*156 As a result of these policies, China's export performance has been outstanding and China has become a leading trading
nation [FN7] and enjoys a huge trade surplus amounting to US$74 billion with the United States and the European Union.
[FN8] The vast majority of this trade has been in goods, [FN9] especially textiles, footwear, toys and electrical products,
though minerals such as coal also form a fair proportion of exports. One of China's motivations in its tenacious attempts
to secure membership of the World Trade Organisation was a strategic desire to ensure that Chinese exports would not be
subject to arbitrary politically motivated restrictions by importing countries and that security of access to foreign
markets would instead be based on the new rules-based system of international trade brought into existence by the birth of
the WTO in 1995. [FN10]

Another matter is also basic to China's foreign trade security. On the microlevel, as opposed to the macro
considerations of international trade diplomacy, is the easily over-looked issue of how China's export trade is to be
financed. Traditionally, the international trade in goods has been financed by a system of letters of credit (or more
accurately, documentary credits). This system of trade finance is of considerable antiquity though innovatory electronic
systems to support all aspects of trade logistics and payments may soon become ubiquitous. [FN11] However, the traditional
paper-based system is one familiar to traders and bankers alike worldwide. China has had to come to terms with this
method of payments and has inevitably encountered problems in adapting its previously isolated and rudimentary banking and
legal systems to come into conformity with international trade practices.

This article seeks to outline the principle legal features of
the documentary credit system as operated in common law
systems relevant to the issues of fraud, as these
jurisdictions have primarily influenced the international
consensus on the form and nature of the trade finance regime
which is exemplified by almost universal incorporation of the
stipulations of the Uniform Customs and Practice for
Documentary Credits (UCP 500) [FN12] in most trade finance
arrangements. The vital importance of security of payment to
the seller of goods will be emphasised as the key success
feature of the system. The simple requirement of production of
*157 documents listed in the credit instrument to ensure
payment is the reason for the widespread acceptance of this
method of trade finance. However, the inherent simplicity of
the system that guarantees its success also has a potentially
fatal weakness, that of fraudulent conduct by the seller, the
shipper or some other person whereby the documents produced to
conform with those listed in the credit are inaccurate or
forged. The conundrum inherent in the system, namely the need
for certainty of payment when backed by appropriate documents
that creates commercial confidence in international trade
transactions needs to be balanced by the siren call of
fairness when financial advantage is to be had by cheating.
The fraud exception to the certainty of payment rule will be
examined in the Anglo-American context. The influence of
Anglo-American case law on Chinese decisions will be assessed
in the context of the unique circumstances of the Chinese
banking and legal systems. An analysis of how China deals with
the fraud issue will then be undertaken, given that in China
such conduct is not in the least unusual. Finally, the article
will seek to assess the seriousness of the problem of trade
finance fraud in China, its potential effect on China's trade
system and possible remedies for the perceived defects in the
Chinese system.


Documentary credits and financing international trade


According to Professor Ellinger [FN13] the documentary letter
of credit has two principal objects that arise from sales
contracts which involve substantial delays between manufacture
and delivery of goods as a result of international shipment,
namely those of furnishing security and raising credit. He
suggests that the sales contract itself provides no security
for either the buyer or seller, as if the seller parts with
the goods before payment, the buyer's defalcation or
bankruptcy, in the absence of an effective retention of title
clause, [FN14] will leave him without remedy. On the other
hand, if the buyer pays before shipment, he may have no
adequate remedy against a defaulting seller as regards the
precise performance of the sales contract stipulations or in
the event of the seller's bankruptcy. In respect of credit,
neither side of the sales contract might wish to finance, out
of their own resources, the possible considerable delay
occasioned by the carriage necessary in international
commerce. The usual solution to these interlinked problems is
the system of irrevocable documentary letters of credit,
whereby a creditworthy third party, a bank, interposes and
agrees to pay the seller on the presentation of the letter of
credit opened at the bank (known as the issuing bank) by the
seller accompanied by all relevant documents of shipment. By
this means, the seller is assured that the goods, in
conformity with the sales contract, have been placed on board
the ship or aircraft and dispatched, whilst the seller is
comforted that once he has complied *158 with the shipment
stipulation in the sales contract, he is guaranteed payment
for the goods. [FN15]

This system is capable of a number of variations which are
beyond the scope of the present discussion. [FN16] However,
one further common feature of the system of documentary
credits needs now to be mentioned, that is the involvement in
the process of a second or corresponding bank, normally
situated in the country of residence of the seller. The
corresponding bank is usually nominated by the issuing bank
and will act as the issuing bank's agent in accepting the
documentary credit tendered by the seller together with the
supporting shipment documents. If the documents are in strict
conformity with the stipulations contained in the letter of
credit, the corresponding bank will make payment direct to the
seller. The corresponding bank is then entitled to
reimbursement by the issuing bank who, of course, will seek
settlement from the buyer. [FN17] These are the essential
features of the documentary credit system, the most common
form of foreign trade finance.

