NORTH WAY INDUSTRIAL LTD. v. JENTECH LTD. AND ANOTHER

1986, No. A5113

Commercial Law - Irrevocable letters of credit - Orders of computer Products from the U.S.A. - Partial delivery of goods to financier Plaintiff in H. K. - Alleged discrepancies between goods delivered and goods covered by letters of credit - Application by financier Plaintiff for quia timet injunction to restrain 1st Defendant (seller/beneficiary) from collecting on the letters of credit on grounds of fraud or possible fraud by the 1st Defendant (seller/beneficiary) in presenting documents to the bank including beneficiary's certificates because they would be false and to restrain 2nd Defendant (Bank) paying out on the letters of credit to the 1st Defendant (seller/beneficiary) - Dispute by 1st Defendant (seller/beneficiary) of fraud or intention to present fraudulent documents. H.K. surveyors reports which contained admitted errors not accepted by 1st Defendant (seller/beneficiary) who preferred to rely on reports of US surveyors.

1986, No. A5113

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

____________

__________

JUDGMENT

__________

1. In this case, the 1st defendant is an importer of computer products from the U.S.A. It wished to sell such goods to a company in Hong Kong and did in fact enter into 3 contracts to do so. There is a suggestion that this company was a cover for a Chinese corporation. The Hong Kong company which was to be the purchaser of the goods has not been named as a party to these proceedings. The plaintiff is the Hong Kong company which provided, the finances to enable the 1st defendant to place firm orders with its U.S.A. suppliers. There is a dispute as to whether it was acting as a financier purely at the request of the let defendant with no knowledge of the 3 sales contracts between the 1st defendant and the purchaser or whether it as acting as agent for the purchaser.

2. The way the plaintiff provided the necessary finance was to open 3 letters of credit with the 2nd defendant, naming the 1st defendant as beneficiary. These were stated to be irrevocable and subject to the uniform customs and practice for documentary credits (1983 Revision, International Chamber of Commerce, Paris, France, Publication No. 400) ("UCP"). Among the documents to be presented under the 3 letters of credit were a beneficiary's certificate certifying that the goods are of Digital Equipment Corporation, U.S.A. original, brand new, unused and in good order and condition, and a certificate of quality and quantity also issued by the beneficiary. In addition to the beneficiary's certificates, the letter of credit provided for the presentation of a surveyor's report issued by a U.S.A. surveyor certifying that the actual quantity, physical condition, brand name and model number are in conformity with the requirements of this credit.

3. It does not appear to be disputed that on the strength of these 3 L/Cs issued by the 2nd defendant, the 1st defendant was able to open 4 L/Cs with the Banque Nationale de Paris (BNP) covering precisely the same goods. The reason for. 4 L/Cs is that the goods referred to in one of the L/Cs issued by the 2nd defendant were in - fact to be ordered from 2 different suppliers in the U.S.A.

4. All the goods covered by the L/C L-01-D-07133 were also covered by the L/C No. 176562 issued by BNP, though the latter L/C was for a mere US$8,229.45 compared to the US$60,349.24 of the former. However, it was stated in the BNP L/C that 85% retention value was to be settled between the applicant and the beneficiary. The beneficiary of the latter L/C was Contrology International Corp. ("Contrology").

5. The goods covered by L/C L-01-D-07134 were covered by 2 L/Cs issued by BNP. The first of these No. 176563 named Cortrology as the beneficiary and was for a sum of US$13,800 compared to US$103,540.80 in the original L/C. Again, there was the same reference to 85$ retention value to be settled between the applicant and the beneficiary. The second of the BNP L/Cs No. 176564 named Beverley Gaye Enterprises Inc. as the beneficiary and coveree the second item of goods in the original L/C issued by the 2nd defendant. Again, it was for a much smaller amount than the original L/C in respect of this item. The sum being US$19,760 as against US$49,237.84. Again, there was a reference to a retention value being settled between the applicant and the beneficiary though in this case the percentage was 49%.

6. All the goods covered by the 3rd. L/C issued by the 2nd defendant No. L-01-D-07135 were also covered by the 4th L/C issued by BNP No. 176565 which named Gerge Foldvary Exports Inc. as the beneficiary. This time, the latter L/C was issued for the same amount as the original L/C issued by the 2nd defendant, namely US$37,995.90. All the BNP L/Cs were stated to be irrevocable and subject to the UCP (1983 Revision).

