On the 9th of September 2014, the Privy Council in the United Kingdom delivered a judgment in Alternative Power Solution Ltd. v. Central Electricity Board [1] reaffirming the established principle that, other than in cases of illegality, a court may only step-in to enjoin a call on a documentary letter of credit in the case of fraud on the part of the beneficiary. This principle is commonly referred to as the "fraud exception." 

This judgment provides a reminder of the rationale underpinning the fraud exception: the commercial importance of autonomy between a letter of credit and the underlying contract to which the letter of credit relates. The decision also highlights the practical difficulty in meeting the evidential burden required to establish the fraud exception at the interlocutory stage. 

Letters of Credit 

A letter of credit constitutes a credit instrument under which a bank commits, on behalf of the applicant, to pay certain sums to the beneficiary against the presentation of specified documents, typically relating to the delivery of certain goods or performance of certain works. Assuming the beneficiary delivers to the issuing bank documents conforming to the requirements of the letter of credit, the bank has an obligation to pay-out even if disputes arise regarding the underlying contract. The independence between the issuing bank's obligation to pay-out and the terms of the underlying contract give the parties to the underlying transaction a "cash-equivalent" means of payment and therefore a high degree of commercial certainty. Moreover, the issuing bank can provide, and earn a fee from, the service without getting drawn into underlying contract disputes. The English courts recognise the irrevocable obligations assumed by banks as "the life-blood of international commerce" [2] and therefore strongly avoid interfering with them, because of the perceived effect on international trade in general. 

The Facts

In 2010, Alternative Power Solution Limited ("APS") submitted a bid for the supply of 660,000 compact fluorescent lamps to the Central Electricity Board of Mauritius ("CEB"). CEB accepted APS' bid and entered into a contract with APS for the supply of such goods. According to CEB, APS made its bid on the basis that it would supply lamps manufactured by, or on licence from, Philips in China. Amongst other things, the contract entitled CEB to inspect the consignment, prior to shipment, to validate its conformity with the contract requirements. 

On CEB's application, Standard Bank issued a letter of credit for the benefit of APS. The letter of credit described the documents that the bank required APS to deliver as a precondition to payment. It did not require APS to deliver any certificate of inspection or similar document to the bank. Notwithstanding CEB's contractual entitlement to inspect the consignment prior to shipment, APS shipped the goods uninspected. CEB applied for an injunction, citing the fraud exception, to halt payment under the letter of credit on the basis that APS had allegedly shipped lamps that did not conform to the agreed specification (CEB suspecting they were not Philips' lamps) and had not afforded CEB an opportunity to inspect the goods prior to shipment. 

The Judge found that CEB had "raised a serious prima facie arguable case that there might be an attempt to defraud it [CEB] which must be left to the competent court or to the arbitrator as provided for in the contract to deal with the issue. The balance of convenience clearly titled heavily in favour of the applicant as APS is debarred to claim the amount until all the disputes had been cleared." 

APS appealed this decision, stating: 1) the Judge imposed an incorrect test; 2) CEB presented insufficient evidence to establish the fraud exception; and 3) the balance of convenience did not justify an interlocutory injunction. The Privy Council's Lord Clarke granted the appeal, disagreeing with the judgment of The Mauritian Supreme Court. He concluded that, in order to grant an injunction preventing the bank paying out under a letter of credit, it must be clearly established at the interlocutory stage that the only realistic inference is (a) that the beneficiary could not honestly have believed in the validity of its demands under the letter of credit and (b) that the bank was aware of this fraud.


The fraud exception sits within an established body of case law. In the US, the leading case remains Sztejn v. J. Henry Schroder Banking Corporation.[3] Lord Denning's decision in Edward Owen Engineering Ltd. v. Barclays Bank International Ltd.[4] is often cited as the leading English law authority, although no single case stands alone and Lord Clarke, in reaching his decision in Alternative Power Solutions, relied on the decision in Bolivinter Oil S.A. v. Chase Manhattan Bank N.A.[5]

Generally speaking, to obtain an interlocutory injunction in the English courts a claimant must show only that its claim is not frivolous or vexatious, that is to say, it has a serious issue to be tried.[6] However, Lord Clarke confirmed that this test does not apply in the case of a letter of credit. The law applies a separate, more stringent, test in the case of letters of credit, to preserve the autonomy between the bank's obligations, on the one hand, and the rights and obligations of the parties to the underlying contract, on the other. Nevertheless, the English courts do recognise that, as a claimant may struggle to establish fraud at a pre-trial hearing, the test cannot be quite the same as at a trail. Therefore, decisions such as that of Ackner LJ inUnited Trading Corp S.A. v. Allied Arab Bank Ltd.[7] led to the development of a two-stage test regarding the establishment of the fraud exception in interlocutory proceedings: (a) that the beneficiary could not honestly have believed in the validity of its demand under the letter and (b) that the bank knew of the fraud at the time the beneficiary makes the demand. In his judgment, Lord Clarke affirmed this as the correct test (therefore finding that The Mauritian Supreme Court applied the incorrect test). 

