Grandpower Ltd v. Man Sun Finance (International) Corporation Ltd and Another

HCA006369/1981

Exception to the strict obligation of a bank to honour its commitments under a letter of credit as widened by United City Merchants (Investment) Ltd. v The Royal Bank of Canada considered.

BETWEEN

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Coram: Hon. Liu, J. in Chambers

Date: 17 April 1982

Appeal, from Master's Decision.

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JUDGMENT

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1. This is an appeal from a decision of the learned Master given on the 2nd January, 1982 granting leave to sign final judgment against the 1st defendant in the sum of $1,336,000 together with interest thereon and costs.

2. The plaintiff's claim against both defendants arose from an irrevocable letter of credit. The plaintiff was the seller of 20,000 pieces of Gent's Swiss watch movements with corresponding cases, of which the 2nd defendant was the buyer. The 2nd defendant was itself financed by a letter of credit opened through the Fast Exchange Limited. At the request of the 2nd defendant and on the force of its letter of credit, an arrangement was made for an irrevocable letter of credit to be opened by the 1st defendant in favour of the plaintiff for the same merchandise in the sum of $1,336,000. Payment was thus secured to the plaintiff by negotiation of its draft at 30 days' sight, drawn on the 2nd defendant for the full value of the goods together with interest for buyer's account and accompanied by commercial invoices, packing lists, clean godown warrant made out or endorsed to the 1st defendant as well as a fire insurance policy. The goods agreed to be sold were 20,000 pieces of 25-Jewel Gent's Swiss watch movements with a calendar indicator at $62 per unit and a like quantity of cases at $4,80 per unit. Any draft drawn in conformity with the terms of the 1st defendant's said irrevocable letter of credit on and accepted by the 2nd defendant was undertaken by the 1st defendant to be honoured on presentation and paid on maturity.

3. On the 10th August, 1981, pursuant to and in purported conformity with the 1st defendant's said irrevocable letter of credit, the plaintiff through its bankers duly presented a draft for $1,336,000 together with a full set of the requisite documents for acceptance by the 2nd defendant. The 2nd defendant accepted the draft and the accompanying documents, of which the godown warrant was thereafter caused to be transferred to the order of the lst defendant.

4. The draft so accepted fell due and payable in the latter part of 1981. The lst defendant experienced difficulty in collection in its own arrangement with the 2nd defendant. Thereupon the 1st defendant was either unable or reluctant to pay the plaintiff in full. It was claimed by the 1st defendant that the plaintiff finally agreed for the amount on the said draft to be retired by three instalments. Such alleged agreement was refuted by the plaintiff, who found any instalment payment as wholly unacceptable and demanded immediate settlement in toto.

5. The embarrassing situation was sought to be explained by the 1st defendant as follows: Due to the late delivery of the first partial delivery under the 2nd defendant's own letter of credit, a request was made for the same to be appropriately amended. The 1st defendant was unsure of the validity of the amendments on account of what was doubted to be the actual date for these amendments, and moreover delay in the return of the amended letter of credit was such that the extended date for the presentation of a draft with accompanying documents for the first partial delivery had again expired. These allegedly aroused suspicion on the part of the 1st defendant, who subsequently caused to he inspected one of the watch movements stored in the godown.

6. There was no clear indication as to precisely when the 1st defendant embarked upon such investigation, but it would appear that it was only in early December that the 1st defendant approached and obtained a "Brief Report" on that single watch movement from a Mr. C. Dubois of the Swiss Watch Industry Information Centre in Hong Kong. It certified that the article presented for examination was a movement of only "one-jewel" but without a "date indicator dial", worth approximately $12 and with its "original manufacturer" Swiss.

7. Prior to the written report of Mr. C. Dubois, the 1st defendant through its solicitor had consulted one Mr. Vuillin who was said to be an expert in Swiss watch movements with 15 years' experience in the manufacture, sale and distribution of similar watch pieces. An opinion had also been obtained from one Miss Sze, a director of a Messrs. Panelec Limited, a Hong Kong company, dealing with manufacture, import and export of watches. Both had confirmed it as a one-jewel movement valued at approximately $14. The said Miss Sze further confirmed that there was no date indicator in the movement so presented for her examination.

8. According to the 1st defendant, charges of fraud were thereupon made, and no time was spared in bringing the matter officially to the notice of the Commercial Crime Bureau.

9. On this evidence, the matter was broached before the learned Master who granted leave to sign final judgment on the 2nd January, 1982.