7. It is common ground that deliveries have been made in Hong Kong to the plaintiff in respect of the goods relating to the BNP L/Cs 0176564 and 0176565. These are therefore the goods covered by the original L/Cs L-01-D-07134 and L-01-D-07135, though in the case of the former the goods represent only the second item of the goods covered by this L/C. So no goods have yet arrived in respect of the 2nd defendant's L/C L-01-D-07133 nor in respect of the 1st item of L-01-D-07134 issued by the 2nd defendant.

8. The way in which delivery occurred is somewhat strange. The goods shipped from the U. S. A. were in fact transported to Hong Kong by air freight services.

9. Those covered by L-01-D-07135 arrived first on "Flying Tigers" flight No. FT .071 on 29th August 1986 and were delivered to the plaintiff on the 3rd of September. According to the air waybill 023-4-715 1775 they were shipped by Gerge Foldvary Exports inc. and the consignee was named as the second defendant whilst the 1st defendant was named as the person to be notified.

10. Those covered by the 2nd item in L-01-D-07134 arrived on Japan Airlines flight No. JL-605 on the 30th of August 1986 and were delivered to the plaintiff also on the 3rd of September. Again, the air waybill indicated that the goods were consigned to the 2nd defendant and the 1st defendant being named as the person to be notified.

11. Before any documents had been presented to the 2nd defendant for payment under the L/Cs, the goods which had arrived were nevertheless delivered to the plaintiff. This apparently was affected by the 2nd defendant endorsing the air waybills.

12. It is common ground that no documents have yet been presented to the 2nd defendant for payment.

13. The plaintiff came before this Court on the 9th of September 1986 and successfully obtained an ex-parte interim injunction restraining the 1st defendant until further order, whether by servants or agents or otherwise howsoever from transferring, assigning, negotiating, drawing on the L/Cs L-01-D-07133 - 35 and in any way dealing with the documents under and/or from disposing of, parting with possession, charging or in any way dealing with the proceeds of these L/Cs and restraining the 2nd defendant until further order whether by itself, its servants, or agents or otherwise howsoever from paying under the same L/Cs.

14. The evidence relied upon was that the Managing Director of the 1st defendant, a Mr Tong, had written a letter to a Mr Lau which purported to show Mr Tong in an unfavourable light and included a statement to the effect that he had decided to go back to the U.S.A. and that if certain matters worsened, he might not be able to return to Hong Kong. It also indicated that he had obtained a passport in the U.S.A. which is "different from here".

15. Also exhibited were 2 copies of the Flying Tiger Air Waybill which the plaintiff got from the 1st defendant and which had' the same number, but which were not identical in that one bore the L/C number and the other did not.

16. The plaintiff also relied at the ex parte hearing on survey reports purporting to show that a company called Asia Union Survey Services Ltd. had carried out a survey and indicating that the goods delivered in those consignments were not up to standard and the goods delivered under the 2nd consignment were well below standard and that the manual brand name was "Control Data Corp. Products" instead of "Digital".

17. Miss Eu submitted that in order to obtain payment under the L/C it will be necessary for the beneficiary (i.e. the 1st defendant) to produce the beneficiary's certificates to which I have referred earlier and in view of the discrepancy revealed in the survey reports, such certificates, she says, will be fraudulent.

18. The matter has now been argued before me and affidavits have been filed on behalf of the 1st defendant which deny that the 1st defendant has been or intends to be in any way fraudulent. The 1st defendant does not trust the plaintiff and although Mr Tong for the 1st defendant affirms that he has not inspected the goods, he affirms that he doubts "the qualifications of the plaintiff's surveyors" because of the obvious mistakes in their reports. He affirms:

"I have not inspected the goods delivered but I doubt the qualification of the plaintiff's "surveyors" because of the obvious mistakes in their reports, for example, there is no such thing as 32 KB: 32 KW in fact equals 64 KB,"

and he exhibits a pricelist to back up this assertion.

 

He further affirms:-

"If the goods do not in fact comply with their description then no certificate will be produced and the matter will be taken up with our supplier. If they do comply with their description then the suppliers will want to be paid under the L/C."