The contractual terms of most documentary credits are based on
the UCP 500; no detailed discussion of these standard terms is
offered here but certain stipulations will be referred to
later, as necessary, in the context of the fraud exception to
payment rule. Two distinct contracts are created when the
credit is opened by the buyer at the issuing bank. The first
is clearly between the buyer and the issuing bank but as soon
as the irrevocable credit is notified to the seller, a second
contract [FN18] is formed between the bank and the seller,
whereby the bank is directly liable to the seller to pay the
agreed price of the goods agreed to be sold as between the
buyer and seller. Thus, there is an autonomous contract [FN19]
to pay *159 the price of the goods to the seller by the
issuing bank or via the corresponding bank upon presentation
of the shipping documents as specified in the credit. As a
result of this absolute undertaking by the bank, the law
allows the bank to rely on the doctrine of strict compliance,
[FN20] whereby the seller must present precisely and exactly
all the documents stipulated in the credit, and failure to
conform minutely with this requirement allows the bank to
refuse payment, though the terms of the credit should be
considered as a whole and in the light of current banking
practice. [FN21] Both of these precepts, the autonomy of the
documentary credit rule and the strict compliance rule, will
be further considered below in light of the effect of a fraud
committed by the seller or his agent, whether by tendering
forged documents or ones that contain a false statement of
fact, so as to be in apparent conformity with the requirements
of the credit, when in fact the tender is defective.


The fraud exception at common law


The one exception to the autonomous nature of the irrevocable
credit is fraud. The basis of this rule is to be found in the
American case of Sztejn v J. Henry Schroder Banking
Corporation. [FN22] Here the seller shipped crates of rubbish
instead of bristles as obliged to do by the contract of sale
but procured documents which, on their face stated that the
cargo was bristles and so in apparent conformity with the
requirements of the documentary credit. The buyer discovered
the truth concerning the shipment and applied for an
injunction to prevent the bank from accepting the tendered
documents. The court held that "[in] such a situation, where
the seller's fraud had been called to the banks attention
before the drafts and documents have been presented for
payment, the principle of the independence of the banks
obligation under the letter of credit should not be extended
to protect the unscrupulous seller". [FN23]

*160 Thus, two issues are vital: first, has the fraud been
perpetrated by the seller or with his knowledge and, secondly,
what level of proof of fraud needs to be furnished to the bank
to trigger a derogation from the autonomy principle. The
leading English case is United City Merchants (Investments)
Ltd v Royal Bank of Canada. [FN24] Here the shipping agents
fraudulently issued a bill of lading dated December 15, when
in fact the true date should have been December 16. This was
done to ensure conformity with the required latest shipping
date as stated in the documentary credit. The bank became
aware of the discrepancy independently of the facts stated in
the bill of lading. The House of Lords held that in this case
the fraud exception did not apply. Lord Diplock, who gave the
only judgment, decided that the English law on the fraud
exception was to be narrowly construed so that only where a
seller fraudulently presents to a confirming bank documents
that contain, expressly or by implication, material
representations of fact that are to his knowledge untrue, is
the bank able to refuse payment. A material fraudulent
misrepresentation made by an agent of the seller, without the
knowledge of the seller, as was the case here, is not
sufficient to invoke the fraud exception. The court was faced
with a proposition from the bank that the law was, in fact,
wider than this narrow construction, namely that where a bank
is aware that documents presented to it, whilst outwardly
conforming to the requirements of the credit, nevertheless
contain some material statements that are not accurate, the
bank is not obliged to pay. Knowledge of the seller is, in
this case, irrelevant. Lord Diplock thought that accepting
such a proposition of law would undermine the basis of
international trade financing. His Lordship considered that
the whole system of documentary credits was based on the use
by the bank of reasonable care to ensure that the tendered
documents on their face conformed in all respects with terms
stated in the credit and if they did so conform to pay the
stipulated sum. His Lordship buttressed his argument with
reference to the decision of the Privy Council in Gian Singh &
Co Ltd v Banque de l'Indochine [FN25] where it was held that a
customer was liable to reimburse a bank that had honoured a
documentary credit upon the presentation of an ingenious
forgery by the seller, which was undetectable by the bank
which was not guilty of lack of care. However, it should be
noted that in this case the bank was completely unaware of the
forged nature of the tendered document, in contradistinction
to the facts in United City Merchants. His Lordship went on to
base his decision on his view that to allow the proposition to
succeed would be to confuse the underlying contract for the
sale of goods with the autonomy of the contract between the
bank and the seller based on the irrevocable documentary
credit, and thus undermine the vitally important autonomy
principle, by forcing an inquiry upon the bank as to the
materiality of the non-conformity of the documents which would
allow the buyer of goods to reject them for breach of a
contractual condition of the sale.

These conclusions are open to considerable criticism, based as
they are on an unattractive argument of form over substance.
As Professor Ellinger points out a curious paradox arises from
the decision, namely:

*161 "It is disturbing that whilst a document stating the true
loading date could have been rejected by the bank in light of
the doctrine of strict compliance, a document in which the
loading date was fraudulently misrepresented by its maker
constituted a valid tender in the beneficiary's hands." [FN26]

Professor Pennington concurs and adds:

"It would be very odd indeed that an issuing bank should be
obliged to take up shipping documents which to its knowledge
are forgeries and worthless and do not represent the goods
conforming to the terms of the credit, and that it should be
obliged to pay or commit itself to pay the amount of the
credit in return." [FN27]

Further, his Lordship also rejected the final submission of
the bank that it was entitled to refuse payment against a
document that it knew to be forged, even though the seller had
no knowledge of that fact. Finally, the situation where the
fact of the forgery deprives the document of all legal effect
and is a nullity, so being worthless to the bank as security
for its advances to the buyer, was not decided as it was
unnecessary to dispose of the appeal. More recently this issue
has been considered by the English Court of Appeal.