10. Messrs. Wood and Browne have, since judgment, been instructed to select at random 20 pieces of watch movements from the plaintiff's consignment to the 2nd defendant then stored to the order of the 1st defendant pursuant to the terms of the said irrevocable letter of credit. Expert testing in Hong Kong was allegedly not readily available. Ultimately, driven by the time scheduled for this appeal, the same gentleman Mr. C. Dubois was invited to examine the 20 pieces movements selected together with the movement which he was allegedly shown last December. According to Mr. Oldham, solicitor for the 1st defendant, Mr. Dubois identified the movement as one similar to what he had inspected earlier, and of the 20 samples of watch movements selected by Messrs. Wood and Browne, his opinion was that they were all "one-jewel" not 25, worth approximately $12 each, without any "date-indicator dial" and assembled locally in Hong Kong with Swiss parts. According to Mr. Oldham, Mr. Dubois further remarked that 17 out of these 20 samples clearly had the words "One Jewel-Unadjusted" obliterated and stamped over with the words of "25 Jewels 5619" and that the remaining three movements together with the movement he had earlier examined bore a clear marking "One Jewel-Unadjusted". These samples were said to be available in Chambers, but no inspection was agreed to between the parties to this appeal. Throughout present in Chambers and assisting counsel was Mr. Oldham who was, I was assured, willing and prepared to confirm his belief in the opinion so expressed by Mr. C. Dubois to himself.

11. This further information was set out in the final affidavit of Mr. Oldham filed on the 19th March, 1982. Its production was objected to, but for reasons given elsewhere it was admitted in this appeal together with a further affirmation filed on behalf of the plaintiff on the 22nd March, 1982.

12. The plaintiff made no admission to these allegations and did not concede the results of the alleged examinations or the source of the movements so inspected. However, for the purposes of Order 14 proceedings, the allegations of the lst defendant must be taken on the basis that they could be so substantiated at the trial. Come what may, the plaintiff would assume no responsibility for the startling inaccuracies in any of the accompanying documents.

13. Counsel for the 1st defendant bowed to the general rule that a financial institution such as the 1st defendant was concerned only with documents and not with goods. It was further conceded that when a financial institution such as the lst defendant was sought to be restrained from making payment under a letter of credit at the instance of a buyer, established or obvious fraud on the part of the seller must be shown to justify the drastic departure from the bank's strict obligation to honour its letter of credit commitments. Counsel laid before the Court with great tenacity the different guideline applicable to the relationship between the banker and the seller in his capacity of a beneficiary in a letter of credit transaction : Dealing with a seller beneficiary, the banker's right to refuse to honour a draft was not limited to the beneficiary's own established or obvious fraud; suffice it for him m to raise an arguable case of fraudulently completed documents brought about by a third party alone.

14. Counsel stood firm on the principle propounded in United City Merchants (investment) Limited v. The Royal Bank of Canada⁽¹⁾, where a Peruvian company agreed to buy equipments for the manufacture of fibre glass from an English company. A letter of credit was issued in Peru and confirmed by an English branch of the Royal Bank of Canada for an amount well exceeding, in fact doubling the contract price. It was in part a scheme to evade the exchange control in Peru. The letter of credit required, inter alia, loading by a certain date to be evidenced by a bill of lading. Loading was one day late, and the bill of lading presented was visibly tampered with to conform with the stipulated loading date together with a signed notation to the same effect by an officer of-the loading brokers. It was held by Mocatta, J. in the Commercial Court that the shipper was not responsible for or affected by the fraud of the loading brokers' officer who was not its servant or agent, but in a second judgment in the same action, it was held that the contract was illegal and unenforceable. Both judgments of Mocatta J. were reversed by the English Court of Appeal, which held that the shipper was not barred from enforcing that part of the contract not involving breaches of the Peruvian Exchange Control Regulations but that the bank was entitled to refuse payment to the innocent shipper on account of the "fraudulently completed" bill of lading which in effect "did not comply with the terms of the letter of credit".

15. Counsel for the plaintiff levelled much criticism at the attempt to enlarge that known exception to the banker's strict obligation to pay in a letter of credit transaction. It was strenuously pressed upon me that only a seller's established or obvious fraud would justify the banker's refusal to pay a draft drawn under a letter of credit with purportedly conforming documents and that the 1st defendant's allegations, even if proved, would fall far short of establishing such or any fraud against the plaintiff. Mr. Faulkner called attention to the fact that if the fraud of a third party could legitimately relieve the banker from his usual strict obligation to pay, no particulars of fraud had in this case been given and its source was yet to be identified. It was urged that United City Merchants⁽¹⁾, which was said to have been decided on its own peculiar facts, should not be lightly acclaimed a rule for general application.

