1. What basic principle of letter of credit law does this decision challenge? 

2. How would the result be different if the draft and documents had been sold and negotiated to a holder in due course who took with no knowledge of the fraud, and who then presented the documents to the issuing bank for payment? 

3. Explain the misrepresentation that took place in this case. How was this “fraud in the transaction”? Can you think of other examples of how fraud could occur in a documentary letter of credit transaction between foreign parties? 

The plaintiff contracted to purchase hog bristles from Transea Traders in India. The defendant bank issued an irrevocable letter of credit to Transea covering a shipment of hog bristles and payable upon presentation of the proper documents. Transea filled fifty cases with cow hair and other worthless rubbish in order to obtain an ocean bill of lading from the steamship company showing the shipment of fifty cases of hog bristles. The documents and draft were presented to the defendant bank by The Chartered Bank of India, acting as agent for Transea. The plaintiff brought this action against the issuing bank to restrain it from paying on the letter of credit. 

One of the chief purposes of the letter of credit is to furnish the seller with a ready means of obtaining prompt payment for his merchandise. It would be a most unfortunate interference with business transactions if a bank before honoring drafts drawn upon it was obliged or even allowed to go behind the documents, at the request of the buyer and enter into controversies between the buyer and the seller regarding the quality of the merchandise shipped . . . Of course, the application of this doctrine presupposes that the documents accompanying the draft are genuine and conform in terms to the requirements of the letter of credit. 

However, I believe that a different situation is presented in the instant action. This is not a controversy between the buyer and seller concerning a mere breach of warranty regarding the quality of the merchandise; on the present motion, it must be assumed that the seller has intentionally failed to ship any goods ordered by the buyer. In such a situation, 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. It is true that even though the documents are forged or fraudulent, if the issuing bank has already paid the draft before receiving notice of the seller’s fraud, it will be protected if it exercised reasonable diligence before making such payment. However, in the instant action Schroder has received notice of Transea’s active fraud before it accepted or paid the draft . . . 

No hardship will be caused by permitting the bank to refuse payment where fraud is claimed, where the merchandise is not merely inferior in quality but consists of worthless rubbish, where the draft and the accompanying documents are in the hands of one who stands in the same position as the fraudulent seller, where the bank has been given notice of the fraud before being presented with the drafts and documents for payment, and where the bank itself does not wish to pay pending an adjudication of the rights and obligations of the other parties. While the primary factor in the issuance of the letter of credit is the credit standing of the buyer, the security afforded by the merchandise is also taken into account. In fact, the letter of credit requires a bill of lading made out to the order of the bank and not the buyer. Although the bank is not interested in the exact detailed performance of the sales contract, it is vitally interested in assuring itself that there are some goods represented by the documents. * * * Accordingly, the defendant’s motion to dismiss the supplemental complaint is denied. 

Decision. The court held in favor of the plaintiff and enjoined the bank’s payment. A court can enjoin an issuing bank from honoring a draft if the bank learns that its customer will suffer irreparable harm as a result of fraud in the transaction.