The Fraud Exception
8.09 The classic exposition of the fraud exception in relation to commercial LCs in the UK and Singapore is Lord Diplock’s statement in United City Merchants (Investments) Ltd v Royal Bank of Canada that the fraud exception applies ‘where the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue’.[725] An example might be where the documents, to the knowledge of the beneficiary, misstate the quantity of goods that have been shipped.
8.10 It is problematic to apply Lord Diplock’s test of documentary fraud to performance bonds, where there is less focus on documents.
Some performance bonds might require merely a written demand, with no prescription as to the form of words to be used. In such cases, no express representations of fact are made to which Lord Diplock’s test can be applied; although it could be argued that there might be an implied representation, based on the presentation of the demand by the beneficiary, that the sums under the performance bond are due. A more detailed requirement might be for the beneficiary to make a written demand to the bank stating that the beneficiary has breached the underlying contract. This would be more in the nature of a statement of belief rather than one of fact. Nevertheless, it could be argued that a statement of whether one holds a particular belief could be regarded as a statement of fact,[726] and it would be a false statement if the person making the statement did not in fact hold the stated belief, ie that the applicant has breached the contract.[727]A test of fraud that is more suited to performance bonds has been developed.
In State Trading Corporation of India Ltd v ED & F Man (Sugar) and the State Bank of India, Lord Denning MR expressed the view that there was a term to be implied in a sale contract with regard to a performance bond that ‘the buyer, when giving notice of default, must honestly believe that there has been a default on the part of the seller’.[728] In GKN Contractors Ltd v Lloyds Bank plc, Parker LJ stated that what was relevant was common law fraud, ‘that is to say, a case where the named beneficiary presents a claim which he knows at the time to be an invalid claim, representing to the bank that he believes it to be a valid claim’.[729] In United Trading Corporation SA and Murray Clayton Ltd v Allied Arab Bank Ltd, the test of fraud was similarly expressed to be whether the beneficiary could not have honestly believed in the validity of its demand on the performance bond.[730] The Singapore Court of Appeal has accepted this statement and elaborated on it by incorporating the other elements of common law fraud set out in the classic English case of Derry v Peek,[731] and held that it would be fraudulent for the beneficiary to make a demand if it knows that the demand is invalid, had ‘no honest belief’ in its validity, or if it presented an invalid demand ‘recklessly, that is ‘indifferent to whether or not it is a valid demand’.[732] On the other hand, it must be emphasised that as the performance bond is meant to allow the beneficiary to obtain payment without waiting for the dispute in the underlying contract to be settled, the understanding between the parties must be that the beneficiary is entitled to call on the bond as long as it honestly believes that the applicant is in breach of contract, even if it may have been wrong in its assessment.[733]8.12
In addition to the concept of documentary fraud, discussed above, there is a broader version of the fraud exception that is accepted in some jurisdictions, known as ‘fraud in the transaction’,[734] although its limits are unclear.lang=EN-US style='font-size: 9.0pt;font-family:"Times New Roman",serif;color:black'>[735] There has been debate on the applicability of the ‘fraud in the transaction’ exception to commercial LCs, and the position in the UK has been described as not settled.[736] A strict reading of Lord Diplock’s statement in United City Merchants v Royal Bank of Canada, which involved a commercial LC, that documentary fraud is the ‘one established exception’ to the autonomy principle suggests that in relation to commercial LCs, ‘fraud in the transaction' is not part of English law.[737] This restrictive interpretation of the meaning of ‘fraud' in commercial LC cases is likely to be applied also in Singapore, where Lord Diplock's statement has been quoted and applied in case law.[738]
8.13 In relation to performance bonds, the fraud exception was applied in Themehelp v West, where the underlying contract was found to have been induced by fraudulent misrepresentation.[739] The English Court of Appeal upheld the High Court's decision to grant an injunction on the basis that the only reasonable inference that could be drawn from the circumstances was that the beneficiaries had been fraudulent.
