1

Fraudunravelsall?Acriticalexaminationofthe

fraudrulesinmarineinsuranceanddocumentary

credittransactions.

KatieRichards

CardiffSchoolofLaw&Politics

CardiffUniversity

October2017

Thisthesisissubmittedinpartialfulfilmentoftherequirementsforthedegree

ofDoctorofPhilosophy.

2

3

Declarations

DECLARATION

This work has not been submitted in substance for any other degree or award at this or any other university or place of learning, nor is being submitted concurrently in candidature for any degree or other award. Signed ……………………………………… (candidate) Date ………………….…………….……… STATEMENT1

This thesis is being submitted in partial fulfillment of the requirements for the degree of PhD. Signed …………………………………………. (candidate) Date …………………………….…………… STATEMENT2

This thesis is the result of my own independent work/investigation, except where otherwise stated, and the thesis has not been edited by a third party beyond what is permitted by Cardiff University’s Policy on the Use of Third Party Editors by Research Degree Students. Other sources are acknowledged by explicit references. The views expressed are my own. Signed ……………………………………….… (candidate) Date …………………….………………… STATEMENT3

I hereby give consent for my thesis, if accepted, to be available online in the University’s Open Access repository and for inter-library loan, and for the title and summary to be made available to outside organisations. Signed ………………………………….…..….. (candidate) Date ………………………………………… STATEMENT4:PREVIOUSLYAPPROVEDBARONACCESS

I hereby give consent for my thesis, if accepted, to be available online in the University’s Open Access repository and for inter-library loans after expiry of a bar on access previously approved by the Academic Standards & Quality Committee. Signed ………………………………………… (candidate) Date ………………………………….………

4

Summary

Thisthesisconsiderstheextenttowhich‘fraudunravelsall’explainsthejudicialresponseto

fraudulent marine insurance claims and fraud in documentary credit transactions. The

simplicityofthemaximsuggeststhatfrauddoesnotundulytroublethecourtsandgivesthe

impressionofauniformanddeterrentapproachtofraudwithinthecivillaw.Thecomparison

madeinthisthesisdemonstratesthisimpressiontobemisleading;thecourtshaveconceived

offrauddifferentlyandhaveemployedcontext-specificpolicyconcernstojustifytheshape

of each fraud rule. The insurance discussions are dominated by deterrence with legal

sanctionsplacedattheheartofthemodel.Bycontrast,thetradefinancecourtsadoptamore

laissez-faireattitudewhichprioritisestheefficiencyofthecreditmechanismandconsiders

deterrenceanexanteissuefortheparties.Accordingly,thisthesisexaminestherespective

policy justifications and considers their continued validity in light of comparative and

empiricalevidence.Intheinsurancecontext,itisarguedthatthejudicialunderstandingof

deterrenceisoutdatedwhichrenderstheresultinglegalruleineffective.Anexaminationof

approachestofraudinotherjurisdictionsthendemonstratesthepossibilityofconstructinga

morenuancedremedialframeworkwhichwouldbalancethecompetingpolicyconsiderations

of deterrence and proportionality. The documentary credit discussion contends that the

narrow English approach to fraud is not an inevitable policy decision andmoreover, has

resultedindetrimentalconsequencesforthecreditmechanism.Itemploysempiricaldatato

developanexplanationofdeterrenceforthedurationofcredittransactions.Inbothcontexts,

these arguments have important implications for the future development of the law. In

summary, this research undermines the utility of ‘fraudunravels all’ and calls instead for

courts and academics to resist instinctively attractive solutions in favour of a robust,

empirically-informedapproachtofraud.

5

Acknowledgements

Thisthesis,andmydreamsofanacademiccareer,wouldnothavebeenpossiblewithoutthe

unwavering support, encouragement and generosity of my supervisors, Professor James

DaveyandDavidGlass.Ithasbeenaprivilegetoworkwiththembothoverthelastfouryears

andIhavebenefittedenormouslyfromtheirguidanceandknowledge.Aspecialthanksto

James who continued to supervisemy thesis despite moving to Southampton University

during theprocess.Thanksarealsodue toDrClionaKellywhoactedas internal reviewer

duringmyprojectandprovidedsupportandencouragementinpersonandviaTwitter!

IwasfortunatetoreceivetheShippingLawPhDStudentshipfromCardiffSchoolofLawand

Politics to finance my studies. Through the PhD I have met some wonderful friends, in

particularmyfellowtroglodytesDrKathyGriffiths,SteffanEvans,AlisonTarrant,DerekTilley

andChenZhangaswellasDrLloydBrown,DrSophieChambers,DrMatthewCole,DrRohit

RoyandDrDaveRiley(specialthanksforproofreading).ThefriendsIhavemadeoverthelast

twoyearsasalecturerinCardiff–DrSinéadAgnew,DrRachelCahill-O’Callaghan,DrAnnegret

Engel, Dr Tom Hayes, Dr Wendy Kennett, Jonathan Marsh, Annette Morris, Dr Ludivine

Petetin,DrBernieRainey,DrRussellSandberg,DrSteveSmith,DrSharonThompsonandDr

BekeZwingmann–havemadethe finalstagesof thePhDmorebearable,not tomention

caffeine-fuelled!IamfurtherindebtedtotheDirectorsofPGRStudiesthroughoutmytimeat

Cardiff–DrNickyPriaulx,DrPeriRobertsandAnnetteMorris–aswellastheextraordinary

postgraduate team Sharron Alldred, Helen Calvert, Hannah Huckson, Abby Jesnick, Sarah

KennedyandLydiaTaylor.

Finally, thanks are due to my parents, brother and friends for their support and their

willingnesstofeigninterestinshippinglawoverthelastfouryears.Ilookforwardtohaving

weekendsfreetospendwithyouall!

6

Contents

Summary 4

Acknowledgements 5

TableofCases 10

Legislation 17

FiguresandTables 18

ChapterOne 19

Introduction 19

I. JudicialConcernsaboutFraud 21

II. TheInsuranceContext 23

III. TheDocumentaryCreditContext 25

IV. AJustificationoftheComparison 28

V. TheAbsenceofPolicyDiscussion 29

VI. Methodology 34

VII. Originality 36

VIII. ChapterOutlines 37

IX. Conclusion 39

ChapterTwo 41

Insurance:ADoctrinalAnalysisoftheForfeitureRule 41

I. Introduction 41

II. TheInsuranceRelationship 43

III. InsuranceFraudStatistics 49

IV. IdentifyingtheAppropriateRemedy:ForfeitureorAvoidanceabinitio? 51

V. TheForfeitureRule 60

A. Thejuridicalbasisofforfeiture 61

B. Thepolicyrationalesofforfeiture 63

C. Theconceptionoffraud 69

D. Thestandardofproof 92

7

E. Thetemporallimit 95

VI. Conclusion 97

ChapterThree 101

Insurance:ACritiqueoftheJudicialResponsetoFraud 101

I. TheDeterrenceCritique 102

A. Economicanalysisofcrime:Rationalchoicetheory 103

B. Theapplicabilityoftheframework 109

C. Analternativeaccountoflegalsanctions:Moderndeterrencetheory 111

D. ModerndeterrencetheoryandtheSupremeCourt 124

E. Aligningdeterrentswithmoderndeterrencetheory 127

II. TheAbsenceofanEffectiveLegalRemedyforWhollyFraudulentClaims 131

III. TheVulnerabilityofModernUnderwriters? 136

IV. AProportionateApproachtoDeterrence 143

A. Balancingdeterrenceandproportionalityinstatute:TheAustralianInsuranceContractsAct1984andtheEnglishCriminalJusticeandCourtsAct2015 145

B. Balancingdeterrenceandproportionalityinmandatoryguidelines:Englishcriminallaw153

C. Theeconomicargumentinfavourofproportionality 154

V. Conclusion 156

ChapterFour 159

DocumentaryCredits:ADoctrinalAnalysisoftheFraudException 159

I. Introduction 159

A. Therisksofinternationaltrade 160

B. Independentguarantees:Performancebondsandstandbylettersofcredit 164

II. TheDocumentaryCreditMechanism:ANetworkofContracts 166

A. Thelawgoverningdocumentarycredits 168

B. Autonomyandstrictcompliance 170

8

III. TheFraudException 177

A. Settingthescene:Judicialconceptionsoffraud 178

B. Circumstancesinwhichthefraudexceptionisrelevant 182

C. Thejuridicalbasisoftheexception 185

D. Criteria 193

E. Standardsofproof 208

F. Theinjunction 211

IV. Conclusion 216

ChapterFive 219

DocumentaryCredits:ACritiqueoftheJudicialResponsetoFraud 219

I. TheAmericanApproachtoFraud 221

A. ConceptionoffraudintheUnitedStates 222

B. Standardofmateriality 227

C. Availabilityofinjunctions 228

II. ACriticalAnalysisofUnitedCityMerchants 233

A. AcritiqueofthereasoninginUnitedCityMerchants 233

B. Analternativeanalysis 238

C. TheunintendedconsequencesofthereasoninginUnitedCityMerchants 242

III. TheEmpiricalCritique 258

A. Theempiricalwork 259

B. Empiricalevidenceofdocumentarycredits:Implicationsforfraud 272

IV. Conclusion 287

ChapterSix 291

Conclusion 291

I. Introduction 291

II. Insurance 292

A. Thejudicialresponsetoinsuranceclaimsfraud 292

B. Thecritiqueofthejudicialresponsetofraud 294

9

C. Lookingforward 299

III. DocumentaryCredits 302

A. Thejudicialresponsetofraud 303

B. Thecritiqueofthejudicialresponsetofraud 304

C. Lookingforward 312

IV. ConcludingReflections 314

Bibliography 319

10

TableofCases

EnglishCaseLaw

PillansvvanMierop(1765)97EngRep1035CartervBoehm(1766)97EngRep1162VallejovWheeler(1774)1Cowp143HolmanvJohnson1Cowp342(1775)PawsonvWatson(1778)2Cowp.785LickbarrowvMason100ER35(1787)MastervMiller(1791)4TR320ThurtellvBeaumont(1823)1Bing339.RobinsonvHarman154ER363(1848)GoulstonevTheRoyalInsuranceCo(1858)1F&F276.LosebyvPriceTheExpress,17August1866(GuildfordAssizes).BrittonvRoyalInsurance(1866)4F&F905.MeyersteinvBarber(1866-67)LR2CP38.BarbervMeyerstein(1869-70)LR4HL317.ChapmanvPole(1870)22LT306.LishmanvNorthernMaritime(1875)LR10CP179.RedgravevHurd(1881)20ChD1.GlynMillsCurrie&CovEastandWestIndiaDockCo(1882)7AppCas591.SandersvMaclean(1883)11QBD327.CastellainvPreston(1883)11QBD380.EdgingtonvFitzmaurice(1888)29ChDiv459.DerryvPeek[1889]14AppCas337.ReHampshireLand[1896]2Ch743.PrudentialInsurancevIRC[1904]2KB658.SPearson&SonLtdvDublinCorp[1907]AC351,LloydvGraceSmith[1912]AC715.ArnholdKarberg&CovBlythe,Green,Jourdain&Co[1916]1KB495.ElfieAIssaiasvMarineInsuranceCoLtd(1923)15LlLRep186.PSamuel&CovDumas(1924)18LlLRep211.MacauravNorthernAssuranceCompany[1925]AC619.GuarantyTrustCoofNewYorkvVandenBerghs(1925)22LlLRep112.EquitableTrustCoofNewYorkvDawsonPartnersLtd(1926)27LlLRep49.LekvMathews[1927]LlLRep141.JamesFinlay&CovKwikHooTong[1929]1KB400.WisenthalvWorldAuxiliaryInsuranceCorporation(1930)38LlLRep54.ArcosvEARonaasenandSon[1933]AC470.LondonAssurancevClare[1937]57LlLRep254.ShirlawvSouthernFoundries(1926)Ltd[1939]2KB206.BaxendalevFane(TheLapwing)(1940)P112.JHRaynervHambro’sBank[1942]1KB37.TransTrustSPRLvDanubiaTradingCo[1952]2QB297.

11

KweiTekChaovBritishTraders&ShippersLtd[1954]2QB459.LazarusEstatesLtdvBeasley[1956]1QB702.HornalvNeubergerProductsLtd[1957]1QB247.HamzehMalas&SonsvBritishImexIndustries[1958]2QB127.CompaniaNavieraSantivIndemnityMarineAssuranceCompany(TheTropaoiforos)[1960]2Lloyd’sRep.469.SlatteryvMance[1962]1QB676.ChandrisvArgoInsuranceCoLtd[1963]2Lloyd’sRep65.InreDellow’sWillTrusts[1964]1WLR451.DoylevOlby(Ironmongers)Ltd[1969]2QB158.PanchaudFrèresSAvEtablissementsGeneralGrainCo[1970]1Lloyd’sRep.53.BroomevCassell[1972]AC1027.WJAlan&CoLtdvElNasrExportandImportCo[1972]2QB189.AstrovlanisCompaniaNavieravLinard(TheGoldSky)[1972]2Lloyd’sRep.187.BankRusso-Iranv.GordonWoodroffe&Co.Ltd.(3October1972,QBD)(notedbyWilliams,LN.,(1972)116SolJo921).SpectorvAgeda[1973]Ch.30.Hindley&CovEastIndianProduceCo[1973]2Lloyd’sRep.515.GianSinghvBanquedel’Indochine[1974]2Lloyd’sRep.1.AmericanCynamidCovEthicon[1975]AC396.DiscountRecordsvBarclaysBank[1975]1WLR315.CompaniaMaritimaSanBasilioSAvOceanusMutualUnderwritingAssociation(Bermuda)Ltd(TheEurysthenes)[1976]3AllER243.RDHarbottle(Mercantile)LtdvNatWestBankLtd[1978]QB146.LiverpoolCityCouncilvIrwin[1977]AC239.EdwardOwenEngineeringvBarclaysBankInternationalLtd.[1978]QB159.HoweRichardsonScaleCoLtdvPolimex-Cekop[1978]1Lloyd’sRep.161.UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1979]1Lloyd’sRep.267.EtablissementEsefkavCentralBankofNigeria[1979]1Lloyd'sRep445.UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1981]1Lloyd’sRep.604;[1982]QB208.IntracoLtdvNotisShippingCorp(TheBhojaTrader)[1981]2Lloyd’sRep.256.PowerCurbervBankofKuwait[1981]2Lloyd’sRep.394.UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]2Lloyd’sRep.1;[1983]AC168.ZLtdvA-Z[1982]QB558.BolivinterOilSAvChaseManhattanBank[1984]1Lloyd’sRep.251.Gill&DuffusSAvBerger&CoInc[1984]AC382.Black King Shipping Corporation andWayang (Panama) S.A. v.Mark RanaldMassie (TheLitsionPride)[1985]1Lloyd’sRep.437.UnitedTradingCorporationvAlliedArabBankLtd[1985]2Lloyd'sRep554.GKNContractorsvLloyd’sBank(1985)30BLR48.TukanTimbervBarclaysBank[1987]1Lloyd’sRep.171.ThePresidentofIndiavLipsMaritimeCorporation(TheLips)[1988]AC395.Proctor&GamblevBecherGmbH[1988]1Lloyd’sRep.88.

12

SchiffshypothekenbankzuLuebeckAGvCompton (TheAlexionHope) [1988]1Lloyd’sRep311.RhesaShippingCoSAvHerbertDavidEdmundsRhesaShippingCoSAvFentonInsuranceCo(ThePopiM)[1988]2Lloyd’sRep.1.FirmaC-TradeSAvNewcastleProtectionandIndemnityAssn(TheFantiandThePadreIsland)(No2)[1991]2AC1.BankersTrustCovStateBankofIndia[1991]2Lloyd'sRep443.RafsanjanPistachioProducersCooperativevBankLeumi[1992]1Lloyd’sRep.513.TheFutureExpress[1993]2Lloyd’sRep.542.DiggensvSunAlliance[1994]CLC1146.PanAtlanticInsuranceCoLtdvPineTopInsuranceCoLtd[1995]1AC501.National JusticeCompaniavPrudentialAssuranceCo (The IkarianReefer) [1995]1Lloyd’sRep.455.GroupJosiRevWalbrook[1995]1WLR1017.GroupJosiRevWalbrookInsuranceCoLtd[1996]1Lloyd’sRep.345.GlencoreInternationalAGvBankofChina[1996]1Lloyd’sRep.135ThemehelpLtdvWest[1996]QB84TurkiyeIsBankasiASvBankofChina[1996]2Lloyd’sRep.611ReH(Minors)[1996]AC563.TransthenePackingCoLtdvRoyalInsurance(UK)Ltd[1996]Lloyd’sRep.LR32.SmithNewCourtSecuritiesLtdvCitibankNA[1997]AC254.InsuranceCorporationoftheChannelIslandsvMcHugh[1997]1LRLR94.RoyalBoskalisWestminsterBVvMountain[1997]LRLR523.EconomidesvCommercialUnionAssurance[1998]1Lloyd’sRep.IR9.StandardCharteredBankvPakistanNationalShippingCorp.[1998]1Lloyd’sRep.684.CargillInternationalvBangladeshiSugar&FoodIndustriesCorp[1998]1WLR461.NsubugavCommercialUnionAssurance[1998]2Lloyd’sRep.682.KvaernerJohnBrownLtdvMidlandBankplc[1998]CLC446.OrakpovBarclaysInsuranceServices[1999]LRLR443.SprungvRoyalInsurance(UK)Ltd[1999]1Lloyd’sRep.IR111.GallowayvGuardianRoyalExchange(UK)Ltd[1999]Lloyd’sRep.IR209.Czarnikow-RiondavStandardBank[1999]2Lloyd’sRep.187.KredietbankAntwerpvMidlandBank[1999]CLC1108.BancoSantanderSAvBayfernLtd.[1999]CLC1321.BirkettvAcornBusinessMachinesLtd[1999]2AllERComm429.CreditAgricolevGeneraleBank[1999]2AllERComm1009.BalfourBeattyCivilEngineeringvTechnical&GeneralGuaranteeCoLtd[2000]CLC252.Motis Exports Ltd v Dampskibsselskabet AF 1912 Aktieselskab andAktieselskabetDampskibsselskabetSvendborg[2000]1Lloyd’sRep.211.StandardCharteredBankvPakistanNationalShippingCorp[2000]1Lloyd’sRep.218.StandardCharteredBankvPakistanNationalShippingCorp.(No.2)[2000]2Lloyd’sRep.511.SafavBanqueduCaire[2000]2Lloyd’sRep.600.K/SMerc-ScandiaXXXXIIvCertainLloyd’sUnderwriters(TheMercandianContinent)[2001]EWCACiv1275;[2001]2Lloyd’sRep.563.SoloIndustriesvCanaraBank[2001]2Lloyd’sRep.578.MontrodLtdvGrundkötterFleischvertreibsGmbH[2002]1WLR1975.DirectLineInsurancevKhan[2002]1Lloyd’sRep.IR364.

