A letter of credit or a bank guarantee is an autonomous instrument that is issued by a financial institution on the directions of a customer. The letter of credit seeks to underwrite the customer’s obligations to the beneficiary under the distinct underlying contract. It entitles the beneficiary to payment on demand from the issuing bank, so long as that demand strictly complies with the requirements set out in the letter of credit.
The obligation of the financial institution to pay when presented with a valid demand is near absolute. The only recognized exception in Canadian law is when there is fraud by the beneficiary that is brought to the financial institution’s attention prior to payment.
In Eurobank Ergasias S.A. v. Bombardier Inc. 2024 SCC 11 (CanLII), the Supreme Court of Canada examined a critical issue of when an issuing bank is required to refuse to honour a demand for payment under a letter of credit based on allegations of fraud brought against a third party to the letter of credit. In this case, the third party was the beneficiary to a corresponding letter of counter-guarantee.
Factual and legal background
The case involved a complex contractual arrangement for the supply of aircraft by Bombardier Inc to the Hellenic Ministry of Defense (“HMOD”) through an “Offsets Contract”. The dispute before the Supreme Court of Canada however centered around a Letter of Counter-Guarantee governed by Quebec law. This letter of counter-guarantee was issued by the National Bank of Canada (on the directions of Bombardier), in favour of a Greek bank, Eurobank Ergasias S.A. Eurobank in turn issued a distinct Letter of Guarantee in favour of HMOD, that was subject to Greek law. If HMOD demanded payment from Eurobank under the Greek Letter of Guarantee, Eurobank would be entitled to call on the National Bank to reimburse it under the Canadian Letter of Counter-Guarantee.
The underlying disputes between Bombardier and HMOD were referred to arbitration under the arbitration rules of the International Chamber of Commerce (“ICC”) with the seat of arbitration in Paris. As part of the arbitration proceedings, HMOD provided an undertaking to the arbitral tribunal that it would not demand payment under the Letter of Guarantee during the arbitration proceedings. In violation of its undertaking, HMOD demanded payment from Eurobank under the Letter of Guarantee before the final award was issued by the arbitral tribunal. This led the ICC tribunal to issue an interim order which restricted HMOD from enforcing the Letter of Guarantee. In parallel, Bombardier obtained a provisional injunction from the Superior Court of Quebec that prohibited National Bank and Eurobank from honouring the letters of credit.
Despite the provisional orders of the arbitral tribunal and the Quebec Superior Court, a few days before the final arbitral award was to be released, HMOD again called upon Eurobank to make payment under the Letter of Guarantee. In its demand, HMOD stated that if Eurobank failed to pay, it would take civil and criminal legal measures against the responsible officers of Eurobank for fraudulent misappropriation. Eurobank complied with the demand, released payment to HMOD and then demanded payment of the full amount from National Bank under the Letter of Counter-Guarantee.
A few days later, the ICC Arbitral Tribunal released its final award where it found the Offsets Contract to be in violation of the law of the European Union and therefore void ab initio. Consequently, no liquidated damages were payable to HMOD. The award was upheld by the Court of Appeal of Paris.
Simultaneously, Bombardier sought a permanent injunction from the Quebec court enjoining National Bank from paying Eurobank under the Canadian Letter of Counter-Guarantee. The trial judge granted the injunction. Eurobank’s appeal to the Court of Appeal was dismissed and further appealed before the Supreme Court of Canada.
The Supreme Court’s decision on the scope of the fraud exception
The high standard for the fraud exception to an issuing bank’s duty to honour a demand for payment under a letter of credit was established in Bank of Nova Scotia v. Angelica-Whitewear Ltd., 1987 CanLII 78 (SCC). Angelica-Whitewear confined the applicability of the fraud exception to cases of “obvious fraud of the beneficiary that is so egregious that the legitimacy of the supporting letter of credit can no longer be assumed”. The concern the court sought to address was that the exception should not extend to the fraud of a third party of which the beneficiary is “innocent”. The exception can apply if there is fraud in the transaction, even if the fraud affects the letter of credit only indirectly. For instance, it would apply to a situation where a person other than the issuer or the beneficiary forged documents that were given to the beneficiary.
While maintaining the appropriately narrow scope of the fraud exception, the majority decision of the Supreme Court’s held that a third party’s fraud “can fairly be attributed to the beneficiary” and becomes its own, when there is “both knowledge and participation” by the beneficiary. The Court clarified that this was not indirect or vicarious liability, but an application of the fraud exception to the beneficiary of the relevant letter of credit. Being mindful that the case involved the conduct of an arm of a foreign state, the court also clarified that it used the term “fraud” only in the specific context of letters of credit where “fraud includes a demand for payment by a beneficiary when it knew it did so without a right to payment.”
As a result, the court found that Eurobank participated in the “fraud” by making payment to HMOD despite its clear knowledge that HMOD had demanded payment under the Letter of Guarantee when it knew that the provisional orders of the arbitral tribunal and the Quebec Superior Court prohibited it from doing so. The court held that the fraud exception applied to the Letter of Counter-Guarantee to preclude National Bank from paying Eurobank. Accordingly, the Supreme Court dismissed Eurobank’s appeal.
Key Takeaways
With the Eurobank decision, the Supreme Court sought to protect the reliability of Canadian letters of credit as an essential component of international trade.
An issuing bank need not examine the performance of the underlying contract to make payment under a letter of credit. To determine its obligation to pay, the bank must ensure, “on reasonably careful examination” (that does not require perfection), that the tendered documents appear to be consistent with one another and must “strictly conform with the terms of the letter of credit”. Immaterial discrepancies may be overlooked in clearly appropriate cases.
A beneficiary will not have the fraud of a third party attributed to it if: (a) it inadvertently facilitates the fraud of a third party; (b) it chooses to not participate in the fraud of a third party; or (c) it demands payment where it did not know of the fraud of the third party. A beneficiary will, however, become a co-author of the fraud of a third party by knowingly participating in the misconduct. Honouring a demand for payment while knowing that the beneficiary has no right to be paid under the underlying contract could constitute fraud.
At Gilbertson Davis LLP, our lawyers can assist you, your business, company, partnership or corporation in applying to court for urgent injunctions to situations of fraud involving loans, letters of credit and bank guarantees. Gilbertson Davis LLP lawyers have experience in proceedings involving Loan Litigation, Fraud Recovery, Injunctions and Urgent Remedies, Business Litigation, Civil Litigation, Commercial and Contract Litigation, Cross-Border Litigation, Commercial Arbitration, Debt and Enforcing Judgments, International Trade and Investment and can assist you in resolving your legal issues in a timely and cost-effective manner. Please contact Gilbertson Davis LLP to schedule a consultation.
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