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Letters of credit: fraud conquers all

26 January 2017. Published by Alan Williams, Senior Associate and Andy McGregor, Partner

The principle of autonomy provides for payments to be made under letters of credit, regardless of disputes under the underlying contract. This decision provides a useful reminder that this principle will not be upheld if the fraud exception applies.

The principle of autonomy provides for payments to be made under letters of credit, regardless of disputes under the underlying contract. The High Court decision in Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA provides a useful reminder that this principle will not be upheld if the fraud exception applies.

Letters of credit

Letters of credit are an essential cog in the mechanics of international trade. In essence, a letter of credit substitutes a bank's credit risk for that of the buyer. The letter of credit creates a payment obligation on the part of the bank to the seller that is independent of the underlying contract between the buyer and seller. This fundamental principle is referred to as the 'autonomy of the credit' or the 'principle of autonomy'. The seller is paid upon the presentation of certain specified documents (eg, an invoice), as long as these on their face meet any requirements specified in the letter of credit. However, if these requirements are provided dishonestly or recklessly as to their truth, the fraud exception to the principle of autonomy (as opposed to the general fraud exception) will apply and payment can be withheld.

Subject to this, the use of letters of credit gives sellers the confidence to ship goods or provide services in the knowledge that they will receive swift payment from the bank. Buyers are given comfort that goods and services will be provided without delay. The fraud exception is therefore narrow and will rarely apply, and should not undermine confidence in letters of credit.


Claimant Petrosaudi Oil Services (Venezuela) Ltd (POS), a Barbadian company, entered into a contract to supply oil rig drilling services to the second defendant, Venezuelan company PDVSA Servicios SA (PDV). As required by the contract, a standby letter of credit was issued in favour of POS by the first defendant, Portuguese bank Novo Banco SA, as security for payment of invoices issued by POS.

POS provided drilling services between July 2015 and June 2016 and rendered invoices to PDV totalling around $129 million. However, a dispute arose which, pursuant to a term in the contract, POS and PDV entered arbitration to resolve.

The contract provided that:

  • if PDV did not dispute an invoice within 15 days of receipt, it was deemed to have irrevocably accepted the invoice as being correct, due and owing; and
  • if PDV did dispute an invoice, it nevertheless had to pay POS the disputed amount which would be repaid (with interest) should POS subsequently accept or PDV provide that the amount was not payable (the 'pay now, argue later' clauses).

However, the contract also provided that Venezuelan law applied to the performance of the contract and in two preliminary (partial) arbitral awards it was held that Venezuelan law rendered the pay now, argue later clauses null and void.

PDV therefore contended that it had no obligation to pay the invoices until the dispute was resolved following a final arbitral award. POS disagreed and contended that it was entitled to make a presentation under the letter of credit and receive full payment of the sums outstanding from the bank.

POS subsequently presented the invoices to the bank for payment. The letter of credit provided that POS had to certify that PDV was "obligated to the beneficiary to pay the amount demanded under the drilling contract", which POS did. Accordingly, the bank gave notice that it considered that there had been a compliant presentation of the invoices and stated its intention to pay out to POS.


The key issues in dispute were as follows:

  • PDV contended that the effect of the preliminary arbitral awards was that it was not obligated to make payment pending the outcome of the arbitration. The pay now, argue later clauses did not alter the position, as the arbitrators had found them to be null and void as a matter of Venezuelan law. Accordingly, POS could not have honestly certified in the presentation of invoices that PDV was obligated to make payment. To have made the presentation was therefore fraudulent within the meaning of the fraud exception to the autonomy principle. Therefore, POS was entitled to no payment under the letter of credit at this time.
  • POS contended that whatever the arbitrators had held (which was in dispute), the invoices had fallen 'due' or 'due and payable', meaning that PDV was obligated to pay them. Accordingly, the presentation of invoices was compliant. Even if PDV was not 'obligated', there was no fraud. Therefore, the bank should pay out to POS.


The court found that the certificate provided by POS which stipulated that PDV was obligated to POS for the sums claimed in the presentation was false. No such sum was due and payable at the time of the presentation. The debt had to be claimed and adjudicated in arbitration; until and unless that happened, there was no present debt due or payable at all. This would have been clear to POS in light of the preliminary arbitral awards.

However, the presentation was on its face compliant and PDV therefore had to rely on the fraud exception to the principle of autonomy to prevent payment. For the fraud exception to apply, PDV had to show that POS had no honest belief in the statement that PDV was 'obligated' or had made it recklessly, not caring whether it was true or false. The court found that this had been the case and that the fraud exception therefore applied. Accordingly, the bank was restrained from paying out to POS under the letter of credit.

The court also considered the hypothetical position of POS presenting a certificate which was false, but honestly made. In these circumstances, the court noted that the fraud exception would not have applied. It noted that the exception was a "very narrow proviso to the autonomy principle".


This case provides a salutary reminder that, despite the courts' general reluctance to contravene the principle of autonomy, the courts will apply the fraud exception where appropriate. The threshold to establish fraud is high, but dishonesty or recklessness on the part of a party seeking payment under a letter of credit can establish a bar to payment even if the principle of autonomy would otherwise apply.

The decision can be contrasted with other recent High Court judgments in National Infrastructure Development Co Ltd v BNP Paribas and National Infrastructure Development Co Ltd v Banco Santander SA ([2016] EWHC 2990), in which the court held that payments had to be made under the letters of credit in question.