Fraud and forgery in trade finance

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Trade Finance 101
Fraud and forgery in
Trade Finance.
The principle of autonomy and the doctrine
of strict compliance.
Andrea Frosinini

Fraud and forgery in Trade Finance.
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1. Overview.
The question as to what precise kind of fact situation, if proven, amounts to fraud is largely nexplored and
the substantive concept of fraud remains rather vague. Such expression for sure connotes a huge variety
of different schemes, all of which involve some degree of dishonesty. Fraud happens whenever a
Beneficiary presents a claim, which he knows at the time to be invalid, representing to the bank that it
was valid. Before the Principal can rely on it, it must be shown that the bank was clearly aware of the
fraud at the time that he paid and passed on the demand, or that the circumstances were such that the
only reasonable inference was that the original demand was fraudulent. Where the claim was presented
in good faith and honesty, but was an invalid one because of some mistakes, then if the invalidity of such
claim was known to the bank and the bank was to pass on the claim as valid and demand payment, it
would be guilty of fraud, which would justify non-payment of the demand, notwithstanding that the
demand on its face appears to be valid. There is no fraud if the Beneficiary has a “bona fide” claim to
payment under the underlying contract and that Beneficiaries will be acting fraudulently, meaning that
they will claim payment to which they know they have no entitlement. There are no indications that there
must be actual proof of “dishonest”, or “mala fide” intentions on the part of the Beneficiary, or evidence of
the Beneficiary’s actual knowledge that he has no entitlement to payment. The existence of such
knowledge, dishonesty or mala fide conduct on the part of the Beneficiary is simply derived from the
established facts.
The possibility of obtaining an injunction against payment is not limited to the case of fraud in connection
with the documents themselves, but that fraud relating purely and simply to the underlying contract
could also form the basis of such an injunction. In appropriate circumstances the court may issue an
interlocutory injunction against the calling of a demand guarantee by a Beneficiary.
Fraud means misrepresentation, with a restriction to documents. Based on this, it is still an open question
whether it has a wider meaning. Since the basis of the fraud exception is public policy, there is no reason
why the exception should be limited to misrepresentations. If the demand by the Beneficiary is tainted by
some form of fraud other than misrepresentation, why should the principle of “fraud unravels all” be
invoked? A term in a demand guarantee may require that a demand should be accompanied by a
Beneficiary’s own certificate stating that the Principal is in default of his obligations under the underlying
contract. When the Beneficiary provides the certificate or gives notice of default, he is necessarily
representing that he honestly believes that there has been a default on the part of the Principal. If he
knows that this is false, he will be guilty of fraud. A term in a demand guarantee may also require that a
demand should be accompanied by a certificate issued by an independent expert. Should the Beneficiary
then make a demand with the clear evidence that he had the certificate issued fraudulently or had forged
it, the bank might be able to refuse payment on the ground of the fraud exception. Whatever fraud may
mean, it is to be determined by reference to the underlying transaction.
There is a distinction between fraud committed by the Beneficiary on the documents, i.e. “fraud in the
narrow sense”, and fraud committed by a Beneficiary that does not pertain to the documents, but relates
to his conduct regarding the underlying contract i.e., “fraud in the wide sense”. The cases dealing
specifically with demand guarantees indicate an acceptance of fraud in the wide sense. A wide approach
to the fraud exception makes sense and is in accordance with judicial developments and a number of valid
considerations substantiate an expansion of such exception. It does not make any sense to consider only
one type of fraud, namely fraud on the documents. When ccepting the wide approach to the fraud
exception, one should keep in mind that it remains the duty of the Applicant/Principal, and not the bank,
to allege and prove the fraud and that there is no duty on the bank to investigate the possibility of fraud
outside the documents. Based on the strict test for fraud, we can expect that frivolous and Applicant-
Principal-inspired litigation, based on the fraud exception, would be kept to a minimum.
Fraud in connection with documentary credits is said to be growing. Among the main precautions are the
words, KYC standing for “know your customer”, this being a common misconception that it is possible to
safeguard oneself 100% by using a documentary credit. Fraud may be committed by the Buyer, as well as
by the Seller or even in cooperation between the parties. A fraud in the underlying transaction is the
typical situation where the Beneficiary commits a documentary credit fraud by offering a supply of goods
in large quantities in order to obtain a big amount of money at a considerably lower price than the one
prevailing in the global markets, often in contexts related to bulk goods like sugar, grain or cement. The

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goal is to induce a Buyer to apply for the issuance of an irrevocable credit, perhaps to be confirmed by a
well reputed bank. To collect the amount, the so called Seller then presents fake or forged documents
then disappears. When the fraud is discovered, the nominated bank is not therefore able to enforce its
claim. The best protection is to know one’s counterparty and not being tempted by an offer “too good to
be true”. Banks should also be on their guard to unveil that a kind of atypical transactions, especially
when the Beneficiaries are unknown or the goods are not characteristic of the Beneficiary.
One way for a Buyer to get his goods without intending to pay for them is to apply for the issuance of a
credit stipulating the goods to be delivered directly to him and maybe featuring conditions the
Beneficiary cannot fulfil, such as documents to be signed or issued by the Buyer after shipment of the
goods. When the documents cannot be honoured on presentation due to discrepancies, the Applicant can
refuse to approve them, and the issuing bank then refrains from paying. The Buyer can protect himself
against legal proceedings only by disappearing or, if he lives in a country where courts do not regard such
conduct as fraud. A variant to this situation is the Buyer refusing the document and later accepts taking
over the goods at a price considerably lower than the market price.
The Buyer and the Seller might jointly try to defraud one of the banks involved by sending a message
directly to the Seller, confirming that he will approve documents containing a specific discrepancy. By
doing so, he will induce the nominated bank to pay, perhaps under reserve and later, when he does not
approve the documents after all, he disappears or goes bankrupt.
As for the fraud in the documentary credit transaction, one of the most common examples is the
consignment that does not contain the goods agreed upon, but boxes filled with rubbish, and a statement
of weight and the genuine documents do not reveal that they are not the goods expected.
According to the Article 5 of UCP 600, “bank deals with documents not goods or services” which means
that “banks deal in written presentations not facts”. The fundamental principle governing documentary
credits and the feature that gives them their international commercial efficacy is that the obligation of the
issuing bank to honour the draft on a credit, when it is accompanied by documents appearing on their
face to be in accordance with the terms and conditions of the credit is independent of the performance of
the underlying contract for which the credit was issued. Therefore, Beneficiary does not have to prove
fulfilment of his obligations in underlying contract and only presentation of complying documents will
entitle him for receiving payment from issuing bank. As a result, strict implementation of autonomy
principle will create three distinctive scenarios regarding presentation of documents by Beneficiary: first,
Beneficiary presents complying documents and performs his obligations under the sales contract with
account party. As a result, a bank will allow payment after checking documents; second, Beneficiary
presents non-complying documents while performing his obligations under the contract of sales with
account party. In such a situation, a bank may or may not authorize payment to the Beneficiary.
Third scenario: Beneficiary presents complying documents to the terms of credit but does not perform his
obligations under sales contract with account party. In such case, the strict application of autonomy
principle might lead us to fraud by Beneficiary and injustice towards account party who has to bear the
loss as the last person in the chain of transaction.
Therefore, in order to prevent fraud, the law of documentary credits has created fraud exception to the
autonomy principle. The UCP 600, as the most popular set of applicable rules to documentary credits,
take an absolute silent position towards fraud rule, which show a drastically non harmonious approach to
the subject matter. Fraud exception in documentary credits is an extraordinary rule because it represents
a departure from the cardinal principle of the law: the principle of independence, that allows the issuer or
a court to view the facts behind the face of conforming documents and to disrupt the payment of a credit
when fraud is seen to be involved in the transaction. Conveying the message that a fraudulent Beneficiary
will not be able to find an action based on his wrongdoing. The rule is an exception to the rule that the
contracts made in connection with credits are autonomous.
To a general statement of principle of independence, as to the contractual obligations of the confirming
bank to the Seller, there is one exception: where a Seller, for the purpose of drawing on the credit,
fraudulently presents to the confirming bank documents that contain, expressly or by implication,
material representations of a fact that to his knowledge are untrue. In accordance with this definition,
material misrepresentation is a sort of fraud that can invoke the fraud rule. Material misrepresentation is
very close to a statement of the elements of fraudulent misrepresentation which constitute the tort of
deceit, whose elements are knowing the representation to be false, without belief in its truth, recklessly,
careless whether it be true or false. The answer to the question of what must the misstatement in the
documents be material should be “material to the price which the goods to which the documents relate
would fetch on sale if, failing reimbursement by the Buyer, the bank should be driven to realise its

