8 May, 2017
The case of So Sau Lai Connie v DBS Bank (Hong Kong) Ltd [2017] HKEC 29 is a typical letter of credit fraud case. This case illustrates whether certain “red flags” may constitute discrepant presentation or a fraud indication.
Background
The case concerns a letter of credit (the “L/C”) issued by DBS Bank in Hong Kong (the “Issuing Bank”) to an overseas supplier. The L/C applicant (the “Buyer”) is a Hong Kong trader. The L/C is available with the advising bank (located in Germany) by payment. When the Issuing Bank received complying presentation under the L/C, the advising bank has already effected payment to the L/C beneficiary. On the due date, the Issuing Bank reimbursed the advising bank and booked a trust receipt loan against the Buyer. Unfortunately, the Buyer subsequently discovered that the presented bills of lading (the “BL”) were forged and no goods were actually shipped. The issue for the Court of First Instance is: whether the L/C drawing should be a loss borne by the Buyer or the Issuing Bank. If it is a loss to be borne by the Buyer, the Buyer is bound to reimburse the Issuing Bank for the L/C payment and repay the trust receipt loan.
Is loss borne by the L/C applicant or the Issuing Bank in cases of fraud?
The legal position on a bank’s payment obligations in cases of fraud is well established: if a bank pays in accordance with the L/C terms, it is entitled to be reimbursed unless there is clear evidence of fraud at the time of payment. So the exception is that if the bank has clear evidence that the beneficiary has made a fraudulent demand and the bank is aware of it at the time of payment, the bank should not pay, and if it does, it will not be entitled to reimbursement from the L/C applicant. This is commonly known as the fraud exception.
The point worth noting in this case is that fraud was discovered post-payment so the Buyer could not trigger fraud exception at the time the Issuing Bank effected payment under the L/C. As such, the Buyer did not purely advance its arguments on fraud exception, the Buyer has based its arguments mainly on the following three grounds:
Implied contractual term: It is an implied term in the agreement between the Issuing Bank and the Buyer that the Issuing Bank should properly advise the Buyer on the terms of the L/C.
Duty of care: By reason of the close proximate relationship between the Issuing Bank and the Buyer, the Issuing Bank owes a duty of care to the Buyer to properly advise it on the commercial arrangement, e.g. the Issuing Bank should have advised the Buyer to obtain a Certificate of Inspection.
Negligence: The Issuing Bank was negligent in checking the presented documents and the presentation should have been found to be discrepant – the Buyer alleged that either the “abnormal” features of the BL should have amounted to a discrepancy or such “abnormal” features should have indicated signs of fraud to an extent that obliged the Issuing Bank to refuse payment.
For allegation (1), the agreement between the Issuing Bank and the Buyer made it clear that the Issuing Bank owed no duty to the Buyer to advise what documents are required under the L/C. The Court ruled that no implied term may contradict the express terms of a contract, so the Court refused to accept allegation (1).
For allegation (2), the Court found no duty of care owed by the Issuing Bank to the Buyer. In particular, the Court noted that the Buyer is experienced in dealing with shipping documents, so such experience would militate against any assumption of responsibility by the Issuing Bank to advise on documents required under the L/C. Further, if the beneficiary could forge the BL, there is no reason why the beneficiary could not forge the Certificate of Inspection.
For allegation (3), this was a live issue which the Court has spent considerable amount of effort to consider and to analyse expert witnesses’ statements. In essence, the question is whether certain “red flags” amount to discrepancy or indication of fraud.
Whether certain “red flags” can amount to discrepancy or indication of fraud?
With respect to the question of discrepancies, the Court considers whether the presented documents are compliant with the L/C terms (which incorporate UCP500) as understood in international standard banking practice under the principle of strict compliance.
With respect to fraud indication, the relevant criterion is whether there is clear and obvious or irrefutable evidence of both (i) fraud and (ii) the bank’s knowledge of such fraud before payment, so the Issuing Bank may refuse to make payment.
The Buyer listed out the following abnormalities on the BL as “red flags”:
- no designated area to set out name of vessel
- no evidence or proper evidence that goods had been shipped on board named vessel
- no letterhead and insufficient information of carrier
- no valid BL number (the number was shown as “1 of 3”, “2 of 3”, “3 of 3”, which the Buyer alleged are too simple/unrealistic)
- notation in wrong loading box (i.e. information not filled in the correct box)
- no container numbers
- no shipping marks
- no measurements of the goods
- no voyage number
- totality of the identified features
- notation in the BL was “odd”
Article 23 of UCP500 (for Marine/ Ocean bill of lading) does not require a BL to indicate any of the above features.
Therefore, after detailed analysis of the UCP and relevant opinions from ICC, the Court ruled that none of the above may amount to discrepancy under the L/C nor be it sufficient to be an indication of fraud to oblige the Issuing Bank to refuse payment under the L/C.
The Court found that (a) international standard banking practice would not require the Issuing Bank to make inquiries into or to investigate into the alleged “red flags”, (b) the presented documents were on their face compliant with the L/C terms and UCP500, and (c) the BL was not so unusual to give rise to any clear indication of fraud. As such, the Issuing Bank could not refuse payment to the advising bank for payment made to the beneficiary and the Court held that the Buyer was liable to reimburse the Issuing Bank for the amount paid under the L/C plus interest.
Conclusion
The case reinforces the autonomy principle of letters of credit under Hong Kong law. The bank document checker need not go beyond the documents to make inquiry or conduct investigation to verify the data content of any document. Further, the burden of proof favours the banks — it is for the L/C applicant to provide the issuing bank with compelling and cogent evidence of fraud, and not for the issuing bank to make inquiries into the merits of “red flags” or carry out investigation into the merits of the allegation if fraud is not obvious. This is positive news to banks.
A side note is that, banks should be very careful not to provide any specific advice to the client with regard to the terms of the L/C. In the current case, the Buyer attempted to argue that the Issuing Bank has provided specific advice to it and it has relied on such advice. The Court found that the evidence was not sufficient to support such allegation, so this allegation was dismissed. However, if the Issuing Bank had in fact provided the advice and the Buyer had in fact relied on it, this case would have been more challenging for the Issuing Bank.
Read the full judgment here.
Annie Lam, Eversheds
annielam@eversheds.com
