In our November alert titled 'Letters of Credit: When not to pay' we highlighted the potential impact of a recent case concerning a bank's obligation to pay out under a letter of credit. The Court of Appeal has since overturned that decision.

Below, we have extracted the key points from the most recent decision which affect the certification required from a presenter in a demand for payment and its relevance to the fraud exemption.

The latest decision in Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA (1) PDVSA Servicos SA (2) PDVSA Services BV (3) [2017] EWCA Civ 9

The facts from the case are given in the previous alert. On appeal, the Court focused on the wording of the demand for payment. In this document, the presenter ("POS") was required to certify that the other contract party ("PDV") was ' pay' the sums being demanded. This certification was given by POS even though PDV were not permitted to pay immediately due to the existence of an ongoing overseas arbitration procedure. The essential questions were whether:

  1. ' pay' meant 'that PDV was both under an obligation to pay POS and presently bound to discharge that obligation' i.e. were they obligated to pay now?; and
  2. as a consequence, had the presenter been entitled to submit the demand or had they been fraudulent in doing so?

(1) Meaning of 'obligated to pay'

It is not normally necessary to distinguish between a liability to pay and an immediate obligation to discharge a liability. The Court clarified that the statement 'obligated to pay' can refer to either eventuality.

(2) Had the presenter acted fraudulently?

For the fraud exemption to apply and prevent the Bank from paying out under the letter of credit, POS would need to have been acting dishonestly or recklessly as to the truth of its certification.

In this case, the meaning of 'obligated to pay' was held to be broad enough to include the situation where PDV were not permitted to pay the liability straight away. Accordingly, POS had not made a false statement; they had been entitled to submit the demand for payment and the fraud exemption was not applicable. The Bank was therefore ordered to pay the amounts demanded.

Takeaway points

The decision does not create any new law but instead it reinforces some of the key features of letters of credit, namely that;

  • commercially, their function is to reverse the risk of non-payment from the payee to the payor;
  • legally,
    • the autonomy principle aims to ensure that the obligation on the Bank to pay is not affected by disputes between the parties to the underlying contract; and
    • the fraud exemption to this principle is narrowly applied and it is unlikely that a Bank will be able to withhold payment unless there is clear evidence of fraud.

The general guidelines that we provided in our previous alert are therefore unchanged. The latest decision has however clarified when a presenter is entitled to certify that payment is due and owing and accordingly, when it is entitled to submit its demand to the Bank.

If you have any concerns about whether the Bank is required to make payment in any given situation we would recommend that you take advice and would be pleased to help you.

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