13

NiruBatteryManufacturingvMilestoneTradingLtd(No.1)[2002]2AllER(Comm)705.GanInsuranceCoLtdvTaiPingInsuranceCoLtd[2002]EWCACiv248,[2002]CLC870.TwinsectraLtdvYardley[2002]2AC164.ManifestShippingCoLtdvUni-PolarisCoLtd(TheStarSea)[2003]1AC469. SecretaryofStatefortheHomeDepartmentvRehman[2003]1AC153.SiriusInsuranceCovFAIGeneralInsuranceLtd[2003]EWCACiv470;[2003]1WLR2214.WilsonvFirstCountyTrustLtd(No2)[2003]UKHL40;[2004]AC816.StandardCharteredBankvPakistanNationalShippingCorp.(Nos.2and4)[2003]1AC959.AgapitosvAgnew(TheAegeon)[2003]QB556.KomercniBankavStone&Rolls[2003]1Lloyd’sRep.383.HIHCasualty&GeneralInsurancevChaseManhattan[2003]2Lloyd’sRep.61.MahoniavJPMorganChaseBank(No1)[2003]2Lloyd’sRep.911.BrothertonvAseguradoraColsegurosSA[2003]Lloyd’sRep.IR746.GlencoreLtdvAlpinaInsurance[2003]EWHC2792(Comm).MahoniaLtdvJPMorganChaseBankandWestLB[2004]AllER(D)10.EagleStarInsuranceCoLtd.VGamesVideoCoSA(TheGameBoy)[2004]EWHC15(Comm),[2004]1Lloyd’sRep.238.InterpartCommerciaoeGestaoSAvLexingtonInsuranceCo[2004]Lloyd’sRepIR690.AxaGeneralInsuranceLtdvGottlieb[2005]EWCACiv112;[2005]Lloyd’sRep.IR369.MarcRichAgricultureTradingSAvFortisCorporateInsuranceNV[2005]Lloyd’sRep.IR396.MicroDesignGroupLtdvNorwichUnionInsuranceLtd[2005]EWHC3093(TCC).TradigrainSAvStateTradingCorporationofIndia[2006]1Lloyd’sRep.216.DanepointLtdvUnderwritingInsuranceLtd[2006]Lloyd’sRep.IR429.StemsonvAMPGeneralInsurance(NZ)Ltd[2006]Lloyd’sRep.IR852.R(N)vMentalHealthReviewTribunal(NorthernRegion)[2006]QB468.JacksonvMinistryofDefence[2006]EWCACiv46.GoldenStraightCorporationvNipponYKK(The“GoldenVictory”)[2007]UKHL12.TonkinvUKInsurance[2006]EWCA1120(TCC),[2007]Lloyd’sRepIR283.PermasteelisaJapanKKvBougesstroiBancaIntesaSpA[2007]EWHC3508(QB).MarconiCommunicationsInternationalvPTPanIndonesiaBank[2007]2Lloyd’sRep.72.KhanvHussain(16May2007,HuddersfieldCountyCourt).ReB(Children)(CareProceedings:StandardofProof)[2008]UKHL35[2009]AC11.DCDFactorsplcvRamadaTradingLtd[2008]BusLR654.AttorneyGeneralofBelizevBelizeTelecom[2009]1WLR1988.ZahoorvMasood[2009]EWCACiv650,[2010]1WLR746.TempletonInsuranceLtdvMotorcareWarrantiesLtd[2010]EWHC3113(Comm)Ul-haqvShah[2010]1WLR616.LiverpoolVictoriavGhadhda(30June2010,CentralLondonCountyCourt).AxaGeneralInsuranceLtdvTheLordAdvocate[2011]UKSC46;[2012]1AC868.YeganehvZurichPlc.[2011]EWCACiv398,[2011]Lloyd’sRep.IR540.JosephFieldingProperties(Blackpool)LtdvAvivaInsuranceLtd[2011]Lloyd’sRep.IR238.FortisBankSA/NVvIndianOverseasBank[2011]EWCACiv58,[2011]2Lloyd’sRep.33.FaircloughHomesvSummers[2012]UKSC26.AvivaInsuranceLtdvBrown[2012]1Lloyd’sRep.IR211.ParkervNFUMutual InsuranceSociety [2012]EWHC2156(Comm), [2013]Lloyd’sRep. IR253.LiverpoolVictoriaInsuranceCoLtdvBashir[2012]EWHC895(Admin).

14

FarivHomesforHaringey(CountyCourt(CentralLondon)9October2012).Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB), [2013] 1Lloyd’sRep.526.VerslootDredgingBVvHDI-GerlingIndustrieVersicherungAg(TheDCMerwestone)[2013]EWHC1666(Comm),[2013]Lloyd’sRep.IR582.BatesvAviva[2013]EWHC1687(Comm),[2013]Lloyd’sRep.IR492.HussainvHussain[2013]RTR11.ScullionvRoyalBankofScotland(CountyCourt(Exeter)24May2013).PlanavFirstCapitalEast(CountyCourt(London)15August2013).TasneemvMorley(30September2013,CentralLondonCountyCourt).BeaconInsuranceCompanyLtdvMaharajBookstoreLtd[2014]UKPC21.BarnesvTheEastendersGroup[2014]UKSC26;[2014]Lloyd’sRepFC461;[2015]AC1.SavashvCISGeneralInsurance[2014]EWHC375(TCC),[2014]Lloyd’sRep.IR471.AlternativePowerSolutionLtdvCentralElectricityBoard[2014]UKPC31.GoslingvHailo,ScrewfixDirect2014WL3002771(29/04/2014).MandaliavBeaufortDedicatedNo.2Ltd[2014]EWHC4039(QB).Royal&SunAllianceInsuranceCovFahad[2014]EWHC4480(QB).VerslootDredgingBVvHDI-GerlingIndustrieVersicherungAG(TheDCMerwestone)[2014]EWCACiv1349;[2015]1Lloyd’sRep32.CavendishSquareHoldingsBVvTalalElMakdessi;ParkingEyeLimitedvBeavis[2015]UKSC67.Marks&SpencerplcvBNPParibasSecuritiesServiceTrustCo(Jersey)Ltd[2015]UKSC72.Atlasnavios-Navegação LDA v Navigators Insurance Co Ltd (The B Atlantic) (No 2) [2014]EWHC4133(Comm),[2015]1Lloyd’sRep.IR151.SuezFortuneInvestmentsLtdvTalbotUnderwritingLtd(TheBrillianteVirtuoso)[2015]EWHC42(Comm),[2015]Lloyd’sRep.IR388.BeachviewAviationLtdvAxaInsuranceLtd[2015]NIQB106.Zimi v London Central Bus Co 2015WL 1472528 (8 January 2015, County Court (CentralLondon))ChurchillInsurancevShajahan(11September2015,BirminghamCountyCourt).VasilevPopLoan(17November2015,WillesdenCountyCourt).VerslootDredgingBVvHDIGerlingIndustrieVersichering(TheDCMerwestone)[2016]UKSC45HaywardvZurichInsuranceCompanyplc[2016]UKSC48.NationalInfrastructureDevelopmentCompanyLtdvBancoSantanderSA[2016]EWHC2990(Comm).HanifvPatel[2016](CountyCourt(Manchester)11May2016).MenaEnergyDMCCvHascolPetroleumLtd[2017]EWHC262(Comm);[2017]1Lloyd’sRep.607.ForeignCaseLaw

Australia

GREInsurancevOrmsby(1982)29SASR498.EntwellsPtyLtdvNationalandGeneralInsuranceCoLtd(1991)6WAR68.BachmannPtyLtdvBHPPowerNewZealandLtd[1999]1VR420.

15

TiepThiThovAustralianAssociatedMotorInsurersLtd[2001]VSCA48.RicciardivSuncorpMetwayInsurance[2001]QCA190.SgrovAustralianAssociatedMotorInsurers[2015]NSWCA262.Canada

BankofNovaScotiavAngelica-Whitewear[1987]1RCS59HallvHerbert[1993]2SCR159EuropeanCourtofHumanRights

JamesvUK(1986)8EHRR123Singapore

LambiasvHSBC[1993]2SLR751.BeamTechnology(MfG)PteLtdvStandardCharteredBank[2002]SGCA53.USA

OldColonyTrustCovLawyers’Title&TrustCo297F152(1924).MauriceO’MearavNationalParkBank146NE636(NYCtApp,1925).SztejnvSchroderBankingCorp177Misc.719(NYMisc1941).AsburyPark&OceanCoveBankvNationalCityBank35NYS2d985(SupCt1942).UnitedStatesvCarrollTowingCo.159F.2d169(2dCir.1947).CommissionerofInternalRevenuevTreganowan,183F2d288,291(2Cir,1950).DynamicsCorpofAmericavCitizens&SouthernNationalBank(1973)356FSupp991.NMCEnterprisesInc,vColumbiaBroadcastingSysInc.14UCCRep.Serv.1427(Sup.Ct.NYCounty1974).UnitedBankLtdvCambridgeSportingGoodsCorp.392NYS2d265(NY1976).ShaffervBrooklynParkGardenApartments250NW2d172(1977).O’GradyvFirstUnionNationalBank296NsC212,250SE2d587(1978).Stromberg-CarlsonCorpvBankMelli467FSupp530(SDNY1979).SideriusvWallace583SW2d852(Tex.Civ.App.,1979).ItekvFirstNationalBankofBoston511FSupp.1341(D.Mass1981).HarrisCorpvNationalIranianRadioandTelevision(1982)691F2d1344.LarsonvFirstInterstateBankofArizonaNA603FSupp467(DAriz1983).AmericanNationalBank&TrustCo.vHamiltonIndustriesInc.583FSupp164(NDIII1984).PaccarInternationalInc.vCommercialBankofKuwait587F.Supp783(CDCal.1984).FoxboroCovArabianAmericanOilCo805F2d34(1stCir.1986).LongobardivChubbInsCo560A2d68,83(NJ,1989).RegentCorpvInternationalInv&CommerceBankLtd686NYS2d24(AppDiv1999).Mid-AmericaTireInc.vPTZTrading768NE2d619(Ohio2002).HendricksvBankofAmerica398F.3d1165(9thCir,2005).LangleyvPrudentialMortgage64UCCRepServ.2d(West661,667)(EDKy,2007).

16

DragovHolidayIsle537FSupp2d1219,1222(SDAla2007).JamesonvPineHillNo.07-0111-WSB,2007WL623807(SDAlaFeb23,2007).

17

Legislation

EnglishLegislation

BillsofExchangeAct1882MarineInsuranceAct1906LawReform(MiscellaneousProvisions)Act1934MisrepresentationAct1967SeniorCourtsAct1981CarriageofGoodsbySeaAct1992Contracts(RightsofThirdParties)Act1999FraudAct2006ConsumerInsurance(DisclosureandRepresentations)Act2012CriminalJusticeandCourtsAct2015InsuranceAct2015EnterpriseAct2016CivilProcedureRulesForeignLegislation

UniformCommercialCodeArticle5(1962)(USA)InsuranceContractsAct1984(Australia)UniformCommercialCodeArticle5(1995Revision)(USA)InsuranceContractsAmendmentAct2013(Australia)InternationalInstruments

ICC, ‘The Uniform Customs and Practice for Documentary Credits’ (2007 Revision, ICCPublicationno.600)ICC,InternationalStandardBankingPractice681(2007Revision,ICCPublicationno.681)InternationalHullClauses(01/11/03)ICC, ‘The Uniform Customs and Practice for Documentary Credits’ (1993 Revision, ICCPublicationno.500)InstituteTimeClauses–Hulls(01/10/83).RomeConventionontheLawapplicabletoContractualObligations1980.

18

FiguresandTables

Figure1:Atypicalletterofcredittransaction 166

Table1:Exturpicausaasjuridicalbasis 188

Table2:Exturpicausaandimpliedtermanalysis 193

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ChapterOne

Introduction

Thephrase ‘fraudunravelsall’ isa simpleone. It isoftenespousedby thecourtswithout

furtherexaminationorexplanation.Themaximispresentedassufficienttodisposeofclaims

tainted by fraud. It hints at a singular judicial and perhaps punitive approach to fraud. It

furthersuggeststhattheeffectoffraudisidentical–anunravellingeffectonthetransaction

towhichthefraudrelates.

Indeed, this notion of simplicity is the starting point for MacDonald Eggers’ excellent

monograph on deceit, inwhich he commences by describing rules on fraud as a singular

entity,underpinnedbyasharedrationaleandpurpose,

Theexistenceandformulationofaparticularruleoflawmayhaveitsgenesisinutility,

certainty,orfairness.Thelawconcerningfraudanddeceit,attestedtobysuchancient

advocatesasHyperides,AristotleandCicero,isunderpinnedbyourmoraldutytotell

thetruthandthesocialandcommercialnecessityofdeterringuntruthsdrawingthe

innocenttotheirharm.1

InRegulatingContracts,ProfessorCollinsmakesasimilarpointandhighlightsthecommercial

consequencesofdeceit,“rulesagainstfraudandmisrepresentation…servetodeterlyingand

thesupplyofmisleadinginformation,practiceswhichwouldunderminethecompetitiveness

ofthemarketandreducetrust.”2

Takentogetherthiswouldsuggestthatfraudrulesareviewedashavingauniformpurpose–

thedeterrenceoffraud–whichemergesfrommoralconcernsabout,andthecommercial

impact,ofdishonesty.Furthermore,thissuggeststhatfraudhasasimilareffect;tounravel

theentiretyofthetransactiontowhichthefraudrelates.

Acloserlooksuggeststhisimpressionmaybefalse.Foronething,theunravellingeffectof

fraudmaynotbesolelydependentontheexistenceoffraudbutalsoonthesatisfactionof

other criteria. Thus, the extent towhich fraud unravels transactionsmay depend on the

1PMacDonaldEggers,Deceit:TheLieoftheLaw(InformaLaw,2009),[1.4].2HCollins,RegulatingContracts(OUP,1999)75.

20

particularcontextinwhichtheruleoperates.Foranother,fraudrulesarevariouslydescribed

bythecourts. Incertaincontexts, fraudrulesarecharacterisedasservingan instrumental

roleforthebroadersocietalgood.Inothercontexts,theflexibilityofthefraudrulemaybe

constrainedbytheparticularidiosyncrasiesofthemechanismtowhichitrelates.Thiswillin

turnconstraintherule’spotentialasaninstrumentofsocialutilityasthecourtsimultaneously

giveseffecttocompetingpolicyobjectives.

Thesimplisticmaximmaythereforenotbesufficienttoexplainwhatisgoingonwhenthe

courtsarefacedwithfraud.Thisthesisbeginstoaddressthisgapbyexploringtheeffectof

fraudintwodistinctbutrelatedareas;fraudulentinsuranceclaimsandfraudintransactions

financedbydocumentarycredit.Aconsiderationof theutilityof ‘fraudunravelsall’asan

explanationofjudicialactionwilldemonstratethattheinsuranceandtradefinancecourts

have conceptualised fraud in different ways. The justification for these particular

characterisationsdependonassertionswhichhavebeenrepeatedlyendorsedincaselawbut

areyettobecriticallyexamined.Thisprojectaddressesthisgapbysubjectingthejustification

forthescopeofeachruleandrespectivejudicialcharacterisationtocritique.

Thisthesis isnotacallforallrulesonfraudtobeidentical inallcontexts. Instead, it isan

attempttounderstandthecontextualdifferenceswhichcallforfraudtobethoughtofand

treateddifferently.WhilemaximsexpressedinLatinmaybepithy,theyfailtorecognisethe

nuance,andthereasonsforthatnuance,whichexistinrealityandagainstthebackdropof

thepiecemealcommonlawsystem.Thereisnoconceptualdifficultywiththelawresponding

to fraud in different ways across areas of law, provided there is a minimum level of

interventiononpublicpolicygrounds.3

This chapter introduces theproject andundertakes severalpractical tasks. Thediscussion

opensbyhighlightingjudicialconcernsaboutcommercialfraud(I).Itthenprovidesasketch

ofhowfraudarisesand is litigated inmarine insurance(II)andwithindocumentarycredit

transactions(III).PartIVjustifiesthecomparisonbetweentheseareasoflawanddefinesthe

3 See P Todd, ‘Non-genuine shipping documents and nullities’ [2008] LMCLQ 547, 550 where Lord Diplock’selaborationof the fraudexception fordocumentarycredits isdescribedas follows:“accepting,albeitwithnotobviousenthusiasm,thattheautonomyprinciplemustgivewaytothegeneralruleofpublicpolicy,exturpicausa.”