19. In fact, no affirmation has been filed verifying the contents of the survey reports and doubt has been cast on the accuracy of the survey reports. It appears that the mistake on the 32 KB point has occurred on more than one occasion. Further, it appears to be conceded in a further affidavit from Mr Wu that there was indeed a mistake which he says was a typing error.

20. Mr Barlow appearing on behalf of the 1st defendant has told me that the 1st defendant's present position is that they don't trust the plaintiff and would prefer to rely on certificates issued by the surveyors in the U.S.A.

21. In view of the fact that the goods have passed into the hands of the plaintiffs, the defendants doubt that they can get a truely independent report in Hong Kong.

22. I now turn to the law. There was a similar situation in Hamzeh Malas & Sons v. British Imex Industries Ltd.⁽¹⁾

23. It is to be noted that in that case the plaintiffs were seeking an injunction to bar the defendants from realizing on the second L/C in respect of which the goods had not even been delivered and in respect of which no attempt had been made or threatened by the defendants to obtain payment.

24. That is a situation similar to the present regarding the goods covered by the first L/C issued by the 2nd defendant L-01-D-07133 and also the goods covered by the first item of L/C No. L-01-D-07134.

25. The next case to which I have been referred is Discount Records Ltd. v. Barclays Bank & Barclays Bank International Ltd.⁽²⁾ there the headnote reads:-

"The plaintiffs, by letter dated April 6, 1974, ordered from P., a French Company, a number of cassettes and gramophone records specified by numbers in accompanying lists.

 

On May 17, 1974 the plaintiffs signed instructions to the first defendant bank for an irrevocable documentary credit with full cash cover, the credit being made through the second defendant. The beneficiaries of the credit were named as the French company and the credit was for 44,175 francs.

 

The goods were delivered to the plaintiffs on June 16, who found that they did not comply with the order and further that the numbers on the boxes had been altered to comply with the specifications. In the circumstances the plaintiff alleged that the French company were guilty of fraud.

 

The plaintiffs therefore instructed the first defendants not to pay on the credit. By letter dated June 24, the first defendants stated that as-the credit was an irrevocable confirmed credit it appeared that there was no way that they could avoid making payment and refused to give an undertaking not to pay

 

The plaintiffs brought a motion for an interlocutory injunction against both defendants restraining them until judgment or further order from inter alia "paying out any sums .......... pursuant to the irrevocable credit ..................... "

 

26. That was a case which was in many ways similar to the present because the plaintiffs submitted evidence to the effect that there were many discrepancies in the goods which were ordered and those which were supplied. Indeed, it would appear that the defects in that case were far worse and more numerous than those which are alleged in the present case. A list of the defects are set out at page 446 of the judgment of Megarry J.

27. Megarry J. referred to the argument in support of the application before him and on the way he dealt with it in the following terms:-

"Mr Pain put his claim for an injunction on two grounds. First of all, he says that this is a case where Promodisc has been guilty of fraud, and that fraud is one of the instances in which the Court will intervene even in the case of bankers' irrevocable confirmed credits. He told me that there was no English authority directly on the point or anywhere near it, but he did put before me the case of Sztejn v. J. Henry Schroder Banking Corporation ............ a case which is summarized in Gutteridge and Megrah, the Law of Bankers' Commercial Credits (4th ed. 1968), pp. 133; 134. There it was alleged that the seller had shipped rubbish and then passed his draft for collection. At p. 633 Judge Shientag referred to the well-established rule that a letter of credit is independent of the primary contract of sale between the buyer and the seller, so that unless the letter of credit otherwise provides, the bank is neither obliged nor allowed to enter into controversies between buyer and seller regarding the quality of the merchandise shipped. However, the learned Judge (and I use the phrase as no empty compliment) distinguished mere breaches of warranty of quality from cases where the seller has intentionally failed to ship any of the goods ordered by the buyer. In relation to the latter case, at p. 634 the Judge uttered a sentence (quoted in the book) upon which Mr Pain placed great reliance.

 

....... where the seller's fraud has been called to the bank's attention before the drafts and documents have been presented for payment, the principle of the independence of the bank's obligation under the letter of credit should not be extended to protect the unscrupulous seller.

