Alternative Power Solutions v. Central Electricity Board and Another [2014] UKPC 31

It is a fundamental principle underlying the operation of documentary credits that the obligations of the parties under the credit are independent of the terms of any underlying commercial transaction. Accordingly, any commercial disputes between the parties to the underlying transaction are irrelevant to the issuing bank’s obligation to pay upon presentation of documents complying with the letter of credit. This obligation is subject only to narrow exceptions where there is fraud on the part of the beneficiary or illegality. 

In a recent judgment, the Privy Council has considered the scope of the fraud exception and confirmed that an injunction restraining a bank from paying under a letter of credit on the basis of fraud will only be justified in extraordinary circumstances.=

The background facts

This matter came before the Privy Council on appeal from the Court of Appeal of Mauritius. Alternative Power Solutions (“APS”) contracted to supply a quantity of light bulbs to the Central Electricity Board (“the CEB”). The contract entitled the CEB to inspect the bulbs to confirm their conformity to the contract prior to shipment. The CEB also alleged that the parties had agreed that the bulbs were to be manufactured by, or under license by, Philips in China, although this was not accepted by APS.

Payment was to be made by way of an irrevocable letter of credit and the CEB duly procured the issue of a letter of credit (“the LC”) by Standard Bank (“the Bank”).  The LC provided for payment against the presentation of certain documents by APS.  Significantly, the list of documents required did not include any certificate of inspection of the goods or written confirmation from the CEB that the goods could be released for shipment. The CEB requested an amendment to require presentation of these additional documents but this was not agreed by APS.

The goods were shipped without the CEB having had the opportunity to verify them and the CEB applied for an interlocutory injunction restraining the Bank from making payment in the event of a compliant presentation of documents by APS. Various allegations of fraudulent conduct were made against APS, including (i) that APS’s tender for the contract required that the goods would be manufactured by or under license by Philips in China (which the Mauritian Court of Appeal subsequently held that APS never had any intention of complying with) and (ii) that APS had not allowed and/or authorised the CEB to inspect and verify the goods at the place of manufacture in China.

The decisions of the Mauritian courts

The Judge at first instance granted the injunction sought by the CEB. The Court was evidently influenced by alleged breaches of the underlying contract by APS.  In particular, the Judge held that it was not open to the Bank to pay under the LC in circumstances in which it was aware that the terms and conditions of the underlying contract had not been complied with. The Judge held that the CEB had raised “a serious prima facie arguable case that there might be an attempt to defraud it” and considered that APS was debarred from claiming payment of the contract price until all disputes had been resolved. He further noted that APS was protected against any damage it suffered as a result of the injunction by the undertaking in damages given by the CEB. On that basis, the Judge concluded that the balance of convenience was heavily in favour of granting the injunction. 

The decision and reasoning of the Judge at first instance was upheld by the Mauritian Court of Appeal.

The Privy Council decision

There were three issues for consideration by the Privy Council: (1) what is the correct test to establish the fraud exception, (2) was there sufficient evidence of fraud in this case to establish the exception and (3) did the balance of convenience justify an interlocutory injunction?

On the first issue, the Privy Council held that the Judge had not applied a sufficiently stringent test in considering whether the fraud exception had been established. The correct test is stated in United Trading Corporation S.A. v. Allied Arab Bank Ltd [1985] 2 Lloyd’s Rep 554, namely whether it is seriously arguable that, on the material available, the only realistic inference is that the beneficiary could not honestly have believed in the validity of its demands and that the bank was aware of that fact.   

As to whether there was sufficient evidence of fraud, the Privy Council noted that the CEB had relied upon the failure of APS to supply bulbs manufactured by Philips and that they had failed to allow the CEB to inspect and verify the bulbs at the place of manufacture. These allegations, however, were allegations of breaches of the sale contract and were thus irrelevant to the liability of the Bank under the LC. In so far as he had relied on these allegations as amounting to fraud, the Judge was held to have erred in principle.

The Mauritian Courts were also influenced by evidence given by the CEB that APS had twice breached undertakings given to the Court. The Privy Council held that even if there was some force in this allegation against APS, it was irrelevant to the position under the LC.

The Privy Council also accepted APS’s submission that the balance of convenience will almost always militate against the grant of an injunction. Even if a party is able to establish the fraud exception, it still faces what was has been described as an insuperable difficulty, in that it will have an adequate remedy against the bank in damages if it pays despite being on notice of fraud. 

By contrast, an injunction would interfere with the issuing bank’s obligations to other banks involved and might cause greater damage to the bank than the party seeking the injunction could pay on their undertaking as to damages. In these circumstances, the balance of convenience will almost always be in favour of allowing the bank to pay.

Comment

This case provides a useful reminder of the autonomy principle underpinning letters of credit and confirms that commercial disputes arising in the underlying transaction are irrelevant to the issuing bank’s obligation to pay upon presentation of documents complying with the credit.

It is virtually impossible to obtain an injunction preventing the bank from making payment because the balance of convenience will almost always be in favour of allowing the bank to make payment. While the decided cases do not go so far as to say that the balance of convenience will never justify granting an injunction, it is clear that extraordinary circumstances will be required. Such circumstances have not so far presented themselves to the English courts.

This underlines the importance of ensuring that any and all documents a buyer requires before the seller is able to obtain payment are accurately listed in the letter of credit.  Once the letter of credit has been issued, any omissions can only be corrected with the agreement of the other party. Absent such agreement, it is highly unlikely that the buyer will have any means of stopping payment once the seller has presented the documents that are listed in the letter of credit.