What you need to know
A letter of credit entitles its beneficiary to be paid on demand from the issuing bank, so long as that demand is compliant with the terms and conditions of the letter of credit. Canadian law recognizes only one exception to this nearly absolute obligation: fraud.
In Eurobank Ergasias S.A. v. Bombardier inc.,1 the Supreme Court of Canada (SCC) clarified in what circumstances could fraud committed by a third party be attributable to the beneficiary of a letter of credit, so that the demand for payment must be refused by the issuing bank.
The decision also touches on important principles of private international law, such as comity and the principles applicable to the recognition and enforcement of foreign judgments by Québec courts. In that vein, the SCC’s decision strongly signals that a foreign judgment’s disregard to a binding international arbitration order or award may violate public order as understood in international relations and thus lead to its unenforceability in Canada.
Background
In 1998, the Greek Ministry of National Defense (GMOD) entered into a procurement contract with Bombardier Inc. (Bombardier). A dispute arose when Bombardier determined that it would not be able to meet its obligations under a related offsets contract (regarding subcontracting to Greek companies). These contracts required Bombardier to secure a letter of guarantee from a Greek bank for potential liquidated damages if it did not fulfil its obligations (Letter of Guarantee). The Greek bank’s obligation to pay GMOD on demand was itself subject to a letter of credit issued in Quebec by the National Bank of Canada (Letter of Counter-Guarantee). Bombardier initiated arbitration proceedings before the International Chamber of Commerce (ICC) to determine whether Bombardier was in breach of the offsets contract.
During the arbitration, GMOD formally undertook to Bombardier and the ICC arbitral tribunal not to demand payment under the Letter of Guarantee before the final award was issued. Nonetheless, GMOD demanded payment from Eurobank Ergasias S.A. (Eurobank) ̶ the Greek bank holding the Letter of Guarantee ̶ while the issuance of the final award was still pending. This led the ICC arbitral tribunal to issue a procedural order which enjoined GMOD from demanding payment under the Letter of Guarantee (Procedural Order).
On the very day the ICC arbitral tribunal informed the parties that the final award would be released shortly, GMOD made a call on Eurobank for payment under the Letter of Guarantee. Believing that it would be exposing itself to serious liability under Greek law if it did not comply with GMOD’s demand, Eurobank made the payment. Eurobank then demanded payment of the full amount paid from National Bank of Canada under the Letter of Counter-Guarantee.
In response, Bombardier sought a permanent injunction from the Superior Court of Québec enjoining the National Bank of Canada from paying Eurobank under the Letter of Counter-Guarantee and also sought the homologation of the ICC arbitral tribunal’s final award, which declared the offsets contract null and void ab initio, such that Bombardier did not owe GMOD any payment for damages.
The Québec courts granted Bombardier’s request for injunctive relief and homologated the ICC arbitral tribunal’s final award. Eurobank appealed the decision to the Supreme Court of Canada.
The Supreme Court’s majority decision
The key issue before the SCC was whether the fraud exception, which is the only recognized exception to a bank’s obligation to pay the beneficiary of a letter of credit on demand, found application in this case. To answer this question, the Court had to determine: (1) whether, under Quebec law, GMOD’s conduct amounted to “fraud by a third party”; and, (2) if so, whether GMOD’s fraud was attributable to Eurobank such that payment by the National Bank of Canada under the Letter of Counter-Guarantee should be prohibited.
The Court held that the fraud of a third party is not enough on its own: the beneficiary must itself be involved or have knowledge of the fraud.
The SCC provided the following guidance:
- The fraud exception is limited to cases of obvious fraud; however, fraud in this context is broader than the concept of fraud in criminal law;
- Fraud requires some aspect of impropriety, dishonesty or deceit;
- The fraud needs to have a link with the demand for payment under the letter of credit;
- If a beneficiary knows that they have no right to be paid but still makes a demand for payment under the letter of credit, that conduct may amount to fraud;
- Knowledge of the fraud of the third party and participation in that fraud are required to attribute the third party’s fraud to the beneficiary.
The SCC stated that the requirements of knowledge and participation ensure that the scope of the fraud exception remains narrow such that the reliability of letters of credit is preserved. Despite this, the Court stressed that the exception need to be sufficiently inclusive to capture most fraudulent conduct.
The SCC relied on these principles to conclude in this case that GMOD’s demands for payment in contravention of the ICC arbitral tribunal’s order and its own undertaking amounted to fraud. The Court found that Eurobank knew of GMOD’s fraud and participated in it by paying GMOD before the issuance of the final arbitral award. Because it knew of and participated in GMOD’s fraud, Eurobank could not demand to be paid under the Letter of Counter-Guarantee.
In the course of its analysis of GMOD and Eurobank’s conduct, the SCC had to consider whether judgments of the Greek courts concluding that GMOD did not commit fraud had any decisive relevance. It held that while foreign judgments not formally recognized in Québec provide prima facie proof of the reported facts and foreign law, the weight given to them is a matter to the trier of fact to decide in light of all of the evidence put before them. The SCC agreed with the lower courts that little or no weight ought to be given to an unenforceable foreign judgment that ignores relevant Canadian judgments or raises public order concerns, such as concluding that a party can disregard an order of an arbitral tribunal.
The SCC further observed that had Eurobank or GMOD sought to recognize and enforce the Greek judgments, the inconsistency of these judgments with the ICC arbitral tribunal’s orders and award might have been sufficient to deny their recognition and enforcement in Québec on the ground that they are “manifestly inconsistent with public order as understood in international relations” (art. 3155(5) of the Civil Code of Québec).
Implications and key takeaways
- Autonomy and strict compliance remain the fundamental principles governing on demand letters of credits. The SCC’s application of the fraud exception indicates that it is essential to balance these two principles with the policy objective of suppressing fraud in commercial transactions.
- The SCC decision is likely to have an impact on issuing banks’ decision-making process with respect to demands for payment under letters of credit. While the SCC clearly stated that banks are not required to inquire into the performance of the underlying contract before honouring a payment demand under a letter of credit, an increased level of scrutiny from banks is warranted. Banks should be mindful that honouring a demand for payment while knowing that the beneficiary has no right to be paid under the underlying contract may constitute fraud.
- The SCC ruling confirms the pro-arbitration stance of Canadian case law and demonstrates that Canadian courts will uphold and support the integrity of the international commercial arbitration system when necessary.
- The SCC decision also sends the message that international comity goes both ways. A Canadian court will be justified to give little or no weight to a foreign judgment that does not give due consideration to a Canadian decision or runs counter to the orders of international arbitral tribunals.
If you need more information, please reach out to any of the authors or key contacts below.
1 Eurobank Ergasias S.A. v. Bombardier inc., 2024 SCC 11.