In Montrod Ltd v Grundkotter Fleischvertriebs GmbH [FN28] the
facts were that the seller (GK), a German company, agreed to
sell 400 metric tonnes of frozen pork sides CIF to Ballaris, a
Russian entity. The transaction was to be financed by a
documentary credit.

GK had no experience of the credit arrangements for
international trade and at all times was guided by the advice
of its German bank, Commerzebank. GK negotiated the sale and
credit terms with Ballaris bona fide including inter alia that
Ballaris could act as Montrod's agent, which was Ballaris's
independent finance company, in agreeing that certain
certificates of inspection, as specified in the credit, could
be signed on behalf of Montrod by GK's employee. A Montrod
company stamp was sent to GK for the purpose (apparently by
Ballaris) and in due course the GK employee duly signed the
required certificates. GK was found by the trial judge to be
entirely innocent of fraud. However, unknown to GK, Ballaris
was not authorised to speak for Montrod, who intended the
provision of the certificates to be a device to withhold
payment on the credit should they themselves not have
previously been put in funds by Ballaris. This state of
affairs was not known to GK, and in any event they dispatched
the goods to Russia, as agreed and then presented the credit
plus the required documentation including the inspection
certificates to the bank for payment.

When Montrod was informed by its bank that the credit plus
accompanying documents had been received and were in apparent
conformity, Montrod told the bank that it had not signed the
certificates and that payment should not be made as the
certificates were apparent forgeries. However, after seven
days, the bank *162 decided that the documents were in
conformity on their face and proposed to pay. Consequently,
Montrod applied for an injunction but this was dismissed inter
partes as there was no evidence of forgery by GK. The bank
later paid in accordance with the terms of the credit.

Montrod pursued its action to full trial alleging fraud on the
part of GK. Further, it was argued that another ground for
non-payment existed in law, namely that of the so-called
"nullity exception".

As proposed by Montrod this exception to the autonomy rule
could be formulated as follows: if, by time of full payment,
the only reasonable inference is that a document (created by
the beneficiary) presented under a credit is not what it
appears on its face to be, but is a nullity, then the bank is
not obliged to pay. The trial judge rejected this argument as
unsupported by authority in England and contrary to the
express provisions contained in UCP 500.

In the Court of Appeal, Potter L.J., who gave the judgment of
the court, held that the combination of the autonomy principle
and the rule that banks deal in documents and not goods,
[FN29] together with the issuing bank's undertaking to pay if
the stipulated documents presented conformed with the terms of
the credit, [FN30] entitled GK as beneficiary to obtain and
obliged the bank, as issuing bank, to make payment against
documents presented provided they complied "on their face"
with the requirement of the credit. [FN31] Neither as a matter
of general principle, nor under UCP 500, is an issuing bank
obliged to question or investigate the genuineness of
documents which appear on their face to be documents, the
nature and content of which comply with the requirements of
the credit. Further, not only is the necessity to examine the
document presented by the beneficiary limited to an
examination of the documents alone, [FN32] but the bank
assumes no liability or responsibility for the genuineness or
legal effect of any such documents. [FN33]

His Lordship later explained that adopting a nullity exception
where a document is worthless in the sense of it not being
genuine and having no commercial value, whether as security or
otherwise, "involves an undoubted extension of the fraud
exception as hitherto expounded in the English authorities".
[FN34] Extending the law to cover the instant facts, where the
beneficiary is innocent of any knowledge of or culpability in,
the presentation of irregular documents, would extend the law.

*163 His Lordship resolutely refused to do so as urged by
Montrod. He opined that:

"The fraud exception to the autonomy principle recognized by
English law has hither to been restricted to, and it is in my
view desirable that it should remain based upon, the fraud or
knowledge of fraud on the part of the beneficiary or other
party seeking payment under and in accordance with the terms
of the letter of credit ... In my view there are sound policy
reasons for not extending the law by the creation of a general
nullity exception." [FN35]

His Lordship enumerated those reasons of policy which included
the incorporation of the UCP 500 into most documentary credits
internationally, the purpose of which was to provide a degree
of uniformity and reliability in the world of international
payments; accepting a general nullity exception would erode
the autonomy principle and undermine the negotiability of
letter of credit transactions. Secondly, the recognised fraud
exception is a very narrow one based on fraud by the seller or
by his agent with his actual knowledge and so deliberately
difficult to invoke at common law. Apparent conformity of
documents is what is required by the UCP for payment; banks
are not required to undertake their own investigations into
the validity of documents presented and allegations of fraud
must be backed by compelling evidence or an application to the
court for injunction by a disgruntled buyer or other affected
party. Thirdly, the acceptance of a general nullity exception
to payment in England would force banks to make extensive
inquiries into the veracity of the documents supporting the
credit, which would be time-consuming and impractical, and
would also violate a cardinal principle enshrined in the UCP
500, namely that banks do not warrant that the documents
presented to them are genuine [FN36]; they merely have to be
satisfied, using reasonable care, that they conform "on their
face" to those required. [FN37] Finally, a nullity exception
might well prejudice beneficiaries participating in a chain of
contracts where their bona fides are not in doubt. Thus, in
conclusion, admitting this new exception would fatally
"undermine the system of financing international trade by
means of documentary credits". [FN38]

Consequently, it is now clear that in England the fraud
exception is a narrow one, requiring knowledge on the part of
a beneficiary of the deceit to be practised before the
autonomy principle can be breached and that mere nullity of a
document will not, of itself, call into question the bank's
decision to pay when there is apparent conformity with the
requirements of the credit. Thus, the nullity argument has
been dealt a mortal blow, given the single judgment in the
Court of Appeal and the refusal of leave to appeal by the
Appeal Committee of the House of Lords. Thus, the English law
on this issue is now clear and certain, though arguably not in
an entirely satisfactory state, given the views of leading
academic writers mentioned above.




