Chuah, J.

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     WestminsterResearch http://www.wmin.ac.uk/westminsterresearch   Documentary credits and illegality in the underlying transaction.  Mahonia Limited v J P Morgan Chase Bank English Commercial Court [2003] EWHC1927 (Comm)  Jason Chuah  School of Law    This is an electronic version of an article published in the Journal of International Maritime Law, 9 (6). pp. 518-521, 2003, and is reprinted her with the permission of the publisher.     The WestminsterResearch online digital archive at the University of Westminster aims to make the research output of the University available to a wider audience.  Copyright and Moral Rights remain with the authors and/or copyright owners. Users are permitted to download and/or print one copy for non-commercial private study or research.  Further distribution and any use of material from within this archive for profit-making enterprises or for commercial gain is strictly forbidden.        Whilst further distribution of specific materials from within this archive is forbidden, you may freely distribute the URL of WestminsterResearch. (http://www.wmin.ac.uk/westminsterresearch).   In case of abuse or copyright appearing without permission e-mail wattsn@wmin.ac.uk. CFR contracts ^ the test ofconforming documentsThe buyers also attempted to justify their refusal to pay on the ground that they were entitled toreject the documents.The argument focused particularly on the bill of lading document where theIntan 6 was named as the first carrying vessel.That fact alone, the buyers argued, was sufficient tocondemn the bill of lading as a non-conforming document, essentially because the ship was notcontractual.The court rejected the argument as far too wide.The court indicated that the t`est is whether thedocuments contain a statement or statements which, without further investigation, demonstratesthat the contract has not been honoured in one or more respects of more than minimalimportance. This point must be apparent from the terms of the documents themselves, withoutenquiry into the physical performance of the contract'.Subject to the issue of fraud, documents are non-conforming if theydo notconformwith the expressstipulations of the sale contract, or if they are not genuine, in the sense that they contain falseinformation. In the present case the bill of lading was clearly genuine and on its face it alsoaccurately identified the carrying ship as Intan 6.Viewed in this manner, there was nothing aboutthe bill of lading that indicated that the contract was not being properly performed, and there wasno obligation to dig any deeper into the actual performance of the contract.DRTDOCUMENTARYCREDITS AND ILLEGALITY IN THE UNDERLYING TRANSACTIONMahonia Limited v JPMorgan Chase BankEnglish Commercial Court [2003] EWHC1927 (Comm)FactsAn interlocutory applicationwasmade on assumed facts.In 2001,Mahonia,Chase Bank and a subsidiary of Enron entered into three swap transactions.Underthose transactions, Mahonia lent Enron through Chase's intermediation a sum of about US$50million. The sum was to be repaid with interest in six months after drawdown. Repayment wasagreed to be partly secured by the issue of a letter of credit by West LB AG at the application ofEnron for the benefit of Mahonia. The overall effect of the three swaps was that Enron was toreceive the use of US$350 million for six months. It was contended by West LB that the transactionwas purely a cosmetic scheme to provide Enronwith a loan of US$350 million at a rate of interest ofroughly 3.4 per cent per annumwhich Enron did not have to record in its accounts as a debt. Enronalso paid Chase an arrangement fee of US$1million.Enron defaulted on the repayment and Mahonia thusmade a demand onWest LB on the basis of theletter of credit.Thebank refused topay arguing that the letter of creditwas taintedby illegality as theletter of credit was arranged to enable Enron to commit an accounting offence under US securitieslaw and as such,wasunenforceable ongrounds of public policy.West LB claimed that itwas not awareof the illegal nature of the underlying transactions until after the claim for payment under the letterof credit was made. They were therefore not privy to the illegality and was not prevented fromrelying on the illegality defence.The question for the court was whether the principle of autonomy required the bank to disregardthe illegality under foreign law and pay according to the terms of the credit.DecisionThe court supported the bank's argument that the illegality affected not only the underlyingtransactions but also the letter of credit. Colman J found that the letter of credit was an essentialrequirement of Chase in order to set up the cosmetic scheme; it was therefore not divisible from518 JIML 9 [2003] 6 : ANALYSIS ANDCOMMENTthe underlying transactions. Not only the three swaps but also the letter of credit must be said tohave an illegal purpose in asmuch asboth the swaps and the letter of creditwere entered into for thepurpose of providing the structure onwhich Enron'smisleading accounts were to be founded.The courtwenton to hold that itdidnotmatter that the illegality wasunder a foreign lawor that theillegality was known only to one party. As Colman J said:Itmust logically be just as contrary to public policy to enable the claimant to enforce a contract whichhas been entered into for a foreign illegal purpose known only to himself as to enable him to enforcesuch a contract the purpose of which is known to both parties.CommentThis is yet another case in very recent times permitting the derogation from the principle ofautonomy in documentary credit. It is on the whole a moral decision but moral decisions often maynot always sitwellwith theparadigms of commercial certainty.Cases on illegality and letters of creditare few, themain one being Group