Letter of Credit. On the other hand, the OFAC letter stated, the Litigation License did authorize Plaintiffs to sue UBAF and "recover . . . from assets of UBAF not blocked . . . under the Executive Orders and implementing Regulations." Pls.' Ex. 46. Thus, by its terms and by OFAC's explanation, the Litigation License authorized "all transactions" by Plaintiffs necessary to recover against UBAF, with the one express exception that Plaintiffs were not authorized to recover from UBAF's blocked accounts. In other words, with this one key exception, the Litigation License removed all hurdles imposed by the Iraqi sanctions orders and regulations -- including, for example, its bans on contracts in support of Iraqi projects and on transfers of funds to Iraqi entities. The one question left unanswered by the Litigation License is whether recovery by Plaintiffs out of UBAF's non-Iraqi funds would constitute recovery out of blocked accounts.
Under the implementing regulations, "blocked account" and "blocked property" are defined as "any account or property in which the Government of Iraq has an interest." 31 C.F.R. § 575.301. "Government of Iraq" is defined to include instrumentalities of the Iraqi government, expressly including the Central Bank of Iraq (id. § 575.306(a)), and companies "substantially owned or controlled" by the Iraqi government (id. § 575.306(b)), which includes Al-Mansour, an Iraqi state enterprise. See Defendant's Statement of Undisputed Material Facts Pursuant to Rule 3(g), P 5. Thus, UBAF's argument reduces to the question: Does the Government of Iraq (including Al-Mansour and the Central Bank of Iraq) have an interest in whether Eaton and Semetex recover on the contract of confirmation against UBAF out of UBAF's non-Iraqi funds? In order to answer this question, it is necessary to address briefly the nature of documentary letters of credit.
2. Letters of Credit and the Independence Principle
Under New York law,
letters of credit are governed by N.Y. U.C.C. article 5. Article 5, however, provides that it is superseded by the Uniform Customs and Practice for Documentary Credits (the "UCP") promulgated by the International Chamber of Commerce, in cases where a letter of credit, by its terms or by agreement, course of dealing, or trade usage, is subject to the UCP. N.Y. U.C.C. § 5-102(4) (McKinney 1991). The UCP is not legislation or a treaty, but a compilation of internationally accepted commercial practices, which may be incorporated into the private law of a contract between parties. Alaska Textile Co. v. Chase Manhattan Bank, N.A., 982 F.2d 813, 816-17 (2d Cir. 1992). In this case, both the Letter of Credit and UBAF's confirmation Provide expressly that they are governed by the 1983 Revision of the UCP, ICC Pub. No. 400; thus, the UCP governs both of them. Id.; KMW Int'l v. Chase Manhattan Bank, N.A., 606 F.2d 10, 15 n.3 (2d Cir. 1979).
The basic letter-of-credit mechanism involves three or, as in this case, four parties: (1) the customer (or "account party"), who opens an account with (2) the issuing bank, which authorizes (3) the confirming bank to make payment to (4) the beneficiary, upon the beneficiary's presentation of certain documents specified in the letter of credit. See UCP art. 2 (1983); Alaska Textile, 982 F.2d at 815. In this case, the customer was Al-Mansour; the issuing bank was the Central Bank of Iraq; the confirming bank was UBAF; and the beneficiaries were intended to be Semetex and (under Semetex's assignment of proceeds) Eaton.
Employed frequently in international transactions, the letter of credit is a device whereby the customer and the beneficiary -- who are parties to an underlying contract (generally buyer and seller respectively) but face each other over a distance -- substitute the credit of the intermediate banks, one in the country of each party, for the buyer's credit. The device gives the seller (the beneficiary) immediate payment from a local bank upon shipment of the goods; merely by presenting to the confirming bank documents evidencing shipment of the ordered goods, the seller receives payment. See Alaska Textile, 982 F.2d at 815.
The central principle of letter-of-credit transactions is the so-called "independence principle": letters of credit, "by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s)." UCP art. 3; Alaska Textile, 982 F.2d at 815-16; Rockwell Int'l Systems, Inc. v. Citibank, N.A., 719 F.2d 583, 587 (2d Cir. 1983) (letters of credit "represent separate contractual undertakings that are, in legal contemplation, wholly distinct from whatever performance they ultimately secure"); Voest-Alpine Int'l Corp. v. Chase Manhattan Bank, N.A., 707 F.2d 680, 682 (2d Cir. 1983) (bank's obligation to the beneficiary "is primary, direct and completely independent of any claims which may arise in the underlying sale of goods transaction").