文章选项：
徐律师(shanghai)
(新手上路)



注册日期： 2004-01-30
篇文章: 49

Re: DOCUMENTARY CREDITS AND FRAUD: ENGLISH AND CHINESE LAW
COMPARED [Re: 徐律师(shanghai)]
#642759 - 2005-01-30 20:37 编辑 回复 引用



*164 The legal framework in China


Since 1978 China has been striving to create a modernised
legal system to support its constitutionally mandated
"socialist-market economy". [FN39] This curious creation is
beset by philosophical and practical difficulties too numerous
to mention here but suffice it to say that the Chinese economy
has been driven by an exportorientated strategy for over 20
years. One of the essential requirements to facilitate
international trade, in addition to clarifying
property-ownership rights [FN40] and contractual obligations,
[FN41] has been the need to modernise its banking system
[FN42] and more especially the processing of international
payments in respect of the import and export of goods.

Contracts in China are now governed by the comprehensive
Contract Law (1999). Contracts are concluded through a process
of offer and acceptance [FN43] but may be void [FN44] as a
result of the use of fraud. Contracting parties also have a
general duty of good faith in conducting and performing
contracts. [FN45] A void contract is void ab initio. [FN46]
Whilst there are many other general provisions [FN47] and
numerous specific contracts are given express and detailed
treatment [FN48] in the Contract Law, there are no special
provisions relating to documentary credits.

Prior to the enactment of the 1999 Contract Law, China had a
very confusing system of contracting with no less than three
different statutes all operating concurrently. One was
confined to foreign-related contracts, [FN49] one was for
purely domestic transactions [FN50] and the third dealt with
technology transfer agreements. [FN51] *165 These arrangements
were highly unsatisfactory as a result of problematic
definitions, scope of coverage, glaring gaps in the
provisions, overlap and outright contradictions. [FN52]
Fortunately, these difficulties are of historic interest only
as the 1999 statute repealed the old provisions in their
entirety. However, one important normative instrument from the
pre-1999 era is still of considerable practical importance in
relation to fraud and documentary credits--the 1989 Supreme
Court Memorandum Concerning Economic Disputes involving
Foreign Elements. [FN53] The underdeveloped nature of the
legal system, both in the 1980s and currently and the
defective quality of much legislation leads the highest
national judicial body habitually to issue interpretations of
statutes, rules, memoranda and instructions to other inferior
courts. The legitimacy and legal basis of these various
pronouncements is questionable constitutionally [FN54] but,
nevertheless, normative instruments that issue from the
Supreme Court are generally followed by lower courts, even
though there is no formal system of stare decisis, in the
common law sense, known to the Chinese legal system. The
rudimentary nature of much of the Chinese legal system also
means that it is common for significant lacunae to exist in
the legislative framework. Where this problem arises courts
habitually resort to any international agreements that China
has ratified, where appropriate and in extremis to
"international practice". This gap-filling, whilst entirely
understandable from the need to base decisions in particular
cases on some legitimate basis, is nevertheless highly
unsatisfactory as it clearly distorts the rational development
of a coherent structure of law in China and is also highly
unpredictable, as no clear rules exist as to when and in what
circumstances such "borrowings" can take place. This is
exactly what has happened in the development of the law on
documentary credits, as will be demonstrated later.

The 1989 Memorandum deals with the rules for the preservation
of assets in pending litigation in cases involving foreigners
or foreign related transactions. The Memorandum specifically
gives guidance as to the approach to be adopted in relation to
cases involving disputes where documentary credits are
involved as the means of payment in relation to underlying
sales contracts. No domestic legal basis for the advice to
Chinese courts was cited in the Memorandum. However, the
Supreme Court referred in general terms to the provisions of
the UCP "which are applied internationally". The Memorandum
stated that sales contracts and the financing of them were
separate matters; banks had the right not to pay in respect of
non-compliant documents presented with credits for payment,
without the need to apply for injunction from the People's
Court. Courts were urged not to freeze funds arbitrarily as a
result of disputes concerning the underlying sales *166
contracts as this would undermine the reputation of Chinese
banks internationally. However, if there was "sufficient
evidence to establish fraud and the Chinese bank has not made
payment under the Letter of Credit, the court may freeze the
Letter of Credit Amount according to the buyer's application
... ". Further, a court wishing to freeze a Letter of Credit
payment "should report the matter to a higher level court for
approval before the [injunction] is issued".

