**4. Fraud committed without the beneficiary's knowledge: will the fraud exception rule apply?**

Generally speaking, banks are not required to check whether the beneficiary has fulfilled its obligations in the underlying contract of sale. This is established in Article (4) of the UCP 600, which stipulates that letters of credit are isolated from the main transaction. This is known as the "Autonomy Principle." As will be seen from the discussion of the case law in this area, the principle of autonomy has been used by dishonest sellers as a vehicle for fraud (**Figure 5**).

In *the American Accord* case, the court held that the fraud exception can only be established if the fraud appears in the documents [71]. The facts of this case is where an English company entered into a contract to sell glass fiber making

<sup>55</sup> See [19].

<sup>56</sup> See [18].

<sup>57</sup> See [19].

<sup>58</sup> See [19].

<sup>59</sup> See [19]. This suggestion will secure rights for both parties; this suggestion is emerged from Jordanian legislations practice, which is applied in most civil law litigations in Jordan.

#### **Figure 5.**

*Fraud triangle explaining the "dishonest person thinking" which led to emerge of fraud acts in finance sector.*

equipment and payment was to be made by an irrevocable letter of credit. Shipment was agreed to be on or before 15 December 1976. However, shipment actually took place on 16 December. Without the knowledge of the sellers, the loading broker's employee fraudulently entered 15 December as the date of shipment. In this regard, the bank refused such tender and held that the presentation was fraudulent because the goods were loaded on 16 December, not on 15 December as agreed.

Lord Diplock held that if the fraud was conducted with the beneficiary's knowledge, the fraud rule will be applied [72]. His Lordship stated: "*there is one established exception [to the principle of autonomy]: that is, where* **the 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 fact that to his knowledge are untru***e*."60 From this passage it is clear that to establish the fraud exception in England, the beneficiary must commit the fraud or have awareness of it. This raises the question of whether the fraud exception should also be invoked when it is conducted by a third party but without the beneficiary's knowledge. It is clear that this is a grey area, subject to inconsistent interpretations across different jurisdictions. Therefore, this section will deal with the issue of the implementation of the fraud exception rule from different legal systems' views; namely the United Kingdom and the United States, by answering "will the fraud exception rule apply if the fraud was committed by a third party without the knowledge of the beneficiary?"

#### **4.1 The position in the UK**

The facts of the milestone case, the *American Accord*, are an appropriate example to highlight the position in England. In the said case, as a result for the bank's decision of rejecting the presentation, the plaintiffs, brought an action against the defendant bank for the wrongful dishonor. The court refused the bank's decision and stated that: "[H]ere I have held that there was no fraud on the part of the plaintiffs, nor can I, as a matter of fact, find that they knew the date on the bills of lading to be false when they presented the documents. Accordingly, I take the view... that the plaintiffs are... entitled to succeed".61

<sup>60</sup> [72], 183.

<sup>61</sup> [72], 278.

#### *Fraud in Letters of Credit under English Law: Issues and Cases (the Three Dimensions) DOI: http://dx.doi.org/10.5772/intechopen.93555*

Surprisingly, the judgment was reversed by the Court of Appeal, which held that the fact that the fraud had been committed by a third party could not prevent the bank from raising the defense of fraud against the beneficiary.62 The Court held that "it is the character of the document that decides whether it is a conforming document and not its origin, then it must follow that if the bank knows that a bill of lading has been fraudulently completed by a third party, it must treat that as a nonconforming document in the same way as if it knew that the seller was party to the fraud".63 However, the House of Lords unanimously reversed the decision of the Court of Appeal and reinstated the trial judge's decision.64 The House of Lords held that the beneficiary should obtain the payment unless it was a party to the fraud.65

Notably, it can be seen that each of the courts that dealt with the *American Accord* case approached the issue of third-party fraud from different points of view. From the trial judge's perspective, the fraud was neither conducted by the seller nor with his knowledge. In turn, the Court of Appeal pointed out that the case fell within the scope of the fraud exception because the document was forged, although without the beneficiary's knowledge. However, from Lord Diplock's perspective, besides the documents themselves, what is important in such transactions is the knowledge of the beneficiary. His Lordship believed that the bank is under a duty to honor the credit if there is no knowledge on the part of the beneficiary in regard to fraud conducted by a third party [73]. This duty is based on the fact that ignoring the beneficiary's knowledge as a requirement for establishing the fraud exception rule might undermine the reliable system of letters of credit [73].

A few years earlier, Brown LJ answered the question regarding fraud by a third party in *Edward Owen* [74], finding that the implementation of the fraud exception under the English courts could be applied if the beneficiary presented forged or fraudulent documents and knew that the presented documents were not true.66 Therefore, the general rule is that if the seller fraudulently presents documents that contain, expressly or by implication, material misrepresentations of fact that to his knowledge are untrue to the confirming bank, the fraud exception will be applied. Consequently, to qualify the fraud rule, such conduct needs to be committed by the beneficiary67 or with their intention and knowledge. Therefore, if the beneficiary is not aware, similar to the *American Accord* case, the rule will not be applied.

