MAHARASHTRA NATIONAL LAW UNIVERSITY

MUMBAI

SEMESTER IX

INTERNATIONAL TRADE LAW

TOPIC: FRAUD AFFECTING LETTERS OF CREDIT

ABSTRACT

SUBMITTED BY SUBMITTED TO FACULTY OF

Vidit Harsulkar International Trade Law

2015 021
International trade can be complicated and risky. Given the fact that a large number of
transactions involved in international trade deal with receiving/sending payments from/ to
unknown businesses in remote geographic location, sellers often look to minimize the risk of
payment subsequent to delivery of goods. One way to reduce such risk is by employing
documentary Letters Of Credit (L/C), A letter of credit (L/C), in international trade is an
instrument of finance carrying a conditional guarantee of payment from the overseas
(buyer’s) bank to the seller. Consequently, a L/C is desirable in high value and/or high risk
transactions. The guarantee is conditional upon the seller complying 100% with the
documentary requirements of the L/C. L/C transactions are governed by Uniform Customs
and Practices for Documentary Credits (UCP 600)1 rules, supposed to have simpler and
clearer wording, to reduce ambiguity and differences in interpretation, and reduce
documentary discrepancy rates and the associated financial risks related to L/C’s in
comparison to the ICC rules. Whilst the introduction of UCP 600 has managed to bring about
some change in the way L/C transactions are done, the “Principle of Autonomy” remains
central to the letter of credit system, i.e. the letter of credit exists independently and
separately of the underlying contract between the applicant and the beneficiary. Under Article
4 of the Uniform Customs and Practices for Documentary Credits (UCP), the letter of credit
is autonomous and independent of the underlying contractual relationships. This means that
the issuing bank is bound to pay the beneficiary, regardless of possible disputes arising from
the underlying contract between the applicant and the beneficiary. The principle of autonomy
involves certain risks and creates opportunity for manipulation and even fraud by the
beneficiary/the seller. The bank’s duty is limited to the examination of documents with
reasonable care, and if documents comply with the terms of the credit, the bank is obliged to
pay the beneficiary. The fact that banks are bound to examine merely whether the documents
on their face comply with the terms of the credit and assume no responsibility if documents
are fraudulent makes it even easier for dishonest sellers to commit fraud. In order to remedy
the risk of fraud, the fraud exception is recognized by the law of letters of credit outside the
UCP. Under this rule, the bank is allowed to reject payment even if the documents on their
face comply with the terms and conditions of the letter of credit, when documents are found
to be fraudulent. However there exist lacunas in the fraud prevention system of the UCP

1
The Uniform Customs and Practice for Documentary Credits were promulgated by the International Chamber
of Commerce (I.C.C.) in 1933, and were revised in 1951, 1962, 1974, 1983, 1993, and 2007 (I.C.C. Pub. No.
600).
which leave banks prone to fraud, this paper will attempt to understand one such lacuna
which is the ‘exception from exception’ rule which excludes the application of fraud
exception rule cases in which the fraud was not committed by the beneficiary. The paper will
further look to provide a short comparative overview to illustrate different aproches taken by
different jurisdictions on the same issue. The primary objective of this paper is to bring some
new arguments aimed at highlighting the potential problems regarding the ‘exception from
exception’ rule.