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security”. Material misrepresentation has been considered as the standard of proof for fraud in
documentary credits and it has been largely accepted.
Preventing Beneficiary from claiming payment will not only include the situation that he is the
responsible for the fraud, but also at the time of presentation, that he should be aware of
misrepresentation existing in tendered documents even though a third party is responsible for them. In
this respect, the degree of Beneficiary’s knowledge of fraud before being infected by fraud exception can
be a concerning problem, because this is likely to require actual, rather than constructive knowledge
based on what the Beneficiary, as a reasonable man, should have known. The question of what constitutes
actual knowledge should be approached cautiously.
Fraud should be relevant to documents. This definition requires a fraudulent aspect of a document to be
material to a purchaser of that document or that the fraudulent act be significant to the participants in the
underlying transaction. The fraud exception to the autonomy of documentary credit should not be
confined to cases of fraud in the tendered documents but should also include fraud in the underlying
transaction, as to make the demand for payment under the credit a fraudulent one. The fraud exception to
the autonomy of a documentary credit should extend to any act of the Beneficiary of a credit the effect of
which would be to allow him to obtain the benefit of the credit as a result of fraud. The fraud exception
should be confined to “fraud by the Beneficiary” of a credit and should not extend to fraud by a third party
of which the Beneficiary is innocent. The fraud exception should not be opposable to the holder in due
course of a draft on a credit.
After the occurrence of the fraud, law of the documentary credits provides three groups of
remedies, namely: bank’s rejection to pay, paying bank’s right to reimbursement and granting
injunction to stop payment by court.
Upon presentation of confirming documents by the Beneficiary, issuing bank and conforming bank, if any,
have the duty to honour the presentation. In case of bank’s decision not to effect the payment to Beneficiary,
it should prove the established fraud. It is rare for a bank to refuse to honour a credit on its own initiative
for generally a bank does not reveal fraud and the information and instructions about fraud come from
the account party. Afterreceiving allegation of fraud from account party, a bank has the option to pay or
not and in case it decides to effect payment, obtaining the injection for court will be the only solution for
the accountparty to prevent payment to Beneficiary. If abank decides not to pay, then either Beneficiary’s
fraud is established or bank will be excused from payment or if otherwise happens, such bank will be in
breach of contract. When it decides not to effect the payment, Beneficiary might apply for summary
judgement against the bank in order to get quick remedy without going to full trail. A court may give
summary judgment against a claimant or defendant on the whole of a claim or on a particular issue if it
considers that such claimant has no real prospect of succeeding on the claim or issue, or such defendant
has no real prospect of successfully defending the claim or issue, and there is no other compelling reason
why the case or issue should be disposed of at a trial. For a court, it is not enough that a bank can show
real prospect of successfully establishing fraud in its defence. A bank should indeed be able to prove the
real established fraud which has the capability of being clearly done at the interlocutory stage. In
occasions that a bank does not resist payment on the basis of fraud rule like invalidity of a documentary
credit, it would be sufficient to satisfy the normal standard while trying to show the real prospect of
success.
The general rule is that a bank, that paid against a conforming presentation, is entitled for
reimbursement. In case of fraud, such bank has no obligation against Beneficiary or entitlement against
the account party for effecting the payment. In case of payment in such circumstances, a bank cannot
claim for reimbursement as a bank that does not have information about the fraud of Beneficiary will not
be prejudiced. In case of improperly paid draft by the issuing bank, the standard of proof for fraud should
be set in the question that whether fraud was so established to the knowledge of issuing bank before
payment of the draft as to make the fraud clear or obvious to the bank. Standard of proof for such cases is
different from when Applicant is trying to obtain interlocutory injunction against a bank to restrain the
payment to the Beneficiary. A bank trying to resist summary judgement against the payment to a
Beneficiary is subject to the higher standard of proof, though this does not apply in the occasion that the
Applicant, the issuing bank or the confirming bank try to resist the summary judgment as a result of being
sued for reimbursement by the bank which has paid the fraudulent Beneficiary. In such occasions,
defendant is expected to provide a real prospect of existing fraud. A Beneficiarymight successfullyobtain
thesummaryjudgementagainst abankas aresult ofbank’s failureto establish a clear evidence of fraud,
thereis no guaranteethat abank can in return obtain summary judgement for receiving reimbursement
against the instructing party, as this should only satisfy the low test of real prospect of fraud in the trial.

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Under deferred payment credits, the nominated bank has the obligation to pay on the maturity date in
accordance with the credit. As under a deferred payment system there is no immediate payment available
to Seller until the maturity date of the credit. The Seller is responsible for shipping goods and expects
payment on maturity. As such a process imposes a financial burden on the him, themarket demand in
similar conditions resulted in thecreation of aforfaiting practice where a nominated bank may agree to
discount the Beneficiary’s documents and expects reimbursement from issuing bank on maturitydate. In
caseof Beneficiary’s fraud before the maturity date, the Applicant and the issuing bank will definitely try
not to reimburse the nominated bank which has paid the fraudulent Beneficiary. The UCP 600 provided
guidance for interbank reimbursements under deferred payment regime, it is worth to studythe right and
obligations of nominated bank and other involved financial institutions under deferred payment before
and after the coming into force of the UCP 600. The Article 7 (c) holds that assignment of rights from the
Beneficiary to the discounting bank is no longer necessary and, as a result, bank is entitled for
reimbursement at the maturity date.
“An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a
complying presentation and forwarded the documents to the issuing bank.
Reimbursement for the amount of a complying presentation under a credit available by acceptance or
deferred payment is due at maturity, whether or not the nominated bank prepaid or purchased before
maturity. An issuing bank's undertaking to reimburse a nominated bank is independent of the issuing
bank’s undertaking to the beneficiary.”
Article 12 (c) has been the subject of a debate arising from the impact of the authorization, for this rule is
considered as the legal basis for mitigating the risk of fraud between the date of payment and maturity date,
while it can be considered as a right given to the nominated bank and it might use such right on its own
discretion and definitely on its own risk. By nominating a bank to accept a draft or incur a deferred
payment undertaking, an issuing bank authorizes that nominated bank to prepay or purchase a draft
accepted or a deferred payment undertaking incurred by that nominated bank:
“Receipt or examination and forwarding of documents by a nominated bank that is not a confirming
bank does not make that nominated bank liable to honour or negotiate, nor does it constitute honour
or negotiation.”
According to the independence principle, courts should not interfere in the process of documentary credit
and demand guarantees operation by granting injunction, unless on the basis a recognized exception.

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2. Fake or forged documents.
A considerable part of the instances of fraud are based on fake or forged documents allowing payment
under the credit. According to Article 34 of UCP 600, banks are under no obligation to examine if a
document is genuine or if the individual signing the document is entitled to do so and often are not even
in a position to do so, nor can they be expected to check if a particular vessel loaded a specific
consignment of goods or left a named port on a given date, for they will only examine documents with
reasonable care to determine on the basis of the documents alone, whether on their face they appear to
constitute a complying presentation (Articles 2, 7(c), 14(a) and 15(a)).
In addition to the documents been falsified with fraudulent intent, they are also presented to the banks
where certain details were forged, sometimes with the only aim of fulfilling the stipulations of the credit.
Some of these falsifications have no actual bearing on the their value to the Buyer, while others are
absolutely to the detriment of the Buyer in terms of insurance, should the goods be damaged.
A Beneficiary committing fraud or falsifying documents cannot claim any right to receive payment under
a credit, whether this is confirmed or not, nor can he do so if the forgery or fraud was committed by
someone else at the instance of the Beneficiary or if he knew of it. Where forgery or fraud is committed by
a third party without the Beneficiary’s knowledge, this gives rise to doubts though. A case has been heard
by a court where a carrier had deliberately included a fake on board notation and the Beneficiary had his
claim against the confirming bank sustained. This case seemed not to support the general attitude that
forgery and fraud will always be a strong basis for defences to the effect that payment under a credit can
be refused.
It sometimes happens that a Beneficiary receives a credit that turns out not to be genuine as it was not
issued by the bank stated in it. There are two types of fraudulent credit: the commercial credit and the
financial standby. Article 9 of UCP 600 ensures to a large extent that a fraudulent credit is not advised by
the advising bank, though without an absolute guarantee against a perfect falsification, where it is not
enough for the bank to take reasonable care to check the authenticity of the credit:
“Advising of Credits and Amendments
a. A credit and any amendment may be advised to a beneficiary through an advising bank. An
advising bank that is not a confirming bank advises the credit and any amendment without
any undertaking to honour or negotiate.
b. By advising the credit or amendment, the advising bank signifies that it has satisfied itself as
to the apparent authenticity of the credit or amendment and that the advice accurately reflects
the terms and conditions of the credit or amendment received.
c. An advising bank may utilize the services of another bank (“second advising bank”) to advise
the credit and any amendment to the beneficiary. By advising the credit or amendment, the
second advising bank signifies that it has satisfied itself as to the apparent authenticity of the
advice it has received and that the advice accurately reflects the terms and conditions of the
credit or amendment received.
d. A bank utilizing the services of an advising bank or second advising bank to advise a credit
must use the same bank to advise any amendment thereto.
e. If a bank is requested to advise a credit or amendment but elects not to do so, it must so
inform, without delay, the bank from which the credit, amendment or advice has been received.
f. If a bank is requested to advise a credit or amendment but cannot satisfy itself as to the
apparent authenticity of the credit, the amendment or the advice, it must so inform, without
delay, the bank from which the instructions appear to have been received. If the advising bank
or second advising bank elects nonetheless to advise the credit or amendment, it must inform
the beneficiary or second advising bank that it has not been able to satisfy itself as to the
apparent authenticity of the credit, the amendment or the advice.”

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The problem exists mainly where a Beneficiary receives the credit directly from a “bank” claimed to be
the “issuing one”, or from another “bank” unknown to him, which has “confirmed” the credit.
Every Beneficiary receiving such a dubious credit should contact his own bank, which will undoubtedly
be able to evaluate the authenticity of the credit.
Fraudulent commercial credits typically cover luxury goods, or high value goods and often stipulate the
goods to be shipped by air, with the air waybill to evidence the “Buyer” as Consignee. If the Seller ships
the goods, the fraud will not be detected until the documents are to be honoured. Fraudulent
documentary credits often contain incorrect details for banks, such names, addresses etc. or wording
which constitute a signal of danger suggesting to an expert that something is wrong.
Recent years have also seen an abundance of various forms of strange financial standbys to emerge, often
for extremely large amounts. Sometimes an offer for a financial transaction is received without the
specific standby being issued and such an offer is about finance, typically for one year and one day,
guaranteed by a top world bank whose name is not stated. The customer is supposed to buy this standby
at a very low price. After the expiry he is then to receive 100% of the amount. In rare cases, the name of
an international bank is stated, though it denied being involved in such transaction. The offers and the
draft standbys often contain lots of foreign words and references to non-existent international rules. This
kind of offers are often sent to companies and individuals known within finance and seldom to banks.
After consulting their bank, the recipients often succeed in stopping these transactions before they take
effect. As a result, the attempts to issue fraudulent instruments seem to exceed the number of fraudulent
standbys actually issued. Because it cannot be ruled out that some of these transactions might be in order,
it is impossible to know the exact number of fraudulent standbys issued and the amount of losses
suffered.

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3. Standard of proof of fraud.
The Beneficiary’s fraud should be established clearly and the burden of proof required is the ordinary
civil one. As in any other case where fraud is alleged, fraud will not be inferred lightly. No special standard
of proof applied to cases where the Applicant sought to interdict the bank from paying on the credit. The
ordinary standard of proof also applies in a case of fraud, but the court weighs the evidence with due
regard to the gravity of the particular allegation and the degree of probabilities depends on the subject
matter. Clearly, a very high degree of probability is required in this context. With regard to the standard
of proof of fraud, the general formulas are that the fraud must be “very clearly established” or “clear and
obvious”, and the proof must be immediately available with no need for lengthy and in-depth
investigation into the underlying transaction. Even the fact that the Beneficiary has made previous
attempts to claim under fraudulent demands in the past does not constitute enough evidence that a future
demand under the same instrument will be fraudulent. In dealing with this matter, it is not up to a bank to
make enquiries about the allegations that were being made one side against the other. If a party wishes to
establish that a demand is fraudulent, it has to put the irrefutable evidence in front of the bank. He should
not merely make allegations and expect the bank to check whether those allegations were founded. Also,
it is not the role of a bank to examine the merits of allegations and counter-allegations of breach of
contract. Holding a different view would place banks in a position where they would in effect have to act
as courts in deciding whether to make payment or not. A totally different situation would arise in an
instance where a Beneficiary admits to the bank that it has no right to make the demand. The mere
allegation of fraud is not sufficient, as “irrefutable” evidence that the claimant is dishonest is required,
before the banker can refuse to pay under the demand.
When dealing with the fraud exception, it is important to establish the exact time at which the fraud must
be clear to the Beneficiary and the bank. It has to be clear evidence of fraud at the time of presentation of
the documents. It does not matter that at the time of trial the Beneficiary and the bank knew that the
documents presented under the letter of credit were not truthful in a material respect. Undoubtedly, the
Beneficiary must know of the fraud at the time of the presentation, for this is the critical moment. If the
Beneficiary does not have such knowledge, he obviously cannot be party to the fraud. If a bank, for
instance, rejects on the grounds of non-conformity at the time of presentation and later finds out prior to
trial that the Beneficiary had committed a fraud at the time of presentation, it would be irrational for such
bank not to be able to rely on the fraud exception, given that the exception is based on public policy.
Whilst the Beneficiary must be a party to the fraud at the time of presentation, so must necessarily have
knowledge of the fraud, the bank may still rely on the Beneficiary’s fraud, if, for instance, it rejects for
some other reason, such as non-conformity, and consequently discovers the fraud. It would be odd if the
bank were unable to rely on the fraud exception simply because, by reason of the efficacy of the fraud, it
did not know of the fraud at the time it rejected the documents.
Banks will often reject in the first instance on grounds of discrepancies and thereafter will justify such
rejection on the fraud exception as well. Article 16(c)(ii) of UCP 600 provides that a bank must state all
the discrepancies in respect of which it refuses the documents. This does not apply to the fraud exception,
because at common law a contract can be set aside for fraud even if that was not the original justification
for the refusal to perform:
“each discrepancy in respect of which the bank refuses to honour or negotiate”.
In any case, the evidence of fraud may only transpire at a later stage as it is often used as an additional
reason for non-payment where the documents had initially only been rejected as non-conforming If a
bank can show that the only proper inference is fraud, it would be absurd to think that the same would
have judgment entered against it. It would not seem right to hold that since the bank can recover from its
customer, it is legitimate to give judgment in favour of the fraudster allowing recovery from the fraudster
only at the suit of the customer.
If a bank, or surety, has a clear case, not at the demand stage, that the demand was fraudulent, then the
bank has a counterclaim against the fraudster which it is capable of establishing for the return of the
money, simply because after demand on a bond it turns out that no amount is due from the customer to
his contractor, that does not lead to the bank or surety having any remedy against the Beneficiary of the
bond. The customer who of course must indemnify the bank or surety may have a right as against the
Beneficiary under the contract but that is all. The point is not restricting the time by which the evidence of

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fraud must be available to the extent of negating evidence of fraud that has come to light after
presentation of the documents, but before hearing the case; it is rather that the bank would have to reach
a decision on whether to pay or not, soon after presentation of the documents. Usually it will only refuse
payment in the light of compelling evidence available to it at that stage. If the bank refuses to pay on a
suspicion of fraud and is sued, and prior to hearing the case acquires evidence, such evidence should be
admissible. Whereas previously the rule that the bank was obliged to pay against a demand that complied
with the terms of the letter of credit, or performance guarantee unless, at the time of presentation, the
bank had clear evidence from which the only inference that could be drawn was that it was fraudulent, it
now looks that a bank may also be entitled to rely on the knowledge it obtained between the demand and
the hearing that the demand was fraudulent or that the letter of credit, or performance guarantee, was
voidable for fraudulent misrepresentation when the demand was made, as grounds for refusing to pay
the Beneficiary.