On the grounds discussed above, it follows that if the fraud was committed through a third party without the beneficiary's knowledge, the fraud exception will not be applied. Therefore, the bank should honor the credit. The justification for such a ruling is because the beneficiary, on this occasion, is also the victim of the fraud; hence, it would not be appropriate to deny them the right of payment [75, 76].

Generally speaking, English courts focus more on the intention of the seller when looking at cases of fraud. As noticed above, the three courts did not accept the idea that the exception should be applied if the fraud was conducted by a third party without the knowledge of the seller. What is important is the knowledge of the seller. Consequently, the fraud rule will only be applied if the fraud act was conducted by the beneficiary or when the beneficiary has knowledge of a fraud committed by a third party. That is to say, the focus on the intention of the fraudster is the standard for the rule to be applied in England. This approach was justified as

<sup>62</sup> [72], 239.

<sup>63</sup> [72], 248.

<sup>64</sup> [72], 183.

<sup>65</sup> [72], 183-184.

<sup>66</sup> [74], 984.

<sup>67</sup> See in general [1] where the beneficiary was party to an agreement with the carrier and its brokers to antedated the bill of lading.

English courts retain the requirement of a beneficiary's knowledge to maintain the efficacy of the letter of credit as a system of payment [77].

#### **4.2 The position in the USA**

In turn, in the US, although there are codified letters of credit rules in legislation and a specific provision for the fraud exception rule, Section 5-114 of the previous version of the UCC 1978 does not identify its position regarding the third-party fraud issue. This matter was left to the courts to deal with. In the previous version, the UCC 1978 was concerned only with the nature of the documents, not the identity of the fraudulent party [78] meaning that the fraud exception rule was applied regardless of the identity of the perpetrator and the knowledge of the beneficiary.

After amending the UCC in 1995, the new standard is not concerned with the intentions of the seller but rather examines "the severity of the effect of the fraud on the transaction" [79]. This means that the US legislation focuses more on the effect of the fraud, neither on the intention of the beneficiary nor on the identity of the fraudster.68 This, implicitly, means that the fraud exception rule will apply if the fraud was committed by a third party, even without the seller's knowledge. From the US courts' perspective, the effect of such a matter on international trading is detrimental, regardless of who perpetrates the fraud or the knowledge of the beneficiary. Therefore, the effect of fraud on the right of payment should have no correlation to the identity of the perpetrator or to the beneficiary's knowledge. Briefly, for US courts, fraud is fraud despite who commits it and whether the beneficiary has knowledge because bank and buyer will still be at risk as a result of such action. Moreover, what matters are the existence and the effect of the fraud, not the source or the knowledge and intentions of the parties.

#### **4.3 Concluding remarks**

In my judgment, although fraud will still harm the utility of a letter of credit transaction, shifting the court focus from the illegal act to the identity of the fraudster or the beneficiary's knowledge will be ineffective. There is no merit in focusing on the identity of the fraudster or on the beneficiary's knowledge at this point. As it stands, a documentary credit is an independent contract between bank and beneficiary; consequently, fraud conducted by a third party without the beneficiary's knowledge, in my judgment, is not a relevant consideration when establishing the fraud rule. What is important here is the conduct of fraud and not the identity of the fraudster nor the knowledge of the beneficiary for these reasons.

Initially, the utmost principle in letters of credit is its autonomy and independence from any dispute in regard to the underlying transaction. That is to say, instead of examining the documents and their compliance, banks will be required to examine the intentions behind the documents. Or in other words, whether the beneficiary is aware of such fraud or not. This is not acceptable and contradicts with Article 5 of the UCP, which will bind banks to go beyond the documents. If the documents complied "on their face" but the applicant alleged that there is fraud, why should the bank stop the payment on this ground. Why should the bank postpone the payment until investigate whether if the beneficiary is aware of the fraud or not? According to Article 34 of the UCP rules "*A bank assumes no liability or responsibility … for the* **good faith or acts or omissions***, solvency, performance or standing of the consignor, the carrier, the forwarder, the consignee or the insurer of the goods or* **any other person.**" This dispute of awareness between the applicant and

<sup>68</sup> [80]; [8], 124; [81].

#### *Fraud in Letters of Credit under English Law: Issues and Cases (the Three Dimensions) DOI: http://dx.doi.org/10.5772/intechopen.93555*

the beneficiary, in my judgment, should be out the scope of the bank's authority and the autonomy principle. The most important condition when applying the fraud rule is to establish that fraud exists in the documents regardless the identity.

Further, the fraud rule will be applied if the fraud accords in the documents only.69 Moreover, it is the beneficiary's duty to present complying documents; therefore, the beneficiary is under a duty to check their compliance. In my judgment, I cannot see any merit in considering the beneficiary's knowledge a material condition when applying the fraud rule. Arguably, claiming that the beneficiary is not aware of the fraud in the required documents is, in my point of view, a "release" key from such allegation. Such claim might create more hardship for the applicant through trying to prove first that fraud exist and later, that the beneficiary is aware of it. No doubt such point of view will not be welcomed from the innocent beneficiary, who might be a victim, yet it is the beneficiary's duty to check their compliance. Therefore, the only exception for this independent right is when the fraud is conducted in the documents regardless of the identity of the fraudster or the beneficiary's knowledge.