Thus, the Chinese system, similar to the common law, also
envisages a fraud exception to the autonomy principle by the
production by the applicant of "sufficient" evidence. Another
interesting point to note is the direct supervisory role of
higher courts to approve, in advance, individual applications
for injunctions in specific cases; this is prior to judgment,
not an appellate process. Direct supervision of individual
decisions, whereby the trial court may simply be a conduit to
higher authority, is common in the Chinese system, due to the
inexperience of most judicial officers and a desire to reign
in protectionist predilections of local courts that would
often unduly favour local applicants or respondents, whatever
the legal merits of the case. [FN55] This phenomenon is
particularly problematic in the view of the central
authorities when it might unfairly prejudice foreign
applicants or respondents, so calling into question the
capacity and impartiality of the Chinese legal system.
Exposure to foreign criticism that might damage trade
relations or the standing of the Chinese banking system are
matters taken very seriously by the Chinese central
government.

An issue of importance regarding the use of the documentary
credit system, as practised internationally, is that the
autonomy principle is based on formality in respect of
checking the compliance of documents and a limited duty of
care by the bank to the applicant as exemplified in the UCP
500; if the documents comply on their face, payment is due.
The reasons for this system and its utility are easy to
discern but can such a system work satisfactorily in China? It
will be suggested later that perhaps the assumptions
underlying the documentary credit system simply do not pertain
in China and that the current "formulaic" system actually
encourages fraud.


Recent cases in China


There have been two recent cases concerning the fraud
exception decided by the Chinese Supreme Court, both of which
exhibit features of common law reasoning without explicitly
acknowledging the root of the rationale adopted.

In Heilongjiang Guoji Gogcheng Jishu Hezuo Group v Hualong
Construction, [FN56] Heilongjiang agreed to sell construction
equipment to Hualong for a price of US $1.77 million, to be
financed through a documentary credit for this amount, which
incorporated the terms of UCP 500. Hualong opened a letter of
credit at China Investment Bank in that amount in favour of
Heilongjiang. Later, after the *167 goods had been received,
Hualong was dissatisfied with the quality of the machinery
delivered and sought to prevent the payment under the credit.
However, the payment had already been made by the
corresponding bank, China Everbright, to Heilongjiang as the
stipulated documents conformed to the credit's requirements
and China Investment Bank had reimbursed Everbright. Hualong
refused to pay the issuing bank. The bank sued its client to
recover the amount of the credit, succeeded in the lower
courts and Hualong appealed to the Supreme Court on the basis
that payment should not have been made due to the fraud
exception. The appellant claimed that the lack of quality in
the goods delivered constituted a species of fraud. The
Supreme Court rejected this argument. The court opined first
that the sale of goods contract and the credit were separate
contacts and that a defect in quality of goods delivered was
not a matter that could affect the liability to pay under the
credit. Further, the correct procedures had been followed as
regards conformity of the documents tendered with the credit
for payment. The court went on to elaborate that:

"The UCP500 does not determine the situation where a
beneficiary who commits fraud is protected by the principle of
the autonomy of the credit. However, a fraud exception
principle has been accepted by many overseas jurisdictions.
The fraud exception accepts the autonomy of the credit
principle and the practical needs of international trade but
cannot ignore the situation where a beneficiary commits fraud
to obtain payment. However, if the appearance of the documents
presented do not show any obvious sign of discrepancy and
there is no evidence to prove the existence of fraud, the law
does not allow the documentary credit applicant to prevent the
right of bank to honour the credit."

Thus, the highest Chinese court has confirmed the principles
of autonomy and the ambit of the fraud exception in China, by
reference to international practice but without citing the
legislative root of rule in Chinese law, as should be
necessary in a civilian jurisdiction.

In the second case, Korea Xin Hu Co v Sichuan Province Ouya
Jingmao, [FN57] the appeal related to a procedural issue as to
whether an arbitration clause in the sale of goods contract
governed any dispute concerning the related contract for a
documentary credit. The seller, Korea Xin Hu, was alleged by
the buyer, Sichuan, to have forged a bill of lading that was
required to be tendered with the letter of credit when payment
was demanded. The buyer went to court seeking an injunction to
prevent the issuing bank making payment on the credit and
succeeded in the lower courts in preventing payment. Xin Hu
appealed and argued that the application was misconceived as
the sale of goods contract stipulated that all disputes
between the parties should be settled by way of arbitration
via a nominated third party. The dispute concerning the
payment under the letter of credit was also covered by this
term. Thus, the application for injunction was inapplicable.

The Supreme Court decided that:

*168 "The injunction was valid on the basis that the buyer had
a right to apply to the court to prevent payment in
circumstances where the buyer had sufficient evidence to prove
fraud. Secondly, the relevant arbitration clause in the sale
of goods contract was unclear as to the extent of coverage of
the term and thus, did not extend to the ancillary and
separate contract for the documentary credit, given that the
two contracts were separate under the autonomy principle.
Further, the two contracts could only be linked where the
fraud exception applied."

Thus, it appears that China's highest court has reinforced the
1989 Memorandum in these two cases. As discussed above, even
in the absence of a formal stare decisis system, it is most
likely that China's lower courts will follow these decisions.

A number of other fraud exception cases are pending in the
Shanghai Higher People's Court, though no decisions have yet
been announced. Unsurprisingly, they often display factual
circumstances that are often analogues to decided cases in
common law jurisdictions. In one case, the facts are
remarkably similar to those in United City Merchants and
another is almost identical to Montrod. It will be very
interesting to see how the Shanghai court deals with cases in
the light of the Supreme Court's decisions related above.


Problems with Chinese decisions


Despite the clarity of these two judgments, major problems
with the Supreme Court decisions are apparent. Although the
robust acceptance of internationally accepted norms in
economic cases is generally to be welcomed as strengthening
China's immature system, in this instance two Chinese domestic
issues are of concern.