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4. Fraud as basis for injunctive relief and interdicts.
It is clear that in appropriate circumstances, where fraud is involved and provided that the Applicant
satisfies the burden of proving it, courts will not hesitate to interdict a bank from paying under a credit
and probably a demand guarantee as well. An interdict restraining a bank from paying under a
documentary credit, or a Beneficiary from making a demand, would only be granted in exceptional
circumstances. The question of fraud only becomes relevant in cases where it is discovered before
payment by the bank has taken place; in such instance, an Applicant/Principal of a credit/demand
guarantee has the option of applying for an interdict restraining the bank from paying and/or restraining
the Beneficiary from making a demand or receiving payment. If fraud is discovered only after the
payment has taken place, the Applicant’s/Principal’s remedy lies in a civil action against the Beneficiary.
Irrespective of whether the payment has been made, the Applicant/Principal may also apply for an anti-
dissipation interdict in order to prevent the Beneficiary from dissipating his assets until such time as the
matter of fraud is finally settled between the parties. A deduction will only be possible in case a clear
fraud is established by an Applicant/Principal and he applies for an interdict restraining the bank from
paying under the credit/demand guarantee. In addition to proving that there is established fraud, an
Applicant or Principal applying for an interdict against the bank and/or the Beneficiary will also have to
satisfy all the other requirements before an interim interdict will be granted. Should the
Applicant/Principal ever succeed in proving established fraud on the part of the Beneficiary, he will also
have to comply with all the other requirements for obtaining an interim interdict, which in practice looks
rather difficult.
The principle that a mere breach of the contract of sale could not provide a basis for blocking payment in
terms of a letter of credit by a prohibitory interdict against the bank is established and the position might
be different where the breach of contract also involved fraud on the part of the Beneficiary. The fraud
exception is normally invoked as a defence of last resort where there is no other means of preventing
payment being made under the instrument. The question of whether there is a contractual basis for
refusing payment under the terms of the instrument itself must be fully explored as one of the main
factors that limits the availability of the fraud exception is the high standard of proof it requires. For the
exception to apply, the evidence of fraud must be “clear” or “obvious”, which requires that at an
interlocutory stage the claimant must show that there is a real prospect of establishing that on the
material available the only realistic inference to draw is that of fraud. A mere allegation of fraud is not
enough, nor is it sufficient to show that there is good reason to suspect fraud. Even the fact that the
Beneficiary has made previous attempts to claim under fraudulent demands in the past is not enough
evidence that a future demand under the same instrument will be fraudulent. Where the injunction is
against the bank, even though a fraud on the part of the Beneficiary is clearly established, that is not
enough as it must, in addition, be shown that the bank was clearly aware of the fraud.
Most cases involving demand guarantees and the fraud exception concern unsuccessful attempts by the
Principal to prevent the Guarantor by injunction from making a payment under the guarantee, where
demand has been made in a proper form, and within time. If a Principal fears that a fraudulent demand is
going to be made under a demand guarantee, he should inform the bank of the evidence of fraud
immediately. The bank will then need to decide whether the evidence of fraud is enough for it to refuse
payment in the event of a demand being made. If the bank refuses to pay, it may damage its own
reputation and become the defendant to litigation by the Beneficiary to enforce the instrument. If the
bank rejects the evidence of clear and obvious fraud and makes payment, then it would be liable to the
Principal if it were subsequently held that it should have invoked the fraud exception on the materials
available at the time. The Principal would also then be entitled to refuse to indemnify the Guarantor, i.e.
the bank. If he obtains an injunction restraining payment, then the bank may avoid damage to its
reputation, because the bank will not be held responsible for having complied with a court order. Where
there is evidence of fraud, a short-term injunction may at least freeze the position for a short period of
time during which the Beneficiary may be forced either to abandon the attempt to obtain payment or to
produce evidence countering the allegations of fraud.
A different approach in LoC cases has been taken though, where the Applicant takes an action against the
issuer for an injunction preventing him from honouring a credit from cases where the Beneficiary takes
an action against the issuer for wrongful dishonour, or cases where the Applicant takes an action against
the Beneficiary to prevent him from demanding payment. A distinction must be drawn between the

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evidence necessary to obtain an interlocutory injunction and the evidence necessary to entitle a bank that
had refused to pay to justify its refusal in proceedings against it. In many cases, a third party such as a
negotiating bank, stands in the shoes of the Beneficiary and has the right to present documents. It would
therefore make no sense to apply different principles to the granting of an injunction depending on the
chance event of whether the documents had been negotiated. When dealing with demand guarantees,
different principles apply to demand guarantees, because there is an important distinction between an
injunction preventing the Beneficiary from making a demand in the requisite form, and an injunction
preventing the bank from making payment upon such demand having been given.
Where a Principal does succeed in establishing fraud, an injunction will not be granted unless the
Principal can also satisfy the “balance of convenience test”, which is part of the general requirement for
an application for an interim injunction, aiming to determine whether it favours the granting or refusal of
an injunction. In the context of an application to prevent payment under a demand guarantee, the
Applicant faces an insuperable difficulty where the application is against the bank. In such a case, an
injunction would be an inappropriate remedy as it interferes with the bank’s undertaking to pay and
might cause greater damage to the bank than the Principal could pay on his undertaking as to damages. In
such a case, damages would be an adequate remedy. Even where the Principal applies for an injunction
against the Beneficiary rather than the bank, and the Beneficiary is a large company with considerable
assets within the jurisdiction, the balance of convenience test will still have a huge weight against the
claimant (Principal). Because of the difficulty in establishing fraud in the first place, and then also
satisfying the balance of convenience test in order to obtain an injunction and restrain the Beneficiary
from making a demand or the bank from paying, it is extremely rare for a Principal to be protected from
an abusive call through recourse to the fraud exception.

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5. The doctrine of strict compliance and the principle of autonomy in documentary
credits.
The doctrine of strict compliance can be defined as the legal principle entitling a bank to reject documents
which do not strictly comply with the terms of a letter of credit. The role of “strict credits” can be clearly
identified in protecting the customer as the possibility of fraud on the part of the Seller is limited by
restricting the discretion of banks to review the documents. The role of a bank is to ensure that the
shipment strictly complies with the underlying transactions as set out in the credit, the rationale for this
requirement being that banks cannot be imputed with knowledge of trade practices for their trade is with
documents, not goods. In addition, a Buyer has the documents as the only security since he has no
opportunity to supervise loading and later examine the goods physically. At the same time, the principle
of strict compliance also benefits the Seller by providing for a steadfast payment. He doesn’t have to wait
until the goods shipped safely reach the Buyer before claiming payment as he can present the documents
required by the Buyer to the bank as soon as the goods have been shipped. A bank also benefits from the
application of the principle of strict compliance as it will be protected against any legal repercussion as
long as the payment to the Seller was made upon strict compliance of Seller’s documents.
A bank is not expected to act beyond what the wording of the credit requires and its role is therefore to
reach a comparison by the mere examination of the documents against its wording. The purpose for
which the Beneficiary is to open the credit is an irrelevant factor to consider for payment. It doesn’t
matter whether the terms imposed by the subject requiring them to open the credit are reasonable, or
look reasonable or unreasonable at all. A bank is not concerned with that and if it accepts the mandate to
open the credit, it must do exactly what its customer requires it to do.
At this point, the doctrine of strict compliance should not be interpreted so stiffly as to deny the
documents on mere minor variations as the strictness referred does not extend to minor variations, such
as singulars instead of plurals, numbers in sets instead of totals and any redundant adjectives. Any
discrepancies between the description of goods shipped and the goods described in the credit will result
into a rejection of the documents. A banker who risks in applying the substantial compliance approach as
opposed to one based on strict compliance in terms of comparing the goods shipped and the description
of those in the letters will not be indemnified. Discrepancies in documents tendered can also lead to
rejection: first, the requirements for good documents are that a document must be effective and legal,
second, a document must be one of current use in the trade and last, such document has to be original and
labelled as such. It follows that the Buyer should give extremely clear instructions in order to avoid any
ambiguity that might result in the bank interpreting them its way which is normally in “a reasonable
manner”.
Bankers who chose by practice to receive documents with irregularities use a “tripartite protective
mechanism” seeking indemnity from the Beneficiary, making payments under reserve or arrangements
for collection under protection of credit. Under the UCP rules, they are expected to notify the Beneficiary
of any defects in the documents tendered in order for them to make appropriate corrections before either
of the two suffer losses. One of the most important aspects of the doctrine of strict compliance is to
provide the Beneficiary with an opportunity to make corrections on the draft by returning the documents
to him and giving him notice of the defects. If a confirming bank does not reject the documents or adopt a
protective mechanism, like seeking indemnity, and accepts the document, it will be liable for damages to
the Beneficiary if it fails to meet its obligation under the credit. The autonomy principle is to the effect
that the obligation of the banks to pay the Beneficiary does not depend on what the Buyer and Seller
agreed, or disagreed upon while they were forming their contract. It rather depends on the documents: if
they’re okay, the bank must not look at the agreement and whether or not all the terms were met by
either parties. The system of financing these operations would breakdown completely if the dispute
between a vendor and a purchaser were to have the effect of freezing the amount in respect of which the
letter of credit was opened.
A Seller who needs his payment cannot be restricted to only suing the Buyer for his money, as he had for
overtime grown to understand that he will receive payment on presentation of the correct documents to
the issuing or confirming bank. To have such belief subjected to an underlying contract would be
disrupting the known course of international transactions, as it would be taking away the certainty with
which international traders enter into these kind of transactions. A Seller who needs financing for goods
he received from the manufacturer should be granted with the chance to access it through the doctrine of

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autonomy in the lettr credit, which is by its nature independent. An issuing bank should discourage the
attempt of including terms of the underlying contract into it, because banks are expected to deal with
documents as opposed to goods and services: if these are correct, courts will not be restrained from
effecting payment.
A bank is in no way concerned with any dispute the Buyer may have with the Seller for the Buyer may say
that the goods are not up to contract: nevertheless, the bank must honour its obligation. A documentary
credit is given by a bank to the Seller with the very intention of avoiding anything in the nature of a set-off
or counterclaim. There is no such an obligation to the bank that the goods should correspond to the
contract description, as the only obligation the bank has is to make sure it is paying on accurate
documents. The Buyer bears the risk of paying and yet the wrong goods are delivered, though in some
cases, few banks might expressly agree with the Buyer to be involved in the underlying contract.
A confirming bank is not to be held negligent if upon failing to notice discrepancies in the documents, the
issuing bank captures them. This is not to be used as an excuse under contributory negligence to deny the
confirming bank an opportunity to recover from the Beneficiary. The concept of autonomy makes it
illogical that actually, court can uphold payment of a Beneficiary when there is underlying evidence that
he is not actually entitled to it.
The only exceptions to the autonomy rule are in cases of fraud and illegality. In case of illegality, the bank
is expected on grounds of public policy to refrain from enforcing payment under an illegal contract.
In some cases, LoCs were enforced because court could not establish fraud, which illustrates the
reluctance of courts to enforce an illegality. As they cannot sanction an illegality, the same can be said in
terms of a contract based on a contract marred with illegality. The other exception is fraud. Where a Seller
presents documents containing representations that are known to him to be untrue, the presentations
should not be honoured, although this case does not perfectly fit in the fraud exception since the Seller is
not aware of the fraud, which can either be in relation to the document, the credit itself or the underlying
contractual transaction. For a bank to rely on the exception of fraud, actual fraud must be proved and the
evidence must be clear, both as to fraud and as to the bank’s knowledge. It would certainly, not normally,
be sufficient that this rests upon the uncorroborated statement of the Buyer, for irreparable damage can
be done to a bank’s credit in the relatively brief time involved. It is therefore evident that nowadays
courts are careful in applying the exception of fraud. Extra proof of the act that constituted the fraud is
required and the Buyer is given an opportunity to counter the allegations as to fraud. In case of fraud, the
Buyer can also apply for a pre-trial injunction in order to prevent the Seller from being paid under the
letter of credit or to prevent other banks from making payment in specific cases: (a) if there is an
imminent payment about to be made by the issuing bank in breach of the contract with the Applicant, (b)
if the balance of convenience is in favour of the Applicant and (c) that the Beneficiary is accountable for
the wrongdoing.
So, why an issuing bank would not in the first place be permitted to be critical on the underlying contract
in order to avoid the absurdities of the presence of fraud? the little regard accorded to the underlying
contract has facilitated false calls, abuse and fraud and plays a significant role in the existence of the
credit. There ought to be a clear distinction on the Seller’s right to certainty of payment and his factual
right to payment under the underlying contract: the former is only possible if the latter is existing.
Therefore, it is not possible to conceive the underlying transaction as separate from the documentary
credit, because it contains a unilateral payment system of considerable complexity. The documentary
arrangement has the required capacity to protect the banks under the doctrine of strict compliance and
the Buyer under the autonomous principle.
The principle of Strict Compliance expresses that the issuing bank’s undertaking to honour the credit is
effective only upon presentation of complying documents, stipulated in the credit by Beneficiary. The
general law of agency provides that an issuing bank is entitled for reimbursement from Principle, i.e. the
Applicant, only in case of acting in accordance with the Principle’s instructions. Therefore, banks acting as
agents for Applicant in documentary credits will receive reimbursement in case of honouring the credit
against presentation of complying documents. The standard for examination of documents has been set in
Article 14 of UCP 600:
“a. A nominated bank acting on its nomination, a confirming bank, if any, and the
issuing bank must examine a presentation to determine, on the basis of the

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documents alone, whether or not the documents appear on their face to constitute a
complying Presentation.
[...]
d. Data in a document, when read in context with the credit, the document itself and
international stanB beneficiary before actualization of payment. There is an
ongoing scholarly debate about what constitutes the complying presentation which
can be traced into legal cases. The most important question can be what is the
characteristic of non-complying presentation?. There are two main theories
regarding the determination of documentary compliance: Doctrine of Strict
Compliance and Doctrine of Substantial Compliance.
On the other side, according to the doctrine of strict compliance, presented documents should strictly
comply with credit. In contrary with theUCP 500, the term of “reasonable care” has been deleted from UCP
600 which shows that only strict compliance is the criteria for reimbursement of bankby Applicant. Word
by word, compliance is not required by the UCP 600, simple mistakes and typographic errors might not
be considered as non-conformity during the examination and banks are unlikely to opt for rejection as a
result of minor defects. The UCP 600 does not use the term “strict” and also provides permission for
insignificant inconsistencies or errors: it is difficult to distinguish the insignificant error from the
significant one.
Discrepancies can be divided into two main groups: “irrelevant irregularities” with noeffects onthe
principleofstrict compliance, and “material orgenuinediscrepancies”, which violate the principle of strict
compliance and result in rejection of documents by bank. Except in case of commercial invoice, UCP 600
does not require for strict compliance of any documents with Credit. In fact, some articles provide
tolerance up to 10% regarding “amount or quantityof credit while terms like “about” or “approximate” are
used in the credit. Other articles provide tolerance of 5% when quantity is not defined in the credit.
Thereare numerous court cases on material discrepancies: caseswherethe goods been shipped were
described in the bill of lading as "machine-shelled ground kernels”, while the credit had the description of
goods as "Coromandel groundnuts". In the judgement of court of appeal, it was held that bank was correct
about rejection of tender despite the fact that terms were proved to be the same. The reason was that
banks are not required to have the knowledge of the meaning of terms in different fields. Other examples
where a credit stipulated an invoice for ‘100% Acrylic Yarn’, while the presented invoice described goods
as ‘Imported Acrylic Yarn’. Bank rejected the presentation and the court held thatbank was entitled to
dishonour presentation despite the fact that description of goods on packing list were matching with
credit on the basis that UCP has differentiated invoice from remaining documents. Another important
case on material discrepancies, where payment was due upon presentation of commercial invoice for
shipment of ‘100 new Chevrolet trucks’ while invoice described goods as ‘in new condition’. Thecourt held
that bank was entitled to reject presentation as “in the new condition” and “new” are not the same.
It is the test which is accepted by few courts in order to balance the interests. The requirement of test is that
banker should “look beyond the face of the documents, investigate the realities of the transaction, and
weigh the credibility of documents, customers and beneficiaries”. Substantial compliance has been
considered in contradiction with Article 5 of UCP 600 which emphasizes on limitation of bank’s
responsibility to deal with documents not goods or services.
The second fundamental principle in operation the “autonomy”, appreciated in national and international
legal frameworks and considered as “the cornerstone of the commercial validity of the letters of credit”,
and “the engine behind the letter of credit”. The autonomy principle has been clearly mentioned in article
4 of UCP 600:
“a. A credit by its nature is a separate transaction from the sale or other contract on which it
may be based. Banks are in no way concerned with or bound by such contract, even if any
reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to
honour, to negotiate or to fulfill any other obligation under the credit is not subject to claims or
defences by the applicant resulting from its relationships with the issuing bank or the
beneficiary.