16. The case of United City Merchants^(l)otherwise known as The "American Accord" as decided in the Commercial Court was reported in [1979] 1 Lloyd's Law Reports 267. There, the wider issue raised by counsel for the bank appeared at page 277 L.H.S.:

17. Mocatta J. held that the view submitted by counsel could not be supported if only by reason that "to hold to the contrary might greatly hold up the smooth running of international trade and might place on banks exceptionally onerous investigations, which they are ill-fitted to perform."

18. Mocatta J. found fraud against the officer of the loading brokers alone. The learned judge completely vindicated the shipper plaintiff even in their presentation of the fraudulently completed bills of lading. On a point of "vital difference'', the learned judge distinguished Sztejn v. Henry Schroder Banking Corporation on⁽²⁾ and Edward Owen v. Barclays Bank⁽³⁾, where there had been "personal fraud or unscrupulous conduct by the seller presenting the documents under the letter of credit", and it was thought "right that the Bank should be entitled to refuse payment against apparently conforming documents on the principle ex turpi causa non oritur actio." See page 278 R.H.S.

19. When the case reached the English Court of Appeal⁽¹⁾with the findings of fact, "the shorter and simpler question" for determination was whether the bank "were entitled: to refuse payment against the documents presented to them because one of the documents so presented (namely, the bill of lading or a part of it) was a false document and was made fraudulently by the person who issued it."

20. At page 262C, having found it irresistible to comment on the "ambiguity in descripting a document as truthful or genuine or as untruthful or false", Stephenson, L.J. continued:

"A document may tell a lie about itself, e.g., about the person who made it, or the time or place of making. If it tells a lie about the maker, it is a forgery; if it tells a lie about the time or place of making "where either is material," it is a forgery Forgery Act 1913 section 1(2). In the former case it may be a nullity, in the latter not..... Or the document may tell a lie about its contents. Then it is no forgery, but the maker or utterer of it may commit a criminal offence of some kind of fraud. Or a document may be untrue in the sense of inaccurate by mistake and without any intention to deceive by its maker or anyone who puts it forward."

The learned Lord Justice observed that the bill of lading in question told a lie about itself on the date of its execution and two lies about its contents.

21. At page 262H, Stephenson L.J. was decidedly of the opinion that the impact of fraud, as an exception to the general rule excusing the banker from honouring a draft under a letter of credit, equally applied when it "was not the fraud of the seller or the beneficiary who tendered the documents."

22. Stephenson, L.J. dwelt on the observations made in Edward Owen Engineering Ltd. v. Barclays Bank International Ltd.⁽⁴⁾ as to the banker's obligation to pay in different situations: First, the observation of Lord Donning M.R in Edward Owen Engineering v. Barclays Bank International Ltd.⁽⁴⁾:

Secondly, an observation of Browne L.J. in the same case at page 172:

"That exception (the exception to the fule that the bank is not in any way concerned with disputes with the buyers and the sellers) is that when the documents under the credit are presented by the beneficiary himself and the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled to refuse payment."

23. Stephenson L. J. was only too conscious of the dearth of authority (except for an article by Professor Goode)⁽⁵⁾ on the banker's right to meet his commitments to an innocent seller beneficiary on the presentation of shipping documents which had been falsely completed by the fraud of a stranger alone. The above quoted passages on the position of the seller beneficiary presenting forged or fraudulent documents left unexplored the effect of fraud exclusively perpetrated by a third party in the preparation of shipping documents on the seller's entitlement to payment.

24. At page 264H, Stephenson L.J. rallied support for the wider application of the exception to the banker's strict obligation to honour his mandate to pay under a letter of credit:

"Banks trust beneficiaries to present honest documents if beneficiaries go to others (as they have to) for the documents they present, it is important to all concerned that those documents should accord, not merely with the requirements of the credit but with the facts, and if they do not because of the intention of anyone concerned with them to deceive, I see good season for the choice between two innocent parties putting the loss upon the beneficiary, not the bank or its customer."

25. Stephenson L.J. was drawn to the observation of Cardozo J. in his dissenting judgment in the New York Court of Appeals in Maurice O'Meara Co. v. National Park Bank of New York⁽⁶⁾ which was not, however, a case of fraud:

"I assume that no duty is owing from the bank to its depositor which requires it to investigate the quality of the merchandise. I dissent from the view that if it chooses to investigate and discovers thereby that the merchandise tendered is not in truth the merchandise which the documents describe, it may be forced by the delinquent seller to make payment of the price irrespective of its knowledge. We are to bear in mind that this controversy is not one between the bank on the one side and on the other a holder of the drafts who has taken them without notice and for value. The controversy arises between the bank and the seller who has misrepresented the security upon which the advances are demanded. Between parties so situated. Payment may be resisted if the documents are false."

At page 266A Stephenson L.J. pondered on "what Cardozo J. would have said if the security had been misrepresented, but not by the seller."

26. The learned Lord Justice searched in vain for any real justificaticn for confining the banker's right to withhold payment to the case of tainted conduct on the part of the presenter, and he doubted the wisdom of explaining the exception to the banker's strict obligation to pay by the "ex turpi causal' principle. For fraud in a letter of credit transaction, so Stephenson, L.J. advocated, the American working rule of applying "the flexible standard ....... as the circumstances of a particular situation mandate" is preferable.

The learned Lord Justice recommended that the courts should, not apply the exception to the strict rule of the banker's obligation to honour a letter of credit only to "situations of fraud in which the wrongdoing of the beneficiary has vitiated the entire transaction" but also to "any fraud which, if known to the issuing or confirming bank, would entitle it to refuse payment". Stephenson L. J. readily embraced the view of Professor Goode that "a fraudulently completed bill of lading does not become a conforming document merely because the fraud is that of a third party."

27. Ackner L.J. posed the question thus at page 275E:

"In short, is the fraud exception to the strict rule that the bank must pay if the documents are, on their face, in order, limited to the case where the fraud is that of the seller/presenter, or does it apply in all cases of fraud to the knowledge of the bank?"

28. The learned Lord Justice did comment at page 275H that that was "no ordinary case". Any case of fraud is not ordinary, but the decision in United-City Merchants⁽¹⁾ with the facts as found presented no special features on its own. Ackner, L, J. had this to say at page 276G/H:

"If I am right about the-view I have expressed in relation to forged documents, where the forgery is not the responsibility of the seller, then the ex turpi causa justification for the fraud exception is not adequate and one must therefore search for what is the acceptable basis for the exception. In order to do so it is necessary to go back to first principles. The buyer has arranged with the bank to provide finance for the seller, in the seller's country, on delivery of certain documents. The banker's authority or mandate is to pay against genuine documents and that is what the bank has undertaken to do. It is the character of the document, not its origin, that must decide whether or not it is a 'conforming' document, that is a document which complies with the terms of the credit."

He concluded, at page 277G, that if the bank was aware of a bill of lading having been fraudulently completed by a third party it must treat it as a non-conforming document "in the same way as if it knew that the seller was party to the fraud."

29. Griffiths L.J. concurred and at page 283D/E placed special emphasis on the security which genuine shipping documents were expected to provide :

"The identity of the forger is immaterial. It is the fact that the documents are worthless that matters to the bank. In such a case the right of the bank to refuse payment does not rest upon the application of the maxim ex turpi causa non oritur actin, but upon the fact that the bank's obligation is to pay upon the presentation of genuine documents in accordance with the requirements of the letter of credit. If the documents presented are fraudulently false, they are not genuine conforming documents and the bank has no obligation to pay."

30. It has been, I hope, sufficiently demonstrated that the mature consideration so very fully given by the Lord Justices in United City Merchants^(l) to the situation of an innocent beneficiary presenting fraudulently completed documents was not in any way diluted by the facts in the case, which were, though not ordinary, by no means exceptional. Thus, the English Court of Appeal did, on principle, widen the scope of the exception to the general rule of the banker's strict obligation.

31. Leave was granted in the United City Merchants⁽¹⁾ case to seek guidance from the House of Lords, but the position as it now stands is and must therefore raise an arguable issue that a document fraudulently completed by a third party alone would entitle a financial institution such as the 1st defendant to refuse payment to an innocent beneficiary.

32. The drastic discrepancies in value and utility of the watch movements are cogent evidence that the original supplier of these false information for completing the shipping documents must have fraudulently misrepresented these particulars without belief in their truth or recklessly careless whether they were true or false. It must be conceded that there is no evidence necessarily implicating the makers or the presenter of those fraudulently completed among these documents and for that matter any suppliers of these obviously false data along the line, but someone must have been responsible for these striking inaccuracies which cannot be satisfactorily explained except for fraud; the documents containing such alarming discrepancies must be or are arguably documents fraudulently completed. The forger's identity cannot be material. The crux of the matter seems to lie in the "character of the document, not its origin." The widened exception to the banker's strict obligation would, therefore, apply or arguably apply to the transaction in this case where there is sufficient prima facie evidence of falsified particulars by the fraud of a culprit or culprits.

33. I come finally to the degree of onus for raising an allegation of fraudulently completed documents in 0,14 proceedings. I should perhaps turn first to the authorities cited in argument.