Josi vWalbrook Insurance Co Ltd & others [1996] 1Lloyd's Rep 345.This case is important in offering guidance on the extent to which illegality might be compared tofraud as an exception to the principle of autonomy. It may be recalled that Lord Diplock in UnitedCity Merchants (Investments) Ltd v Royal Bank of Canada [1983] 1AC168 took care in stressing thatfraudby the beneficiary was only one e`stablished exception' to the principle that the bank's duty wasto pay againstdocumentswhich on their face conformedwith therequirements of the letter of creditand without reference to any challenge to those documents arising from disputes between theapplicant and the beneficiary. Hence, the first hurdle for the bank in the present case was to showthat it was not contrary to principle to rely on the illegal purpose for which the letter of credit wasobtained as a defence against a demand for payment. In the present case,Colman J did not considerthatplain emphasis of LordDiplock a rejection of illegality as a defence.The judge reasoned that LordDiplock's explanation for the fraud exception, by reference to the general maxim that the courtshould not permit the use of their process by a dishonest person to carry out a fraud stronglyindicated that illegality should similarly be admitted as a defence.There is however an aspect which the court did not quite consider: in fraud cases, the fraud isnormally practised on the applicant and/or the bank. In cases where the underlying transaction issaid to be illegal, the illegality is likely not practised on either the applicant or the bank. It wouldappear that, as far as the court was concerned, that was immaterial. So long as an offence (be itunder English or foreign law) is to be committed through the use of the letter of credit, it mustprevent the beneficiary from benefiting from it as long as the beneficiary was a participant in theoffence and the bank had no prior notice of the illegality. It is clear that this reliance on the publicpolicy rule that a dishonest person should not benefit from his crime is to ensure that beneficiariesare suitablydeterred.There is however no emphasis on thebank's role in all this ^ it is notrequired tomake inquiries into the purpose of the application for the letter of credit. Even where the unusualnature of the terms of the letter of credit might have put the bank on enquiry that something maynot be entirely right, there is nothing to prevent the bank from refusing to pay. For even where thebank is fully complicit in the illegality, on the basis of ex turpi causa the beneficiary need not be paid.The analogymade with fraudmeans that before the defence of illegality can be relied on, it must beshown that the beneficiary was privy to the illegality and, secondly, that it is not enough for the bankto claim that it has suspicions that the underlying transactionwas illegal. Itmust be able to show thatthe bank hadmore than mere suspicion and that not only was the underlying transaction illegal butthe letter of creditwas central to achieving the illegal purpose or cannotbe separated from the illegalpurpose.InGroup Josi, J, a reinsurer, agreedwithWthat the latterwouldpayover to themcertain loss reservesin exchange for a letter of credit under whichWwould be entitled to draw down against debit notesstating that J was liable for the amounts in question. J brought proceedings to prevent W fromdrawing down under the letter of credit. It argued that it was not properly authorised under theANALYSIS ANDCOMMENT: JIML 9 [2003] 6 519Insurance Companies Act1982 to carry on insurance business in Great Britain and as the contractsweremade in the jurisdiction, they and the letter of credit were illegal and unenforceable.Clarke J atfirst instance held that the letter of credit was not tainted by the illegality (if proved) not onlybecause it represented a contract separate from the underlying reinsurance contracts, it was amere facility provided subsequently to the entering into of the illegal reinsurance contracts whichassisted performance in a manner not specifically rendered illegal.Where, on the other hand, theletter of credit plays from the outset an integral part in the illegal transaction, the letter of creditcould not and should not be enforced.Staughton LJ inGroup Josi gave the following as anexample ofwhen the letterof creditwas deemed tobe an integral part of the underlying transaction:It seems to me that theremust be cases when illegality can affect a letter of credit.Take for example acontract for the sale of arms to Iraq, at a timewhen such a sale is illegal.The contract provides for theopening of a letter of credit, to operate on presentation of a bill of lading for1,000 kalashnikov rifles tobe carried to the port of Basra. I do not suppose that a court would give judgment for the beneficiaryagainst the bank in such a case.Staughton LJ went on to state, in passing, that if the reinsurance contracts were illegal and if theletter of credit was used as a means of paying sums due under those illegal contracts, the courtwould restrain the bank from making payment to the beneficiary. That would not be because theletter of credit contract was itself illegal but because it was being used to carry out an illegaltransaction.This reversal of Clarke J's finding demonstrates starkly that, in commercial law, it is onlyin very rare situations that the letter of credit would not be found to play an integral part in theunderlying transaction. Payment is, after all, virtually always an integral part of commercial orfinancial transactions.It is however open to argument that the reasoning in Bowmakers Ltd v Barnet Instruments Ltd [1945]KB 65 may avail the beneficiary in such a position. It might be possible for him to plead his claim forpayment not on the illegality but on some other legal interest. Clarke J in Group Josi, for example,relied on this as