A Yellow Book Tale: Termination, Letters Of Credit And A Question Of Fraud

In this Insight, we look at a recent Court of Appeal case on On-Demand Performance Securities (specifically Standby Letters of Credit) provided by a Brazilian contractor ("Construtora" or "OAS") to the National Infrastructure Development Company ("NIDCO") pursuant to a FIDIC Yellow Book contract. Fenwick Elliott1 acted for the successful party, NIDCO, against Santander in a claim for circa US$38 million.

NIDCO v BNP Paribas; NIDCO v Santander: the First Round2

NIDCO v Santander, like Petrosaudi,3 reaffirms the autonomy principle for On-Demand Performance Securities and the narrow scope of the fraud exception to that principle. If the party making the demand on the security honestly believed it was entitled to make the demand, fraud will not be made out, even if that party's belief proves to be wrong. It also provides some comfort to FIDIC users that the system of securities in place for contractual terminations (even if disputed) is sound.

In NIDCO v Santander the Court of Appeal also clarifies the law as to the proper test to be applied on summary judgment applications by beneficiaries under letters of credit. 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". This test will also apply where the beneficiary of an On-Demand Bond wishes to force the bank or other entity that issued it to pay out (to be contrasted with a Contractor seeking to injunct a bank from paying out to an Employer).

However, before seeking to distil the lessons learnt from the Court of Appeal, it is perhaps worth recapping on NIDCO's claims for payment against both BNP Paribas and Santander at first instance.

Santander was one of a number of banks that had provided securities (retention, advance payment and performance securities) at the request of a Brazilian contractor (Construtora) pursuant to a FIDIC Yellow Book contract (with bespoke amendments) for the construction of a major highway project in Trinidad and Tobago. The Employer for the contract was NIDCO, a corporate vehicle used by the government of Trinidad and Tobago to effect public infrastructure works.

The securities under the contract were all issued in the form of Standby Letters of Credit. They were also subject to English law and the jurisdiction of the English courts.

Standby Letters of Credit and the Autonomy Principle

For those wondering, Standby Letters of Credit are a special form of letter of credit frequently used in international trade contracts. They originate from the US where prohibitions were imposed on national banking associations from issuing bonds by way of guarantees as "payment of last resort". As with both traditional letters of credit and bonds the bank gives an undertaking to pay against documents, which creates a primary obligation on the bank that is autonomous of the underlying transaction.4 Letter of credit transactions are, by their nature, international and have retained their role as an instrumentality for the financing of foreign trade.

As such, Standby Letters of Credit are subject to the autonomy principle (as are On- Demand Performance Securities more generally under English law). Basically, if the demand made complies with the terms for making a demand on its face, then the monies claimed must be paid. The only exception under English law (as opposed to other jurisdictions such as Singapore and Australia where a doctrine of "unconscionability" has developed) is fraud.

Lord Denning famously explained this in Edward Owen Engineering Ltd v Barclays Bank International:5

"A bank which gives a performance guarantee must honour that performance guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether...