Reed Smith Client Alerts

In international trade, a letter of credit is regarded as one of the most secure means for a seller to obtain payment for goods sold to a buyer under a sale contract. Similarly, many high value commercial contracts rely on the certainty provided by standby letters of credit, performance guarantees or on demand bonds1 issued by banks to guarantee performance or payment obligations. What these instruments, correctly construed2, all have in common is that they are independent, irrevocable and documentary in nature. The major benefit of such credits is that the party in whose favour the credit is granted obtains a credit issued by an independent bank. The beneficiary is not therefore reliant upon its counterparty or at risk of significant changes in the creditworthiness or solvency of its counterparty. The autonomous nature of such credits, which are separate from the underlying sale or other commercial contract, also means that any disputes in relation to the underlying commercial contract should not affect the beneficiary’s right to receive payment under the letter of credit or similar instrument.

However, a recent spate of cases in Singapore suggests otherwise. These cases mainly arose out of the collapse of oil trading giant Hin Leong Trading Pte. Ltd. Several disputes were commenced before the Singapore court between counterparties of Hin Leong and various banks, with the former seeking payments under letters of credit issued by the latter.3

These cases therefore serve as a useful reminder that a letter of credit does not guarantee payment, as there may be circumstances where a bank can legitimately refuse to make payment or can be restrained from making payment through injunctive relief obtained from the courts. In this alert, we summarise the position under English, Singapore, U.S. and Chinese law.

The English law position

The autonomy principle

It is a fundamental principle of English law that a documentary credit is autonomous and separate from the underlying sale or other commercial contract.4 According to the autonomy principle, the bank is required to pay the seller in accordance with the terms of the documentary credit and upon presentation of conforming documents. The bank is not concerned about the terms of the underlying sale or commercial contract or any issues regarding performance of such contract. As such, the English courts will not interfere with a bank’s obligation to make payment on the grounds of matters that do not concern the credit. For example, a dispute over the quality of the goods between the seller and the buyer under the sale contract will not affect the bank’s obligation to make payment to the seller under the letter of credit.

The rationale for the autonomy principle often given by the English courts is that the irrevocable nature of a bank’s obligation to make payment under such a credit is the “life-blood of international commerce”.5 The autonomy of the letter of credit is upheld on the basis that such commitments from banks should be honoured free from interference by the courts; otherwise “trust in international commerce could be irreparably damaged”.6 Thus the certainty provided by such credit is considered to be of the highest importance to commerce. However, this is of little comfort to a buyer who, for example, has not received the goods it contracted for and, unable to restrain its bank from making payment under the letter of credit, is instead required to recover its losses from a seller who may have become insolvent or may be located in a jurisdiction where there are difficulties in enforcement.

The exceptions

The English courts have repeatedly emphasised that “it is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks”.7


One exception to the autonomy principle under English law is where fraud has been committed in relation to the documents presented by the seller to the bank or in obtaining the issuance or the setting up of the credit (known as the ‘fraud exception’). This has included situations where signatures on documents have been forged,8 where the beneficiary under a performance bond presented a certificate stating that written notice of default had been served when it was common ground that such notice had not been served9 or, in the case of a standby letter of credit, where the seller had no honest belief in the validity of its demand.10 However, an allegation of fraud does not constitute sufficient grounds in support of an application seeking an injunction. The English courts will only restrain payment under a credit if the fraud and the bank’s knowledge of the fraud are “very clearly established”.11 This requires the applicant to establish that it was seriously arguable that, on the material available, the only realistic inference was that the party claiming under the credit was guilty of fraud.12 The high burden of proof required means that the English courts have found that the fraud exception applies only in a limited number of cases.

Invalid calls or nullity

In addition to the fraud exception, it should be remembered that every claim under a letter of credit or a call on a performance bond must comply with the relevant terms of that credit or bond. The English courts will therefore intervene to restrain what has been referred to as an ‘invalid call’ or in cases where the call would be a nullity. Examples cited by the court13 are where a condition precedent to a call has not yet been fulfilled; where the bond is a ‘see to it’ bond necessitating prior proof of loss by the beneficiary or poor performance by the third party which has not yet been established; or where the demand, or the supporting documents show that the demand, does not conform to the requirements imposed by the bond for a valid demand.

Breach of faith

In the context of performance bonds or guarantees, the English courts have recognised that a breach of faith by the beneficiary in threatening a call might be a ground for restraining the beneficiary from calling on a bond or receiving payment out.14 Such a breach of faith must be significant and clearly established. In Elian and Another v. Matsas and Others,15 which is often cited as the first case in which the breach of faith exception was applied, Lord Justice Danckwerts said that the court should interfere to prevent what might be an “irretrievable injustice”. In that case, the charterers agreed to provide a bank guarantee in favour of the shipowners if the shipowners agreed to release goods that were the subject of a shipowner’s lien for demurrage. As soon as the bank guarantee was provided, the shipowners released the lien for demurrage, but then immediately exercised another lien on the goods for a further delay and refused to release the goods. When the shipowners subsequently sought to claim under the bank guarantee, the charterers applied for an injunction to restrain the shipowners from doing so. The Court of Appeal upheld the injunction granted by the judge at first instance. Further examples of breaches of faith given by the courts include a failure by the beneficiary to provide an essential element of the underlying contract on which the bond depended; a misuse by the beneficiary of the guarantee by failing to act in accordance with the purpose for which it was given; a total failure of consideration in the underlying contract; a threatened call by the beneficiary for an unconscionable ulterior motive; or a lack of an honest or bona fide belief by the beneficiary that the circumstances, such as poor performance against which a performance bond has been provided, actually exist. However, on the facts of that last case there was no requisite significant or clearly established factual basis for arguing that the beneficiary had acted in bad faith and recent case law has again emphasised the autonomy principle and the very limited nature of the circumstances in which payments will be restrained. As such, whilst the breach of faith exception may be a more abstract concept than the fraud exception, it is likely to be equally difficult to prove in practice.


The question of illegality is one that the English courts have grappled with most recently (albeit not in the context of letters of credit or similar payment instruments) in Mirza v. Patel.16 Whether the court should decline to enforce a letter of credit, or any other credit or contract by reason of illegality should now be decided using a factors-based approach, including whether the policy underlying the rule or regulation that has been infringed would be advanced or frustrated by the application of the doctrine. Regard is to be had to other public policy considerations and to the seriousness of the illegality concerned. It is clear from Mirza v. Patel that the mere fact that a contract had been concluded to carry out an illegal activity will no longer be sufficient in and of itself to refuse any and all claims arising in that connection, including a claim for payment out under a credit.

The balance of convenience

Even if the applicant proves one of the limited exceptions, this may not be sufficient for the English courts to grant an injunction restraining payment, as the courts will also consider (as with all interim injunction applications) whether the balance of convenience favours granting the injunction. In short, this involves weighing up whether more harm would be done by granting or refusing the injunction. In cases where the point has been considered, the English courts have invariably found that the balance of convenience favours not granting the injunction. The basis for this decision appears to be the autonomy principle: if the injunction is granted, a bank’s obligations under a credit may no longer be perceived as irrevocable, and the bank’s market reputation may suffer if it fails to honour its obligations under a letter of credit. By contrast, if the injunction is not granted, the buyer will be still able to claim damages for its losses under the contract, even if the chances of making a recovery where the seller has been party to a fraud may be slim.