First, there is no clear legitimate legal basis in the Chinese
system for creating legally enforceable rights in the absence
of explicit legislative provisions either through the
constitution, a statute or, in the absence of a domestic
provision, reliance upon the provisions of an international
treaty acceded to by China. The legal basis for these
decisions is decidedly weak.

Secondly, whilst the acceptance of Chinese courts of
international practices in commercial law is to be generally
welcomed, the strict nature and narrow compass of the fraud
exception may not be applicable in China where collusion
between issuing or corresponding banks and beneficiaries to
defraud buyers may be quite common, a situation perhaps less
in evidence elsewhere, especially in developed economies,
where the UCP 500 rules were created and have worked well for
many years. The strict compliance rule coupled with the
narrowness of the fraud exception rule may unwittingly
conspire actually to encourage fraud in China where corrupt
collusion by banks or their employees [FN58] with
beneficiaries may *169 well be a significant problem. Coupled
with very weak civil and criminal law enforcement and
widespread bribery of all types of officials including judges
and police, [FN59] it is easy to envisage the ease with which
the documentary credit system could be abused by unscrupulous
sellers and corrupt officials.

This type of problem has been recognised as a serious one, not
only in China, by the International Chamber of Commerce. The
Commercial Crime Services division of the Chamber opined that
"it was clear that buyers and sellers involved had acted in
collusion for a number of years, building a substantial
documentary credit trade record that led banks to lower their
guards and accept financial exposure". [FN60] Here, it should
be stressed that the bank is the victim, not a co-conspirator.

However, collusion between sellers and banks is only one type
of fraud common in China. Gao Yu [FN61] suggests that three
types of fraud are common. First, simple fraud by the seller
who forges or alters a bill of lading to prejudice a genuine
buyer. Secondly, conspiracy between the seller and others
(even with the apparent buyer) to fabricate a transaction to
defraud the bank who pays on an apparently compliant credit
and is unable to recover from the "buyer" who disappears. Here
collusion with bank officials would allow the granting of
credit facilities to the bogus buyer. The corrupt bank
employee may then share in the illicit payment to the
detriment of the bank. Finally, fraud committed by an agent in
backdating a bill of lading, to show apparent conformity with
a specified shipping date. Gao suggests that the huge
potential rewards for fraud, coupled with the simplicity of
ensuring apparent compliance, encourages potential fraud
especially when the chances of detection are low. He also
recognises that there is an inherent dilemma in ensuring a
reliable method of payment in international trade and the
potential danger of fraud, especially where collusion is so
easy and punishment a remote possibility.


Conclusion


The law in England relating to documentary credits on strict
compliance, the fraud exception and the nullity fallacy, is
now reasonably clear as is the overriding *170 importance of
maintaining the existing system of international payments
concerned with the trade in goods based, almost universally,
on the provisions of the UCP 500. The overriding practical
need to ensure a reliable and certain system of international
trade payments is a paramount consideration. Interestingly,
China---with a very different legal system and particular
environmental problems---has also adopted almost identical
legal rules to those of the common law, notwithstanding that
the traditional documentary credit system may, in China,
actually encourage an evil--fraud--that the law seeks to
prevent and punish. A trade-off has had to be sought between
ensuring that the majority of transactions proceed without
incident, so as to promote trade and burnish the reputation
for reliability of Chinese banks, and the reality of
potentially increasing fraud in the Chinese banking system.
The losers in this Faustian pact may sometimes be the innocent
buyer, to whom the traditional common law admonishment caveat
emptor is still the best advice, or the proprietors of the
paying bank whether Chinese or foreign. Moving away from the
traditional formulistic system of apparent compliance to one
more based on substantive compliance might provide a solution
to China's particular problems. But this palliation would be
bought at the unacceptable price of weakening the principle of
the autonomy of the credit, running contrary to the
internationally accepted stipulations contained in the UCP 500
as well as being impracticable and uneconomic, given that the
vast majority of transactions, even in China, are not tainted
by fraud. Presumably, unless the level of fraud reaches
unacceptable levels in China, so affecting banks willingness
to finance China trade, the current modus vivendi will
continue.



FNa1. bumarkw@polyu.edu.hk. The author gratefully acknowledges
the assistance of Wong Shui Kai and Zhang Jinsong in
translating various Chinese language materials into English
for use in this article.



FN1. China's trade statistics reveal that in 1980 imports were
US$20bn and exports US$18bn but by 2001 imports were US$243bn
and exports were US$266bn. China Statistical Yearbooks (1992)
and (2002).



FN2. China in this article means the mainland of the People's
Republic of China (PRC) excluding Taiwan and the Special
Administrative Regions of Hong Kong and Macau, who all have
separate legal regimes to that of the mainland.



FN3. The decision was taken to begin the opening of the
economy to the outside world at the Third plenum of the 11th
Communist Party Congress in 1978.



FN4. Total FDI was US$40.7bn in 2000 and US$46.8bn in 2001, of
which roughly US
$15bn came from Hong Kong and some US$4bn in each year from
Singapore and Taiwan. Thus almost half of the total originated
from the Asian Chinese diaspora. China Statistical Yearbook
(2002).



FN5. The balance of FDI comes mainly from the EU and the USA.
China Statistical Yearbook (2002).



FN6. Various types of customs tariff concessions, corporation
tax holidays, freedom from local taxation.



