, where the courts do not appear to have been confronted with the question whether or not the law recognizes the illegality exception, there is an obiter dictum which appears to suggest that the exception may be available in addition to the fraud exception.989

8.51In Canada, the courts appear to have rejected the exception. Thus in Morguard Bank o f Canada v. Reigate Resources (Canada) Ltd and Canada Trust Company99 Power J. said that since the letter of credit is a separate and distinct agreement it is not tainted by the illegality of the underlying contract.100 It is true that Power J .’s statement was obiter, but it was cited with approval in a subsequent case101 and does not appear to have been repudiated by other authorities. Indeed in one case102 Blair J., after noting that the principle of autonomy

95 G. McLaughlin, ‘Exploring Boundaries: A Legal and Structural Analysis of the Independence Principle of Letter ofCredit Law’ (2002) 119 Banking LJ 501, 527-528. See also, G. McLaughlin, ‘Letters of Credit and Illegal Contracts: The Limits of the Independence Principle (1989) 49 Ohio St. LJ 1197, 1217-1235.

96 J. Barnes, comment on M ahonia v. West [2004] EWHC 1938 (Comm) in J. Byrne and C. Byrne (eds),

2005 Annual Survey o fLetter o f Credit Law and Practice (Institute of International Banking Law and Practice Inc, Montgomery Village, 2005) 331. Similarly, in Wunnicke, Wunnicke and Turner, Standby and Commercial Letters o fCredit (3rd edn, Gaithersburg, Aspen Law and Business), where the authors discuss the fraud excep­ tion in Chapter 8, there is no discussion of an illegality exception. See also, R. Aicher, D. Cotton and T. K. Khan, ‘Credit Enhancement: Letters ofCredit, Guaranties, Insurance and Swaps (The Clash of Cultures)’ in J. Byrne and C. Byrne (eds), 2005 Annual Survey o f Letter o f Credit Law and Practice (2005, Institute of International Banking Law and PracticeInc, MontgomeryVillage, 2005) 12, 19-20.

97KM W International v. Chase Manhattan Bank 606 F 2d 10 (1979) at 16. See also Centrifugal Casting Mach. Co, Inc v. American Bank & Trust Co, 966 F 2d 1348, 1352 (1992).

98Fletcher Construction Australia Ltd v. VarnsdorfPty Ltd, 24 November 1997, it was said (obiter) ‘In the

absence of fraud or illegality, [the beneficiary] cannot be restrained from acting in conformity with the contract’ [per Charles J.A.).

99 (1985) 40 Alta LR (2d) 77.

100Ibid., at 81.

101Morguard Trust Co v. RoyalBank o f Canada (1988) ACWS (3d) 416 at [54].

102Cineplex Odeon Corp v. 100 Bloor Street West GeneralPartnership Inc [1993] OJ No 112 at 9.

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V. Authorities in O therJurisdictions

is fundamental to the nature of letters of credit, stated bluntly that the only admitted excep­ tion to it is fraud’. He even went on to explain fraud by distinguishing it from illegality, quoting the statement of Riddell J. to the effect that much confusion is created by the use of the word ‘fraud where ‘illegality’ is really the appropriate expression.103 And Blair J.’s statement has been referred to in more recent decisions without criticism.10415

In Singapore there appears to be no reported decision on the illegality exception. However, 8.52 the availablejudicial opinion appears to be against the exception. In American HomeAssurance

Co v. Hong Lam Marine Pte L tdws the issuer of performance bonds refused to make payment on the ground that the underlying shipbuilding contract was illegal and unenforceable because it had been backdated to avoid compliance with certain statutory provisions. The Singapore Court of Appeal held that the underlying shipbuilding contract was not illegal and unenforceable as alleged.106 However, the court went on to state that even if the underly­ ing contract had been illegal the illegality would not have defeated the beneficiary’s claim under the performance bonds. The court reasoned that since the performance bonds were ‘independent of the underlying contract, there was no reason why the illegality in the form of the backdating had to have any effect on the respondents’ claim’.107