 

During the argument on this point before me, the familiar English phrase "Fraud unravels all" was also discussed. However, it is important to notice that in the Sztejn case the proceedings consisted of a motion to dismiss the formal complaint on the ground that it disclosed no cause of action. That being so, the Court had to assume that the facts stated in the complaint were true. The complaint alleged fraud, and so the Court was dealing with a case of established fraud. In the present case there is, of course, no established fraud, but merely an allegation of fraud. The defendants, who were not concerned with that matter, have understandably adduced no evidence on the issue of fraud. Indeed, it seems unlikely that any action to which Promodisc was not a party would contain the evidence required to resolve this issue. Accordingly, the matter has to be dealt with on the footing that this is a case in which fraud is alleged but has not been established. I should also add that on the facts required to be assumed in the Sztejn case the collecting bank there was not a holder in due course, who would not be defeated by the fraud, but was merely an agent for the fraudulent seller. "

Later he said at p. 448:-

"I would be slow to interfere with bankers' irrevocable credits, and not least in the sphere of international banking, unless a sufficiently grave cause is shown; for interventions by the Court that are too ready or too frequent might gravely impair the reliance which, quite properly is placed on such credits. The Sztejn case is plainly distinguishable in relation both to established fraud and to the absence there of any possible holder in due course. I do not say that the doctrine of that case is wrong or that it is incapable of extension to cases in which fraud is alleged but has not been established, provided a sufficient case is made out. That may or may not be the case. What I do say is that the present case falls far short of establishing any ground upon which it would be right for the court to intervene by granting the interlocutory injunction claimed, even in its revised form. The motion accordingly fails and will be dismissed. "

In R. D. Harbottle (Mercantile) Ltd. and another v. National Westminster Bank Ltd. and others⁽³⁾ Kerr J. in discharging interim injunctions to restrain banks paying out on a performance bond held at p. 870:-

"It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. They are the lifeblood of international commerce. Such obligations are regarded as collateral to the underlying rights and obligations between the merchants at either end of the banking chain. Except possibly in clear cases of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts. The courts are not concerned with their difficulties to enforce such claims; these are risks which the merchants take. "

28. Reference was made in that case to the Hamzeh Malas case⁽¹⁾ the Discount Records case⁽²⁾ and the Sztejn v. J. Henry Schroder case: The Judge took the view that the facts in that case were a long way from a case where the bank had notice of established fraud.

29. Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. and anr.⁽⁴⁾ was another case where the plaintiffs sought to obtain an injunction to restrain a bank from paying out on a performance bond. The plaintiffs had obtained an interim injunction on their ex parte application. Kerr J. (the judge who had presided in the Harbottle case) discharged the injunction and the plaintiffs appealed to the Court of Appeal. It was held that a performance bond stands on a similar footing to an L/C and a bank giving such a guarantee must honour it according to its terms unless it had notice of clear fraud.

30. In that case, it was held on the facts that it was impossible to say that fraud had been established by the beneficiary. The Harbottle case⁽³⁾ was approved.

31. Denning L. J. at p. 170 referred with approval to the words of Kerr J. in the case then before the Court and in the Court below in the following terms:-

"In cases of obvious fraud to the knowledge of the banks, the courts may prevent banks from fulfilling their obligation to third parties. "

32. Browne L. J. at P. 172 referred to the fraud exception in the following terms:-

"That exception is that where the documents under the credit are presented by the beneficiary himself' and the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled to refuse payment.

 

But it is certainly not enough to allege fraud; it must be "established", and in such circumstances I should say very clearly established. "

33. The leading case on this subject is United City Merchants (Investments) Ltd. v. Royal Bank of Canada⁽⁵⁾. Diplock L. J. giving the judgment at the House of Lords referred to the exception in the following words at p. 183:-

"To this general statement of principle as to the contractual obligations of the confirming bank to the seller, there is one established exception: that is, where the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of the fact that to his knowledge are untrue. Although there does not appear among the English authorities any case in which this exception has been applied, it is well established in the Amercian cases of which the leading or "landmark" case is Sztejn v. J. Henry Schroder Banking Corporation (1941) 31 N.Y.S. 2d 631. This judgment of the New York Court of Appeals was referred to with approval by the English Court of appeal in Edward Owen Engineering Ltd. v. Barclays Bank. International Ltd. .............. though this was actually a case about a performance bond under which a bank assumes obligations to a buyer analogous to those assumed by a confirming bank to the seller under a documentary credit. The exception for fraud on the part of the beneficiary seeking to avail himself of the credit is a clear application of the maxim ex turpi causa non oritur actin or, if plain English is to be preferred, "fraud unravels all". The courts will not allow their process to be used by a dishonest person to carry out a. fraud. "

34. This dictim makes no mention of the fact that the Court should not only be satisfied that it is clear case of fraud on the part of the beneficiary but also that the bank has knowledge of that fact.

