The High Court recently applied the ‘fraud exception’ to prevent payment under a standby letter of credit where the signatory who certified a presentation thereunder was aware that requirements being certified as true were in fact untrue.

The judgment in Petrosaudi Oil Services (Venezuela) Ltd v. Novo Banco SA and others acts as a cautionary reminder to those certifying presentations under a letter of credit to carefully consider whether the requirements of the credit being certified have been satisfied.

Autonomy of Credit and the Fraud Exception

A letter of credit is aimed at enabling a seller to substitute the creditworthiness of its buyer with that of a creditworthy bank. It is a fundamental principle underlying the operation of a letter of credit that the obligations of the parties to the credit are totally independent of the terms of the underlying commercial transaction – the ‘autonomy principle’.

Fraud and illegality are the key exceptions to the autonomy principle of letters of credit, and allow an issuing bank to withhold payment even where the presented documents appear on their face to comply with the credit. The courts have effectively shown over time that they are reluctant to apply such exceptions, save in clear and exceptional circumstances, in order to uphold the sanctity of letters of credit as a key risk mitigation tool in international trade.

The Case

The claimant, Petrosaudi Oil Services (POS), supplied oil rig drilling services to Venezuelan state entity PDVSA Servicios SA (PDV). The underlying contract was governed by Venezuelan law and a standby letter of credit (the L/C) was issued in favour of POS. The contract provided that PDV would pay POS invoiced amounts, regardless of any disputes, i.e. ‘pay now, argue later’. Subsequently, POS issued an invoice for nearly US$130 million, which PDV challenged, invoking the contract’s arbitration clause. The arbitral tribunal found that the ‘pay now, argue later’ clause was null and void under Venezuelan law, as it directly contradicted Article 141 of the Venezuelan Public Contracting Law. This article prohibits state entities from making payment without verification and approval of invoices.

Nevertheless, POS contended that it was entitled to make a presentation under the L/C and receive full payment regardless of the arbitration having been instigated due to the ‘pay now, argue later’ clause. Accordingly, POS made a presentation to the issuing bank, certifying that PDV was “obligated” to pay POS under the contract (as the L/C required such certification). The issuing bank confirmed compliant presentation and its intention to pay and PDV consequently sought injunctive relief.

The High Court held that, under the L/C and at the time of presentation, the sums demanded had to be due for immediate payment and “not at some defined or undefined point in the future”. Judge Waksman QC considered it clear that whether the sum was immediately payable should have been obvious in light of the arbitrators’ ruling. The court did not accept that the signatory, a POS director (also POS’s general counsel), honestly believed that the sum was due and owing at the time of certification. The certification under the L/C was, therefore, held to be fraudulent and the bank was restrained from making payment.

Summary

Despite the courts’ general reluctance to undermine the autonomy principle of letters of credit, and stringent thresholds that need to be satisfied to rely on the fraud exception, the Petrosaudi case illustrates that the fraud exception is a tool the courts are willing to use to uphold the balance of risk between the various parties to a documentary credit.

The key thing for parties to avoid such difficult situations, when presenting and seeking payment, is to give due consideration to the types and content of documents to be presented under a letter of credit.

The following tips are suggested as good practice when reviewing letters of credit:

  • Tailor the requirements of the credit to the underlying sale contract requirements and ensure no inconsistencies between the two.
  • Draft presentation requirements clearly and try to keep these simple.
  • Avoid certification requirements if the subject matter of such certification requires the person certifying to interpret the underlying contract in order to determine the validity of that subject matter.