3. UN Convention

The UN Convention on Independent Guarantees and Standby Letters of Credit makes 8.53 provision for an invalidity exception which includes invalidity on the ground of illegality. Article 19(l)(c) of the Convention provides that if it is manifest and clear that a demand ‘has

no conceivable basis, the guarantor/issuer, acting in good faith, has a right, as against the beneficiary, to withhold payment’. For the purposes of this provision it is then stipulated in paragraph (2) of Article 19 that situations in which a demand has no conceivable basis include the case where ‘the underlying obligation of the principal/applicant has been declared invalid by a court or arbitral tribunal, unless the undertaken indicates that such contingency falls within the risk to be covered by the undertaking’. Thus, if the underlying contract is found to be illegal and consequently declared invalid a demand for payment under the demand guar­ antee issued in respect of the contract will be one with no conceivable basis and therefore the bank will have a right to refuse to pay. It is clear that this illegality or invalidity exception

103Washburn v. Wright (1913) 31 OLR 138 (App. Div.) at 147 where Riddell J. stated ‘Fraud is not mistake, error in interpreting a contract; fraud is something dishonest and morally wrong, and much mischief is . . .

done, as well as much unnecessary pain inflicted, by its use where “illegality” and “illegal” are the really appropriate expressions.’

104e.g. Standard Trust Co (Liq) v. Bank o fNova Scotia [2001] NFCA 27 (Newfoundland Court of Appeal);

RoyalBank o fCanada v. Centra Canada Investments Inc [2000] OTC 86 at [36].

105[1999] 3 SLR 682.

106In doing so, the court distinguished the case from the decision of the English courts in Alexander v. Rayson [1936] 1 KB 169, the Privy Council decision in Palaniappa Chettiarv, Amnasalam Chettiar [1962] AC 294, and the decision of the Singapore Court ofAppeal in SuntosoJacob v, KongM iao Ming [1986] SLR 59 on the (questionable) ground that, although the purpose of backdating the shipbuilding contract was to deceive the authorities, the purpose of the shipbuilding contract was not to deceive the authorities.

107[1999] 3 SLR 682 at [68]. See also the Hong Kong case of YorkAirconditioning dr Refrigeration Incv. Lam Kwai Hung T/A North Sea A/C Elect Eng Co [19951 1 HKC 287, where Kaplan ]. was prepared to accept the

suggestion that illegality of the underlying contract arising under its proper law (Chinese law) could not affect a bill of exchange because the proper law of the bill ofexchange (Hong Kong law) was different from that of the underlying contract.

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The Illegality Exception

applies only where the underlying contract has been declared invalid by a court or arbitral tribunal. Therefore the bank cannot refuse to pay on the ground of illegality or invalidity where a demand is made before the underlying obligation is declared invalid, even if the bank has knowledge of clear evidence from which the only realistic inference is that the underlying contract is invalid and even though that very point may be under consideration by a court or arbitral tribunal. It is not clear whether in such a case the account party will be able to obtain an interim injunction to restrain the beneficiary from demanding payment and the bank from paying pending the outcome of the court of arbitral proceedings on the issue of invalidity.

4. France

8 .5 4 To understand the French authorities on the illegality exception it is helpful to understand the general effect of illegality on a contract under French law. The starting point is Article 1131 of the French Civil Code which provides that an illegal contract10819‘cannot have any effect’. This means that an illegal contract is void ab initio.m It is not merely unenforceable, as is normally the case under English law;110 it has no legal existence111 and is an absolute nullity.112 Since under French law an illegal agreement is a nullity, it may be argued that where the underlying contract is illegal and therefore a nullity, so that nothing can come from it, a performance bond issued in respect of the contract must also be a nullity with the consequence that the issuing bank should not be required to pay.