FN7. China is now ranked as the world's fourth largest
exporter of goods
(www.wto.org/english/res_e/statis_e/its2002_e/its02_bysubject_e.htm#leading_
traders).



FN8. China's trade surplus with the US was some US$30bn in
2000 and US$34bn in 2001; for the EU the surplus was some
US$40.8bn in 2001. China Statistical Yearbook (2002) and
www.wto.org/english/res_e/statis_e/its2002_e/section3_
e/iii39.xls.



FN9. Goods in the form of textiles, clothing, footwear, toys
and electrical/electronic products make up more than half of
all China's exports,
US$147bn out of an export total of US$266bn; services exports
are negligible except for tourism. China Statistical Yearbook
(2002).



FN10. China formally became the 143rd member of the WTO on
December 11, 2001.



FN11. The Tradecard system of automated logistical support and
payments is being pioneered in Hong Kong and may eventually
supersede the manual documentary credit system of payments.
See www.tradecard.com. See also, International Chamber of
Commerce eUCP rules that came into force on March 31, 2002
www.iccwbo.org/home/menu_banking.asp.



FN12. The Uniform Customs and Practice for Documentary Credits
(1993 Revision), ICC Publication No.500. See
www.iccwbo.org/home/menu_banking.asp.



FN13. A.G. Guest, ed., Benjamin's Sale of Goods, 6th ed.,
Sweet & Maxwell, London, (2002), p.1624.



FN14. Such a contractual term is commonly known as a Romalpa
clause after the dictum in Aluminium Industrie Vaassen BV v
Romalpa Aluminium [1976] 1 W.L.R. 676.



FN15. A letter of credit is generally to be treated as cash
and refusal to pay by a bank generally entitles the
beneficiary to claim summary judgment for debt. However, in
the unusual circumstance that the bank is also involved in the
underlying transaction and fraud is a possible defence to
payment, summary judgment against the bank is inappropriate:
SAFA Ltd v Bank Du Caire [2000] 2 All E.R. (Comm) 567. See
also a similar application of the principle in relation to a
performance bond in Solo Industries UK Ltd v Canara Bank
[2001] 2 All E.R. (Comm) 217.



FN16. For a full discussion of the variations possible on this
basic system of irrevocable documentary credits, see "The
Financing of International Trade" in R. Goode, Commercial Law,
2nd ed., Penguin Books, London, (1995).



FN17. This is even the case where the corresponding bank has
paid a discounted amount before the maturity date and fraud
was later alleged against the beneficiary: Czarnikow-Rionda
Sugar Trading Inc v Standard Chartered Bank Ltd [1999] 1 All
E.R. (Comm) 890. When there is a direct dispute between the
issuing bank and the corresponding bank concerning an early
discounted payment, the right to indemnity only arises on the
maturity date and if a fraud defence to liability would be
available at that date, the decision to make early discounted
payment shifted the risk of early payment to the paying bank:
Banco
Santander SA v Bayfern Ltd [1999] 2 All E.R. (Comm) 18.



FN18. per Rowlatt L.J. in Urquhart, Lindsay & Co v Eastern
Bank Ltd [1922] 1 K.B. 318 at 322-323. See also Arts 3 and 6,
UCP 500.



FN19. There is a theoretical problem with the existence of the
autonomous payment obligation, namely that no consideration
moves from the seller to the bank when he receives the
documentary credit. Two explanations have be offered, namely
that consideration is present and does move from the seller as
until he receives notification of the documentary credit, he
is under no obligation to ship the goods, as provision of the
credit was a requirement of the sales contract per Greer J. in
Dexters Ltd v Schenker & Co (1923) 14 Ll.L.R.586. The second
explanation is based on mercantile usage and expediency per
Jenkins L.J. in Malas (Hamazeh) & Sons v British Imex
Industries Ltd [1958] 2 Q.B. 127 at 129. Whilst both views
confirm the existence of the autonomous obligation, neither
are particularly convincing from a theoretical point of view
as regards the English law of contract. But this outcome is a
good example of how civilian-based commercial law, the Lex
Mercatoria, trumps one of the idiosyncratic doctrines of
common law in order to align English law with ubiquitous
international commercial usage.



FN20. The rule is clearly stated in English, Scottish and
Australian Bank v Bank of South Africa (1922) 13 Ll.L.R 21 at
24 per Bailhache J. where he opined: "It is elementary to say
that a person who ships in reliance on a letter of credit must
do so in exact compliance with its terms. It is also
elementary to say that a bank is not bound or indeed entitled
to honour drafts presented to it under a letter of credit
unless those drafts with the accompanying documents are in
strict accordance with the credit as opened." However, where a
party expressly agreed not to draw down payment unless certain
conditions were met, that agreement could be enforced, so
displacing the autonomy principle in this special case: Sirius
International Insurance Corp (Publ) v FAI General Insurance Co
Ltd [2002] 2 All E.R. (Comm) 745.



FN21. See Art.13(a), UCP 500.



FN22. 31 N.Y.S. 2d 631 (1941).



FN23. ibid. at 634.



FN24. [1983] A.C. 168.



FN25. [1974] 2 All E.R. 754.



FN26. Benjamin's Sale of Goods, n.13 above, p.1683.



FN27. R.R. Pennington, Bank Finance for Companies, Sweet &
Maxwell, London, (1987), p.28.



FN28. [2002] 3 All E.R. 697.