As is commonly noted, the parties to a letter-of-credit transaction "deal in documents, and not in goods, services and/or other performances to which the documents may relate." UCP art. 4; Alaska Textile, 982 F.2d at 815-16. Thus, the issuing or confirming bank must honor a proper demand even though the beneficiary has breached the underlying contract, Centrifugal Casting Machine Co. v. American Bank & Trust Co., 966 F.2d 1348, 1352 (10th Cir. 1992); even though the insolvency of the account party renders reimbursement impossible, Wood v. R.R. Donnelley & Sons Co., 888 F.2d 313, 318 (3d Cir. 1989); and notwithstanding supervening illegality, impossibility, war or insurrection, KMW, 606 F.2d at 16. This independence principle is universally viewed as essential to the proper functioning of letters of credit and to their particular value. Centrifugal, 966 F.2d at 1352. The central purpose of the letter-of-credit mechanism would be defeated if courts felt free to examine the merits of underlying contract disputes in order to determine whether letters of credit should be paid. Id.
3. Iraq's Interest in Plaintiffs' Recovery
This independence principle has been held dispositive of the issue before us by those few courts that have examined the issue. In the most comprehensive of these cases, Centrifugal Casting Machine Co. v. American Bank & Trust Co., 966 F.2d 1348 (10th Cir. 1992), the Tenth Circuit examined a somewhat similar fact pattern also arising out of the Iraqi Sanctions Regulations. Centrifugal involved the claim of an American company, Centrifugal Casting, to a $ 2.7 million downpayment on a $ 27 million letter of credit issued by the Central Bank of Iraq and confirmed by Banca Nazionale del Lavoro. Centrifugal drew on the $ 2.7 million downpayment and deposited it in a United States bank, American Bank of Tulsa, where it became the subject of litigation with regard to a related $ 2.7 million standby letter of credit issued as security for the downpayment amount. Following Iraq's invasion of Kuwait and the issuing of Executive Orders 12722 and 12724, the United States intervened, asserting that Iraq had a property interest in the downpayment. Id. at 1349-50.
The United States argued that the $ 2.7 million at issue was in effect a downpayment made by Iraq on a contract that Centrifugal did not then perform, and that accordingly, Iraq had a property interest in the asset on the basis of a purported breach-of-contract claim. Id. at 1351. Since Iraq had a property interest in the $ 2.7 million, the government argued, the money was blocked by the sanctions regulations. The court of appeals rejected this analysis as "directly contrary to the legal principles governing [letters of credit]." Id.
Centrifugal parallels the case before us in that both cases address the scope of Iraq's property interests under letters of credit. In Centrifugal, the Tenth Circuit concluded that Iraq did not have a property interest in the funds at issue because of the independence of the letter of credit from the contract underlying it. Id. at 1353. The court stated:
No authority supports the argument that Iraq, as the account party on a letter of credit [as Al-Mansour is in the case before us], has a property interest in the beneficiary's payment on the basis of the beneficiary's alleged breach of the underlying contract. To the contrary, such a holding would defeat the principle of independence universally recognized by the courts . . . . The beneficiary's bargained-for right to retain the payment pending contract litigation would be effectively defeated.
Id. The right the beneficiary bargained for, the court noted, is the right to be paid not by the account party, who might become insolvent or refuse to pay, but by the bank, out of the bank's own funds. Id. at 1352. Thus, Iraq's interest in restitution from the bank or from the beneficiary was entirely separate from the bank's obligation to pay the beneficiary, and accordingly Iraq had no property interest in the beneficiary's recovery from the bank.
The same conclusion was reached in the other decision in which this issue was raised, a decision which, interestingly, involved a claim by UBAF similar to the one it makes now before us. In Engel Industries, Inc. v. First American Bank, 803 F. Supp. 426 (D.D.C. 1992), as here, UBAF confirmed an Iraqi letter of credit for the benefit of an American company. The court noted that the letter of credit and the Iraqi collateral on deposit at UBAF were blocked property under the sanctions regulations. Id. at 427-28. The Engel court held, however, that "this determination does not prevent [the beneficiary] from getting a judgment against UBAF. UBAF Arab American Bank confirmed the letter of credit, meaning that it undertook liability in its own right." Id. at 428. The court therefore entered summary judgment against UBAF, requiring it to pay both the beneficiary and the beneficiary's assignee under its confirmation and assignment of proceeds of the Iraqi letter of credit.
We find the reasoning of both Centrifugal and Engel persuasive and UBAF's attempts to distinguish the cases unpersuasive, and accordingly we conclude that neither Al-Mansour nor the Central Bank of Iraq have a property interest in whether Eaton and Semetex recover on the contract of confirmation against UBAF out of UBAF's non-Iraqi funds. Accordingly, UBAF has failed to point to evidence sufficient to raise a triable issue regarding its Iraqi sanctions defense.