8.55 The response of the French courts to arguments based on the nullity of the underlying contract indicates that a distinction may be drawn between two types of case. The first is where the bank has not yet paid and the illegality exception is relied upon in order to prevent payment under the guarantee. The second type of case is where the bank has already made payment to the beneficiary and the account party, who has reimbursed the bank, brings an action in restitution against the beneficiary. In the first type of case, the courts have rejected illegality as a ground for refusing payment. In Siegfried Dunes Sharjah Leasing Corporation v. Banque de Paris,113 the beneficiary was contracted to construct a steel plant in Iraq. Part of the work was then sub-contracted to the account party who was required under the sub-contract to provide a performance bond. The bond was issued by Banque de Paris in return for acounter-indemnity by the account party. When the beneficiary demanded payment under the performance bond and the bank demanded payment under the counter­ indemnity the account party argued that the underlying contract was a nullity and that therefore the bank should be prevented from paying under the performance bond until it is established whether or not the underlying contract is a nullity since, if the underlying con­ tract is a nullity the performance bond must also be a nullity. But the Com de Cassation rejected that contention and held that because the bank’s obligation under the performance bond was independent of obligations arising under the underlying contract the alleged nullity of the underlying contract had no effect on the bank’s independent obligation to pay

108"Ццц. t0 a contract based on an illegal ‘cause’.

109See, e.g. M ari v. Stefani S. 1886.1.205; Comp, des Messagerie du Sahelc. DelaiseD . 1909.11.127.

110See, N. Enonchong, Illegal Transactions (Lloyds of London Press, London, 1998) 29-31.

111Loumiet v. Veuve Garden D. 1894.11,528.

112See Enonchong, ‘Effects of Illegality: A Comparative Study in French and English Law’ (1995) ICLQ 196 at 198.

1,3 Cass. Com. 20 December 1982, D. 1983. J. 365.

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V. Authorities in OtherJurisdictions

in accordance with the terms of the bond. The same applies to a claim by the paying bank under the counter-guarantee given by the instructing party. Thus, in Baldessari v. Soc. Bordelaise de Credit Industriel et Commercials4 the Gourde Cassation held that the nullity of the underlying contract did not affect the obligation of the instructing bank to pay under its counter-guarantee since the instructing bank’s obligation owed to the issuing bank was inde­

is seeking restitution from the beneficiary, the nullity of the underlying contract could pro­ vide a basis for the claim in restitution. In Ste Borie SAE c. Ste Matra Transport117 a demand guarantee was issued in connection with a construction contract. The beneficiary demanded and received payment under the guarantee. It turned out that the underlying contract was null and void. The account party brought an action in restitution against the beneficiary to recover the amount paid under the guarantee. It was argued for the beneficiary that the claim should be rejected because it goes against the independence principle by which the bank was not allowed to raise any defence to payment arising from the underlying contract. But the Corn de Cassation rejected that contention and upheld the decision of the Court of Appeal which allowed the account party’s claim. The decision of the courts in this case can be sup­ ported on the basis that although the independence principle prevented the bank from rely­ ing on the nullity of the underlying contract as a ground for refusing payment under the demand guarantee, the account party’s claim is not based on the guarantee and therefore it is not affected by the independence principle. The claim is based on the fact that the parties to the underlying contract assumed that the contract was valid and agreed that a demand guar­ antee should be given to secure performance of the contract. Since the underlying contract has been found to be null and void, the normal consequence of restitution following nullity applies and the beneficiary, a party to the supposed underlying contract, must restore what he received under the contract, namely, the proceeds of the guarantee.

1,4 Cass. Com. 13 December 1983, D. 1984. J. 420.

115Paris 14 January 1993, JCP. G. II No. 22069, note Dumesnil-Rossi.

116Although the decision of the Court of Appeal was affirmed on another ground. See para 8.57 below.

117Com. 7 June 1994, Bull. 1994. IV. No. 202, p. 162, affirming Paris 5ech C. 14 January 1993, JCP. G. II No. 22069, note Dumesnil-Rossi.

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9

DEMAND IN BREACH OF AN AGREEMENT

WITH THE ACCOUNT PARTY

I. IN TRO D U CTIO N

payment without first giving the account party 10 days’ notice of intention to make the demand) but under the terms of the instrument itself there are no such restrictions so that the beneficiary has, under the instrument, an unrestricted right to demand and receive payment.

1 It does not extend to fraud or forgery of which the beneficiary did not have knowledge at the time of presentation. See discussion at paras 5.36 to 5.38.

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D em and in Breach o f an Agreement w ith the Account Party

In such a case, if the beneficiary demands payment without giving the notice required by the underlying contract, he commits a breach of that contract but the bank cannot rely on that breach as a ground to refuse payment. So, the bank will have to pay.2 Since the beneficiary has committed a breach of the underlying contract with the account party, the account party will be entitled to bring an action against the beneficiary for a remedy for breach of contract. In the ordinary case that should be damages. Such a claim for damages does not affect the principle of independence, the integrity of which is maintained by the bank honouring its independent obligation to the beneficiary under the instrument.

9.03However, in some cases the account party may consider that damages, which are awarded after the breach has been committed (that is to say, after the beneficiary has received pay­ ment), will not be an effective remedy. Instead, the account party would prefer to obtain restraining relief before the beneficiary commits a breach of the underlying contract by demanding and receiving payment under the instrument. To achieve that goal the account party may want to apply for an injunction either against the beneficiary, to prevent him

from demanding payment from the bank, or against the bank, to prevent it from making payment to the beneficiary. Ih e question then arises whether such an invitation for the court to interfere with payment under a letter of credit or demand guarantee on the basis of a breach or threatened breach of the underlying contract is one which affects the principle of independence and, if so, whether such interference should be allowed as an exception.

9.04 An important issue which arises in this context is whether the independence principle, which undoubtedly applies to the bank’s undertaking under the instrument, extends to the benefi­ ciary’s right to request payment. As indicated in Chapter 10, there is some controversy on this point. One view is that judicial intervention to restrain the beneficiary from exercising his right to demand payment under the letter of credit or performance bond (as opposed to restraining the bank from paying) does not threaten the independence principle. According to this view, therefore, the independence principle is not affected by an injunction to stop the beneficiary from committing a breach of the underlying contract by demanding payment under the instrument if the bank is not also involved in the proceedings. If this is correct, it may be argued that the court should be able to grant an injunction against the beneficiary unhindered by the considerations that apply where the independence principle is affected. The contrary view is that an injunction restraining the beneficiary from demand­ ing payment under the instrument affects the independence principle. According to this view, therefore, to restrain the beneficiary from demanding payment on the basis of provi­ sions in the underlying contract is to go against the independence principle. Indeed, one objection to judicial intervention on this ground is that such interference is contrary to the general nature of an unconditional performance bond, i.e to be independent of the underly­ ing contract.3

9.05However, even if the independence principle applies to a beneficiary’s right to demand pay­ ment, that is not a sufficient basis for saying that any intervention on the ground of restric­ tions in the underlying contract should be rejected. If there are sufficient policy reasons to justify it, intervention on this ground could be allowed by way of exception to the prin­ ciple of independence, in the same way as the fraud exception. Hie real question therefore is

2And claim reimbursement from the instructing party.

3J. O ’Donovan and]. Phillips, TheModem Contracto fGuarantee (English edn, 2003) para 13-27.

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LI. State o f the Exception in English L aw

whether, in addition to the fraud exception, the law should recognize another exception based on limitations in the underlying contract on the beneficiary’s right to demand payment. It will be submitted in this chapter that this question should be answered in the affirmative. However, it may be helpful first to consider the state of the authorities in England. This will be followed by a brief discussion of the experience of some other jurisdictions before an examination of the policy considerations involved.

II. STATE OF TH E EXCEPTIO N IN ENGLISH LAW

1. Towards Recognition

4 [1978] QB 146, 155.

5Ibid., at 156.

