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Often described as the lifeblood of international commerce, a bank can only refuse payment under an LC if the documents are non-compliant or if the seller who seeks presentation, has presented documents fraudulently. This, in turn, raises what seems to be a more basic question but one that does not have a uniform answer at law: what constitutes fraud, particularly when refusing payment under an LC.  

Singapore’s apex court decided the issue last week affirming the judgment for the banks who had refused to pay out on fictitious trades originated by Hin Leong Trading, the commodity trading corporation, through a pre-structured circular trade between Hin Leong, the commodities firm Trafigura, and Winson Oil Trading Ltd., an energy trading company. This involved Winson making false representations in its LOIs, as to:

1. Cargo being shipped pursuant to valid bills of lading (BLs) onboard the Ocean Voyager and Ocean Taipan (as described in the LOIs) for the Winson-Hin Leong Sale; and
2. Winson having good title to that cargo and having passed that title to its buyer Hin Leong.

The facts

Winson sued the banks OCBC Ltd. and Standard Chartered Bank (Singapore) Ltd. for non-payment under LCs that the banks had issued to pay for gasoil that Winson had sold to Hin Leong Trading Ltd. under two sale contracts. The sales by Winson to Hin Leong were the final legs of circular trades, involving the following chain of sales using copy BLs between Hin Leong, Trafigura, and Winson 

The banks argued that the pre-structured circular trade involving Winson did not have cargo shipped for the transactions and that the copy of non-negotiable BLs which purportedly showed such shipments were forgeries. In particular, the original BLs were allegedly used by Hin Leong to sell the same cargo to a different party under a different contract. Winson had relied on those copy BLs in preparing the payment letters of indemnity (LOIs) which it presented to the banks for payment. 

Payment LOIs are documents unique to the oil trade which a seller presents in lieu of the original BLs to obtain payment. By way of a payment LOI, amongst other things, the seller typically represents that cargo was shipped pursuant to valid BLs; warrants that it has good title, the right to transfer title to the buyer, and that it is entitled to receive original BLs from its supplier and transfer them to the buyer (and thus, pass possession of that cargo on board the vessel). These were the representations said to be fraudulent. 

Fraud by any other name is still fraud 

The classic test of fraud is contained in Derry v Peak as constituting three limbs: when a false representation has been made (a) knowingly, (b) without belief in its truth, or (c) recklessly, careless whether it be true or false. The first instance court found that the representations made in the LOI were fraudulent in the sense of reckless indifference to the truth or falsity of the statements. The principal question of appeal was whether the fraud test also encompasses the third limb of reckless indifference, particularly in the context of LCs which create independent payment obligations. 

Derry v Peak was a case based on the tort of deceit. Likewise, the law on independent guarantees such as performance bonds has also established a fraud test which includes the third limb of reckless indifference. However, the argument before the Court of Appeal was that a narrower standard of fraud should apply in LC cases to avoid the danger of diluting the autonomous function of an LC which is the backbone of international trade. 

An earlier decision of CACIB v PPT (SGHC 2022) which held the third limb would not be sufficient to establish fraud in LC cases. The authors of this article disagreed with the decision of CACIB in 2022 in that there is no principled basis to have different fraud tests when dealing with letters of credit (compared with performance bonds), a position now clarified and supported by the decision of the Court of Appeal. 

The principle behind including a fraud test that covers recklessness is best captured by the observations of Chao Hick Tin JA in Beam Technology v Stan Chart (SGHC 2013): 

“While the underlying principle is that the negotiating/ confirming bank need not investigate the documents tendered, it is although a different proposition to say that the bank should ignore what is clearly a null and void document and proceed nevertheless to pay… [t]o say that a bank, in the face of a forged null and void document (even though the beneficiary is not privy to that forgery), must still pay on the credit, defies reason and good sense.”

The Court noted that it would be incongruent if the bank had to pay because it could not avail itself of the recklessness limb, even though after paying the beneficiary, the same bank can mount a claim in the tort of deceit to recover the same amount from the beneficiary. In that regard, the Court deemed the standard of fraud should not be so narrow to allow the beneficiary to bury its head “ostrich-like in the sand”.

What constitutes recklessness? 

The Court of Appeal also clarified that the third limb of recklessness does not create a duty of care between the bank and the beneficiary. In that regard, recklessness in Derry v Peak was a subjective test – an indifference the defendant is conscious of and not an objective test synonymous with negligence. Recklessness in the third limb is defined as:

“where the fraudster does not actually have sufficient certainty to know the true state of affairs but take steps or chooses not to take steps in order to isolate his or her mind from the truth.” 