B. UBAF's Fraud Claim
Alternatively, UBAF invokes the fraud exception to the letter-of-credit independence principle. UBAF admits that the documents presented to it on August 1, 1990 complied on their face with the requirements of the Letter of Credit. Transcript of Proceedings of April 8, 1993, at 28. It contends, however, that the documents were in compliance only because Plaintiffs misrepresented the flight information on the air waybill and forged the signature of an Iraqi Airways representative. Alison noted flight dates of July 26 and 29 on the air waybill when it made its second drawing attempt on August 1, UBAF contends, even though Alison and Plaintiffs knew that the ion implanter had only been picked up by truck in Austin on July 31 and that it was not scheduled to reach JFK Airport until August 2. UBAF contends that these discrepancies rise to the level of "outright fraudulent practice" that is required under New York law to supersede the independence principle.
Plaintiffs contest this assertion. They argue as well that UBAF, by stating and then repeatedly reconfirming that Plaintiffs' documents complied with the Letter of Credit's requirements, and by joining Plaintiffs in their initial license application, waived its right to assert a fraud defense. As described below, we conclude that triable issues of fact remain about whether UBAF waived its fraud defense with full knowledge of the material facts. We conclude, however, that UBAF has failed to present evidence of fraudulent intent motivating the discrepancies in Plaintiffs' documents. Since UBAF does not contest that Semetex's transport documents complied on their face with the Letter of Credit's terms, UBAF's failure to raise triable issues regarding fraud is dispositive.
1. Whether UBAF Waived its Fraud Claim
Article 16 of the UCP codifies the waiver principle with respect to letters of credit. It provides that an issuing bank must examine documents presented under a letter of credit within a "reasonable time" to determine, "on the basis of the documents alone," whether they comply with the credit's terms or whether instead they "appear on their face not to be in accordance with the terms and conditions of the credit." UCP art. 16(b), (c). If the bank decides to refuse the documents, "it must give notice to that effect without delay," and must state the discrepancies in respect of which it refuses the documents. Id. art. 16(d). If the bank fails to act in accordance with these provisions, the bank "shall be precluded from claiming that the documents are not in accordance with the terms and conditions of the credit." Id. art. 16(e); Alaska Textile Co. v. Chase Manhattan Bank, N.A., 982 F.2d 813 (2d Cir. 1992); Bank of Cochin, Ltd. v. Manufacturers Hanover Trust Co., 808 F.2d 209 (2d Cir. 1986); Integrated Measurement Systems, Inc. v. International Commercial Bank, 757 F. Supp. 938, 946-48 (N.D. Ill. 1991); Kuntal, S.A. v. Bank of New York, 703 F. Supp. 312, 314 (S.D.N.Y. 1989); Habib Bank, Ltd. v. Convermat Corp., 145 Misc. 2d 980, 554 N.Y.S.2d 757, 758-59 (App. Term 1990).
UBAF responds, however, that article 16 applies only to nonconformance which appears on the face of presented documents, and so is inapplicable in cases such as this one where the beneficiary has allegedly falsified documents for the very purpose of making them conform to the terms of the letter of credit. See Prutscher v. Fidelity Int'l Bank, 502 F. Supp. 535, 537 (S.D.N.Y. 1980) (former UCP article 8 (now article 16) does not require confirming bank to make payment on a letter of credit when the documents presented were fraudulent). UBAF's reading adheres to the text of article 16, which requires that banks make their determination of compliance "on the basis of the documents alone." UCP art. 16(b). Additionally, it does not appear to be contravened by the case law; all of the cases cited above which applied article 16 concerned documents which contained facial discrepancies. Thus, we assume that UCP article 16 provides no relief to Plaintiffs, and we examine the question of UBAF's waiver in light of the New York law of waiver.
The Second Circuit has recognized that equitable waiver principles govern letter of credit transactions under New York law. See Alaska Textile Co. v. Chase Manhattan Bank, N.A., 982 F.2d 813 (2d Cir. 1992); Voest-Alpine Int'l Corp. v. Chase Manhattan Bank, N.A., 707 F.2d 680, 685 (2d Cir. 1983). "To establish waiver under New York law one must show that the party charged with waiver relinquished a right with both knowledge of the existence of the right and an intention to relinquish it." Alaska Textile, 982 F.2d at 820; Voest-Alpine, 707 F.2d at 685.
