The second post

Readers may recall on 2 December 2016, we took a look at the strict approach English judges take to enforcing payment under standby letters of credit. I shared then two first instance decisions I was involved in (National Infrastructure Development Co Ltd. vs BNP Paribas [2016] and National Infrastructure Development Company Ltd vs Banco Santander S.A. [2017]), in which Fenwick Elliott, acting for the National Infrastructure Development Company (NIDCO), successfully obtained summary judgment of about $58m (£47m) against BNP and $38m (£31m) against Santander.

The end of last year also saw the first instance decision of Petrosaudi Oil Services (Venezuela) Ltd vs Novo Banco SA & Ors [2016]. This was an oil and gas case, in which Petrosaudi provided oil rig drilling services to PDVSA Servicios S.A. (PDV), under a Venezuelan law contract. As credit support for PDV’s payment of Petrosaudi’s invoices, Novo Banco S.A. issued an English law-governed standby letter of credit in favour of Petrosaudi. PDV failed to pay various invoices and Petrosaudi demanded payment from Novo Banco under the standby letter of credit.

The court held that presentations made under a standby letter of credit, where the sums demanded were not due and payable immediately under the underlying contract at the time of the presentation, were fraudulent. As in this case, the signatory of the presentation knew that payment was not due at the time, the fraud exception was engaged, preventing payment under the standby letters of credit.

The cases of NIDCO vs Banco Santander S.A. and Petrosaudi both made it to the Court of Appeal.

The threshold for ‘fraud’ is high. It is not sufficient to show that a beneficiary was claiming more than it was entitled to, or had no entitlement to make a claim

In Petrosaudi, the Court of Appeal considered that an honestly held incorrect opinion on legal entitlement should not necessarily make a demand fraudulent. It is only if the person making the demand actually knows and believes that it has no entitlement under the performance security that fraud will be found, or if the person is “recklessly indifferent” to whether it has an entitlement. No such knowledge or belief existed here.

In Banco Santander, the Court of Appeal clarified the law as to the proper test to be applied by beneficiaries on summary judgment applications under letters of credit. Lord Justice Longmore confirmed that the correct test to apply was that there must be a “real prospect” of establishing “that the only realistic inference is that [the claimant] could not honestly have believed in the validity of the demands”.

The judge at first instance had applied too high a test by using the phrase “seriously arguable” rather than the wording of the summary judgment provisions within the civil procedure rules, “no real prospect of success” (some chance of success). The prospect must be real and not false, fanciful or imaginary.

The NIDCO vs Banco Santander and Petrosaudi Court of Appeal judgments uphold the autonomy principle under English law. As Lord Justice Longmore emphasises: “Letters of credit are part of the lifeblood of commerce and must be honoured in the absence of fraud on the part of the beneficiary. The whole point of them is that beneficiaries should be paid without regard to the merits of any underlying dispute between the beneficiary and its contractor.”

Pegging the threshold at this level gives comfort to banks, because it permits them to step back from the contracting parties’ relationship

The Court of Appeal judgments in both cases serve to confirm two significant matters regarding performance securities.

Foremost, that the threshold for “fraud” is a high one. It is not sufficient to show that a beneficiary was claiming more than it was actually entitled to, or that it had no entitlement to make a claim under a performance security.

It needs to be clearly demonstrated, that the beneficiary either knew it had no entitlement, or was recklessly indifferent as to whether it had an entitlement.

Pegging the threshold at this level gives comfort to banks, because it permits them to step back from the contracting parties’ relationship and meet a demand in confidence of being obliged to do so; upholding the autonomous nature of performance securities. Only if there is a very clear case of fraud must the bank refuse payment.

Moreover, it confirms the value of “on demand” performance securities familiar to most readers with major project experience. That demands on them usually cannot be prevented, or halted, if there is a genuine dispute over whether the beneficiary is entitled to the sums it seeks to recoup through calling on the security. The question of “who owes what to whom” is to be resolved in court or arbitration, between the employer and the contractor. But it does not usually hold up the conversion of a security in the meantime. The security is treated as being “as good as cash”.

Simon Tolson is senior partner in Fenwick Elliott.

This article was co-written with Claire King, a partner in Fenwick Elliott