a possible ground to permit the enforcement of the letter of credit; the judge foundthat the fact that opening the letter of credit amounted to effecting conditional payment under thereinsurances bymeans of a separate contractual engagement between the bank and the reassureds,and as such a conditional payment was not rendered illegal by the Insurance Companies Acts. Theapplicability of that reasoning was rejected by Staughton LJ in the Court of Appeal and as far as thepresent case was concerned, Colman J too thought that the separate nature of the letter of creditcould notbeused to trump thepublic policy that thebeneficiary should notbenefit fromhis illegality.The court also confirmed that Waller LJ's guidance in Balfour Beatty Civil Engineering vTechnical &General Guarantee Co Ltd (1999) 68 Con LR 180 on the issue of the quantum of proof wasapplicable to the present circumstances. It may be recalled that in that case that the following testwas laid down:(a) When the demand was made under the demand bond [or letter of credit], did the surety or thebank have clear evidence from which the only inference to be drawn was fraud [illegality]? If theanswer was no, prima facie the beneficiary was entitled to judgment.(b) What, on the information available at the time of the application for summary judgment, was thestrength of the surety's case that the demandwas fraudulent [for an illegal purpose]?ö If the evidence was now clear, then no judgment would be given in favour of the beneficiarybecause of the fact that the surety [bank] would be entitled to a judgment of the equivalentsum.ö If the evidence was powerful but not quite sufficient to enable summary judgment to be en-tered in favour of the surety on the basis that the demand was fraudulent [or founded on anillegal purpose], then either judgmentwouldbe enteredwith a stayof execution or probably nojudgmentwouldbe entered at all untilwhatwas in effect the counterclaimhadbeen foughtoutat trial.520 JIML 9 [2003] 6 : ANALYSIS ANDCOMMENTö If the evidencewas less than powerful, judgmentwould be entered in favour of the beneficiaryand the surety wouldbe left either to pursuehis remedy against the applicantor pursue a claimor counterclaim for reimbursement formonies paid if it subsequently transpired that therewasindeed fraud [an illegal purpose].In case itmightbe thought that thepresentcasemakes iteasy for banks toplead illegality, it shouldbenoted that these guidelines (which are not entirely free from controversy) mean that the bank willneed to show that it has c`lear evidence'of illegality.This is not easily established, especially where theillegality is one under some arcane foreign law.The judgment is very much grounded on public policy but policy can sometimes be a bluntinstrument. For example, how should a court deal with the validity and enforceability of a letter ofcreditwhere theunderlying transaction is illegalbut that illegality is amere technicalmisdemeanour?On this issue,Colman J commented:There ismuch to be said for the view that the public policy in superseding the impregnability of lettersof credit where there is an unlawful underlying transaction defence may not be engaged where thenature of underlying illegal purpose is relatively trivial, at least where the purpose is to beaccomplished in a foreign jurisdiction.Such a qualitative assessment of what is trivial is difficult ^ should the triviality be evaluated fromEnglish eyes or under foreign law or both? How is such an assessment of gravity to be approachedgiven the principle of international judicial comity?An addendum.Colman J's judgmentdoesnot setout in anydetail therespective arguments of counsel.Although it was justified on the need to keep the judgment to ``manageable proportions in the timeavailable'', it would have been interesting to see how counsel for the beneficiary developed thereasoning in Bowmakers.JCOIL POLLUTION ^ CONTRACT REGARDING AN INTERIM SUPPLEMENT TOTANKER LIABILITY FOR OIL POLLUTION (CRISTAL) ^EXCLUSIONS ^ POLLUTION DAMAGECaribbean Petroleum Corporation and General Electrical Capital Business Asset FundingCorporation v Cristal Ltd (The Morris J Berman)[2003] EWHC 2357 (Comm) English Commercial CourtFactsShortly after theMorris J Berman, a tank barge, sailed from San Juan in tow of the tug Emily Swith acargo of 1.47 million gallons of No. 6 fuel oil, the towline parted and the barge grounded on a coralreef. 800,000 gallons of her cargo were spilled, posing a threat of further pollution by the oilremaining on board. The Morris J Berman was owned and operated by the Bunker Group and wasvoyage chartered to the first claimants,Caribbean Petroleum Corporation (CPC), a member of thedefendants (Cristal), whichwas also the owner of the oil on board.The owner of the tug wasMetlifeCapital Corporation (Metlife), later known as General Electric Capital Business Asset FundingCorporation, a financial institution which held the title to the tug by way of security for financeprovided to the Bunker Group, to whom it had bareboat chartered the tug.The Bunker Group wasinsured for pollution liabilities up toUS$10million.The limiton this coverwasreachedafter eightdaysand the US Government organised the clean-up thereafter through the medium of the USCoastguard. To this end, contracts for clean-up work were entered into between the USCoastguard and independent contractors. The liability of the US Coastguard arising out of thesecontracts was discharged by the United States Oil Spill LiabilityTrust Fund ( t`he US fund').ANALYSIS ANDCOMMENT: JIML 9 [2003] 6 521

Documentary credits and illegality in the underlying transaction.  Mahonia Limited v J P Morgan Chase Bank

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Documentary credits and illegality in the underlying transaction. Mahonia Limited v J P Morgan Chase Bank

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