The test, especially when presenting evidence of fraud, is a particularly difficult test to satisfy because proving that the bank knew of the fraud at the time the beneficiary called on the letter of credit is an extremely onerous burden to meet.[8] In Alternative Power Solutions, Lord Clarke held that there had been no suggestion that any of the documents presented to Standard Bank were forgeries or contained "any express material misrepresentations." As a result, the court held that the evidence presented was not enough to trigger the fraud exception because it could not infer that Standard Bank was aware of the APS' alleged fraud at the time it called on the letter of credit. 

In addition to this test, the claimant must also satisfy the court that the "balance of convenience" favours the granting of the injunction. Lord Clarke found The Mauritian Supreme Court misinterpreted the balance of convenience test. In considering this maxim, Lord Clarke accepted APS' submission that injunctions granted under the fraud exception are rare because, amongst other things, the balance of convenience will almost always militate against the grant of an injunction. In essence the court must consider whether the interference in question, i.e., with the bank's obligation, might, in fact, cause greater damage to the bank than the claimant. 

Other exceptions for other instruments? 

It is often thought that the autonomy of the bank's obligations under a letter of credit distinguish letters of credit from other similar financial instruments, such as performance bonds, for example. An on-demand performance bond imposes a contractual obligation on the issuer to pay a specified sum of money on the happening of a specified event or events. However, in the case of a true on-demand bond, the same autonomy exists: the only practical distinction is that the parties to a letter of credit expect the beneficiary to call on the letter of credit whereas the parties to a performance bond, in the normal course of events, do not expect the beneficiary to call on a performance bond. Historically, the fraud exception has equally applied to on-demand bonds. However, the recent decisions in Simon Carves Ltd. v. ENsus UK Ltd. [9] and Doosan Babcock Ltd. v. Commercializadora de Equipos y Materiales Mabe Limitada [10] indicate a departure from the established position. Both cases concerned on-demand bonds in the context of construction contracts. 

In Simon Carves, the underlying construction contract contained a provision stating that the performance bond shall become null and void, and returned to the contractor, immediately upon the issue of an acceptance certificate by the employer. The employer issued an acceptance certificate prior to the expiry date of the bond and subsequently purported to make a call on the bond. The court held that the bond remained valid between the employer and the issuing bank, but as between the employer and the contractor the bond was "null and void". The court, however, did not grant an injunction preventing a call on the bondper se but instead granted an injunction preventing a breach of an express term of the underlying contract which regulated the ability of the employer to call on the bond. In its passing comments the court contemplated the existence of an alternate possible ground on which a contractor might resist a call on a bond—straight breach of contract. 

In Doosan, the underlying construction contract contained similar provisions to those in Simon Carves in that the contract stated the bond was to expire on the earlier issue of a taking-over certificate by the employer or a fixed expiry date. The employer did not actually issue the taking over certificate prior to making a call on the bond. The contractor, however, sought an injunction against the employer's subsequent call on the basis that the employer ought to have issued a taking-over certificate but had not done so in breach of the underlying contract, and had it done so it would have no entitlement to call on the bond. The court granted an injunction preventing the call on the bond, relying on the common law principle that a party should not profit from its own breach of contract. 

Commentators have much-maligned the decisions in Simon Carves and Doosan for their perceived broadening of the circumstances in which a court may enjoin a call on a bond beyond fraud and illegality. Nevertheless, these decisions suggest that the courts may look to provisions in an underlying contract, which regulate calls on a bond related to such contract, in a way that pierces the autonomy between the parties' obligations under the contract and the issuing bank's obligation under the associated bond. The distinction between Alternative Power Solution, on the one hand, and Simon Carves and Doosan, on the other seems not that the former concerns a letter of credit and the latter a performance bond, but that the latter concerned a contract which contained provisions regulating the beneficiaries' call on the bonds, whereas the former did not. 


Lord Clarke's judgment reaffirms and clarifies the fraud exception test. The decisions in Simon Carves andDoosan, however, indicate a departure from the traditional exceptions of fraud and illegality. These decisions are not necessarily inconsistent with the decision in Alternative Power Solution, in which the court did not consider provisions in the underlying contract regulating a call on the letter of credit, because it did not contain any. The contractual provisions which the courts looked to in Simon Carves and Doosan were technical in nature, essentially preventing a call on the bond where the discharge of obligations under the contract meant the security afforded to the beneficiary through the bond had, or ought to have, effectively expired. It is interesting to consider, but difficult to conceive, whether the Simon Carves and Doosanconcepts could be used to broaden the fraud exception itself (for example, by including provisions in the underlying contract which prohibit the beneficiary from calling on the bond or credit where he knows he has not performed his obligations under the underlying contract). Such further extensions seem to lack jurisprudential justification.