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A beneficiary can in no case avail itself of the contractual relationships existing between banks
or between the applicant and the issuing bank.
b. An issuing bank should discourage any attempt by the applicant to include, as an integral
part of the credit, copies of the underlying contract, proforma invoice and the like.”
Based on autonomy principle and on the wording of article 4 of UCP 600, the Beneficiary has assurance
that his payment will be due upon presentation of complying documents to the issuing bank, while
neither bank nor the account party can deny payment based on the arguments related to performance of
underlying contract. Therefore, even in case of argument on performance of the underlying contract
account party and issuing bank have no other choice but to pay Beneficiary upon presentation of
complying documents and seek remedy by suing him for the breach of the underlying contract. The
autonomy principle has been considered a means of promoting international trade by following the logic
of “pay first, argue later” and has been considered as the foundation for smooth operation of credits.
The main functions of the autonomy principles in operation process of documentary credits are payment,
commercial and financing. By separating the underlying contract from credit and replacing risks of each
party, the autonomy principle reduces the commercial risk of trade. As a consequence, Beneficiary
receives payment after the tender of complying documents and bank receives reimbursement from
account partyregardless of existence ofany relevant dispute to underlying contract. The account party
should also pay first upon tender of complying documents and argue later about any unconformity in
goods. The commercial function of principle of autonomy has been defined as an “assurancefor
reimbursement” of issuer onlybased on tender of complying document by Beneficiary while requiring
issuing bank to undertake the ministerial function of document checking and fund transfer in order to
remove any doubts about its payment undertaking. On this basis, courts force the issuing bank to pay even
on the occasion of tendering forged and incorrect documents and regardless of the facts represented by
documents.
Financing function has two main characteristics: first, it protects confirming and issuing bank from any
interference, preventing them to receive reimbursement from the Applicant,after making payment to the
Beneficiary and second, it provides support of leveraging other transactions for Beneficiary by the credit
which has been issued in his favour. A bank is not concerned in any way with the merits or demerits of the
underlying transaction, and only in the most extreme circumstances should a court interfere with the
payment bank honouring a letter of credit in accordance with its terms bearing in mind the importance of
the free and unrestricted flow of normal commercial dealings.

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6. Exceptions to the autonomy principle: the fraud exception.
The autonomy principle provides Beneficiary with the shielded undertaking of the bank for payment
against any interferences on issues out of the terms of documentary Credits. Such undertaking intends
regardless to any disputeover the underlying contract, the bank should pay Beneficiary upon tender of
complying documents. The autonomyprinciple results in weak position of account party against abusive
demands by the Beneficiary and his fraudulent claims. On such occasions, the only defence for the
Applicant is to rely on strict compliance principle and rejection of non-complying documents by bank. This
defence might not work when he is determined to obtain payment on the basis of presenting fraudulent
documents. On the other hand, the Beneficiaryhas the upper hand against the issuing bank and account
partyin which regardless to any dispute on the contract of sales, he is entitled for payment upon the tender
of complying documents. Such upper hand can be an incentive for abusive demand for payment or
presentation of fraudulent documents by beneficiary.
For a long period of time the general belief was supportive towards the absolute nature of independent
principle. It later became clear that exceptions are needed to deal with abusive and fraudulent demands
and the fraud exception has been established and recognized by all common law countries. In cases of
fraud, a court has the obligation to decide between respecting the principle of autonomy and grating
injunction to stop payment, after considering public policy, statutes, and public interest and third party
rights.
Despite the fact that fraud rule is a recognized exception to principle of autonomyof documentary credits,
there is no standard regarding time and circumstances in which it should supersede the autonomy
principle. Later it became clear that exercising the public interest requires application of exceptions in
case of illegal underlying contract. The principle of autonomy, or independence of letters of credit law
provides guarantee of payment for Beneficiary upon presentation of complying documents and separates
the obligation of issuing bank for making the payment to the Beneficiary from his obligations under the
contract of sales with account party. Such absolute guarantee might result in presentation of documents
which comply with terms of credit on their face while the fraudulent Beneficiary has not performed any of
his obligations in the framework of underlying contract. Fraud is a very old and well-known phenomenon
in the business world. It has been considered as the most controversial and confused area as it goes to the
very heart of letter of credit by providing the bank with the possibility to look at the facts behind
complying presentation of Beneficiary and stop payment in cases of fraud in transaction.
When the account party is looking for injunction to prevent the Beneficiary from demanding payment, or
bank from enforcing payment on the basis of fraud exception, the first necessary step for him is meeting
the standard of proof, i.e. what it’s called the standard of “only realistic inference”, in order to provide an
alternative to the “clear evidence”, the evidence of fraud that has to be clear, both as to the fact of the
fraud and as to the guarantor’s knowledge. The mere assertion or allegation of fraud would therefore not
be sufficient: for the evidence of fraud to be clear, it would be expected that the Buyer was given the
necessary opportunity to answer the allegation against him and he, the Buyer, fails to provide any
adequate answer in circumstances where one could properly be expected.
It can be clearly understood that standard of proof for fraud has been formulated differently, one reason
for this can be that courts try to set a high standard from one hand to safeguard the autonomy principle
and from the other hand set it too high not to be attainable in practice. As a result, there are different
standards of proof includingestablishedor obvious fraud,good arguablecasewhichis therealistic
inference on the material available for Beneficiary to be fraudulent or the “real prospect” of establishing
fraud.
The second step for obtaining the injunction is satisfying the balance of convenience. One reason is that in
most cases evidence was not enough to establish fraud and as a result the case did not proceed to the
stage for considering the balance of convenience. Therefore, when claimant manages to establish the
basis for injunction, the court will then consider the balance of convenience in order to issue the
injunction, to prevent either Beneficiary from claiming the payment or bank form effecting the payment.
In most cases, the balance of convenience is against granting the injunction the main reason for this been
named as resistance of adequate remedies for damages, imminent expiry date of credit, availability of
freezing injunction and availability of final accounting between parties.
Letters of credit and demand guarantees are often said to be as good as cash because a bank’s obligation
under them is independent of its customer’s, i.e. Applicant’s/Principal’s, obligation to its trading partner,

