Okla. Stat. tit. 12A § 5-109
Okla. Stat. tit. 12A, § 5-109
Oklahoma Code Comment
Revised Section 5-109 continues the high drama of the "fraud" exceptions in LC transactions while clarifying former sub section 5-114(2) . The issuer may voluntarily invoke one of the fraud exceptions to dishonor even a presentment that on its face complies strictly with the LC's requirements. More typically, the applicant rushes to court seeking an injunction against either the issuer's honor of such a presentment or the beneficiary's draw, or both.
The fraud exception represents a departure from the golden principle that the LC is independent from all underlying dealings, whether between the beneficiary and the applicant or between the issuer and the applicant. When the fraud exception applies, but only then, it allows the issuer or a court to look behind the face of presented documents in suppressing honor. This departure is designed to be minimal and is necessary to cool the heels of an unscrupulous beneficiary willing to claim anything in presented papers so as to exact payment under the LC. If the issuer were always bound by the face of presented papers, even when seemingly clean in form but fouled by forgery or other fraud, then LCs could become so prone to abuse as to become useless. Courts thus have recognized the need for narrow fraud exceptions to the independence principle.
Revised Section 5-109 advances this need for narrowness by tightening considerably when and how the fraud exception applies, as compared with the loose formulations in former Section 5-114 . Where former sub section 5-114(2) spoke of excusing honor when "forged or fraudulent" documents were presented for a draw under the LC, revised Section 5-109 speaks of "forged or materially fraudulent" documents. The breadth and width of "materiality" necessarily will be left to the courts, but the statutory use of the word requires that the fraudulent aspect of a presented document be material to a purchaser of that document. For example, a one-ounce shortage where a required document must certify shipment of 10,000 pounds is unlikely to constitute "material" fraud.
Forgery continues to have its well understood meaning under both the former and revised sections. However, revised Section 5-108 provides that the true beneficiary is not prejudiced by a prior forged draw (subsection (i)(5)), and as a result, the applicant may be obligated to reimburse twice (subsection (i)(1)).
More importantly, revised Section 5-109 abandons the loose notion of "fraud in the transaction" in favor of the much tighter rule that if fraud is not found in the presented documents, then a material fraud must have been committed by the beneficiary on the issuer or the applicant. As Official Comment 1 points out, this "occurs only when the beneficiary has no colorable right to expect honor and where there is no basis in fact to support such a right to honor."
How revised Section 5-109 works can best be shown by walking through its two subsections in steps. Revised sub section 5-109(a) covers the issuer's ability to dishonor voluntarily for material fraud. Assuming the presented documents meet the test of strict compliance, the issuer's first step is to ask three questions: (1) Is a required document forged? (2) Is a required document materially fraudulent? (3) Would honor of the presentation facilitate a material fraud by the beneficiary on the issuer or applicant? If the answer is yes to any one or more of these questions, then the issuer's second step is to ask another question: Is the presenter a UCC "prince," essentially a person who has given value without notice of the forgery or material fraud? If the answer to this second question is yes, then the issuer has no choice but to honor despite the presence of fraud. However, when the presenter is not a UCC "prince," the issuer has a choice. The issuer may in good faith (tested by the issuer's honesty in fact) honor in the face of the applicant's claim of fraud, or the issuer may dishonor and defend the dishonor by showing forgery or material fraud.
Revised sub section 5-109(b) deals with a court's ability to enjoin the issuer's honor or the beneficiary's draw based on fraud grounds. The steps are similar. Assuming the test of strict compliance has been met or is about to be met, and the applicant has asked the court to enjoin the issuer's honor or the beneficiary's draw under the LC, the court's first step is to ask the same three questions asked by the issuer under subsection (a). If the answers all are no, then the court has no choice but to deny the injunction or similar relief requested. But if (and only if) the answer to one or more questions is yes, then the court must proceed to a second step.
In the second step, the court may grant an injunction to block the issuer's honor or the beneficiary's draw only if the court makes four findings: (a) the relief is not prohibited by the law governing accepted drafts or deferred obligations incurred by the issuer; (b) a beneficiary, issuer or nominated person who may be adversely affected is adequately protected (for example, through a bond or otherwise), (c) all conditions of local state law are met (for example, irreparable harm has been shown), and (d) on the basis of evidence submitted to the court, the applicant has at least a 51% probability of showing both the presence of forgery or material fraud and the absence of a UCC "prince" as the presenter. If the court is unable to make any one or more of these findings, then the court must decline to block the issuer's honor or beneficiary's draw under the LC.
The standard for injunctive relief is clarified from former Article 5 and is high under revised Section 5-109 . The burden remains on the applicant to establish a probability of success on the fraud claim. A "sliding scale" with the element of irreparability (as some courts seem to have employed) is not permitted. In short, as irreparable harm goes up, the need to establish fraud does not decline; the court must, as a matter of UCC Article 5 law, find that the applicant likely will win on the facts of forgery or material fraud.
Only a handful of cases exist on former sub section 5-114(2) , as enacted in Oklahoma. See, e.g., Centrifugal Casting Machine Co. v. American Bank & Trust Co., 966 F.2d 1348, 1352 n.5 (10th Cir.1992); Ward Petroleum Corp. v. FDIC, 903 F.2d 1297, 1300-01 (10th Cir.1990); Arbest Constr. Co. v. First Nat'l Bank & Trust Co., 777 F.2d 581, 584 n.3 (10th Cir.1985). These cases recognize the fraud exception as only a narrow departure from the independence principle governing LCs. Revised Section 5-109 thus goes hand in hand with these cases.
Prior Statutory Provisions:
15 Okla. Stat. § 406 (1910).