FN29. Arts 3 and 5, UCP 500.



FN30. Art.9 ibid.



FN31. Arts 3, 13a, 14a, 14b and 14c ibid. Banks have a
contractual duty to use reasonable care when examining
presented documents that are stipulated in the credit
(Art.13a) but an inspection company, instructed by a seller,
also has a tortious duty of care to a buyer of goods or the
issuing or corresponding bank in respect of the accuracy of
any quality report prepared in respect of the underlying sale
of goods transaction: Niru Battery Manufacturing Co v
Milestone Trading Ltd [2002] 2 All E.R. (Comm) 705.



FN32. Art.14b ibid.



FN33. Art.15 ibid.



FN34. [2002] 3 All E.R. 697 at 709.



FN35. ibid. at 712.



FN36. Art.15, UCP 500.



FN37. Art.13a ibid.



FN38. [2002] 3 All E.R. 697 at 714.



FN39. Arts 11 and 15 of the Constitution of the PRC mention
this concept but do not define it.



FN40. China does not have a comprehensive law of property; one
is being drafted but presently a precise definition of what is
capable of being "owned" in China is unavailable.



FN41. A new and comprehensive Contract Law was enacted in
1999.



FN42. China's banking system is a socialist one and does not
comply with international standards of capital adequacy. In
fact, many observers believe that the impact of opening the
banking sector to foreign competition may well prove
catastrophic as the state-owned sector is saddled with a
mountain of bad debt that may be as much as 50% of outstanding
loans. See Lardy, China's Unfinished Economic Revolution
(Brookings Institution Press, 1998); Chang, The Coming
Collapse of China (Random House, 2001); Supachai and Clifford,
China and the WTO (Wiley, 2002).



FN43. Arts 9-34, Contract Law (1999). This innovation is a
direct borrowing from common law, whereas the majority of the
Contract Law is based on the civilian system. See Williams,
"An Introduction to the General Principles and Formation of
Contracts in the New Chinese Contract Law" (2001) 17 Journal
of Contract Law 13.



FN44. Art.52 ibid.



FN45. Art.6 ibid.



FN46. Art.56 ibid.



FN47. See Williams, n.43 above.



FN48. Sales of goods (Pt 9), supply of water, gas and
electricity (Pt 10), contracts of gift (Pt 11), loans (Pt 12),
leasing contracts (Pt 13), finance-leases (Pt 14), provision
of labour (Pt 15), construction contracts (Pt 16), carriage
(Pt 17), provision of technology (Pt 18), bailment (Pt 19),
storage (Pt 20), and agency (Pt 21).



FN49. Foreign Economic Contract Law (1986).



FN50. Economic Contract Law (1981).



FN51. Technology Contract Law (1987).



FN52. For further details see Williams, n.43 above, at 14-17.



FN53. www.court.gov.cn in Chinese (June 12, 1989).



FN54. Under Art.62(3) of the Constitution of the PRC, the
National People's Congress has the power to make "basic" laws;
under Art.67(3) and (4) the
Standing Committee of the National People's Congress also has
law-making powers and the power to interpret laws. The
Standing Committee also has supervisory power over the Supreme
Court: Art.67(6). No power of law creation or interpretation
of the constitution or statutory law is give to the courts in
Pt VII of the Constitution. Judicial power is limited to
deciding individual cases in accordance with the law created
by the People's Congress.



FN55. For a full description and analysis of the nature,
capacity, deficiencies and processes of the Chinese legal
system see R. Peerenboom, China's Long March toward the Rule
of Law, Cambridge University Press, (2002).



FN56. Decision No.21 of 2002,
www.court.gov.cn/study/civil/200303050009.htm.



FN57. Decision No.35 of 2001,
www.court.gov.cn/study/civil/200303040123.htm.



FN58. There are numerous examples of corrupt bankers acting in
concert with customers to defraud the state-owned banks by
colluding in establishing fraudulent loans to fictitious
entities or uncreditworthy borrowers. The amounts involved can
be enormous. For example, in December 2001 the former chairman
of the Bank of China was arrested in connection with frauds
perpetuated against his employer valued at more than US$500m.
In another case
the former head of the Bank of China in Hong Kong is suspected
of involvement in fraudulent loans to Hong Kong and Shanghai
property companies worth over US $120m. "Former Bank of China
President Facing Corruption Prosecution", Financial Times,
July 9, 2002 and "Bank of China Admits Former HK Chief is
Detained", South China Morning Post, June 11, 2003. Banks or
their employees being involved in fraud concerning letters of
credit is not only a problem in China as exemplified in
Standard Chartered Bank v Pakistan National Shipping Corp
[2000] 1 All E.R. (Comm) 1.


FN59. Over the years 1997-2002 the Chinese Communist Party
inspection department investigated 790,000 members which
resulted in 780,000 officials being jailed, executed or
subjected to internal party discipline. "Crackdown on corrupt
cadres hailed as a big success", South China Morning Post,
October 15, 2002. China was also ranked as a very corrupt
country by Transparency International in the 2003 Global
Corruption Report (http:// gcr.netscript.kunde.sserv.de/download.shtml).


FN60. www.iccwbo.org/home/news_archives/1999/cargo_frauds_warning_to_banks.asp.

FN61. "Letters of Credit Fraud", Journal of the China International Economic and Trade Arbitration Commission, Summer 2001 (Beijing) (in Chinese).