6[1996] QB 84.

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D em and in Breach o f an Agreement w ith the Account Party

fraud to cases where the beneficiary under the guarantee is alleged to be in non-fraudulent

breach of the main contract’.7

B. Subsequent acceptance

9.09More recent cases appear to indicate that the English courts may now be more receptive to applications for injunctive relief against the beneficiary on the basis that the beneficiary’s demand under the instrument is or will be in breach of a negative promise in the underlying contract.

9.10In T T I v. Hutchison 3G UK Ltd8 which concerned an application by an account party to restrain the beneficiary from demanding or receiving payment under an advance payment bond, Judge Thornton QC appeared to entertain the proposition that an injunction may be granted to restrain a demand if the demand was made in breach of a condition precedent in the underlying contract. In that case the underlying contract, which required the account party to procure an advance payment bond, stipulated that the bond ‘will only be exercised if this agreement is terminated in accordance with Clause 35’. Elowever, the bond itself did not contain any such restriction on the right of the beneficiary to demand payment under it, although it required a demand to be accompanied by: (i) a copy of the beneficiary’s notice to the account party of its intention to demand payment, and (ii) a beneficiary’s certificate stat­ ing that the account party is in breach, the respects in which it is in breach and that the amount claimed represents the extent of the account party’s liability to repay the advance payment. Following disputes between the parties as to delays in the account party’s perfor­ mance, the beneficiary gave notice to the account party terminating the contract under clause 35 and a separate notice of its intention to demand payment under the bond. The account party’s application for restraining relief against the beneficiary was based on the ground, inter alia, that the threatened demand was subject to a conditions precedent in the underlying agreement that the underlying agreement had been terminated under clause 35 but that this condition had not been fulfilled as the termination notice was bad. The court examined the account party’s allegations in detail and held that, on the evidence, the termi­ nation notice under clause 35 could not be held to be invalid so that the demand was not in breach of the term of the underlying contract. The injunction was refused for this reason. The decision would have been different if it had been established that the demand was in breach of the term in the underlying contract which permitted a demand only where the underlying contract had been terminated in accordance with clause 35.

9.11 In the T T I case it was assumed rather than decided that a beneficiary could be restrained from demanding payment under a bond where to do so would be in breach of a term in the underlying contract. In Sirius International Insurance Corp v. FAI GeneralInsurance Co Ltd9 there was argument on the point. In that case, Agnew, a syndicate at Lloyd’s, wished to rein­ sure its liabilities. FAI General Insurance were proposed as the reinsurers. Agnew were not happy with this and wanted a more solid reinsurer. Sirius International became that rein­ surer. Under the arrangement, Sirius wrote the policy on the basis that, if it were called upon to pay Agnew, FAI would in turn pay Sirius. In other words, Sirius ‘fronted’ the arrangement and ‘retroceded’ it to FAI. As a requirement for fronting the arrangement Sirius requested

7Ibid., at 99.

8[2003] EWHC 762 (TCC); [2003] 1 All ER (Comm) 914.

9[2003] 1 All ER (C o m m ) 863 at [26].

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taken as a whole, these authorities disclose a movement towards recognition of an exception whereby the court may restrain a beneficiary from demanding or receiving payment under a letter of credit or demand guarantee where the beneficiary’s demand is or will be in breach of a negative promise in a separate agreement with the account party and where the bank is not joined as a defendant in the proceedings. So it may be helpful to consider the nature of such an exception.

10The question did not arise since the sums secured by the letter ofcredit had already been drawn down and deposited into an escrow account.

11[2003] 1 AU ER 865 at [29].

12[2004] UKHL 54.

13i.e. R. D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd[ 1978] QB 146; Ihemehelp Ltd v. West [1996] QB 84 at 99; TTI v. Hutchison 3G UK Ltd [2003] 1 All ER (Comm) 914; Sirius International Insurance Corp v. FAI GeneralInsurance Co Ltd [2003] 1 All ER (Comm) 865.

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