Letters of Credit: Fraud conquers all – if it is fraud

The High Court decision in Petrosaudi Oil Services (Venezuela) Ltd v. Novo Banco S.A. and Others [2016] EWHC 2456 provided a useful reminder that the principle of autonomy, which provides for payments to be made under letters of credit, regardless of disputes under the underlying contract, will not be upheld if the fraud exception applies. In its decision at first instance the High Court had found that the fraud exception had applied. However, the High Court judgment was appealed. This update discusses the Court of Appeal's decision.

The Court of Appeal's decision

The Court of Appeal has now found that there was no fraud and therefore no reason to depart from the principle of autonomy.  The Court of Appeal in effect exonerated the claimant's general counsel, taking the same view that he had of the legal position underpinning the presentation made to the bank by the claimant under the relevant letter of credit.  This has helpfully given lawyers comfort that the courts should not second guess honest representations of law.  Absent clear evidence that the signatory acted fraudulently, the autonomy principle should be upheld.

Accordingly the Court of Appeal made an order for payment to be made by the bank under the letter of credit in question.   

We discuss the case in more detail below.

The facts in this case

The claimant and appellant, Petrosaudi Oil Services (Venezuela) Ltd (POS), a Barbadian company, entered into a contract to supply oil rig drilling services to the second defendant PDVSA Servicios SA, a Venezuelan company (PDV). As required by the Contract, a standby letter of credit was issued in favour of POS by the first defendant, Novo Banco SA, a Portuguese bank as security for payment of invoices issued by POS.

POS provided drilling services between July 2015 and June 2016 and rendered invoices to PDV totalling in the region of $129m.  However, a dispute arose which, pursuant to the underlying contract, POS and PDV entered arbitration to resolve. 

The underlying contract provided that:

• if PDV did not dispute an invoice within 15 days of receipt it was deemed to have irrevocably accepted the invoice as being correct, due and owing; and
• if PDV did dispute an invoice it nevertheless had to pay POS the disputed amount which would be repaid (with interest) should POS subsequently accept, or PDV provide that the amount was not payable (the 'pay now, argue later' clauses). 

However, the underlying contract also provided that Venezuelan law was applicable to the performance of the Contract and in two preliminary (partial) arbitral awards it was held that Venezuelan law rendered the 'pay now, argue later' clauses null and void. 

PDV therefore contended that it had no obligation to pay the invoices until the dispute was resolved following a final arbitral award.  POS disagreed and contended it was entitled to make a presentation under the letter of credit and receive full payment of the sums outstanding from the bank. 

POS subsequently presented the invoices to the bank for payment ("the Presentation").  The letter of credit provided that POS had to certify that PDV was "obligated to the beneficiary to pay the amount demanded under the drilling contract", which POS did.  Accordingly, the bank gave notice that it considered that there had been a compliant presentation and stated its intention to pay out to POS.

Decision at first instance

The High Court found that the certificate provided by POS that PDV was obligated to POS for the sums claimed in the Presentation was false.  No such sum was due and payable at the time of the Presentation.  The debt had to be claimed and adjudicated in arbitration; until and unless that happened there was no present debt due or payable at all.  This would have been clear to POS in light of the preliminary arbitral awards and accordingly POS cannot have had an honest belief in the statement that PDV was "obligated" or had made it recklessly, not caring whether it was true or false.  The fraud exception therefore applied and the bank was restrained from paying out to POS under the Letter of Credit. 

Decision on appeal

The Court of Appeal over-turned the decision at first instance.  The Court of Appeal found that, contrary to the decision at first instance, the certificate provided by POS correctly stated that PDV was obligated to POS for the sums claimed in the Presentation.  The Court of Appeal agreed with the analysis of POS's general counsel of the meaning of the certificate, which underpinned the presentation made to the bank under the letter of credit.  Accordingly POS was entitled to provide the certificate. The fraud exception did not apply. 

The Court of Appeal went on to order the bank to make the payment due to POS following the Presentation. 

Comment

The decision of the Court of Appeal provides a useful reminder of the difficulty in establishing the high threshold of fraud and that the fraud exception to the principle of autonomy is likely to be relevant in only very few circumstances.  In arriving at its decision the Court of Appeal emphasised that the construction of the terms of the letter of credit in relation to the provision of the certificate necessary for the Presentation, as put forward by POS, was "consistent with commercial good sense".  It noted in this regard that "The availability of the letter of credit was of critical importance given PDVSA's dilatory payment history".

The Court of Appeal also expressed disquiet at the finding at first instance that the director at POS who had signed off on the certificate provided to the bank – its general counsel – had acted other than honestly, noting that "Whilst there is only one true construction of an instrument such as the certificate, different legal minds may obviously take different views on such a question".  This provides comfort that the courts should not second guess honest representations of law.  Absent clear evidence that the signatory acted fraudulently, the autonomy principle should be upheld.

Update

The Supreme Court has now considered and refused an application for permission to appeal the Court of Appeal's decision.