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i.e. the Beneficiary, under the underlying contract. Even through the Beneficiary is in breach of the
underlying contract, or that contract has been terminated for breach, in principle the bank must still pay
if the demand complies with the instrument’s requirements.
What happens in case the Beneficiary turns to be defective or does not perform at all in accordance terms
of the underlying contract, but still presents documents that comply with the credit/guarantee? Will the
bank be allowed to refuse paying under the letter of credit/demand guarantee under such circumstances?
Two conflicting and competing principles need to be taken into consideration: the principle of
independence, applying to letters of credit and demand guarantees, entails that the bank is not allowed or
obliged to take notice of the provisions of the underlying contract, in considering whether it must pay the
credit/guarantee; at the opposite end, it seems unacceptable, on the grounds of reasonableness and fair
dealing, that a Beneficiary that deliberately falsifies documents so as to comply with the requirements of
the underlying contract and the credit/demand guarantee, while in reality rendering defective
performance under the underlying contract, should be able to claim payment under the credit/guarantee.
As the Beneficiary might benefit from its own fraudulent conduct in letters of credit and demand
guarantee transactions, a limited number of exceptions to the autonomy principle are currently
acknowledged and accepted in practice and the autonomy can be ignored by the bank in specific
circumstances. Although the main exceptions concern fraud and illegality, many other are still very
controversial and several uncertainties regarding their existence, scope and application.
In a transaction based on a letter of credit/demand guarantee, the bank is obliged to pay only in case the
documents presented are in line with the terms of such credit/guarantee, which means that the situations
where there is fraud or abuse of rights are excluded. In principle, a breach of the underlying contract will
not affect a bank’s obligation to pay.
In case of a “clear” fraud, the situation is quite different though for the fraud exception to the principles of
the autonomy and strict compliance is well established and recognised. Fraud is for sure the most
proclaimed exception to the autonomy principle and the absolute detachment of demand guarantees and
documentary credits from their underlying contracts. Although acknowledged as an exception, it remains
elusive to the point of being in practice illusory.
The question of fraud arises every time a defence against payment is made, usually based on grounds
derived from the underlying transaction. Defence is solely and directly based on the terms of the
guarantee itself with the result that the payment obligation does not materialise. Non-compliance with
the terms of the demand guarantee has nothing to do with fraud. Clearly, the most common type of fraud
in letters of credit transactions is where the Beneficiary has forged, or deliberately falsified the
documents, so as to comply with the requirements of the credit, while the goods in reality do not conform
to their description. Owing to the fact that demand guarantees often require only that a written demand
for payment be made, without submitting any other additional documents, this type of fraud does not
often occur in practice in relation to demand guarantees.
Where dealing with the fraud exception, one should distinguish between fraud committed by the
Beneficiary on the documents i.e. “fraud in the narrow sense”, and fraud committed by the Beneficiary
which does not relate to documents, for example, by intentionally dispatching goods of an inferior quality,
i.e. “fraud in the wide sense”. The question of fraud can arise in different scenarios.: in most cases, the
Principal raises the defence in proceedings in which he applies for an injunction against the bank
restraining it from effecting payment, and/or applies for an injunction against the Beneficiary, and/or
other bank, in the case of indirect demand guarantees, restraining them from calling on the guarantee or
counter-guarantee. Both types of preventative actions are referred to as applications for restraining or
stop payment orders, made in proceedings known as provisional, interim, preliminary or interlocutory.
Should the Principal hear that the Beneficiary intends to make a fraudulent call on a demand guarantee,
an interlocutory injunction, i.e., an interim interdict, may be sought either against the guarantor
preventing payment, and/or against the Beneficiary preventing the making of a demand on the
Guarantor.
The Principal could also raise the defence of fraud after payment by the bank when it claims
reimbursement or when the Principal seeks to undo the debiting of his account by the bank, though this
strategy is rarely pursued
The defence of fraud can also arise where the Guarantor of a demand guarantee refuses to pay a
Beneficiary based on fraud on part of the Beneficiary, and the latter then takes legal action against the
guarantor, thus seeking summary judgment against the guarantor. In these cases, the high standard of
proof that applies to the fraud exception to the principle of autonomy when a Principal tries to prevent
payment, apparently does not apply and all that a bank needs to show is a reasonable or real prospect of

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establishing fraud in order to avoid summary judgment. The issue of fraud can also arise in cases where
banks have claimed damages from the parties concerned, other than the Applicant/Principal, after they
made payments against fraudulent documents. Last, the issue of fraud can also arise in cases where the
Applicant/Principal tries to recover damages from the Beneficiary after the bank has paid against
fraudulent documents.
Most jurisdictions acknowledge the principle that fraud by the Beneficiary constitutes a defence against
payment, despite formal compliance with the terms and conditions of the guarantee, and that it may be a
basis for injunctive relief for the Principal. The main issue though is to define what kind of facts and
conduct in which circumstances render a demand for payment fraudulent such as to justify a judicial
intervention. The extent of the fraud exception and the ensuing consequences for the Beneficiary and/or
the Guarantors may differ from one local jurisdiction to another. It is up to domestic courts to protect the
interests of all “bona fide” parties concerned fairly. Basically, it is domestic law that governs fraud in
demand guarantee, standby and commercial letter of credit transactions.

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7. Meaning of and rationale for the fraud exception.
The fraud rule may be summarised as one under which, though documents/demands presented are on
their face in strict compliance with the terms and conditions of the letter of credit/demand guarantee,
payment thereunder may be stopped if fraud is found to have been committed in the transaction before
payment is made, provided that the presenter, or party demanding payment, does not belong to a
protected class.
Such rule allows the issuer/guarantor, i.e. the bank, or a court to view the facts behind the face of the
conforming documents and to disrupt payment when fraud is seen to be involved in the transaction. With
the goal to establish fraud and contrary to the general principle, a court may take into account an
evidence apart from the terms of the credit and the content of the documents themselves, as the fraud
rule is the most controversial and confused area in the law governing documentary credits, mainly
because the standard is so hard to define. There are three main reasons why it is necessary to have this
controversial fraud rule: to close a loophole in the law, to protect public policy for the control of fraud and
to maintain the commercial utility of documentary credits and demand guarantees. All parties under a
credit/guarantee transaction deal in documents, not goods or services: if documents/demands
tendered/presented appear on their face to be in strict compliance with the terms and conditions
stipulated in the credit/guarantee, the issuer/guarantor will make the payment, irrespective of any
disputes or claims regarding other related transactions. The issuer/guarantor is entitled to make
payment with full recourse against the Applicant/Principal, though the documents received turns out to
be a forgery, or includes fraudulent statements. The issuer’s/guarantor’s only duty is to exercise
reasonable care in order to ensure that the documents tendered on their face comply with the terms and
conditions of the credit/guarantee. This is the mantra.
The principle of autonomy may in some instances produce results that can be counterproductive to the
original purpose of the principle, especially whenever there is fraud involved in the transaction. Owing to
the documentary nature of letters of credit and demand guarantees, Beneficiaries demanding payment
under these instruments do not have to show that they have properly performed their duties in the
underlying contracts. All they have to do is producing documents that conform on their face.
The separation of the documents from the actual performance of the underlying contract creates a
loophole in law for any Beneficiaries willing to abuse the system, for they are allowed to run away with
others’ money by presenting forged or fraudulent documents, or making fraudulent demands. If the fraud
rule is applied, the loophole in the letter of credit and demand guarantee system is shrunk. Although, the
fraud rule will not prevent every injustice that fraud can cause, but at least its effects are minimised.
Applying the autonomy principle strictly and granting absolute guarantee for payment to Beneficiary
upon presentation of complying documents might provide an opportunity for fraud perpetrators to harm
the system of international trade and operation of documentary credits by presenting forged or
fraudulent documents to the bank which comply on their face with terms of credit, but do not perform
their obligations under the contract of sales with the account party. The strict application of independent
principle and complete separation of credit from underlying contract might result in false calls, abusive
demands and fraud which can be considered as one of the reasons behind development of fraud rule.
Thereare doubts about capability of this rule to prevent any injustice resulted from fraud, though
definitely it will reduce the loophole created by the autonomy principle.
The second rational for fraud exception is the result of public policy’s concern over controlling and
defying fraud. There should not be the possibility for a fraudster Beneficiary to benefit from autonomy
principle while trying to obtain payment by presenting forged documents. The interest of public policy in
preventing fraud has been reflected in many authorities. There is as much public interest in discouraging
fraud as in encouraging the use of letters of credit.
Documentarycredits act towards balancing the contradictory interests of Beneficiary and Applicant. In
their operations, the issuing bank willreplaceits ownguarantee forpayment with creditworthiness of the
account party, while the Beneficiary will receive money only by safeguarding the interests of the
Applicant after tendering documents which comply with terms of credit. Tendered documents, including
the bill of lading, do not only play a significant role in operation of thecredits, but also provide security for
the bank before being reimbursed by the account party. The security interest of the bank will be abused
in case of fraud by the Beneficiary and, as a result, the balance in the operational scheme of documentary
credits will be undermined while no user will have faith in commercial utility of documentary credits any

