Letters Of Credit: Privy Council Reaffirms Autonomy Principle

The autonomy principle is fundamental to the utility of letters of credit (LCs). Under this principle, a bank must pay against a presentation of documents that appear on their face to comply with the credit. This obligation is "autonomous" from the underlying transaction. In a recent case, the Privy Council rejected an argument that would have made it easier to invoke one of the few exceptions to the autonomy principle - namely the fraud exception. David Williams explains.

The autonomy principle

Under the autonomy principle an issuing bank's duty to honour a compliant presentation of documents under an LC is independent of the underlying contract and despite any disputes between the parties to that contract. Banks should not concern themselves with goods, services and underlying transactions. Nor should they look beyond the documents presented under the credit. The English courts have summarised the autonomy principle by saying LCs should be treated as equivalent to cash.

Exceptions

There are very few exceptions to the autonomy principle. These include:

where it is illegal under local law in the place of payment for the bank to pay under the credit; and the fraud exception. The English courts are still working out the precise scope of the fraud exception. The mere fact of some fraud arising in connection with the LC or the underlying transaction does not of itself trigger the fraud exception. For example, if the beneficiary of a credit presents the bank with forged documents that appear to comply with the credit, the fraud exception will not apply unless the beneficiary knows of the forgery and the bank is aware of this.

In Alternative Power Solution v. Central Electricity Board [2014] UKPC 31, the Privy Council was asked to consider whether the fraud exception applied in a dispute originally heard in the Mauritian courts.

Alternative Power Solution v. Central Electricity Board

Alternative Power Solution (APS) had sold light bulbs to Central Electricity Board (CEB). Payment would be by LC. Following delivery, CEB claimed the bulbs had not been made according to specification, and APS had not allowed it to inspect the bulbs before shipping. In an earlier Mauritian court hearing, an officer of APS had stated that the goods would not be shipped until CEB had had an opportunity to inspect them. It later transpired that, when he made that statement, the goods were already on ship. CEB argued that the fraud exception applied. It sought an...