34. In the case of Etablissement Esefka v. Central Bank of Nigeria⁽⁷⁾ the plaintiff claimed against the Central Bank of Nigeria for payment under a letter of credit. There was strong evidence that previous payments effected under the same letter of credit were on false or not genuine documents in respect to cargo on eight ships which never even existed. Points of law also emerged as to whether the previous payments allegedly obtained by fraud formed part of the same transaction to found an equitable set-off. Lord Denning M.R. held that there was a good arguable defence by reason of the alleged forged or fraudulent bills of lading covering the previous shipments on the eight phantom ships with the following remark at page 447 R.H.S.:

"Was there such a fraud or not? Of course it is a debatable question. We have not got anywhere near the trial itself."

35. In his recital of facts in the United City Merchants⁽¹⁾ case, Stephenson L.J. made a passing reference to the Order 14 proceedings as follows:

"So the writ was issued by the plaintiffs and the defendants got leave in R.S.C. Order l4 proceedings to defend and joined the third parties. The trial of the action began on February 6, 1978, on the defendants arguable defence that they were entitled to reject the documents on two grounds, non-conformity with the terms of the credit and fraud, and after 32 days and two further defences Mocatta J. rejected that defence."

36. As in the Etablissement Esefka International Austalt v. Central Bank of Nigeria⁽⁷⁾ and the United City Merchants⁽¹⁾ case, no allegation of fraudulently completed documents can be acted upon unless it must, if ultimately established on the balance of probabilities, inevitably lead to a finding of fraud on the part of some culprit responsible for these false entries. In view of the alleged glaring discrepancies, the culprit or culprits could hardly have been innocently mistaken. On the 1st defendant's allegations, these particulars must have been fraudulently completed or furnished by the said culprit or culprits knowing the same to be false. The Court need not perhaps even consider whether he or any of them had no belief in their truth or was being recklessly careless whether they were true or false. The marked contrast in value and quality, if proved, will evidently speak the loudest.

37. In an application by a buyer for restraining a bank from paying a seller in a letter of credit transaction, even on the cases decided before the recently reaffirmed criterion of "a serious question to be tried", it can be readily appreciated that the bank, which is unconcerned with the disputes between the seller and the buyer and would probably leave the scene after the injunction, should be provided with evidence of "established or obvious fraud". But on seeking leave to defend in an 0.14 application, there would seem to be no justification for making any departure from the usual burden cast upon a defendant merely to disclose a triable issue. Naturally, there are recognized duties and functions on the part of as well counsel as the Court in an allegation of fraud. Miss Eu, counsel for the lst defendant, was conscious of her responsibility as counsel, and the prima facie evidence here seems cogent enough to sustain counsel's submissions. Whatever degree of proof demanded of the buyer in his application for an interlocutory injunction restraining the bank from paying the seller in a letter of credit transaction, the 1st defendant here as a defendant need show only a prima facie case of documents having been fraudulently completed.

38. In my judgment, the 1st defendant has shown a bona fide defence on the alleged fraudulently completed documents. Moreover, in this appeal the points of law canvassed deserve a fuller argument at the trial.

39. For all these reasons, save for orders for costs on the applications for a stay and payment into Court out of time, I order that the decision of the learned Master and the judgment entered in pursuance thereof be set aside, that the amount paid into Court be paid out to 1st defendant's solicitors and that save as aforesaid, the 1st defendant is to have costs of this appeal and before the learned Master.

(1)    [1981] 3 W.L.R. 242

(2)    (1941) 31 N.Y.S. 2nd. 631

(3)    [1977] 3 W L R. 764

(5)      "Reflections on Letters of Credit - I" published in "Centre point, The Centre for Commercial Law Studies, Queens Mary College, University of London" criticising the judgment of Mocatta, J. in the United City Merchants case.

(6)    (1925) 239 N.Y. 386 at page 401.

(7)    [1979] I Lloyd's Rep. 445

Representation:

Mr. Raymond Faulkner instructed by Messrs. John Ip & Co. for the Plaintiff.

Miss Audrey Eu instructed by Messrs. Philip K.H. Wong & Co. for the 1st Defendant/Appellant.

Action No.: High Court Action No. 6369 of 1981

Date of Hearing/Trial: 24th, 25th and 26th March, 1982.

Date when Judgment Was Delivered: 17th April, 1982.

ORDER:

1.    Appeal allowed.

2.    Order in terms of orders set out in written judgment.

Case Cited by Counsel for the Plaintiff but not mentioned in the Judgment:

Cases Cited by Counsel for the Defendant/Appellant but not mentioned in the Judgment:

Actual Cases Cited in the Judgment: