Sztejn v Henry Schroder Banking Corporation

The American case of Sztejn v Henry Schroder Banking Corporation²⁴⁰ had a significant effect on development of the Fraud rule in documentary letters of credits²⁴¹. It is considered a landmark judgment as it has been used in codification of the 1962 version of UCC as well as being basis for judgment in

237 Maurice O’Meara Co v National Park Bank of New York 146 NE 636 (1925) 641

238 Buckley RP & Gao X (2002) 675

239 Ibid

240 Sztejn v Henry Schroder Banking Corporation 31 NYS 2d 631 (1941)

241 Buckley RP & Gao X (2002) 676

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following cases of fraud in documentary credits inside and outside United States of America²⁴². According to Gao, “It shaped the fraud rule in ‘virtually all jurisdictions”.²⁴³

In case of Sztejn, underlying contract of sale was between Sztejn (buyer) and Transea Traders Ltd (seller). The payment was due under the letter of credit issued by Schroder by drawing a draft on the Chartered Bank (presenting bank). Sztejn asked for injunction before presentation of documents for payment on the basis of dispatching “cow hair, other worthless material and rubbish with intent to simulate genuine merchandise and defraud the plaintiff”²⁴⁴. Sztenjn also mentioned Chartered bank as colleting bank for Transea Trades not the holder in due course for the draft. However, Chartered Bank defended that the presenting bank “is only concerned with the documents and on their face these conform to the requirements of the letter of credit”²⁴⁵. In the course of hearing, all allegations of cases were considered as true by Justice Shientag who rejected the motion to dismiss the complaint of plaintiff by Chartered Bank based on two arguments: allegation that fraud has been commented and established fact that fraud has been committed in the underlying transaction. However, he started his statement by acknowledgment of the principle of autonomy:

"It is well established that a letter of credit is independent of the primary contract of sale between the buyer and the seller. The issuing bank agrees to pay upon presentation of documents, not goods .This rule is necessary to preserve the efficiency of the letter of credit as an instrument for the financing of trade”²⁴⁶

However, in continuation, he pointed at necessity for overruling the principle of autonomy in case of fraud:

"Of course, the application of this doctrine [the principle of independence] 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 actions. 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

242 In 1964 version of UUC fraud rule was under Article 5 section 5-114 but after revision of 1995 it is under Article 5, section 5-109.

243 Kelly-Louw M (2008) 179

244 Sztejn v Henry Schroder Banking Corporation 31 NYS 2d 631 (1941) 633

245 Ibid,632

246 Ibid

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fraud had 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 tinder the letter of credit should not be extended to protect the unscrupulous seller... Although our courts have used broad language to the effect that a letter of credit is independent of the primary contract between the buyer and seller, that language was used in cases concerning alleged breaches of warranty; no case has been brought to my attention on this point involving intentional fraud on the part of the seller which was brought to the bank’s notice with the request what it withhold payment of the draft on this account”³³⁸²⁴⁷

The Justice Sheintag held that motion of Chartered Bank for dismissing complaint of plaintiff is dismissed as well as injunction was granted to the Sztejn on the basis that:

"Transea was engaged in a scheme to defraud the plaintiff... that the merchandise shipped by Transea is worthless rubbish and that Chartered Bank is not an innocent holder of the draft for value but is merely attempting to procure payment of the draft for Transea's account"²⁴⁸. Apart from the beneficiary’s fraud, two other issues where discussed in the hearing²⁴⁹. First was bank’s security interest as one of the supporting reasons behind application of fraud rule. The Justice Shientag mentioned:

"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”.²⁵⁰. Second issue was exemption of the holder in due course from being subjected to the application of fraud rule.

"On this motion only the complaint is before me and I am bound by its allegation that the Chartered Bank is not a holder in due course but is a mere agent for collection for the account of the seller charged with fraud. Therefore, the Chartered Bank's motion to dismiss the complaint must be denied, if it had appeared from the face of the complaint that the bank presenting the draft for payment was a holder in due course, its claim against the bank issuing

247 Ibid 634-635

248 Ibid .633

249 Lu, Lu. "The Exceptions in Documentary Credits in English Law." (2011). 75

250 Sztejn v Henry Schroder Banking Corporation 31 NYS 2d 631 (1941) ,634-635

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the letter of credit would not be defeated even though the primary transaction was tainted with fraud."²⁵¹

Therefore, decision of Sztejn established the basic principles of the Fraud Rule which can be listed as below:²⁵²

1- The payment process and autonomy principle of the letters of credit can be superseded only in case of fraud. However, the fraud should be established and only allegations of fraud will not suffice for interruption of payment.

2- The payment to the holder in due course or presenter with similar status will not be interrupted even in case of established fraud.

However, it should not be forgotten that in cases of Sztejn all allegations were considered as fact and as a result issue of the standard of proof for fraud was left open to be one the most controversial issues in application of fraud rule in documentary letters of credits.²⁵³ On the basis of prevalent situation in the case, detailed issues relevant to the standard of proof for an established fraud in order to apply the fraud rule were not necessary to be discussed. Therefore, it is possible to conclude that “Shientag J was only making decision for Sztejn case where the fraud had been already proved from the beneficiary side and there was doubt about it”²⁵⁴.