35. This may however be inferred from the apparent approval of the decision of the Edward Owen Engineering Ltd. case. ⁽⁴⁾

36. It is perhaps with this in mind that Sir John Donaldson M. R. in giving judgment in Bolivinter Oil S.A. v. Chase Manhattan Bank &. others⁽⁶⁾ at P. 352 said:-

"Judges who are asked, often at short notice and ex parte, to issue an injunction restraining payment by a bank under an irrevocable letter of credit or performance bond or guarantee should ask whether there is any challenge to the validity of the letter, bond or guarantee itself. If there is not or if the challenge is not substantial, prima facie no injunction should be granted and the bank should be left free to honour its contractual obligation, although restrictions may well be imposed on the freedom of the beneficiary to deal with the money after he has received it. The wholly exceptional case where an injunction may be granted is where it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly be fraudulent. But the evidence must be clear, both as to the fact of fraud and as to the bank's knowledge. It would certainly not normally be sufficient that this rests on the uncorroborated statement of the customer, for irreparable damage can be done to a bank's credit in the relatively brief time which must elapse between the granting of such an injunction and an application by the bank to have it discharged. "

37. At the ex parte hearing when I granted the interim injunction I was referred to the House of Lords case. I was not referred to any of the earlier cases nor to the later case where the words of Sir John Donaldson that I have just quoted were uttered. Had I been referred to these cases, it is unlikely that I would have granted these interim injunctions because there was no evidence that the bank had any knowledge at all of any fraud. All I was told was that the bank had knowledge of the ex parte proceedings but I was not informed of the extent of their knowledge or whether they had seen any of the affidavits.

38. Now that the matter has been brought before me on an interpartes summons. The bank (2nd defendant) has appeared. I am told that it takes a neutral view and counsel for the bank has asked that the bank be excused and that they need not attend any further part of this hearing. This was granted.

39. I have been asked to give judgment at an early date by the 1st defendant since the L/Cs expire on the 14th October. That is still some 8 days away.

40. After anxious consideration I have decided that the facts in this case are not sufficient to enable me to continue the injunctions.

41. I am conscious of the fact that this is an interlocutory application. There are affidavits on both sides. Fraud on the part of the 1st defendant is disputed. The alleged discrepancies in the goods are not accepted. The goods are in the physical possession of the plaintiffs. There is no affidavit from the surveyor verifying the contents of their reports. There are admitted errors in the reports.

42. In Rosen v. Pullen⁽⁷⁾ at p. 69 Craig J. at the interlocutory stage summed up the position as follows:-

43. In the circumstances of this case, it seems to me that in respect of the goods that have been delivered, there are allegations and counter allegations. The first defendant certainly does not accept the word of the plaintiff's Mr Wu and does not accept their surveyor's reports which contain errors. The goods are in the hands of the plaintiff who the 1st defendant does not trust.

44. It seems to me that these matters can only be satisfactorily resolved at a trial. So far as the undelivered goods are concerned, there just isn't any evidence as to their nature.

45. The 2nd defendant bank is only concerned with the documents as is clearly stated in Article 4 of the UCP (1983 Revision) and there is not sufficient evidence before the Court even now to show fraud is established or to show clear fraud or even a strong prima facie case of fraud on the part of the plaintiff to the knowledge of the bank, though I do consider the circumstances to be very suspicious.

46. In the circumstance, I order that the injunctions be discharged forthwith with costs to the defendants.

(1) [1958] 2 Q.B. 127

(2) [1975] 1 Lloyds Rep. 444

(3)    [1977] 2 All E. R. 862

(4) [1978] 1 Q.B. 159

(5)    [1983] A.C. 169

(6)     [1984] 1 ALL ER 351

(7)    126 D.L.R. (3rd edition) 62