On its facts, this case can be classified as involving ‘fraud in the transaction', since the fraud did not involve the documents. However, the Court of Appeal did not elaborate on the meaning of ‘fraud' and the term ‘fraud in the transaction' was not used in its judgment. The term ‘fraud in the transaction' has similarly not been used in Singapore cases, but it can be observed that the question of whether there is ‘fraud in the transaction' is consistent with the fraud test articulated above for performance bonds cases, of whether the beneficiary had no honest belief in the validity of its demands. The commonality between the two is that the ‘no honest belief' test, like the ‘fraud in the transaction' enquiry, does not look at the documents alone, but extends to considerations beyond the contents of the documents. It seems preferable, in relation to performance bonds, to use the ‘no honest belief' formulation rather than to ask whether there was ‘fraud in the transaction', as the ‘no honest belief' test directs us squarely to the nub of the enquiry: did the beneficiary honestly believe it was entitled to call on the performance bond? It is possible that the scope of ‘fraud in the transaction' is potentially wider than ‘no honest belief', as the former could extend beyond questions of entitlement to call on the bond; and, if so, it would be desirable to limit the applicability of the fraud exception in performance bonds to cases where there is no honest belief in the validity of the call instead of using the broader concept of ‘fraud in the transaction', so as not to stray too far from the autonomy principle.8.14 In the US, both versions of the fraud exception are set out in § 5-109 of the Uniform Commercial Code (‘UCC'), which applies equally to commercial and standby credits. Under this section, an injunction can be granted to prevent the issuer from honouring a demand ‘if a required document is forged or materially fraudulent', or if honour of the presentation ‘would facilitate a material fraud by the beneficiary on the issuer or the applicant', provided that certain conditions are satisfied.
The first part of this provision corresponds roughly to the idea of documentary fraud, and the second part to the idea of ‘fraud in the transaction', where a court could look beyond the documents at external matters, for example, whether a demand was made despite there being no breach in the underlying contract; or whether there was fraud in the procurement of the instrument or the underlying contract. The US approach in § 5-109 goes further than the UK or Singapore position in relation to commercial LCs, but it seems generally consonant with the ‘no honest belief' approach in performance bonds, although the test of whether honour would ‘facilitate a material fraud by the beneficiary on the issuer or the applicant' makes the UCC rule more nuanced than the common law approach of ‘no honest belief' adopted in the UK and Singapore.[740]In deciding whether to grant an injunction restraining a bank from honouring a performance bond, courts in the UK and Singapore will look at whether there is clear evidence of the fact of fraud and as to the bank's knowledge.[741] The mere allegation of fraud will not be sufficient. The standard of proof that applies is the one articulated by Ackner LJ in United Trading Corp v Allied Arab Bank, to ask whether the applicant has shown that ‘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 on the performance bonds?'[742] Although the strict ‘only realistic inference' standard of proof is still in use in Singapore, the courts have also accepted the less onerous standard of a ‘strong prima facie case',[743] drawing guidance from the Canadian case of CDN Research & Development Ltd v Bank of Nova Scotia.New Roman",serif;color:black;font-weight:bold'>[744] The reasons for adopting this more relaxed standard of proof for performance bonds are consonant with the reasons for developing the unconscionability exception, which are discussed below.
8.16
In contrast with the UK approach towards the grant of interim injunctions, where the ‘balance of convenience' test propounded in the case of American Cyanamid Co Ltd v Ethicon Ltd[745] is applied in determining whether to grant injunctions, the Singapore courts have dispensed with this test in cases involving commercial LCs and performance bonds, so that the question of whether there was fraud (or unconscionability in the case of performance bonds) was the sole consideration in applications for injunctions to be granted.[746] The view of the courts is that once fraud (or unconscionability) can be established, the question of ‘balance of convenience' becomes superfluous, and ‘it did not lie in the mouth of the defendant to claim that damages would still somehow be an adequate remedy'.[747] If this test were applicable, it would mean that the court would have to deal with both the equitable principle as well as the balance of convenience.
In the opinion of the Singapore courts ‘to require such a “double-barreled” test would be dichotomous and illogical'.[748] However, they have emphasised that dispensing with the balance of convenience did not make an injunction any easier to obtain, as the requirement to establish a clear case of fraud or Unconscionability in interlocutory proceedings would apply a higher level of strictness, and mere allegations would be insufficient.[749] The Court did not explain this statement. If a balance of convenience test is applied to the grant of an injunction, the applicant faces two obstacles. At the first stage of the enquiry, as discussed above, the applicant must show a clear case of fraud, to satisfy the standards imposed by the ‘only realistic inference' test, or the ‘strong prima facie case' test.[750] Most applicants will fail at this stage as these standards are high. In Singapore, an applicant who passes this test will be granted an injunction. There are no further considerations. Although the result of the next step of the American Cyanamid test, whether damages would be an adequate remedy for the applicant, might in some cases cause a court to deny an injunction despite a finding of fraud in the first stage, this escape route is not available to a beneficiary in Singapore. The language quoted above, that ‘it did not lie in the mouth'[751] of the beneficiary to claim that damages would still somehow be an adequate remedy, suggests that the court felt that it was justified to dispense with the second stage because the defendant had acted dishonestly (or unconscionably). In the UK, an applicant who succeeds in the herculean task of satisfying the standard of proof for fraud at the interlocutory proceedings, must still move on to the second stage of the enquiry, to show that the balance of convenience lies in its favour, and this might present an ‘insuperable difficulty'.[752]IV.