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longer. One might argue about thecapabilityof theissuing bank and account party to take legal action
against Beneficiary, based on the breach of the underlying contract, such legal action shall not as a
valuable alternative because a fraudulent Beneficiary absconds before the fraud or forgery is discovered.
Application of fraud rule will shrink the legal loophole of the autonomy principle, maintaining the
commercial utility of documentary credits by reducing opportunities for abusive actions and keeping the
balance between conflicting interests of involvedparties in the credit. Not only its development closes the
loophole in the law of letters of credit and demand guarantees, but also fills a public policy requirement.
The rationale for the fraud exception appears to lie in the notion that an “unscrupulous” Beneficiary
should not be able to rely on the principle of the independence to obtain payment notwithstanding its
own forgery or falsification. The basis for the exception is that courts will not allow their process to be
used by a dishonest person for carrying out a fraud. For established fraud is an exception to the autonomy
principle and that fraud unravels everything, there is as much public interest in discouraging fraud as in
encouraging the use of documentary credits. Therefore, the fraud rule is part of a sound legal system
upholding the public policy of limiting fraud.
Not only fraud conflicts with the public policy against fraud, but also poses an equally serious potential
threat to the commercial utility of documentary credits. The popularity of this instrument lies in the fact
that they can provide a fair balance of competing interest among the parties involved. Their normal
operation not only provides the Beneficiary with safe and speedy access to a sum of money, but also
provides the Applicant with credit and/or other commercial benefits such as protecting the Applicant
against inappropriate calls on the credit, requiring the Beneficiary to present documents indicating that
he has properly performed his obligations under the underlying transactions and, more importantly,
assisting the Applicant in achieving his commercial goal.
On the other hand, a demand guarantee will only be used if a risk occurs that is to be covered by that
guarantee, for instance, if the goods are not delivered in time. Parties do not expect that such a risk will
materialise and the Principal that provides the guarantee hopes that it will never be used. Therefore,
payment on a demand guarantee is the “exception”, rather than the “rule”. The Principal is primarily
responsible for the performance to which the demand guarantee refers, and the agreement requires that
the Beneficiary resorts to the bank only if the Principal defaults, expressly or by implication. If the
Beneficiary is allowed to call on the demand guarantee fraudulently, despite the fact that the Principal has
not committed a breach of the underlying contract, for sure it will hurt the Principal but could also
damage the interest of the Guarantor, because if it pays under such circumstances the Principal could
refuse to reimburse the Guarantor for having paid under a fraudulent demand, and this could then lead to
a lengthy and expensive court battle. If a party uses the loophole and defrauds other parties concerned by
presenting forged or fraudulent documents, or by making a fraudulent demand in the case of a demand
guarantee, it harms the interests of the other parties and undermines the balance assumed in the scheme.
In a transaction based on a commercial letter of credit, the Seller that ships nothing but gets paid by
presenting fraudulent documents will hurt the Applicant; although this will be able to proceed against the
Seller, based on fraud in the underlying contract, such a proposition is unattractive because the Seller
usually disappear before the fraud or forgery is discovered. Such a fraudulent conduct may also damage
their interest, banks often agree that they will issue the credit on condition that the goods will serve as
security. If nothing is shipped, their security interest over the goods fails too.
The popularity of the documentary credits and demand guarantee is based on the faith of their users. If
any possibility of abuse cannot be curtailed, or fraud be repeated without a proper remedy, such faith in
the system will fade, as will the commercial convenience of these instruments.
Nowadays, the fraud exception is generally acknowledged and law has not developed the fraud rule to
any great extent in relation to commercial letters of credit and most of the cases on the fraud rule concern
demand guarantees, where slightly different issues arise. Although, many of the principles stated in the
demand guarantee cases are applicable to commercial letters of credit and vice versa. As a matter of
principle, the rule of independence ceases to apply where fraud is involved in a transaction. The opening
of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods,
which imposes upon the latter an absolute obligation to pay, irrespective of any dispute there may be
between the parties as to whether the goods are up to contract or not.
Adhering to the strict non-interference approach requires courts to establish the existence of a ‘clear’ or
‘obvious’ fraud also known to the bank in order to invoke the fraud rule. Courts will also possibly prevent
payment under a demand guarantee, where a bank was induced by fraud to issue such guarantee.
If courts are too ready to intervene too frequently, it would seriously impair the reliance which, quite
properly, is placed on such credits.

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To the extent that the substantive concept of fraud is concerned, it appears from the forbidding language
and the way the independence principle has been applied in leading cases that courts also employ a very
restricted concept of fraud. Only in exceptional cases, they will interfere with the irrevocable obligations
assumed by banks for they are the life-blood of international commerce, except in clear cases of fraud of
which the banks have notice, courts will leave merchants to settle their disputes under the contracts by
litigation or arbitration as available to them or stipulated in the contracts, as the machinery and
commitments of banks are on a different level. The only exception where a bank does not have to pay
under a demand guarantee is when there is a clearly established fraud of which the bank has notice as the
fraud exception entails that where the documents under a credit are presented by the Beneficiary himself
and the bank knows, when the documents are presented, that they are forged or fraudulent, such bank is
then entitled to refuse payment. The only circumstances that would justify a bank not complying with a
demand made under that agreement would be those that would absolve them under similar
circumstances if they had entered into a credit. The issuer is acknowledged to be the sole arbiter on the
question whether payment under the credit should be refused on the basis of fraud.
If, on their face, the documents presented to the confirming bank by the Seller conform with the
requirements of the credit as notified to him by the confirming bank, that bank is under the contractual
obligation to the Seller to honour the credit, notwithstanding that the bank has knowledge that the Seller
at the time of presentation of the documents is alleged by the Buyer to have committed a breach of his
contract with the Buyer for the sale of the goods to which the documents appear on their face to relate,
that would have entitled the Buyer to treat the contract of sale as rescinded and to reject the goods and
refuse to pay the Seller the purchase price. The whole commercial purpose for which the system of
confirmed irrevocable documentary credits has been developed in international trade is to grant the Seller
with an assured right to be paid before any dispute with the Buyer arises as to the performance of the
contract of sale being used as a ground for non-payment or reduction or deferment of payment. There is
an established exception to the autonomy Principal, that is, when a Seller, for the purpose of drawing on
the credit, fraudulently presents to the confirming bank documents containing, expressly or by
implication, material representations of fact that to his knowledge are untrue. The exception for fraud by
the Beneficiary seeking to avail himself of the credit is a clear application of the maxim “fraud unravels
all”.
Courts can only grant for an injunction to the Principal to prevent a call on a demand guarantee where
there is clear evidence of fraud available to the bank to which the Beneficiary, or his agent with his actual,
knowledge is a party. Even though document presented to a bank could be a nullity because of forgery or
fraud, the bank is still under an obligation to pay if the Beneficiary is not a party to that fraud. Banks must
pay for documents that are nullities, provided the Beneficiary acted in good faith and the documents
appear to conform. Whether the obligation arise under a letter of credit or a guarantee, the bank shall in
any case perform what is required by that specific contract. Such obligation does not generally depend on
the correct resolution of a dispute as to the sufficiency of performance by the Seller to the Buyer, or by the
Buyer to the Seller, as the case may be under the sale and purchase contract. The bank is simply
concerned to see whether the event happened upon which its obligation to pay arose.
It is quite wrong for a court to interfere with the Beneficiary’s apparent right under the bank guarantee to
demand payment from the bank, because doing so would involve putting upon the bank an obligation to
inquire whether there was timely performance of the Seller’s obligations under the contract of sale.
The Principal of a demand guarantee should only be allowed to apply for an injunction against the bank
restraining it from honouring its undertaking in exceptional circumstances, otherwise he would
undermine the bank’s reputation for financial and contractual probity. Furthermore, if this happened too
frequently, the value of all irrevocable letters of credit and guarantees would be undermined.
Exceptionally, an injunction may be granted when it is proved that the bank knows that any
demand for payment already made or which may thereafter be made will clearly be fraudulent,
and such evidence must be clear, both as to the fact of fraud and as to the bank’s knowledge.
In general, courts have a very strict approach to the concept of fraud and are indeed inclined to treat the
fraud exception as a principle of a rather theoretical nature that ought not be put into practice. They are
extremely hesitant to interfere with the absolute and unconditional undertaking by the bank and to allow
an exception to the principle of independence if this would affect the position of the bank, for instance, in
the case of an application by the Principal for a restraining order against the bank to prevent it from
paying. A possible reason for such a very strict approach in relation to demand guarantees is the fact that
often they are treated in the same way as letters of credit.

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As far as a bank issuing a demand guarantee is concerned, the underlying contract is irrelevant and such
bank is under an obligation to honour the guarantee when a call is made. In this regard, the bank is in the
same position as one that had issued an irrevocable credit, when the correct documents are tendered
timely. The only instance in which it should not honour the guarantee or credit is that of proven fraud to
which the Beneficiary is a party. In the past it was often thought that a higher degree of protection against
fraud was provided in cases where payment of a demand guarantee or letter of credit is conditional on
the production of a third-party certificate. In such cases, it would then be open to the Principal to
establish that the certificates were issued fraudulently, which did not prove to be necessarily true. Some
of the more recent cases have also indicated that courts might have started to move away from the strict
non-interference approach. So far, limited examples were produced where they have accepted that a
sufficient case of fraud had been made out in relation to demand guarantees.1

Fraud and forgery in trade finance

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