Recklessness in this sense does not mean the risk inherent in the transactions but a risk that arises because of ‘red flags’ that should prompt the beneficiary to do the necessary checks before the beneficiary can be said to have formed an honest belief in the truth of the representations. In the present case, the red flags were not to be viewed in isolation but in a continuum to support the finding of reckless indifference as to the verity or falsity of statements made. 

The red flags – where are the original BLs?

The uniqueness of the case was that Winson had made an earlier presentation to OCBC for the Ocean Voyager but when the presentation was rejected on the basis that there “was no physical cargo that was shipped to the Ocean Voyager”, Winson made a second presentation to OCBC by switching the vessels and preparing new invoices to Ocean Taipan. 

Instead of checking with Hin Leong on the loading documentation or the original BLs, Winson simply switched the documents for Ocean Voyager and presented them to SCB instead. This was one of several red flags, leading up to the relevant point of assessment – Winson’s representations at the time of the second presentation to OCBC.

In particular, Winson’s conduct regarding the absence of queries of the original BLs even when faced with the rejection of the first presentation by OCBC, as well as the absence of the loading documentation featured heavily in the decision both at first instance and Court of Appeal. Other red flags raised included: 

Pre-structured circular trades using copy BLs: The issue of whether the trades were pre-structured was relevant to Winson’s state of mind, i.e., whether it had an honest belief in the representations it was making as to the cargo and its ownership. Of note, Winson’s LOI (based on Hin Leong’s copy BL) representing goods shipped on board Ocean Voyager simply had no basis when it was issued before Winson’s supplier had issued its LOI. In other words, via its LOI, Winson was holding out its cargo was loaded on the Ocean Voyager, at a time when the vessel could have been substituted by its supplier who had yet to issue its LOI to Winson confirming that the cargo was indeed loaded. 

No Original BLs: While the court noted that circular trades may not be unusual per se in the oil trading market, what was unusual was the use of LOIs in a situation where all relevant parties were based in Singapore, which should have facilitated the ease in producing original BLs and the loading documents. The Court noted that a party like Winson would have been expected to query why the original BL were not available, even more so when a copy of the BL became somehow available but not the original. 

Lack of loading documents and inability to produce Original BLs: The court noted that “the critical original BL and loading documents remained inexplicably unavailable” even some 13-16 days after the vessels were loaded with the Ocean Taipan loaded at Universal Terminal Singapore (a terminal controlled by Hin Leong) and for which the loading documents should have been easily accessible. Even after OCBC had rejected the first presentation, it appeared that Winson did not even approach Hin Leong or Ocean Tankers for the original BLs, when it was communicating with them at the material time. 

Change in quantity after issuance of Ocean Taipan BL: Winson failed to ask for an explanation for a change in the quantity of gasoil, even when that change remarkably came about after the BL fixing the quantity was issued. 

Winson’s concerns over clean title of the cargo: Evidence pointed to Winson’s concerns over whether there was clean title of the cargo when discussing with OCBC for a prospective sale to a third party when news of Hin Leong’s financial difficulties came out.  

A new standard for sellers presenting under an LC? 

The facts of the case are so unique that they are unlikely to replicate; nonetheless, key themes emerge for traders and lenders to understand. Creative structures like repos, circular, and sleeving arrangements in oil trading, put a trader further away from the actual physical cargo being traded and the critical original BL, increasing the risk of fictitious trades. 

Concerns persist about questionable practices in oil trading. A troubling trend is that market participants appear happy to insert themselves into chains fraught with red flags, using LOIs instead of BLs. This practice is often justified by the perceived safety net of an independent payment guarantee of a bank as backing.

But the case is a timely reminder that the buck doesn’t always stop with the bank. Traders being asked to insert themselves into a chain and present documents for an easy small margin would no longer be rewarded for burying their heads in the sand when confronted with dubious signs. 

A payment LOI should no longer be seen as a single piece of paper to trigger payment under an LC, but one that contains heavy representations as to the essential feature of the trade – that cargo was shipped pursuant to valid BLs and that the seller has and will pass good title to that particular cargo.  

The risk/reward paradigm has shifted, and recklessly indifferent traders might find themselves facing a huge unpaid exposure for what is effectively a margin of a few dollars per ton.