As an established commercial bank UBAF, we may assume, had constructive, if not actual, knowledge of its rights and obligations under letter-of-credit law. Voest-Alpine, 707 F.2d at 685. Additionally, at least since April or May 1991, when UBAF reviewed Plaintiffs' detailed statement of facts and responded with its own Confirmation Letter, UBAF was aware of the material facts concerning the shipment of the equipment and expressed a clear intention to support Plaintiffs' license application allowing Plaintiffs to draw payment on the Letter of Credit from UBAF's Iraqi accounts.
As described above (pp. 14-15), UBAF reviewed Plaintiffs' initial license application and issued a letter, dated May 7, 1991, confirming that Plaintiffs' August 1, 1990 "drawing request and documentation satisfy the terms of the Letter of Credit." Pls.' Ex. 31. UBAF then reviewed Plaintiffs' draft license application (Pls.' Ex. 28), including its detailed recitation of facts, and reconfirmed the application's accuracy as well as the accuracy of its earlier letter and joined Plaintiffs in their application. Pls.' Ex. 34. One month later, in June 1991, UBAF wrote OFAC concerning the license application. UBAF made no mention of fraud or any other objections to the application; it requested of OFAC only that it be allowed to satisfy its obligation to Plaintiffs out of its Iraqi collateral. Pls.' Ex. 36. Several months later, in an August 1991 letter to OFAC, UBAF expressly reconfirmed the accuracy of its earlier confirmation letter and once again expressed its concern that it be allowed to pay Plaintiffs out of its Iraqi collateral. It requested that OFAC "please note P 9 of the Letter in which [UBAF] confirms that the drawing request satisfies the [Letter of Credit]." Pls.' Ex. 37. It was not until after this lawsuit was filed that UBAF first raised the issue of fraud.
UBAF's actions, we conclude, are strongly at odds with an intention to stand upon its right to assert a fraud defense. See Voest-Alpine, 707 F.2d at 685. However, since our conclusion on the waiver issue is predicated on our substantive analysis of UBAF's fraud defense, we proceed to the merits of UBAF's claim of fraud.
2. "Outright Fraudulent Practice "
Fraud provides a well-established exception to the rule that banks must pay a beneficiary under a letter of credit when documents conforming on their face to the terms of the letter of credit are presented. See Rockwell Int'l Systems, Inc. v. Citibank, N.A., 719 F.2d 583 (2d Cir. 1983); KMW Int'l v. Chase Manhattan Bank, N.A., 606 F.2d 10, (2d Cir. 1979); Old Colony Trust Co. v. Lawyers' Title & Trust Co., 297 F. 152 (2d Cir.), cert. denied, 265 U.S. 585, 68 L. Ed. 1192, 44 S. Ct. 459 (1924); United Bank Ltd. v. Cambridge Sporting Goods Corp., 41 N.Y.2d 254, 392 N.Y.S.2d 265, 360 N.E.2d 943 (1976); Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup. Ct. 1941). The exception has been codified in New York U.C.C., which provides that an issuing bank may refuse to honor documents which "appear on their face to comply with the letter of credit terms" but for which "a required document . . . is forged or fraudulent or there is fraud in the transaction." N.Y. U.C.C. § 5-114(2) (McKinney 1991) (emphasis added). Although the UCP does not explicitly provide for a "fraud in the transaction" defense, New York law nevertheless recognizes the availability of this defense with regard to letters of credit governed by the UCP. Rockwell, 719 F.2d at 588; Cambridge Sporting Goods, 392 N.Y.S.2d at 269 n.2.
The fraud defense, however, is a narrow one. All Service Exportacao, Importacao Comercio, S.A. v. Banco Bamerindus do Brazil, S.A., 921 F.2d 32, 35 (2d Cir. 1990). The defense is available only where intentional fraud is shown, not where the party alleges improper performance or breach of warranty. Id. It does not apply, for example, to situations in which performance of the underlying contract has been interrupted by "supervening illegality, impossibility, war or insurrection." KMW, 606 F.2d at 16. Traditionally, it was restricted to situations in which the drafts presented under a letter of credit were forged or fraudulently procured, but the defense has gradually expanded. Cambridge Sporting Goods, 392 N.Y.S.2d at 270-71. As the Second Circuit stated in Rockwell:
The "fraud in the transaction" defense marks the limit of the generally accepted principle that a letter of credit is independent of whatever obligation it secures. No bright line separates the rule from the exception, to be sure, but . . . "fraud" embraces more than mere forgery of documents supporting a call. The logic of the fraud exception necessarily entails looking beyond supporting documents . . . . We must look to the circumstances surrounding the transaction and the call to determine whether [the] call amounted to an "outright fraudulent practice."