21

researchquestionsaddressedinthisproject.Themajorargumentisthatpolicyconsiderations

usedtojustifylegalrulesmustbecriticallyexaminedtoassesstheir(continuing)validity.Part

V, therefore, places the project in context by demonstrating the current absence of

consideredpolicydiscussionintheseareas.Theremainingsectionsoutlinethemethodology

(VI)andthewaysinwhichthethesismeetstherequirementoforiginality(VII).Asummaryof

eachforthcomingchapterisprovidedinpartVIII.

I. JudicialConcernsaboutFraudIt is unsurprising that the courts have repeatedly expressed concerns about fraud in the

commercialarena.4ThesestatementscanbetracedtothetimeofLordMansfield,thekey

eighteenthcenturyarchitectofthecommerciallaw,inPawsonvWatson.5Therehesaidthat

fraud,onceproven,“vitiatesjudgments,contractsandalltransactionswhatsoever.”6These

ideashavebeenendorsedinmoderncaselawbytheCourtofAppeal7and,morerecently,by

theHouseofLords.8

Judicial intervention in cases of fraud primarily responds to moral concerns about

dishonesty.9Insomecases,interventionwillconsistofarefusaltobecomeembroiledinthe

disputeathandforfearofsullyingthecourt’sintegrity.10Inthecasewhichestablishedthe

defenceofillegality,HolmanvJohnson,LordMansfieldremarkedthatthecourtwouldnot

lend“itsaidtoamanwhofoundshiscauseofactionuponanimmoraloranillegalact.”11In

othercircumstances,thecourtswilltakemoreovertstepstopreventthefraudsterprofiting

fromhiswrongdoing.Thismaymean that thecommon lawrule resemblesanattempt to

sanctionorpunishthewrongdoer.Inthesecases,thecourtwillnotbeswayedbyarguments

that the claimant in somewaycontributed tohis loss. TheCourtofAppealhave recently

summarisedthisapproachinthefollowingterms,“highwaymenincommerceforfeittheright

4JDolan,TheLawofLettersofCreditCommercialandStandbyCredits(4thed.ASPratt&Sons,2007)[7-66]:“Fraudhaslongbeenasourceofmajorconcernforcommerciallaw.”5PawsonvWatson(1778)2Cowp.785.6Ibid788perLordMansfield.7LazarusEstatesLtdvBeasley[1956]1QB702,712perDenningLJ.8HIHCasualty&GeneralInsurancevChaseManhattan[2003]2Lloyd’sRep.61,[15][16]perLordBingham.9 Standard Chartered Bank v Pakistan National Shipping Corp. (Nos. 2 and 4) [2003] 1 AC 959, [20] per LordHoffmann:“moraldisapprovaloffraud.”10HallvHerbert[1993]2SCR159,169perMcLachlinJ;BirkettvAcornBusinessMachinesLtd[1999]2AllERComm429perColmanJ;LawCommission,TheIllegalityDefence(LawComCP189,2009),[2.24].11HolmanvJohnson1Cowp342(1775),343.

22

tojustandequitabletreatment…Inthisfielditisallornothing.”12Forpresentpurposes,the

judicialresponsetofraudinthecontextsunderdiscussionisaclearattempttopreventthe

fraudsterprofitingfromhiswrongdoing.Afindingoffraudwilldeprivethefraudsterofhis

entirerighttoindemnityorpaymentunderthepolicyorcredit,respectively.

Bycontrast,amoreproactiveresponseto fraud–designedtoupholdabasicstandardof

commercialmorality–isoftenevidentinrelationtowrongdoinginthepre-contractualphase.

Courtswill,forexample,refusetoenforceaclausepurportingtorelieveonepartyfromthe

consequencesofhisownfraud.13Anexplicitconcernaboutmoralityisalsoevidentinthelaw

ofmisrepresentationwhichprovidesremediesforinnocentpre-contractualmisstatements.14

Withoutremediesinthissituation,themisrepresentorwouldbepermittedtotakeadvantage

ofasituationpremisedonfalsityandthis,asLordJesselMRheldinRedgravevHurd,would

be “a moral delinquency.”15 This same logic underpinned the law of non-disclosure in

insurance.16InCartervBoehm,LordMansfielddeterminedthatremedieswouldbeavailable

evenwherethenon-disclosurewasinadvertentbecause“stilltheunder-writerisdeceived…

becausetherisquerunisreallydifferentfromtherisqueunderstoodandintendedtoberun,

atthetimeoftheagreement.”17Remediesforbreachofthedutyoffairpresentationunder

the Insurance Act are now tied to the nature of the breach18 or the impact that the

misstatementhadontheunderwriter.19Theunderwriterremainsentitledtoaremedyinthe

caseofinadvertentnon-disclosurewhichdemonstratestheongoingimportanceofupholding

basiccommercialmorality.

Thereisalsoaneconomicjustificationforcommonlawrulesagainstfraud.Theprocessof

contractualnegotiationsenablesthepartiestomakeprovisionforforeseeablecontingencies

whichmayariseduringtheirexchange.Thereareclearlycostsassociatedwiththisprocess,

but these can be justified on the basis that parties know their rights and liabilities with

12StandardCharteredBankvPakistanNationalShippingCorp.(No.2)[2000]2Lloyd’sRep.511,[126]perWardLJ.13SPearson&SonLtdvDublinCorp[1907]AC351,353-354perLordLoreburnLC.14MisrepresentationAct1967s.2(2).15RedgravevHurd(1881)20ChD1,12-13perLordJesselMR.16CartervBoehm(1766)3Burrow1905.17Ibid1909perLordMansfield.18InsuranceAct2015Sched.1(2).19InsuranceAct2015s.3;Sched1.(3).Foranimportantconsiderationofwhatproportionalityactuallymeansinthis context, see J Davey, ‘Proportionality & the hypothetical bargain: The Law Commission’s remaking ofcommercialinsurancelaw’(2016)(Workinprogress).

23

certaintyfromtheoutset.Fraudisadifferentmatter.Itisnotaneventualitywhicharisesdue

to some external event beyond the parties’ control, but rather because one party

intentionallydeceives theother.Accordingly, theriskofdishonestyrequires thedesignof

elaborateprotective clauses and this imposes considerable costson contractingparties.20

These costs cannot be justified in the same way as ordinary contractual clauses can be.

Common law rules against fraud, therefore, represent an attempt to prevent thewasted

expenditurethatwouldotherwisebeincurredasaresultofnegotiatingaboutthefraudrisk

in advance. The increased costs associated with fraud also extend to litigation and this

necessarily impacts upon the courts. As Lord Reed has argued extra-judicially, sanctions

should be imposed on the dishonest litigant because such dishonesty “imposes an

unnecessaryburdenoncourtresources.”21

Similarconcernsaboutfraudhavebeenvoicedbythecourtsinthespecificcontextsunder

discussion,marine insurance claims anddocumentary credit transactions. Frauddoes not

affect thesetransactions identically; it involvesdifferentpartiesandreaches thecourtsat

differentstagesofthetransaction.Asabasisfortheforthcomingdiscussion,anoverviewof

eachmechanismandtheimpactoffraudisnowprovided.

II. TheInsuranceContextThenatureoftheinsurancerelationshipiswellknown.Itisdesignedtoprovidetheassured

withafinancialsafetynetintheeventofharmcausedbyaninsuredperil.Thissafetynetis

constructed through the transfer and spreading of risks in the market.22 A risk averse

individualorentitytransferstheriskoflosstoaprofessionalrisktaker,theunderwriter,in

exchangeforthepaymentofthepremium.23Theassuredsuffersasmallfinanciallossinthe

short term – the premium – as a safeguard against the potential for greater loss in the

future.24Risksarepalatabletotheunderwriterbecauseitcanpoolassuredswithsimilarrisk

profilesandchargethesamepremium.Efficientunderwritingdependsonsufficientpremium

20RPosner,EconomicAnalysisofLaw(5thed.AspenPublishers,1998),123.21 Lord Reed, ‘Lies, damned lies: Abuse of process and the dishonest litigant” 3 (26/10/2012) available at:https://www.supremecourt.uk/docs/speech-121026.pdf(accessed12/09/2017).22TBaker,InsuranceLawandPolicy(AspenPublishers,2003),2.23Ibid2.24 H Beh and J Stempel, ‘Misclassifying the insurance policy: The unforced errors of unilateral contractcharacterization’[2010]32(1)Card.LRev.85,105.

24

incomewithinagivenpooltoindemnifytheunluckyfewwhosufferasignificantloss.25This

enablestheinsurertospreadtheriskoflossthroughoutthegroupofassureds.26Thisprocess

ofwritinglargenumbersofrisksisfacilitatedbythelawoflargenumbers;27itispossibleto

estimatehowmanyshipswillsink inagivenyear, forexample,butvirtually impossibleto

identifywithprecisionwhichshipswillsink.

Thepremiumissetbyreferencetotheriskinessoftheindividualinsured.28Thismakespre-

contractual negotiations critical; it is vital for theunderwriter to gather asmuch relevant

informationabouttheriskashecan.Thisprocessisexpensiveandtheunderwriterwillbe

keen to ensure that these pre-contractual expenditures do not exceed the value of the

business.Accordingly,theunderwriterwillneedtorelyontheinformationprovidedbythe

prospective assured and this necessarily creates incentives for the assured to withhold

informationwhichwouldtendtoincreasehisrisk.Thedeliberatesuppressionofinformation

at this stagewouldbe regardedas fraudbut its consideration isbeyond thescopeof the

project.29 Payment of the premium constitutes the assured’s major obligation under the

insurancecontract.Inreturnforthispremium,theunderwriterpromisestoholdtheassured

harmlessagainstcoveredperilsor,topayasumofunliquidateddamagestoindemnifythe

assuredfollowingaloss.30

Theclaimsprocessisthetimeatwhichtheinsuredholdstheunderwritertohisbargain.This

process,yetagain,createsincentivesfortheassuredtobehavefraudulentlyanditisthiskind

offraudwhichisthefocusofthisproject.Fraudattheclaimsstagemaytakeseveralforms.

Theinsuredmay(i)deliberatelydestroyhispropertyforthepurposesofmakinganinsurance

claimor(ii)mayexaggeratehislossesfollowinganinsuredevent.UntiltherecentSupreme

CourtdecisioninVersloot,31athirdcategoryofbehaviour–thevalidclaimsupportedbyfalse

25TBaker,‘Constructingtheinsurancerelationship:Salesstories,claimsstories,andinsurancecontractdamages’(1993-1994)72TexLRev1395,1401.26Baker,InsuranceLaw(n22)2.27KAbraham,InsuranceLawandRegulation(3rded.FoundationPress,2000),2;Baker,InsuranceLaw(n22)3.28Abraham,InsuranceLaw(n27)2.29Foracomprehensiveaccountofpre-contractualfraudbytheassured,readersaredirectedtoBSoyer,MarineInsuranceFraud(InformaLaw,2014),17-68.Pre-contractualdutiesofthecommercialassuredarenowgovernedby Insurance Act 2015 s.3, sched. 1. The position for consumer assureds is contained in Consumer Insurance(DisclosureandRepresentations)Act2012.30FirmaC-TradeSAvNewcastleProtectionandIndemnityAssn(TheFantiandThePadreIsland)(No2)[1991]2AC1,35,perLordGoff.31VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG[2016]UKSC48(hereafterreferredtoasVersloot(SupremeCourt)).

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evidence–wasalsotreatedasfraud.32Theassuredmayalsobetreatedasafraudsterifhe

failstodisclosetheexistenceofadefencetohisunderwriter.Regardlessofthetypeoffraud,

theunderwriter’sliabilityissubjecttothetermsofthecontractanditisnotuncommonfor

him to attempt to identify a legitimate basis for resisting the claim. The validity of these

defencesmustbedeterminedbeforeanypaymentwillbemadetotheassured.Itiscorrect

thentodescribetheinsurancerelationshipas‘arguenow,paylater’.33Wherethepartiesare

unabletoagreeasettlement,theinsuredwillneedtobringaclaimagainsttheinsurerforthe

indemnity.34Thefraudrulewillthenbedeployedbytheinsurerasadefencetoliability.The

actionwill,saveforthemostexceptionalofcases,35involvetheallegedlyfraudulentassured

and the insurer.A findingof fraudat trialwill cause theassured to forfeithis claim in its

entirety, including any genuine loss. The nature of the insurance relationshipmeans that

allegationsoffraudmustberesolvedbeforeanyindemnityispayable.This,fromastructural

perspective,isarelativelystraightforwardprocess.Inthissense,theinsurancefraudenquiry

ismuch lesscomplicatedthanthatwhichoccurs in transactions financedbydocumentary

credit.

III. TheDocumentaryCreditContextTheletterofcreditisacomplexmethodoftradefinancing.36Itcreatesanetworkofcontracts

tobridgethegapbetweenbuyerandsellerandassuagemutualconcernsaboutdealingwith

an unknown party located abroad. The major risks of international trade concern the

fundamentalcontractualobligationsofeachparty;theseller’sdutytosendgoodsconforming

to the contract and the buyer’s obligation to pay. The documentary creditmechanism is

designed to manage these risks by introducing banks into the contractual network. The

primarypaymentobligation isborneby thebankandthiseliminates theseller’sconcerns

32AgapitosvAgnew(TheAegeon)[2003]QB556.AcomprehensiveaccountoftheshiftingcommonlawdefinitionofinsuranceclaimsfraudwillbeprovidedinChapterTwo,seelater,texttofn186etseq.33Thisisthereverseofthecharacterisationoftheletterofcreditcontract,seeGMcMeel,‘Paynow,arguelater’[1999]LMCLQ5.34JFeinman,‘Theregulationofinsuranceclaimspractices’[2015]5UCIrvineLRev1319,1416.35Theclaimforindemnitymaybebroughtbyarepresentativeoftheassuredsuchaswhentheassuredhasdiedfollowingtheoccurrenceoftheloss,seeTheAegeon(n32)558perManceLJ.36PTodd,MaritimeFraud&Piracy(2nded.InformaLaw,2010),[4.019].However,theICCwouldseemtodisagreewiththischaracterisation,seeDBischof,‘Lettersofcredit(LCs):recognizingthevalueofsimpletradeinstruments’(12/07/16) available at: http://www.iccwbo.org/News/Articles/2016/Letters-of-credit-(LCs)-recognizing-the-value-of-simple-trade-instruments/(accessed16/08/16)wherethecreditisdescribedas“well-wornandsimple”.

26

regardingthebuyer’sinsolvency.Moreover,paymentiscontingentonthesellerpresenting

documents indicatinghehasperformedhisobligations,which reduces thebuyer’s riskof

payingforpoorqualityornon-existentgoods.Effectively,the letterofcreditestablishesa

channelthroughwhichdocumentsrepresentingthegoodscanreachthebuyerinexchange

fortheprice.Thefundamentalpurposeofthemechanismistoensureaswiftandvirtually

unassailablemeansofpaymenttofinanceinternationalsales.

Theletterofcreditdoesnotremovetherisksofinternationaltradeentirely.Thedocumentary

natureofthetransactioncreatesincentivesforthesellertocommitfraudinthecourseofhis

obligations.37 The first, and most deliberate, type of fraud occurs when the seller ships

worthlessgoodsornothingatallandprocureswhollyfalsedocumentationtosubstantiate

his right topayment. The secondcategoryof fraud isopportunistic innature.Thisoccurs

whenthesellerhasshippedthecontractgoodsbutthenbreachesthecreditcontract,and

possiblyalsotheunderlyingcontractofsale,byshippingthegoodslateorfromthewrong

port. The fraud occurs where the seller procures fraudulent documentation, such as a

backdatedbilloflading,toconcealthisbreach.

The fraudenquiry in documentary credit transactions is particularly complexbecause the

fraud rulecanbe raisedbothbeforeandafterpaymenthasbeenmade,andactionsmay

whollyexcludetheallegedfraudster.Inaddition,thefraudenquiryisconstrainedbythefact

thatthecourt’spriority istoensurethatthedocumentarycreditremainsaswiftpayment

mechanism. This limits the opportunities for fraud prevention since the investigation

necessarytouncoverfraudwillinevitablydelaypayment.Itisforthisreasonthatthegeneral

organisingprincipleofdocumentarycredits is ‘paynow,argue later.’38Awareofthefraud

potentialincredittransactions,thecourtshavedevelopedanarrowfraudexceptionwhich

canbeinvokedbothbeforeandafterpaymenthasbeenmadetothecreditbeneficiary.From

thebuyer’sperspective, itwill bepreferable to raise fraudprior topaymentand thiswill

requirehimtoobtainaninteriminjunctionagainstthesellerorthepayingbank.Successat

thisstageisveryrare,thoughhypotheticallypossible,inEnglishlaw.Thefraudexceptionis

morelikelytooperateafterthesellerhasreceivedpayment.Itistypicallyraisedasadefence

37Thisistobedistinguishedfromfraudcommittedbythebuyerorschemesconcoctedbetweenbuyerandsellertodefraudthebank.TheseissuesarebrieflyconsideredinAMalekandDQuest,Jack:DocumentaryCredits(4thed.TottelPublishing,2009),[9.20].38McMeel(n33)5.

27

bythebuyerinanactionbroughtbythebankforreimbursement.39Inthesecircumstances,

thecourtiseffectivelyaskedtoapportionlossbetweentwoinnocentparties.Ofcourse,an

action to recover themoney from the seller after payment is theoretically possible, but

unlikelywherethefraudwasdeliberatelyorchestratedbyadishonesttrader.

The fraud rule indocumentary creditswill rarely target the fraudsterdirectlyand instead

typicallyoperatesasariskallocationdevicebetweentwoinnocentparties.Mattersaremuch

more straightforward in the insurance context where the forfeiture rule only operates

betweenallegedfraudsterandpotentialvictiminafinaltrialoftheissues.Thesedifferences

areexplicablebyreferencetothedifferentroleofeachmechanism.Thecreditisaprimary

paymentmechanismwhich,toserveitspurpose,mustbepermittedtofunctionswiftlyand

withlimitedjudicialintervention.Thisgivesthepotentialvictimonlyaveryshortperiodin

whichtogathersufficientevidenceoffraud.Bycontrast,considerationsofspeedarefarless

pressingintheinsurancecontext.Oncethelosshasoccurred,therearefewstructuralreasons

toprevent theunderwriter conductinga comprehensive investigationandpresenting this

evidencetoacourt.Providedtheunderwritersubmitssufficientevidence,thereisnoreason

topreventthecourtreachingaconclusiononthefraudallegation.Therequirementsofthe

respectivemechanisms affect the ability of the courts to intervene in a timely fashion to

counterfraud.Thishasledthecourtstoconceptualisethefraudproblemandthepurposeof

judicialinterventionindifferentways.Thefollowingchapterswillexaminethesedifferences

ingreaterdepthbutanoverviewisprovidedatthisstage.

Theinsurancecourtshaverecognisedfraudasaseriousthreattotheinsurancerelationship.

Thenarrativeisoneofdishonestyanddeceitwhichportraysthelawininstrumentaltermsto

discouragefraudintheclaimsprocess.Bycontrast,thenarrativeofthetradefinancecourts

largelymarginalisesfraud,offeringanimageofhonestcommercialdealinginwhichtheneeds

ofthemarket-aswift,certainpaymentmechanism-trumpthesecuritymechanismsneeded

toeffectivelydetectanduncoverfraud.Inbothcontexts,thesenarrativesareunderpinned

by simplistic assertions about howpeople respond to the threat of legal sanctions in the

39Forexample,GianSinghvBanquedel'Indochine[1974]1WLR1234;CreditAgricolevGeneraleBank[1999]2AllERComm1009;DCDFactorsplcvRamadaTradingLtd[2008]BusLR654.

28

insurancecase,andbyreferencetomarketneedinrelationtodocumentarycredits.These

assertionshavenotyetbeenthesubjectofconsideredanalysisandcritique.

IV. AJustificationoftheComparisonThedifferencesinthejudicialnarrativesurroundingfrauddemandfurtherexaminationand

consideration.Whiletherulesunderdiscussion–theforfeitureruleinmarineinsuranceand

thefraudexceptionindocumentarycredit–eachdepend,tosomeextent,onexturpicausa,

thisiswherethesimilarityends.Indeed,theruleshavebeendevelopedindifferentdirections

by the courts. This results fromadifferent characterisationof theparties involved in the

relevanttransaction,constraintssupposedlydictatedbytheparticularmechanismandthe

intendedpurposeof the fraud rule. Thisdivergence in judicial treatmentmakes the rules

worthycomparators.

The comparison is further justified by the fact that these mechanisms converge in the

practicalsetting.Themarineinsurancepolicy,forexample,isoneofthedocumentsthatthe

sellermustpresenttoobtainpaymentunderadocumentarycredit.Thepotentialfraudsters

are commercial traders who, over the course of their careers, will be presented with

opportunities to commit fraud both as seller under a documentary credit and insurance

policyholder.Thispracticaloverlapoftenmeansthatissuesconnectedtomarineinsurance

and international trade financing are examined within the same work but academic

treatments tend to regard these areas as largely distinct.40 This project continues in this

tradition, but advances thediscussionby comparing a crucial aspectof these commercial

mechanisms;therespectivefraudrulesandhowtheyhavebeenconstructedbythecourts.

Themechanismsunderdiscussion–theinsurancepolicyandthedocumentarycredit–serve

verydifferentpurposesininternationaltrade.Thisprojectisnotthenastudyofcomparable

mechanisms and nor does it suggest that fraud rules should be identical irrespective of

context.Rather, itseekstoidentifythepolicyconsiderationswhichhaveshapedthefraud

ruleineachcontextandtheextenttowhichtheseconsiderationsremainvalid.

40 Exampleswould include Todd,Maritime Fraud& Piracy (n36) (chs. 3-4 concern documentary credits, ch.6concernsmarineinsurance);ICarr,InternationalTradeLaw(5thed.Routledge,2014)(chapter13dealswiththesetopicsdistinctly.)

29

Accordingly,thefollowingresearchquestionsareposed:

1. Howisthefraudruleconstructedindoctrinalandproceduralterms?41

2. Whatpolicyargumentshavebeenusedbythecourtstojustifythescopeofandthe

proceduralcriteriarequiredtoinvokethefraudrule?42

3. Towhatextentdothesepolicyjustificationsremainvalidtoday?43

Thisthesismeetsagapintheliteraturebychallengingthepolicyargumentsusedtojustify

thescopeofthefraudrulesinthelawofmarineinsuranceanddocumentarycredits.Atthis

stage,itisconvenienttodemonstratethecurrentabsenceofpolicydiscussionintheseareas.

V. TheAbsenceofPolicyDiscussionThefraudrulesunderdiscussionhavedevelopedfromasimilarstartingpoint;thenotionthat

fraudunravelsall.44Despitethissharedbasis,theruleshavedevelopeddifferently.Ineach

setting,thecourtshavereliedonparticularpolicyargumentsdeemedrelevanttothecontext

athandtojustifytheparticularscopeandpurposeoftherule.Considerationsofdeterrence

haveframedthediscussionintheinsurancecases,whereasanemphasisoncommercialneed

hasbeenemployedinlettersofcredit.

Thereis,ofcourse,noconceptualdifficultywithusingpolicyargumentstodevelopthelaw.

Indeed,suchargumentsareroutinelyadoptedbythecourtsincaseswhere“therulesofthe

legalsystemdonotprovideaclearresolutionofadispute.”45Butsincepolicyargumentsare

simply“value-judgements”,46thepolicyconstructionemployedinaparticularcontextisnot

fixednorinevitable,butopentoquestioninsubsequentcases.Bell’ssuggestionthatcourts

are“tooreadytoassumethatthereisnofundamentaldisagreementaboutthevaluestobe

41ThisisaddressedinChapterTwo(insurance)andChapterFour(documentarycredits).42ThisisaddressedinChapterTwo(insurance)andChapterFour(documentarycredits).43ThisisaddressedinChapterThree(insurance)andChapterFive(documentarycredits).44FortheinsurancecontextseeManifestShippingCoLtdvUni-PolarisCoLtd(TheStarSea)[2003]1AC469,[62]perLordHobhouse;forthedocumentarycreditcontextseeUnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]2Lloyd’sRep.1,6perLordDiplock,(hereafterreferredtoasUnitedCityMerchants(HouseofLords)).45JBell,PolicyArgumentsinJudicialDecisions(ClarendonPress,1983),22-23.46Ibid36.

30

applied”47iscertainlyapplicableintheinsuranceandtradefinancecontexts.Thisabsenceof

critiqueisparticularlyproblematicwhenoneappreciatesthatmanyoftheseargumentswere

developedinthenineteenthcenturyorbyanalogytomucholdercommercialmechanisms.

Thenatureofcommercehaschangeddramaticallyintheinterveningyears.Itiscertainlynot

agiventhatmoderncourtswouldbeasinfluencedbytheseargumentsiftheywerestarting

fromscratchtoday.

Firstly,themarineinsurancecontext.ThediscussioninTheStarSeaconfirmsthattherule

prohibitingfraudulentclaimsisanalogoustoexturpicausa,

Thelawisthattheinsuredwhohasmadeafraudulentclaimmaynotrecovertheclaim

which could have been honestly made. The principle is well established and has

certainlyexistedsincetheearly19thcentury…Justasthelawwillnotallowaninsured

tocommitacrimeandthenuseitasbasisforrecoveringanindemnity(Beresfordv

RoyalInsuranceCoLtd[1937]2KB197),soitwillnotallowaninsuredwhohasmade

afraudulentclaimtorecover.48

Thisisnot,however,acomprehensiveaccountoftheforfeiturerule.Thisisbecausethecourt

usuallyrefusestoengagewithissuesofillegalityandthisleavesthelosstoliewhereitfell.49

Theconsequencesofforfeiturearemoresevere;theassuredalsoloseshisclaimforgenuine

lossandisrequiredtoreturnanysumspaidpriortothediscoveryofthefraud.50Thiscannot

beexplainedbyreferencetoexturpicausabutinsteaddependsonconsiderationsofpolicy,51

namelythedeterrenceoffraud.AsLordHobhousecontinuedinTheStarSea,

Thelogicissimple.Thefraudulentinsuredmustnotbeallowedtothink:ifthefraud

issuccessful,thenIwillgain;ifitisunsuccessful,Iwilllosenothing.52

47Ibid36.48TheStarSea(n44)[62]perLordHobhouse.Seealso,BrittonvRoyalInsuranceCo(1866)4F&F905.49 (Lord) J Sumption, ‘Reflexions on the law of illegality’ (Speech to Chancery Bar Association, 23 April 2012)available at: http://www.chba.org.uk/for-members/library/annual-lectures/reflections-on-the-law-of-illegality.pdf(accessed18/09/2017),3.50AxaGeneralInsuranceLtdvGottlieb[2005]1AllER(Comm)445,[29]perManceLJ.51Ibid[29]perManceLJ.52TheStarSea(n44)[62]perLordHobhouse.

31

The view that legal sanctions are required to prevent widespread claims fraud has been

repeatedincaselawsincethe1860s53andistypicallyendorsedinacademiccommentary.

ProfessorBennett,forexample,reiteratestheaboveexcerptfromTheStarSeabeforegoing

ontocommentthat“[i]ffraudcarriednorisk,therewouldbenodeterrent.Onthecontrary,

therewouldbeaperverseincentivetobefraudulent.”54ProfessorToddhasalsoconfirmed

theoverridingimportanceofdeterrenceintheconstructionoftheforfeiturerule,

Theintentionisclearenough,todiscouragetheassuredfrompresentingfraudulent

claims,offraudulentlyembellishingclaims.55

The ‘forfeiture as deterrent’ narrative remained largely unchallenged until the recent

litigationinVersloot.56Earlierscepticismofthedeterrenteffectofthecivillawappearedin

ProfessorClarke’s,LawofInsuranceContracts,57inwhichhenotedthatthecivillawwasnot

usuallytaskedwithpunishingoffenders58andcontinued,

Moreover, the case for penal sanctions rests partly on their efficacy for social

engineeringfordeterrence,which,inthiscontextatleast,isdoubtful.Theassumption

isthatitworks.59

Clarkerepeatedtheargument,originallymadebyMustillLJ,60thatthecivillawcannotdeter

ifthemajorthreatofthecriminallaw,imprisonment,hasnotdissuadedtheoffender.61He

continued,

Ofcoursefraudisnotmurder,buttoasignificantdegree,surely,thesamecanbesaid

ofcoldbloodedcrimessuchasfraud,ifthefraudstersthinkthattheirchancesofbeing

53Britton(n48)909perWillesJ;GallowayvGuardianRoyalExchange(UK)Ltd[1999]Lloyd’sRep.IR209,213perLordWoolfMR;TheStarSea(n44)62perLordHobhouse.54HBennett,TheLawofMarineInsurance(2nded.OUP,2006),719.55Todd,MaritimeFraud&Piracy(n36)[6.048].56ThecasereachedtheSupremeCourt,seeVersloot(SupremeCourt)(n31).57MClarke,Lawof InsuranceContracts (4thed.Service Issue351April2016) (hereafterreferredtoas ‘Clarke(looseleaf)’)58Ibid[27-2C3].59 Ibid [27-2C3]. The judgment in Versloot Dredging BV v HDI-Gerling Industrie Versicherung AG (The DCMerwestone)[2014]EWCACiv1349;[2015]1Lloyd’sRep32(hereafterreferredtoasVersloot(CourtofAppeal)promptedfurtherconsiderationofthedeterrenteffectofforfeiture,seePRawlings,andJLowry,‘Insurancefraud:The“convolutedandconfused”stateofthelaw’[2016]LQR96,98;PRawlingsandJLowry,‘Insurancefraudandtheroleofthecivillaw’(2017)80(3)MLR525,537etseq.60MMustill,‘Faultandmarinelosses’[1988]LMCLQ310,319.61Clarke(looseleaf)(n57)[27-2C3].

32

caughtaresmall.Thecourts,however,appeartohavetakenadifferentview,forthe

prospect of deterrence has been a significant policy factor in decisions such as

Galloway,andmorerecentlyinAxavGottlieb.62

It iscorrecttosuggestthatpre-Versloot,Clarke’sscepticalaccountoftherulewasunique

amongstthemajoracademiccommentariesoninsurancelaw.Indeed,hisscepticismwasthe

inspirationfortheauthor’sLLMdissertationwhichcritiquedtheLawCommission’sproposals

for reformfromacriminologicalperspective.63 Thisprojectcontinues ina similarveinby

providing theoretical and empirical evidence to demonstrate the ineffectiveness of the

forfeitureruleasdeterrent.

TheleadingEnglishaccountofthefraudexceptionindocumentarycreditsistracedtoLord

Diplock’sjudgmentinUnitedCityMerchantsvRoyalBankofCanada.64Muchlikeitsinsurance

comparator,thefraudrulewasexplainedas

aclearapplicationofthemaximexturpicausanonorituractioor,ifplainEnglishisto

bepreferred,fraudunravelsall.65

Policy considerations have been equally influential in this context, enabling the courts to

justifytheparticularscopeandpurposeofthefraudexception.Notably,however,thepolicy

arguments employed in relation to documentary credits are different to those deemed

relevant in the insurance setting. This is not altogether surprising since thenatureof the

documentarycredittransactionmeansthatfraudraisesdifferentconsiderationsandinvolves

different parties. In particular, themajor policy argument employed by the trade finance

courtsistheideathatcommercialpartiesrequireapaymentmechanismwhichisonlysubject

tojudicialinterventioninlimitedcircumstances.Indeed,LordDiplockusedthe‘commercial

need’argumenttorejectabroaderfraudexception,

This proposition which does not call for knowledge on the part of the

seller/beneficiary of the existence of any inaccuracy would embrace the fraud

exceptionandrenderitsuperfluous.MyLords,themorecloselythisboldproposition

62Ibid[27-2C3].63 KRichards, ‘Deterring insurance fraud:A critical and criminological analysis of the English and Scottish LawCommissions’currentproposalsforreform’(2013)24ILJ16.64UnitedCityMerchants(HouseofLords)(n44)6-7perLordDiplock.65Ibid6perLordDiplock.

33

issubjectedtolegalanalysis,themoreimplausibleitbecomes;toassenttoitwould,

inmyview,underminethewholesystemoffinancinginternationaltradebymeansof

documentarycredits.66

Academiccommentariesofdocumentarycredit fraudtypicallyrepeatthesalientpointsof

LordDiplock’sjudgmentbeforeidentifyingtheproceduralcriteriawhichtheclaimantmust

satisfy.67Thereis,asfarastheauthorcanidentify,nosuggestionthatcommercialneedisan

inappropriatebasisbywhichtodeveloptherule.Theissue,however,isthenatureofthe

reasoningwhich enabled theHouse of Lords to reach their conclusions on fraud and the

related questions of forgery and nullity.68 Professor Goode’smain contention is that the

judgmentinUnitedCityMerchantsmisstatesthecontractualbasisofthecreditmechanism

andunderminesthemajordoctrinesonwhichthedocumentarycreditdepends.69Thishad

significant consequences for the judicial elaborationof the fraudexception inUnitedCity

Merchants.While Goode does not suggest that the policy arguments were incorrect, his

explicitcritiqueofthejudicialreasoningintheHouseofLordsisanotableexceptiontothe

generalpatternofacceptance.

Asacritiqueofthepolicyapproachesadoptedbythecourts,thisprojectfitswithinabroader

tradition in private law, most notably in relation to insurance law. One of the earliest

examplesofsuchworkisHarnettandThornton’scritiqueofthedoctrineofinsurableinterest

fromasocio-economicperspective.70Theretheauthorsnotedthevalueofsuchwork;itwas

required“toprevent…deteriorationintoasetoffixedandunyielding‘principles’,constant

andvigilantre-evaluationofconceptsisnecessarytoenablelegalconceptstokeeppacewith

adjustmentsinexternalvariables.”71Morerecently,ProfessorDaveyhasemployedasimilar

66Ibid7perLordDiplock.67Forexample,MalekandQuest,Jack(n37)[9.8]-[9.19];PEllingerandDNeo,TheLawandPracticeofDocumentaryLettersofCredit(HartPublishing,2010),138etseq.;NEnonchong,TheIndependencePrincipleofLettersofCreditandDemandGuarantees(OUP,2011),[5.10].68RGoode,‘Abstractpaymentundertakings’inPCaneandJStapleton(eds.),EssaysforPatrickAtiyah(ClarendonPress, 1991) (hereafter referred to as ‘Goode, ‘Abstract payment undertakings’); E McKendrick, Goode onCommercial Law (4th ed. Penguin, 2010); D Horowitz, Letters of Credit and Demand Guarantees: Defences toPayment(OUP,2010),[3.18].SeealsoEPEllinger,‘Fraudindocumentarycredittransactions’[1981]JBL258.69Goode,‘Abstractpaymentundertakings’(n68)228,232.70BHarnettandJThornton,‘InsurableInterestinProperty:ASocio-EconomicRe-evaluationofaLegalConcept’(1948)48ColLRev1162.71Ibid1162.

34

approachinanumberofareasofinsurancelaw,72explicitlysubjectingthejudicialapproach,

mostnotablythatofLordMance,tocritique.73

Havingidentifiedtheacademictraditioninwhichthisprojectsits,itisconvenientatthisstage

toconsiderthespecificmethodologyemployedhere.

VI. MethodologyAsacritiqueofcommonlawrulesonfraud,thisthesishasbeenadesk-basedproject.The

purposeoftheprojectwastounpickthepolicyreasoningwhichhasbeenusedtoconstruct

fraud rules in themarine insuranceanddocumentary credit contexts. Thisnecessitateda

close,doctrinalanalysisof the relevantcase lawandassociatedacademiccommentary to

determinethepolicybasis/basesunderpinningtherespectivefraudrules.

Academiccommentatorsandsubsequentcourtstypicallyendorsethepolicyargumentsused

tojustifythefraudruleswithoutconsideringtheirvalidityorexplanatorypower.Bycontrast,

thisprojectcriticallyexaminesthesepolicyargumentsandconsiderswhethertheyremaina

validexplanationof judicial intervention in fraud cases. Indeveloping these critiques, the

project drew comparisons with foreign jurisdictions and literatures beyond law. It is

important to highlight, however, that as each rule is premised on context-specific policy

considerations,thecritiquesnecessarilydifferbothincontentandthesourcesonwhichthey

depend.Itisforthisreasonthatasingletheoreticalframeworkisnotdevelopedinthisthesis.

Bothcritiquesadoptacomparativeapproach.Intheinsurancecontext,acomparisonismade

with the approach to fraudulent insurance claims in Australia and the English courts’

approachtofraudulentclaimsincriminalandpersonalinjurylaw.Inthedocumentarycredit

chapter,theEnglishapproachiscontrastedwithapproachesadoptedinotherjurisdictions,

primarily the USA and Singapore. The more expansive approaches adopted in foreign

72JDavey,‘Honesty&therelationalcommercialcontract:Towardsalawofpost-contractualmisrepresentation’,(InsuranceFraudSymposium,UniversityofSouthamptonLawSchool,13July2016),5.73JDaveyandKRichards,‘Deterrence,humanrightsandillegality:Theforfeitureruleininsurancecontractlaw’[2015]LMCLQ315;JDavey,‘Thereformofinsurancewarranties:Abehavioraleconomicsperspective’(2013)JBL118;JDavey,‘Remedyingtheremedies:Theshiftingshapeofinsurancecontractlaw’[2013]LMCLQ476;JDavey,‘Claimsnotificationclausesandthedesignofdefaultrulesininsurancecontractlaw’(2012)23ILJ245.

35

jurisdictionsareusedtoreflectontheEnglishemphasisoncommercialneedasabasisfor

thenarrowfraudrule.

Theprojectalsoadoptsempiricalworkontheuseofdocumentarycredits.Thedatawasno

longer available at the time of writing74 and so the project draws upon commentaries

explaining the original survey.75 This data fits within empirical legal scholarship which

demonstratesadivergencebetweenthe lawonpaperandthe law inaction.Thisbroader

contextisausefulperspectivefromwhichtoconsiderthecontinuedpopularityofthecredit

mechanismandtoreconceptualisefraudanddeterrenceincredittransactions.

Broadlyspeaking,themethodologyadoptedinthisprojectbuildsontheapproachtakenin

earlierwork. In the author’s LLMdissertation, criminological theories of deterrencewere

usedtoanalysetheLawCommission’sproposals forthereformof insurance law.76 Inthis

project,insightsfromlaw&economics,behaviouraleconomicsandrelationalcontracttheory

are used to critique the policies said to underpin fraud rules in the insurance and

documentary credit contexts. In thisproject, theauthor views theory in the samewayas

suggestedbyProfessorRogerBrownsword,

thepurposeoftheoryistoofferusacriticalvantagepointfromwhichwecanassess

theappropriatenessofthestandardsandvaluesembodiedinparticularregimesof

contractlaw.77

Themethodologyemployedinthisthesiswasdevelopedwiththeresearchquestionsinmind.

The combination of close doctrinal work and theoretical insights enabled the author to

contribute to the existing literature on insurance claims fraud and fraud in transactions

financedbydocumentarycredit.

74InpersonalcorrespondencewithProfessorMannhehasconfirmedthatthedataarenolongeravailable,seestatementbyProfessorRonaldMann(Personalemailcorrespondence,20May2015)(onfilewiththeauthor).75 RMann, ‘The role of letters of credit in payment transactions’ (1999-2000) 98Mich L Rev 2494; AWKatz,‘Informality as abilateral assurancemechanism.CommentsonRonaldMann’s ‘The roleof lettersof credit inpaymenttransactions’(1999-2000)98MichLRev2554;CGillette,‘Lettersofcreditassignals.CommentsonRonaldMann’s‘Theroleoflettersofcreditinpaymenttransactions’’(1999-2000)98MichLRev2537.76ThiswassubsequentlypublishedasRichards(n63).77RBrownsword,‘Maps,methodologies,andcritiques:Confessionsofacontractlawyer’inMvanHoecke(ed.),MethodologiesofLegalResearch(HartPublishing,2011)133.

36

VII. OriginalityAdoctoralthesismustcontributetotheexistingbodyofknowledgeandthisprojectsatisfies

thiscriterioninseveralways.Attheoutset,itisimportanttonotetherarityofasimultaneous

considerationoffraudinthemarineinsuranceanddocumentarycreditcontexts.Although

these areas of law often converge in practice, they do not typically form the basis of

comparativeresearch. Moreover, thispractical inseparabilityhighlights the fact thateach

areaoflawhasdevelopedadifferentresponsetofraud.Thisisstrikingandmeritsfurther

enquiry.Thesuggestionmadehere isnot that rulesagainst fraudshouldbe identical,but

rather tohighlight the importanceof context inunderstanding the limitsof a ruleandof

interrogatingthepolicieswhichhavedictatedtheselimits.

Theinsurancediscussiondependslargelyontheuseofdeterrenceliteraturefromthefields

ofcriminologyandpsychology.Theseinsightshavenowbeguntopermeatethepolicymaker

andjudicialdebatebecauseofsubmissionsmadeinpartbytheauthoronthistopic.78This

projectbuildsonearlierworkinwhichtheseideaswereusedtosuggestthattheforfeiture

rule is an ineffective deterrent79 in two ways. Firstly, by providing a more sophisticated

account of the law& economics literature and how this accordswith a consideration of

insurancefraud.Inaddition,discussionsofdeterrenceusuallyfocusontheexaggeratedclaim

whereasthediscussionhereextendstheanalysistoincludethewhollyfraudulentclaim.

Discussions of fraud in the documentary credit context have largely concerned whether

exceptionstoautonomyshouldbeextended.Thisprojectchangesthefocusofthedebateby

consideringwhetherthepolicyfactorsunderpinningthenarrowconceptionoffraudarevalid.

It does this by adopting a comparative approach and by highlighting the detrimental

consequencesflowingfromtheHouseofLords’reasoninginUnitedCityMerchants.Though

78LawCommission,InsuranceContractLaw:BusinessDisclosure;Warranties;Insurers’RemediesforFraudulentClaims; and Late Payment (Law ComNo 353, 2014) 218, [23.10]; Insurance Fraud Taskforce, Insurance FraudTaskforce Final Report (2016) available at: https://www.gov.uk/government/publications/insurance-fraud-taskforce-final-report(accessed13/09/2016),40; InsuranceFraudTaskforce, InsuranceFraudTaskforce InterimReport (2015) available at:https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/413146/PU1789_Insurance_Fraud_Taskforce_interim_report_-_final.pdf(accessed13/09/2016),16-17.79Theauthor’sLLMdissertationrepresentsthebeginningofthisworkandwassubsequentlypublishedasRichards(n63).

37

thesearenotnecessarilynewcriticisms,theoriginalityexistsinthefactstheyarediscussed

togetherandtodemonstratethattheyunderminetheveryconstructionofthefraudrule.

Oneofthemajorareasoforiginalityliesinthepresentationofempiricalworkconductedin

theUnitedStates.Thishas,asyet,notpermeatedtheUKdiscussionofdocumentarycredits.80

Theempiricalworkpresentsaradicallydifferentaccountofthepracticaluseofcreditsand

developsananalysiswhichexplainsparties’continueduseofthemechanism.Theparticular

contribution in this project is to adapt this data to the fraud context and develop a new

accountoffrauddeterrenceinoverseastransactionsfinancedbydocumentarycredit.

VIII. ChapterOutlinesForeaseofexposition,andtoprovideanoverviewofthedirectionofthisthesis,asummary

ofeachchapterisnowprovided.Asacomparisonoffraudrulesintwocontexts,theproject

followsapattern;achapteronthedoctrinallimitsoftherelevantruleisfollowedbyachapter

inwhichthepolicyconstructioniscritiqued.

Followingtheintroductioninthischapter,ChapterTwoassessestheinsuranceforfeiturerule

fromadoctrinalperspective.Itsketchesthecontoursofthefraudulentclaimsjurisdictionand

analysesthewealthofrecentcaselawandtheimpactoftheInsuranceAct2015.Theprimary

policy justification in judicialdiscussions is frauddeterrence.Theexistenceof information

asymmetriesintheinsured-insurerrelationshipcreatesincentivesforfraudandnecessitates

rulestoprotecttheunderwriter.Thechapterdemonstratesthatthecourtshaveadaptedan

expansive approach to questions of fraud; establishing relatively low materiality

requirementsandresistingcallstointroduceelementsofproportionalityintotheremedial

framework.TherecentdecisioninVersloot81curtailstheotherwiseexpandingapproachto

fraudbyremovingacategoryofconductsufficienttoinvoketherule.Therelevanceofthe

maxim‘fraudunravelsall’inthiscontextisalteredbythisdecision.Itwouldhavebeencorrect

80SeveralauthorshavecitedtheworkinpassingbuthavenotdevotedanyrealtimetodiscussioninUKliterature,seeMBridge,‘Documentsandcontractualcongruenceininternationaltrade’inSWorthington(ed.),CommercialLawandCommercialPractice(HartPublishing,2003)227(fn68inoriginal);JUlph,‘TheUCP600:Documentarycreditsinthe21stcentury’[2007]JBL355,363(fn29inoriginal).81Versloot(SupremeCourt)(n31).

38

to suggest that, prior to Versloot, any degree of fraud by the assured was sufficient to

disentitlehimtotheindemnity.Thecurrentpositionismorenuanced;themaximstillbears

weightinrelationtoexaggeratedandfabricatedclaimsbutitsreachhasbeencircumscribed

atthelowerendoftheculpabilityspectrum.

ChapterThreesubmitsthejudicialconstructionoftheforfeitureruletodetailedcritique.The

majorpremise is that theavowedpurposeof the rule–deterrence– isdependentonan

outdatedmodel of decisionmaking.Modern deterrence theory suggests that the judicial

frameworktocounterfraud–harshlegalsanctions–islikelytobeineffective.Itisfurther

contendedthatforfeitureisparticularlyineffectiveinresponsetothemostseriousfrauds–

thewhollyfabricatedclaim–sincetheassureddoesnothaveanygenuinelosstosacrifice.

The third critique suggests that modern developments in investigative and scientific

techniquesmeanthattheunderwriterisnolongerassusceptibletofraudashisnineteenth

century counterpart. The final argument highlights that information asymmetries and the

consequentriskoffraudarenotuniquetotheinsurancerelationship.Thismeansthatthe

remedialframeworksemployedincomparablesettingscanbeusedtoexaminetheapproach

developedbytheinsurancecourts. Inthis light, itwillbesuggestedthatconsiderationsof

proportionalityaredirectlyrelevantto,andshouldbeincorporatedinto,theconstructionof

rulestocounterfirst-partyinsurancefraud.

Thefocusthenturnstofraudindocumentarycredittransactions.ChapterFourprovidesthe

doctrinalaccountofthefraudexceptiontoautonomyincredittransactions.Thetradefinance

courtshavetakenanarrowapproachtoquestionsoffraud.Theoperationoftheruledepends

onthesatisfactionofonerouscriteriawhichmustbeprovedwithinaverylimitedtimeframe.

Theresultisafraudexceptionthatrarelyoperatestoprotecttheinnocentbuyer.Assuch,

thenotionthatfraudunravelsalldoesnotadequatelyexplainthejudicialapproachtofraud

inthissetting.Theconstructionofthefraudruleistiedtotherequirementsofthecommercial

community;inparticular,aswiftandunassailablepaymentmechanism.Thecourtshavenot

regarded fraud as a particular risk andhave assumed that parties limit their exposureby

contractingwithhonesttraders.

ChapterFivecritiquestheconstructionofthefraudruleindocumentarycredits.Thecourts

haverepeatedlyadvancedanarrowexceptionpremisedoncommercialneed.Theargument,

however, is that the English approach is a distinct policy choice and not the inevitable

39

elaboration of best commercial practice. Three distinct arguments are deployed for this

purpose.Thefirstcontendsthatabroaderapproachtofraudwouldnothavethedetrimental

impactontradethatcourtsfear.ThisisexemplifiedbythepositionintheUnitedStateswhere

abroaderdefinitionoffraudisenshrinedinlegislationandinjunctivereliefiseasiertoobtain.

Secondly,itwillbearguedthattheleadingEnglishcaseonfraudmadeafundamentalmisstep

in elaborating the fraud rule. The courts have continued to apply this versionof the rule

notwithstandingitsconsequenceswhicharedetrimentaltothemechanismandcommercial

need.Thefinalargumentadoptsempiricaldataonthepracticaloperationofcreditscollected

intheUnitedStates.Thisisusedtocounterthejudicialsuggestionthatfrauddeterrenceis

simply an ex ante concern and presents a framework in which prevention is critical

throughoutthelifeoftheexchange.

The fraud rules share a similar juridical underpinning but they have been developed in

differentdirectionsbythecourts.Thisprojectisnotacallforrulestobetreatedinthesame

wayorshapedbythesamepolicyconcerns;afterall,thecourtsmustbecognisantofcontext.

Thediscussioninthesefourchaptersisdesignedtoilluminatethefactorswhichhaveshaped

the rules and theextent towhich these factors canbe justified. Theproject concludes in

Chapter Six where the discussion summarises the findings of the project and identifies

directionsforfuturework.

IX. ConclusionRulesonfraudareanimportantpartofthelawrelatingtomarineinsuranceanddocumentary

credits.Theyrespondto judicialconcernsabout fraud in themarketplaceandprotect the

integrityofthecourt.Simplephrasessuchas‘fraudunravelsall’aregenerallyusedtoexplain

judicialactivitytocounterfraudintheseareas.Thesephrases,however,arefartoosimplistic

once one appreciates the diverse circumstances in which fraud arises and the variety of

competingpolicyargumentswhichcourtsarerequiredtobalance.Thisprojectwillprovidea

detailedexaminationoftheforfeitureruleininsurancecontractlawandthefraudexception

indocumentarycredits.Itwillexploretheextenttowhichpithyphrasesadequatelyexplain

whatthecourtsaredoing,byidentifyingthecontextualandpolicyconsiderationswhichhave

shaped each rule. These considerations are then critically examined to determine their

(ongoing)validity.

40

This area of enquiry is highly topical in the insurance context. In recent years, the Law

Commissionhaveconductedalengthyconsultationintoinsurancecontractlaw,82including

thelawrelatingtofraudulentclaims,andthishasresultedinnewlegislationwhichelevates

theremedytostatute.83Thecommonlawcourtshavealsoconsideredseveralissuesrelating

tothescopeofthefraudulentclaimsruleoverthisperiod.84

The lawondocumentarycreditshasnotprovokedsimilardiscussionanddebate inrecent

years. English policymakers have preferred to leave general matters to the International

ChamberofCommerce(ICC)whichroutinelypublishestheUniformCustomsandPracticefor

DocumentaryCredits(UCP),anoptionalsetofrulesembodyinginternationalpractice.Almost

allcredittransactionsincorporatetheUCP.85TheUCP,however,makesnoprovisionforfraud

andthisleavestheissuetonationaljurisdictions.Ashasbeensuggested,theEnglishfraud

exceptionisrelativelyrestrictiveandthisappearstohavemadepartiesunwillingtolitigate

on the letterofcreditcontract.Thisnecessarily limits thecourts’ability to reconsider the

scope and policy construction of the exception. Beyond the judicial arena, however, the

mechanismremainsimportantasamethodoffinancing86andanewversionoftheUCPis

reportedtobeinthepipeline.87Whetherthisnewversionoftherulesmakesprovisionfor

fraudremainstobeseenbut,regardless,adetailedconsiderationofthecommonlawruleis

importantinitself,andasamappingexerciseinlightofpotentialdevelopments.

Havingoutlinedthepurposeanddirectionoftheproject,thesubstantivediscussioncannow

begin. Chapter Two addresses the first and second research questions in the insurance

context,bysubmittingtheforfeitureruletodoctrinalanalysis.

82LawCom353(n78).83InsuranceAct2015s.12.84TheAegeon(n32)(appropriateremedyforfraudulentdeviceclaims);Gottlieb(n50)(whetherinterimpaymentswererecoverablewhenclaimwaslaterprovenfraudulent.)85FLorenzon,‘Internationaltradeandshippingdocuments’inYBaatz(ed.),MaritimeLaw(4thed.Informa,2017)116.86Bischof(n36).87See,forexample,InstituteofInternationalBankingLawandPractice,‘Thecommunityspeaks:TheUCP700wishlist’ (26/03/2015) available at: http://iiblp.org/the-community-speaks-the-ucp700-wish-list/ (accessed12/09/2016).

41

ChapterTwo

Insurance:ADoctrinalAnalysisoftheForfeitureRule

I. IntroductionInsurance contracts are characterised by information asymmetries. These arise both at

formation–wheretheassuredhasgreaterknowledgeabouttheinsuredsubjectmatterand

hislosshistory–andfollowingalosswhereagain,theassuredknowsmoreaboutthecause

and extent of the loss than his underwriter. These asymmetries create incentives for the

assuredtolieandmisrepresentforprivategain.1Followingaloss–thefocusofthischapter

–thisincentivemanifestsinthesubmissionofafraudulentclaim,eitherbecausetheassured

inventsalossforthepurposeofmakingaclaimorseekstoexaggerateorembellishaninsured

loss.Thedatasuggestthatinsuranceclaimsfraudisaconsiderableproblem2thecostofwhich

isbornebythehonestmajorityofpolicyholders.3

Thelegalresponsetofraudhasdevelopedovermorethan150years.4Thetaskhaslargely

beenundertakenbythecourtsalthough,morerecently,theLawCommission5andparliament

haveenteredthearena.6Theresultistheforfeiturerulewherebytheassuredlosestheentire

claimtowhichthefraudrelates,includinganygenuineportionofloss.Theruleisfoundedon

principlesanalogoustoillegality7andpolicyconsiderations,mostnotablythedeterrenceof

fraud.8ThefollowingdescriptionoftheforfeitureruleofferedbyManceLJ,ashethenwas,

demonstratestheutilityofaligningforfeiturewiththenotionthat‘fraudunravelsall’,

1 J Feinman, ‘Insurance fraud, agency and opportunism: False swearing in insurance claims’ (Insurance FraudSymposium,UniversityofSouthamptonLawSchool,13July2016),3.2ABI, ‘Thecon’snoton– Insurersthwart2,400fraudulent insuranceclaimsvaluedat£25millioneveryweek’(07/07/2017) available at: https://www.abi.org.uk/news/news-articles/2017/07/the-cons-not-on--insurers-thwart-2400-fraudulent-insurance-claims-valued-at-25-million-every-week/(accessed04/09/2017);ABI,‘FromMrWhippytogigglingconmen–Noletupasinsurersturnuptheheatoninsurancecheats’(13/09/2016)availableat:https://www.abi.org.uk/News/News-releases/2016/09/From-Mr-Whippy-to-giggling-conmen-no-let-up-as-insurers-turn-up-the-heat-on-insurance-cheats(accessed14/09/2016).3VerslootDredgingBVvHDIGerlingIndustrieVersicherung(TheDCMerwestone)(Hearingon16/03/16,morningsession), 2h 12 per Lord Mance available at: https://www.supremecourt.uk/watch/uksc-2014-0252/160316-am.html(accessed31/07/16)2h16perLordSumption,Feinman,‘Agencyandopportunism’(n1)4.4BrittonvRoyalInsuranceCo(1866)4F&F905.5 LawCommission, InsuranceContract Law:BusinessDisclosure;Warranties; Insurers’Remedies forFraudulentClaims;andLatePayment(LawComNo353,2014).6InsuranceAct2015,ss.12-13.7ManifestShippingCoLtdvUni-PolarisCoLtd(TheStarSea)[2003]1AC469,[62]perLordHobhouse.8Ibid[62]perLordHobhouse;AxaGeneralInsuranceLtdvGottlieb[2005]1AllER(Comm)445,[29]perManceLJ;GallowayvGuardianRoyalExchange(UK)Ltd[1999]Lloyd’sRep.IR209,214perMillettLJ.

42

more fundamentally, it is clear that the rule relating to fraudulentclaimsoperates

generallyinamannerwhichcannotberegardedaspurelyprospective…aninsurance

indemnityispayablefromthemomentaninsuredperilcausesaloss…sotheeffectof

afraudulentclaimistoretrospectivelyremoveorbartheinsured’spre-existingcause

ofaction.9

Thisapparenteaseofcharacterisingfraudashavinganunravellingeffectiscomplicatedbya

longstandingtensionininsurancecontractlaw,namelytheco-existenceoftheforfeiturerule

alongsides.17,MarineInsuranceAct1906.Famously,s.17providedthatinsurancecontracts

were underpinned by a duty of utmost good faith to be observed by both parties. This

distinguishestheinsurancerelationshipfromalmostallothereconomicexchangesinEnglish

law and is traced to the eighteenth-century decision inCarter v Boehm.10 InCarter, Lord

Mansfield justified the duty of good faith by reference to the information asymmetries

presentininsurancerelationships,

Goodfaithforbidseitherpartybyconcealingwhatheprivatelyknows,todrawthe

otherintoabargain,fromhisignoranceofthatfact,andhisbelievingthecontrary.11

Theimportanceofthisdutywasfurtherunderlinedbytheremedyavailabletotheinnocent

party ifhis counterpart failed toact ingood faith;avoidanceab initio.12Avoidancewould

return the parties to their pre-contractual positions and would require the assured to

reimbursetheunderwriterforvalidclaimspaidwithinthatpolicyterm.Though,quiterightly,

onewouldregardthesubmissionofafraudulentclaim–adeliberateattempttodeceivethe

underwriter–asthemostegregiousexampleofafailuretoobservegoodfaith,13thecourts

haveconsistentlyrefusedtorecogniseavoidanceasanappropriateresponsetofraudulent

claims, preferring instead the less severe remedy of forfeiture. This has been justified by

9AgapitosvAgnew(TheAegeon)[2003]QB556,[26]perManceLJ.10CartervBoehm(1766)3Burr1905.11Ibid1910perLordMansfield.12MarineInsuranceAct1906s.1713TheAegeon(n9)[2003]QB556,[21]perManceLJ;SirALongmore,‘Goodfaithandbreachofwarranty:Arewemovingforwardsorbackwards?’[2004]LMCLQ158,167.

43

reference to the disproportionate nature of awholly retrospective remedy.14 Clearly, the

remedy of avoidance would take the notion of unravelling contractual obligations to its

extremeandtherebylimitstheextenttowhichtheforfeiturerulecanbedescribedinthis

manner.

Thetensioncausedbytheco-existenceof theforfeitureruleandthestatutoryremedyof

avoidancehasnowbeenresolvedbytheInsuranceAct2015.15Itisnowsettledthatavoidance

isinappropriateinthiscontextandthatforfeitureisthesolestatutorysanctionforinsurance

claimsfraud.16Viewedfromthisperspective,therefore,frauddoesexerciseanunravelling

effectandex turpi causa isuseful shorthand for theoperationof the forfeiture rule.This

chapter addresses the first and second research questions, namely by identifying the

constructionoftheforfeitureruleindoctrinalandproceduraltermsandthenbyascertaining

thepolicy considerationswhich havebeenused to justify this approach.Accordingly, the

chaptercommencesinPartIIbybrieflyexplainingthenatureoftheinsurancebargainand

theinformationasymmetriespresentintherelationship.PartIIIthendiscussesthescaleof

thefraudproblemwiththeuseofdatagatheredbytheinsuranceindustry.Thelongstanding

tensionbetweentheforfeitureruleands.17anditseventualresolutionisthefocusofPart

IV.Thisenablestheremainderofthechaptertofocussolelyonforfeitureandthescopeof

thefraudulentclaimsjurisdiction(V).

II. TheInsuranceRelationshipRisks,broadlyconceivedas“event[s]…primafacieadversetotheinterestoftheassured”,17

are an inevitable part of commercial life. The management of these risks is critical for

businessestoexpandandundertakenewventures.18Insurance–thetransferofriskfromthe

assuredtoaprofessionalrisktaker,theunderwriter–is,asAbrahamhassuccinctlyexplained,

14TheStarSea(n7)[51]perLordHobhouse;LawCommission,‘ReformingInsuranceContractLawIssuesPaper7:TheInsured’sPost-ContractDutyofGoodFaith’(July2010),[7.34].15InsuranceAct2015s.14.16InsuranceAct2015s.12.17PrudentialInsurancevIRC[1904]2KB658,664perChannellJ.18MClarke,PoliciesandPerceptionsofInsurance(ClarendonLaw,1997),5.

44

amethodofmanagingriskbydistributingitamonglargenumbersofindividualsor

enterprises…Bypayingarelativelysmallsum–theinsurancepremium–theinsured

policyholderreceivesapromisefromaninsurancecompanytopaytheinsuredifhe

orshesuffersaloss.Theinsuredavoidstheriskofsufferingalargelossbysubstituting

thecertaintyofsufferingasmallone.Assumingthattherisksacompanycoversare

largely independent of each other, the insurer protects itself against suffering net

losses by covering a large number of different insureds. In effect, the insurer

distributesriskamongallofitsinsureds.19

The resulting contract of insurance is contingent in nature, meaning the parties do not

performtheirsubstantiveobligationssimultaneously.Theassuredperformsfirstbypayinga

premiumtotheunderwriter.Thisishisconsiderationfortheunderwriter’sacceptanceofthe

risk.Theunderwritercalculatesthepremiumbyreferencetotheriskinessoftheassured.This

processdependsoninformationprovidedbytheassured20aswellastheunderwriter’sability

topredictthelikelihoodoflossbyreferencetohistoricaldata.21Thistaskisfacilitatedbythe

lawoflargenumberswhichstatesthatlargersamplesizesshouldrenderpredictionsmore

accurate.22Whileitisvirtuallyimpossibletopredictwhetheracertainshipwillsinkinagiven

year,forexample,itisfareasiertodeterminehowmanyshipsinagroupof500willbelost.

Theunderwritercanthencombine“fairlyhomogeneousrisksinacommon‘pool’innumbers

largeenoughthattheactuallossesoftheentiregroupcanbeexpectedtofallwithinstatistical

norms.”23

Theinsurerisonlyrequiredtoperformasunderstoodinthecolloquialsense–thepayment

ofanindemnitytomakegoodthelosstheassuredhassuffered24–whenaninsuredlosshas

occurred. On a formal analysis of the insurance contract, the insurer’s actual primary

obligation is to hold the insuredharmless from the specified risks.25Notwithstanding the

19KAbraham,DistributingRisk:Insurance,LegalTheoryandPublicPolicy(YaleUniversityPress,1986)1-2.20InsuranceAct2015ss.3-4.21Clarke,PoliciesandPerceptions(n18)39citingPHenry(1775)“Ihavebutonelampbywhichmyfeetareguided,andthatisthelampofexperience.Iknownowayofjudgingofthefuture,butbythepast.”22PBernstein,AgainsttheGodsTheRemarkableStoryofRisk(Wiley&Sons,1996)122-123.23CommissionerofInternalRevenuevTreganowan,183F2d288,291(2Cir,1950).24MarineInsuranceAct1906s.125FirmaC-TradeSAvNewcastleProtectionandIndemnityAssn(TheFantiandThePadreIsland)(No2)[1991]2AC1,35perLordGoff.

45

conceptual difficulties of the hold harmless doctrine,26 the occurrence of an insured loss

constitutesbreachofcontractbytheinsurerforwhichhewillbeliabletotheassured.The

contingentnatureoftheunderwriter’sliabilitymeans,therefore,thattheunderwritermay

neversubstantivelyperforminthesenseofpayinganindemnityduringthepolicyterm.

Theassuredmustprovethatthelosswascausedbyaperilinsuredagainsttosucceedina

claim for indemnity.27Hemust also complywithanyprocedural andnotice requirements

contained in the policy28 and refrain from conduct contrary to public policy. This chapter

focuses on perhaps the most egregious example of such conduct – the submission of a

fraudulentclaim–whichwillretrospectivelydeprivetheassuredofhiscontractualrightto

makeaclaim.29

A simplistic analysis of the insurance relationshipwould therefore suggest that it will be

straightforwardfortheassuredtoavoidlosinghisclaimbecauseofmisconduct;hesimply

refrains from fraudulent conduct in the claims phase. However, both the insurance

relationshipandtheclaimsprocesscreateincentivesforfraudulentconduct.

Asameansoftransferringanddistributingrisk,theinsuranceproduct,asdescribedbyBeh

andStempel,providesreassurancetotheassured,

Triteasitmaysound,policyholdersdopaypremiumsinordertoobtainthe"peaceof

mind"ofknowingthattheyareprotectedfrompotentialliabilityorloss.Insuranceis

definedastheincurringofasmallbutcertainloss(thepremiumpayment)inreturn

forprotectionagainstalargerbutcontingentloss.Puttingthepeaceofmindconcept

moretechnically,thepolicyholderaspartofariskmanagementplandevotesaset

26MClarke,Lawof InsuranceContracts (4thed.Service Issue351April2016) (hereafterreferredtoas ‘Clarke(looseleaf)’)[30-2];FDRose,MarineInsurance:Law&Practice(2nded.,InformaLaw2012)[25.1]27Rose,MarineInsurance(n26)[26.1];RhesaShippingCo.S.A.v.HerbertDavidEdmundsRhesaShippingCo.S.A.v.FentonInsuranceCo.Ltd.(ThePopiM)[1985]2Lloyd’sRep.1,3perLordOakbrook.28Rose,MarineInsurance(n26)[26.1].29Gottlieb(n8)[26]perManceLJ;PTodd,MaritimeFraud&Piracy(2nded.InformaLaw,2010),[6.049].

46

portionofitsresourcestothepurchaseofcontractualprotectionagainstcontingent

risk.30

Onthisbasis,theoptimumoutcomeofaninsurancerelationshipwouldbetoreachtheend

ofapolicytermwithoutincurringaloss.Itappearsthatsomepolicyholders,however,donot

understand this function of the insurance relationship. The Insurance Fraud Taskforce –

establishedbytheUKgovernmentin2015todevelopmechanismsforreducingclaimsfraud31

–outlinedacommonmisperceptionoftheinsurancerelationship,

Some do not understand that insurance is designed to cover the risk of an event

occurring,insteadbelievingthattheydeservearefundofpremiumspaidwhereno

claimhasbeenmade.32

Thismeansthat thepolicyholdermay feelcheatedormisledby theunderwriterwhenhe

reachestheendofapolicytermwithoutanytangiblebenefit.Thismaycausetheassuredto

attempttorecoversomeofhispremiumoutlaybywayofafraudulentorexaggeratedclaim.33

Thestructureoftheclaimsprocesshasalsobeenshowntocreateincentivestofraudulent

conduct.34 These incentives largely stem from the information asymmetries which exist

betweenunderwriterandassured.35Theassuredwill typicallyhavefargreaterknowledge

about the cause and extent of the loss than his insurer. This information is vital for the

underwriter to determine his liability on the policy. This disparity in knowledge gives the

30 H Beh and J Stempel, ‘Misclassifying the insurance policy: The unforced errors of unilateral contractcharacterization’[2010]32(1)Card.LRev.85,105.SeealsoClarke,(looseleaf)(n26)[1-1];MClarke,PoliciesandPerceptionsofInsuranceLawintheTwenty-firstCentury(OUP,2005),3.31 Insurance Fraud Taskforce, Insurance Fraud Taskforce Final Report (2016) available at:https://www.gov.uk/government/publications/insurance-fraud-taskforce-final-report(accessed13/09/2016),3.32Ibid[2.88].33 Clarke, Twenty-first Century (n30) 210; K Gill, Insurance Fraud: Causes, Characteristics and Prevention(unpublishedPhD thesis,Universityof Leicester2001)109availableat:https://lra.le.ac.uk/handle/2381/29106(accessed26/06/2017);STennyson,‘Economicinstitutionsandindividualethics:Astudyofconsumerattitudestowardinsurancefraud’(1997)32(2)JofEcBehaviorandOrganization247,249-250;ABI,‘ResearchBrief:Deterringopportunisticgeneralinsurancefraud’(August2010)2-3availableat:http://docplayer.net/39000873-Deterring-opportunistic-general-insurance-fraud.html(accessed26/062017)(Copyalsoonfilewithauthor).34KRichards,‘Deterringinsurancefraud:AcriticalandcriminologicalanalysisoftheEnglishandScottishLawCommissions’ current proposals for reform’ (2013) 24 ILJ 16, 35-37; See generally on the concept ofcriminogenesis,MLNeedlemanandCNeedleman,‘Organizationalcrime:Twomodelsofcriminogenesis’(1979)TheSociologicalQuarterly517.35 S Viaene and G Dedene, ‘Insurance fraud: Issues and challenges’ (2004) 29(2) Geneva Papers on Risk andInsurance313,315.

47

assured theopportunity to behave fraudulently by, for example, exaggerating the loss or

providinganexplanationofthecasualtywhichomitsdetailswhichmightotherwiseafford

theunderwriteradefence.Theseincentivesmaybeparticularlytemptingwheretheassured

finds himself in financial difficulty.36 The decision to commit fraud may, in other

circumstances, predate the occurrence of loss. Such fraud occurs when the assured

deliberatelydestroyshispropertyorconnivesinitslossfortheexpresspurposeofsubmitting

aninsuranceclaim.

Whateverthedriverforfraudinaparticularcase,fabricatedandexaggeratedclaimsthreaten

theinsurancemodel.Thisis,simplyput,becauseinsurerssetpremiumsbyreferencetothe

likelihoodandextentoflossforaclassofpolicyholdersoveragivenperiod.Theunderwriter’s

solvencydependsonhisabilitytoprocurepremiumincomewhichexceedshistotalliability

topolicyholders.Iftheunderwritermakespaymentonafraudulentclaim,thegapbetween

premium income and anticipated liabilitywill be narrowed. Thiswill increase the cost of

insuranceand,overtime,threatentheviabilityofinsurancecompanies.Asaresult,several

contractualmechanismsaredesignedtopreventtheassuredfromsucceedinginafraudulent

claim.37

Thefirstofthesemechanismsistheindemnityprinciple.Manymarinepoliciesareindemnity

contractswhich,bydefinition,limittheassured’srecoverytohisactualloss.38Damagesare

designedtoindemnifytheassuredi.e.tomakegoodthelosshehassustained.Theoperation

ofthisprinciplewill,therefore,constraintheassured’sabilitytoclaiminexcessofhisactual

loss.Theindemnityprincipleisnot,however,acomprehensivemeansofcurtailingfraud.This

isbecausetheMarineInsuranceAct1906expresslypermitspartiestocontractonthebasis

ofavaluedpolicywherethevalueofthesubjectmatterisconclusivelysettledinadvance.39

Theindemnityprinciplehaslimitedutilityinsuchpolicesgiventhatthecontractuallyagreed

36Clarke,Twenty-firstCentury(n30)210.37Thishasbeenrecognisedmoregenerallywithintheinsurancerelationship,seeAbraham,DistributingRisk(n19)15:“becauselosspredictionsareimperfectandbehaviorcannotbemonitoredwithoutcost,insurancemaycreateincentiveeffectsthatareinefficient.Tosomeextenttheseinefficienciescanbecounteractedbycontractualandlegaldevicesthatreducethemoralhazardofinsurance.”38CastellainvPreston(1883)11QBD380,386perBrettLJ;MarineInsuranceAct1906s.1.39MarineInsuranceAct1906s.27(2)(3).

48

valueof the vesselmay exceed the assured’s actual loss. Indeed, theremaybe a further

incentivetofraudinvaluedpolicies.40

Thesecondmechanism–theprincipleoffortuity–reflectsthefactthatinsuranceprovides

coveragainstrisksandnotcertainties.Wheretheinsuredperilisdefinedbyanelementof

fortuity–asisthecaseforperilsoftheseas,forexample–theassuredwillonlybeableto

recoverwhereheprovesthefortuitousnatureoftheloss.41Yetagain,however,thereare

limits on the effectiveness of the fortuity principle as a means of preventing fraud. In

particular,themechanismisunabletolimitrecoveryincircumstanceswheretheperil–most

notably,fire–doesnotcontainanyelementoffortuity.Torecoverinrespectofalosscaused

byfire,therefore,theassuredneedonlyprovethatfirewasthecauseoftheloss.42

Theinabilityofthesecontractualmechanismstoconstraintheassured’spropensitytofraud

inallcircumstancesnecessitatesthedevelopmentofrulesspecifictofraudandfraudulent

claims.Twosuchrulescanbedistinguished.Firstly,thewilfulmisconductdefencecontained

ins.55MarineInsuranceAct1906.43Thisprecludesrecoveryincircumstanceswheretheloss

hasbeendeliberatelyengineeredbytheassured.Thisreflectsthepurposeofinsurance–to

guard against risks andnot certainties –but also responds topublic policy concerns. The

statutorydefencewillonlybeavailableincircumstanceswheretheassuredhasconnivedin

thelossandtheonuswillbeontheunderwritertoestablishtheassured’swilfulmisconduct.

Thisisnoeasytask.44Furthermore,thewilfulmisconductdefencecannotbeinvokedwhere

thefraudconsistsofsomethingelse,suchasexaggerationofgenuineloss,thesuppressionof

adefenceortheuseofforgedevidence.Fraudulentbehaviourduringtheclaimsprocess–as

distinct from an intentionally caused loss – requires a furthermechanism to prevent the

assured’srecovery.AswasmadeclearbytheLawCommission,

40BSoyer,MarineInsuranceFraud(InformaLaw,2014)[3-26];Clarke,(looseleaf)(n26)[28-7]notingthatavaluedpolicyoverridestheindemnitynatureofmarinepolicies.Whetheraparticularpolicyisindemnityorvaluedwilldependontheconstructionofthecontract.41MarineInsuranceAct1906Sched1,r.742SchiffshypothekenbankzuLuebeckAGvCompton(TheAlexionHope)[1988]1Lloyd’sRep311,319perNourseLJcf.theexclusiontodeliberatelyinflictedlosswithinInstituteCargoClausesBandC2009cl.4.7.43MarineInsuranceActs.55(2)(a).44SeeSlatteryvMance[1962]1QB676,681perSalmonJ.

49

It isgenerallyaccepted,however,thatapolicyholderwhoactsfraudulentlyshouldrisk

more than thenon-paymentof the fraudulentpartof theclaim.Thereshouldalsobe

someelementofpenalty45

Thedevelopmentoftheappropriatelegalresponsetofraudisthefocusofdiscussioninthis

chapter.TheCommission’sreferencetothepenalnatureoftheresponseusefullysummarises

howthecourtshaveapproachedthistask.Thediscussionisprefacedbyestablishingthescale

ofthefraudulentclaimsprobleminPartIII.

III. InsuranceFraudStatisticsThereisnoshortageofpubliclyavailabledataonfraudulentinsuranceclaims,mostofwhich

emanates from the Association of British Insurers (ABI). ABI data published in 2017

demonstratedthatinsurersidentifiedanaverageof2,400fraudulentclaimsworth£25million

perweekin2016.46Incomparisontothedatafor2015,thisconstitutedanoverallreduction

inthenumberandvalueoffraudulentclaims.47Thisdataisthenusedtopredictundetected

fraudwhichisestimatedtocosttheindustryafurther£2.1billionperyear.48Itisnotpossible

todrilldownanyfurtherintothepubliclyavailabledata;theABIstatisticsdonotindicatethe

scale of fraudulentmarine claims or the category of behaviour inwhich the assured has

engaged.49

Thedifficultyofobtainingaccuratestatisticsshouldbementionedatthisjuncture.50Firstly,

the data is largely gathered by the insurance industry which has a vested interest in

presentinganimageofwidespreadclaimsfraud.51Perhapsconnectedtothisisthefactthat

thestatisticswedohavemaynotbeparticularlytransparent.Forexample,intheCanadian

context,fraudistypicallyestimatedtoinfectbetween10and15%ofallclaimsbut,asEricson

45LawComIssuesPaper7(n14)[2.8].46ABI,‘Thecon’snoton’(n2)47Ibid.48 InsuranceFraudTaskforce,FinalReport (n31), [2.4]citingNationalFraudAuthority, ‘AnnualFraud Indicator’(2014).49Seelaterdiscussiononthetypologyoffraudulentclaims,texttofn222etseq.50Attemptstomeasurethescaleofclaimsfraudonlybeganinthe1980s,seeViaeneandDedene(n35)317.51JFeinman,DelayDenyDefend(Penguin,2010),170;REricsonandADoyle,‘Themoralrisksofprivatejustice:Thecaseofinsurancefraud’inREricsonandADoyle(eds.),RiskandMorality(UniversityofTorontoPress,2003),324.

50

andDoylehavemadeclear,“fewactuallyknowwherethismeasurementcamefromor,for

thatmatter,howaccurateitis.”52Thereisnoreasontosupposethatthisdoesnottranslate

totheEnglishcontextwheretheABIhavesuggestedthatfraudadds£50toeachhousehold’s

annualinsurancebill.53Theissueisthatthisfigureof£50hasbeenusedformanyyearsbut

has not been revised upwards to reflect the increasing trend of fraudulent claims

demonstratedbyindustrydata.54

Otheraspectsoftheinsurancerelationshiprenderaccuratestatisticselusive.Foronething,

thefraudsterisattemptingtoconcealhisdishonestyfromtheunderwriterandthiscreates

measurementdifficulties.55Aseconddifficultyexistsinthefactthatsuspectclaimsmaybe

settledbytheunderwriterandnotrecordedasfraudintheofficialdata.56Inaddition,there

is some suggestion that underwriters may be prepared to overlook a degree of fraud

committed by particularly lucrative policyholders on the basis that they wish to retain

premiumincome.57Theunderwritermayalsochoosenottopursuefraudincircumstances

wheremakinga‘nuisancepayment’ischeaperthaninvestigatingthelossorwhereadequate

investigativemethodsdonotexist.58

Intheabsenceofmoredetailedandindependentdata,whatcanbesaidwithcertaintyisthat

the courts have accepted the scale of the problem. Indeed, it is not uncommon to see

referencetothescaleofclaimsfraudinjudicialdecisions.59Thisperceivedproblemhasbeen

usedtojustifytheparticularcontoursofthelegalresponsetofraud–theforfeiturerule–

52EricsonandDoyle,‘Themoralrisks’(n51)325.Seealso,Feinman,Delay,Deny,Defend(n51)170–171foranaccountofasimilarpositionintheUnitedStates.53 ABI, ‘Fraud’ available at: https://www.abi.org.uk/Insurance-and-savings/Topics-and-issues/Fraud (accessed09/08/2016).54PersonalemailwiththeABIStatisticsdepartment:“Thisisaveryhighlevelfigurebasedonthecurrentamountof fraud in theUK and the total number of policy holders in theUK, please do treat this number as a roughestimate.”(08/11/2016).55REricsonandADoyle,‘Criminalizationinprivate:thecaseofinsurancefraud’inLawCommissionofCanada,WhatisCrime?(UBCPress,2004),103;ViaeneandDedene(n35)319,322.56EricsonandDoyle,‘Criminalizationinprivate’(n55)105;EricsonandDoyle,‘Themoralrisks’(n51)324.57EricsonandDoyle,‘Themoralrisks’(n51)338,359.58EricsonandDoyle,‘Themoralrisks’(n51)323,336;REmerson,‘Insuranceclaimsfraud:Problemsandremedies’(1991-1992)46UMiamiLRev907,924.59VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG[2016]UKSC48(hereafterreferredtoasVersloot(SupremeCourt)),[56]perLordHughes;Royal&SunAllianceInsuranceCovFahad[2014]EWHC4480(QB),[24]perSpencerJ;DirectLineInsuranceplcvKhan[2002]Lloyd’sRep.IR364,[38]-[39]perArdenLJ;KhanvHussain(16May2007,HuddersfieldCountyCourt)[9]perJudgeHawkesworthQC.

51

andrecentlegislationelevatingtheruletostatute.60Theindustrytoohastakenactionand

reportannualexpenditureof£200milliontocounterfraud.61Scepticismabouttheaccuracy

ofthedatashouldnotbeconfusedwithdisbelief;thereisnodoubtthatfraudoccursandthat

fraudulentpolicyholdersshouldbesanctioned.62Thescepticismisinsteadanexplicitappeal

forrecognitionoftheindustry’sincentivetopresentacertainimageofclaimsfraud.63

UntiltheInsuranceAct2015,64thelegalresponsetoclaimsfraudwasshapedentirelybythe

courts.Thisjurisprudencestretchingbackmorethan150yearsprovidesmuchmaterialfor

discussion.Thefirstissuetoconsiderrelatestotheappropriateremedyforinsuranceclaims

fraud.Thishasbeendifficultforthecourtstodeterminebecauseofatensionbetweenthe

early case law and the existence of amore severe, andprima facie applicable, statutory

provision.

IV. IdentifyingtheAppropriateRemedy:ForfeitureorAvoidanceabinitio?

During consultation, the Law Commission described the jurisprudence on the fraudulent

claims rule as “convoluted and confused”.65 This was wholly attributable to the courts’

difficultyinreconcilingthecommonlawremedyofforfeiturewiththesubsequentstatutory

remedyofavoidanceforbreachofgoodfaith.66Itisimportant,therefore,toconsiderhow

the courtsdealtwith this tensionand to identify thepolicy considerationsused to justify

forfeiture,andnotavoidance,asappropriateinthiscontext.Thisdiscussionalsoprovidesa

usefulperspectivefromwhichtoconsidertheutilityofthemaxim‘fraudunravelsall’asa

descriptionofthejudicialresponsetoinsurancefraud.

60InsuranceAct2015s.12(1)(a);LawCom353(n5)[19.1],[19.3],[21.3],[21.5].61 ABI, ‘Insurerswill dowhatever it takes to protect honest customers against insurance fraud’ (18/01/2016)available at: https://www.abi.org.uk/News/News-updates/2016/01/Insurers-will-do-whatever-it-takes-to-protect-honest-customers-against-insurance-fraud(accessed09/08/2016).62Feinman,Delay,Deny,Defend(n51)170.63Ibid170-171wherehenotestheUSexperience;official industryfigurescompiledbytheInsuranceResearchCouncil were not backed up by research conducted by the quasi-governmental agency, the MassachusettsInsuranceFraudBureau.64InsuranceAct2015s.1265LawCom353(n5)[19.3].66Ibid[19.3],[20.37].

52

Insurance fraud first arose for consideration in the context of fire policies in the mid-

nineteenth century. The case of Britton v Royal Insurance67 involved an assured who

exaggeratedhislossfollowingafireathispremises.Theinsurancepolicydidnotcontainany

expressprovisionsrelatingtotheimpactoffraudduringtheclaimsprocess.WillesJdiscussed

thelegalresponseinthefollowingterms,

…suppose the insuredmade a claim for twice the amount insured and lost, thus

seekingtoputtheofficeoff itsguard,andintheresulttorecovermorethanhe is

entitledto,thatwouldbeawilful fraud,andtheconsequence isthathecouldnot

recoveranything.Thisisadefencequitedifferentfromthatofwilfularson.Itgives

thego-byetotheoriginof the fire,and itamounts tothis– that theassuredtook

advantage of the fire tomake a fraudulent claim. The law upon such a case is in

accordancewithjustice,andalsowithsoundpolicy.Thatlawis,thatapersonwhohas

madesuchafraudulentclaimcouldnotbepermittedtorecoveratall...Andifthereis

wilfulfalsehoodandfraudintheclaim,theinsuredforfeitsallclaimwhateveronthe

policy.68

Thisresultwasfurtherexplainedbyreferencetothenatureofinsurancecontracts,

Thecontractof insurance isoneofperfectgoodfaithonbothsides,andit ismost

importantthatsuchgoodfaithshouldbemaintained…sucha[n][express]conditionis

onlyinaccordancewithlegalprincipleandsoundpolicy.69

Thereasonthattheremedy is forfeiture–ratherthanthesimplerefusalof theclaim– is

explainedby the contractual relationshipbetweenunderwriter and assured.As discussed

above,theunderwriterundertakestoholdhisassuredharmlessfromtheperilsspecifiedin

thepolicy.70Thismeansthattheunderwriterwillbe inbreachupontheoccurrenceofan

67Britton(n4).68Ibid909perWillesJ.69Ibid909perWillesJ.70Seeearlier,texttofn25etseq.

53

insuredlossandwillbecomeimmediatelyliabletotheassured.71Theeffectoffraudduring

theclaimsprocessistobarthispre-existingrighttorecovery.72Theunderwriter’sliabilityis

notcontingentonthepresentationofan(honest)claim73butaccruesfromthedateofthe

casualty.

Theresponseofnineteenthcenturycourtstoinsurancefraudwasrelativelystraightforward;

theassuredwouldnotbepermittedtorecoveratallinrespectofthetaintedclaim.74Halfa

century later, however, the enactment of the Marine Insurance Act 1906 complicated

matters. The Act did not make any express provision for insurance claims fraud. It did,

however,containtwoprovisionsrelevanttofraud.Thefirst,containedins.55(2)(a), isthe

wilful misconduct defence, discussed above.75 More significantly, s.17 of the 1906 Act

characterisedtheinsurancerelationshipasbasedonutmostgoodfaith.Thiswasamutual

duty – applicable to both assured and underwriter – breach of which would entitle the

innocentpartytoavoidthepolicyabinitio.76S.17providedanoverarchingcharacterisation

ofinsurancecontractsbeforess.18-20identifiedspecificinstancesofhowgoodfaithwould

manifest in the pre-contractual context. The Act did not make specific provision for the

operationofutmostgoodfaithduringthecurrencyofthepolicy.

Thisexistenceofs.17–andtheremedyofavoidance–complicatedthejudicialapproachto

fraudulentclaims.Ontheonehand,itisdifficulttoconceiveofamoreegregiousbreachof

good faith than the intentional submission of a fraudulent claim77 and yet avoidance,

requiringtheassuredtorepayanysumspaidonaccountinrespectofthefraudulentclaim78

aswellasanypriorvalidclaimssubmittedduringthatpolicyterm,wasmuchmoresevere

thanforfeiture. Indeed,avoidanceasaresponsetoclaimsfraudwouldhaveextendedthe

71ChandrisvArgoInsuranceCoLtd[1963]2Lloyd’sRep65,74perMegawJ;TheFanti(n25)35-36perLordGoff;Rose,MarineInsurance(n26)[26.1].72Gottlieb(n8)[26]perManceLJ.73Versloot(SupremeCourt)(n59)[24]perLordSumption.74Britton(n4)909perWillesJ;GoulstonevTheRoyalInsuranceCo(1858)1F&F276,280perPollockCB;LosebyvPriceTheExpress,17August1866(GuildfordAssizes),48perWillesJ.75Seeearlier,texttofn43.76Carter(n10)1909-1910perLordMansfield.77TheAegeon(n9)[21]perManceLJ;Longmore(n13)167.78SeeGottlieb(n8)[27],[28],[32];InsuranceAct2015s.12(1)(b).

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“penaleffectofthelaw…toitsultimate.”79Thistensioncontinuedtovexthecourts inthe

century since the Marine Insurance Act was passed. In particular, the courts needed to

determine i) whether the duty of utmost good faith extended into the post-contractual

sphere and, if so, ii) the contentof that duty and iii) the appropriate remedy for breach,

namelywould the underwriter be entitled to remedies in addition to forfeiture.80 As the

followingdiscussionwilldemonstrate,thecourts,ingeneral,attemptedtoconfineremedies

forfraudtoforfeiturebutstruggledtoadequatelyreconcilethiswiththeexistenceofamore

severe,andprimafacieapplicable,statutoryresponse.

InTheLitsionPride, thevesselwas renderedaconstructive total lossafter itwashitbya

missileinarestrictedzone.81Theownerthenfraudulentlybackdatedalettertoadvisethe

underwriter that the vessel had entered the zone and was thus liable for an additional

premium.Thejudgmentproceededonthebasisthatutmostgoodfaithappliedinthepost-

contractualphase.Theonlydisputerelatedtotheextentandcontentofthisduty.HirstJheld

that“itmustberight…togosofarastoholdthatthedutyintheclaimssphereextendsto

culpable misrepresentation or non-disclosure.”82 This was more extensive than that

contendedforby theassured–adutyofhonesty in theclaimsphase83 -andwouldhave

requiredtheassuredtodisclosematerialinformationinthepost-contractualphase.HirstJ

derivedsupportforhispositionbyreferencetothefactthat ifs.17appliedbothpre-and

post-contractually,therewasnothinginthestatutetosuggestthatthecontentoftheduty

should differ in any way.84 Accordingly, the submission of a fraudulent claim was to be

regardedasbreachofutmostgoodfaithwhichwouldentitletheunderwritertotheremedy

ofavoidanceabinitio.85Asthewordingofs.17didnotcompeltheinnocentpartytoavoid–

theoriginallanguagespecifiedthat“thecontractmaybeavoided”86–theunderwritercould

simultaneouslyestablishbreachofgoodfaithwithoutinsistingonavoidance,87asoccurredin

79DRThomas,‘Fraudulentinsuranceclaims:Definition,consequencesandlimitations’[2006]LMCLQ485,513.80HBennett,TheLawofMarineInsurance(2nded.OUP,2006),[22.101].81BlackKingShippingCorporationandWayang(Panama)S.A.v.MarkRanaldMassie(TheLitsionPride)[1985]1Lloyd’sRep.437.82Ibid512perHirstJ.83Ibid509perHirstJ. 84Ibid511perHirstJ.85Ibid515perHirstJ.86MarineInsuranceAct1906s.17(emphasisadded).87TheLitsionPride(n81)515perHirstJarguingthattherewas“muchcommercialgoodsense”inthisposition.

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TheLitsionPride.ItwassubsequentlyheldinTheStarSeathatthis“shouldnotanylongerbe

treatedasasoundstatementofthelaw”88notleastbecauseit“decouplestheobligationof

good faith both from section 17 and the remedy of avoidance and from the contractual

principleswhichwouldapplytoabreachofcontract.”89Thedecisionisalso“questionable”90

onthefactsgiventhattheclaimwasfora losscausedbyan insuredperilduringaperiod

whenaheldcoveredclausewasoperating.

Amoremoderate approachwas adopted inOrakpo v Barclays Insurance.91 The Court of

Appealunanimouslyagreedthats.17wasrelevant inthecontextoffraudulentclaimsand

limitedthedutytooneofhonesty,asdistinct frommoreexpansivedisclosureobligations

during the claims process.92 Hoffmann LJ and Sir Roger Parker argued that the reasons

requiringgoodfaithcontinuedtoexistpost-contractually,mostnotablybecause

just as the nature of the riskwill usually bewithin the peculiar knowledge of the

insured, so will the circumstances of the casualty; it will rarely be within the

knowledgeoftheinsurancecompany.93

Therewas,however,confusionabouttheappropriateremedyforbreachbytheassured.On

theonehand,StaughtonandHoffmannLJJlimitedtheremedytoforfeiture.94WhileSirRoger

Parkerbeganhisjudgmentbystatingthatfraudwouldcausetheclaimtofallintoto,95hewas

infavourofavoidanceabinitiobytheendofhisjudgment,

itiscontrarytoreasontoallowaninsurertoavoidapolicyformaterialnondisclosure

or misrepresentation on inception, but to say that, if there is subsequently a

88TheStarSea(n7)[71]perLordHobhouse.89Ibid[71]perLordHobhouse.90Ibid[71]perLordHobhouse.91OrakpovBarclaysInsuranceServices[1995]LRLR433.92Ibid451perHoffmannLJ,452perSirRogerParker.93Ibid451perHoffmannLJ.Seealso452perSirRogerParker:“Justasoninceptiontheinsurerhastoalargeextenttorelyonwhattheassuredtellshim,soalsois itsowhenaclaimismade.Inbothcasesthereisthereforeanincentivetohonesty,iftheassuredknowsthat,ifheisfraudulent,atleasttoasubstantialextent,hewillrecovernothing,evenifhisclaimisinpartgood.”94Ibid451perHoffmannLJ,451perStaughtonLJ.95Ibid452perSirRogerParker.

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deliberateattemptbyfraudtoextractmoneyfromtheinsurerforallegedlosseswhich

hadneverbeenincurred,itisonlytheclaimwhichisforfeit.96

Anattempt to reconcile s.17with the forfeiture rulewasnextattemptedby theCourtof

Appeal in TheMercandian Continent.97 Longmore LJ took the view that as the 1906 Act

specified circumstances inwhich avoidancewas available for pre-contractual breaches of

good faith,98 similar conditions could be attached to avoidance in the post-contractual

context.Heargued,therefore,thatavoidancewouldonlybeanappropriateresponsetopost-

contractual breaches of good faith where (i) the fraud wasmaterial in the sense that it

affected the underwriter’s ultimate liability and (ii)where the gravity of the fraudwould

enabletheunderwritertoterminateforbreach.99Asthelieinthiscasewasdirectedtothird

parties inanattempttoachieveamorefavourable jurisdictionforthedispute, it failedto

satisfybothlimbsofLongmoreLJ’stest.100Thetypicalcaseoffraudwould,however,easily

satisfybothcriteria101andthereforetheanalysisdidnotassistinconfiningtheoperationof

s.17inanyrealway.

TheHouseofLordsthenconsideredtheissueinTheStarSeaandinsodoingclarifiedthe

scopeofutmostgoodfaithinthepost-contractualstage.Thecontentofthedutywillvary

according to the particular situation.102 Where the underwriter is called upon to make

underwritingdecisionsinthepost-contractualstage–aswillbethecaseforrenewalsand

variations– theassuredwouldbeheld to thesameexpansivedisclosureobligationsasat

inception.103Thepositionisdifferentwhentheassuredmakesaclaimunderthepolicy.The

duty at this stage is limited to one of honesty104whichwould prohibit the assured from

96Ibid452perSirRogerParker.97K/SMerc-ScandiaXXXXII v Certain Lloyd’sUnderwriters (TheMercandianContinent) [2001] EWCACiv 1275,[2001]2Lloyd’sRep.563.98Marine Insurance Act 1906 ss.18-20; the remedy for breach in these circumstances has been amended byInsuranceAct2015,sched1.99TheMercandianContinent(n97)[35]perLongmoreLJ.100Ibid[42]perLongmoreLJ.101LawCommission,InsuranceContractLaw:PostContractDutiesandOtherIssues(LawComCP201,2011),[6.39];TheAegeon(n9)[44]notingthatthefirstcriterionwouldbeeasilysatisfiedwheretheclaimwaswhollyfraudulentorexaggerated.102TheStarSea(n7)[48]perLordHobhouse;Clarke(looseleaf)(n26)[27-1A1].103TheStarSea(n7)[54]perLordHobhouse;LishmanvNorthernMaritime(1875)LR10CP179.104TheStarSea(n7)[102],[111]perLordScott.

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submitting a fraudulent claim but would not require him to disclose every material

circumstance.105 This difference in duty reflects the fact that the doctrine in the pre-

contractual setting isdesigned toprevent theunderwriter frombeing saddledwithabad

bargainwhenmaterial informationhas beenwithheld.106Once the risk has attached, the

doctrinenolongerservesthispurposebutinsteadenablestheunderwritertoassessliability

andquantumaccurately.LordHobhousereferredtothisdistinctioninhisjudgment,

[Avoidance]isappropriatewherethecause,thewantofgoodfaith,hasprecededand

beenmaterialtothemakingofthecontract.But,wherethewantofgoodfaithfirst

occurs later, it becomes anomalous and disproportionate that it should be so

categorisedandentitletheaggrievedpartytosuchanoutcome.Butthiswillbethe

effect of accepting the defendants’ argument. The result is effectively penal…This

cannotbereconciledwithprinciple.107

Accordingly, Lord Hobhousewas reluctant to permit avoidanceab initio as a remedy for

fraudulentclaims.Heexpressedhisconcerninthefollowingway,

The potential is also there for the parties, if they so choose, to provide by their

contractforremediesorconsequenceswhichwouldactretrospectively.Allthisshows

thatthecourtsshouldbecautiousbeforeextendingtocontractualrelationsprinciples

oflawwhichthepartiescouldthemselveshaveincorporatedintotheircontractifthey

hadsochosen…Wheretheapplicationoftheproposedprinciplewouldsimplyserve

theinterestsofonepartyanddosoinadisproportionatefashion,itisrighttoquestion

whethertheprinciplehasbeencorrectlyformulatedorisbeingcorrectlyappliedand

itisrighttoquestionwhetherthecodifyingstatutefromwhichtherightcontended

forissaidtobedrawnisbeingcorrectlyconstrued.108

105Ibid[54],[57]perLordHobhouse;[95],[96],[102]perLordScott;HBennett,‘Mappingthedoctrineofutmostgoodfaithininsurancecontractlaw’[1999]LMCLQ165,198.ThepositionhasnowbeenalteredbytheInsuranceAct2015s.3whichrequirestheassuredtomakeafairpresentationoftherisk.106Bennett,‘Mappingthedoctrine’(n105)198.107TheStarSea(n7)[51]perLordHobhouse.108Ibid[61].

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LordHobhouse’sreferencetothedisproportionatenatureofavoidancereflectsthefactthat

although the duty of utmost good faith is mutual, it is virtually impossible to think of

circumstancesinwhichtheassuredwouldmakeuseofthisremedy.109Theassured’spriority

willbetomaintaininsurancecoveragenomattertheseverityoftheunderwriter’sbreach.

Theseconsiderationssuggestthatavoidanceabinitiomaynotbeanappropriateremedyin

thepost-contractualphase.ThisviewisstrengthenedbyLordHobhouse’sinsistencethatthe

earlierfirecaseswereauthorityfortheremedyofforfeiture.110TheHouseofLordsdidnot,

however,whollyoutlawavoidanceinthepost-formationstage.111Thisisattributabletothe

factthattheissuewasnotdeterminativeonthefactsandtheirLordshipspreferredtoleave

the matter open.112 The judgment in The Star Sea did confirm, however, that the post-

contractualdutyofgoodfaithceasedwiththecommencementoflitigation.113Theissueof

thewritengagestheCivilProcedureRuleswhichcontain,interalia,remediesfordishonesty

duringlitigation.114Therulesofthecourtarefarbetterequippedtodeterminetherightsand

obligationsofpartiesinvolvedinanadversarialdispute.115

Thefirstconsiderationoftheroleofs.17inthecontextoffraudulentclaimsfollowingThe

Star Sea occurred in The Aegeon.116 In the leading judgment,Mance LJ, as he thenwas,

simplifiedthetensionwhichhadtroubledpreviouscourts.Hissolutionwassimply“totreat

the common law rules governing themaking of a fraudulent claim…as falling outside the

scopeofs.17[withtheresultthat]…Noquestionofavoidanceabinitiowouldarise.”117This

was a clearpolicy choicedue to the severityof avoidanceab initio.118 This analysis – the

suggestionthatdeliberatefraudwouldnotconstituteabreachofutmostgoodfaith–is,as

theLawCommissionsubsequentlynoted,119difficulttoreconcilewiththeoverarchingnature

109Ibid[57]perLordHobhouse.110Ibid[62],[66]perLordHobhouse.111Ibid[110]perLordScott:describingtheissueas“moredebateable”.112Ibid[66]perLordHobhouse,[110]perLordScott.113Ibid[75]perLordHobhouse.114Ibid[75]subsequentlyappliedinSuezFortuneInvestmentsLtdvTalbotUnderwritingLtd(TheBrillianteVirtuoso)[2015]EWHC42(Comm),[2015]Lloyd’sRep.IR388.115LawCom201(n101)[6.30]“therulesofcourtprocedure,whichsetoutdisclosurerequirementsandappropriatesanctionsfornon-compliance.”116TheAegeon(n9).117Ibid[45]perManceLJ.118Ibid[44]perManceLJ.119LawCom201(n101)[6.44].

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of insurance contracts. Nevertheless, Mance LJ later reiterated his position in Axa v

Gottlieb,120arguingthat“thereisnobasisorreasonforgivingthecommonlawrulerelating

tofraudulentclaimsaretrospectiveeffectonprior,separateclaimswhichhavealreadybeen

settledunderthesamepolicybeforeanyfraudoccurs.”121

It was this tension – and the complex jurisprudence resulting from judicial attempts to

reconciles.17andtheforfeiturerule122–thatprovidedthebackdroptotheLawCommission’s

consultation on fraudulent claims. The Commission’s proposal – to limit the remedy to

forfeiture123 – was supported by several policy considerations. Firstly, the Commission

emphasisedtheimportanceoffinalityinEnglishlaw.Itwouldbe“unprincipled…[and]…wrong

thatavalidclaimmadeunderavalidpolicycanbeunderminedbysubsequentevents”124and,

inaddition,wouldriskbringingtheindustryintodisrepute.125Avoidancewasalsoregarded

as impractical. This was because most assureds would be unable to satisfy a judgment

perhaps some years after valid claims had been paid and the indemnity spent.126 Legal

certaintywouldbeunderminedif,ingeneral,underwriterswereunabletoenforcejudgments

inthesecircumstances.Thomashassuggestedthatincombination,thesepolicyarguments

are“capableofsupportingtheexclusionoffraudulentclaimsfromtheambitoftheprinciple

ofpost-contractgoodfaith.”127Withrespect,thejudicialapproachisslightlymorenuanced

thanThomashassuggested;frauddoesengagegoodfaithinthepost-contractualphasebut

theremedywillbelimitedtoforfeitureoftheentireclaim.

TheInsuranceAct2015enactstherecommendationscontainedintheLawCommission’sfinal

report.128Theremedyforthesubmissionofafraudulentclaimislimitedtoforfeiture129and,

subjecttotheunderwriter’ssatisfactionofanoticerequirement,prospectiveterminationof

thepolicy.130Thisentitlestheunderwritertorecoverinterimpayments131madeinrespectof

120Gottlieb(n8).121Ibid[23]perManceLJ.122LawCom201(n101)[6.15]“convolutedreasoninganduncertainty”.123LawCom353(n5)[19.4].124LawCom201(n101)[7.10].125Ibid[7.10]citingtheviewofRoyRodger(broker).126Ibid[7.13].127Thomas(n79)515.128LawCom353(n5)344(recommendations30-33).129InsuranceAct2015s.12(1)(a).130InsuranceAct2015s.12(1)(c).131InsuranceAct2015s.12(1)(b).

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claimsnowdiscoveredtobefraudulentbutleavesprior,validclaimsuntouched.Theabsence

ofavoidanceabinitiointhiscontextplacesasignificantlimitontheextenttowhichinsurance

claims fraud unravels all. The remainder of this chapter considers the forfeiture rule in

isolation.Itseekstodeterminetheextenttowhich‘fraudunravelsall’providesanaccurate

explanationofjudicialinterventioninthiscontext.

V. TheForfeitureRule

There is no longer any doubt that the submission of a fraudulent claim will result in

forfeiture.132 The assured will lose the entirety of the claim to which the fraud relates,

includinganygenuineportionofloss.Thediscussionnowassessestheextenttowhich‘fraud

unravelsall’accuratelyportraystheforfeiturerule.SectionAfirstconsidersthejuridicalbasis

oftherule.Thistaskissimplifiedfollowingthe2015Actandrevealsacorrelationbetween

forfeitureandthegenerallawofillegality,embodiedbythemaximexturpicausa.Thistask

alsoenablesustoappreciatetheimportanceofpolicyinthedevelopmentoftheforfeiture

rule.Accordingly,sectionBexaminesthepolicyrationalesusedtojustifyforfeiture.Themost

notableof these is frauddeterrencewhichhasbeenusedby the courts to legitimise the

severityof forfeiture.SectionCthenconsiderstherangeof fraudulentconductwhichwill

attracttheremedyofforfeiture.Untilrecently,itwouldhavebeencorrecttosuggestthatthe

courtshadconceivedofactionablefraudinbroadterms.Thispermittedthecourtstoadopt

aninterventionistapproachwhichwasinkeepingwiththeexpansivenessofthemaxim,ex

turpi causa.A recent SupremeCourtdecisionhasnarrowed the common lawmeaningof

fraud and thus reduces the circumstances in which forfeiture will be imposed.133 The

traditionalimpressionofanactivejudiciaryis,however,reinforcedbytheminimalevidential

(D)andtemporalconstraints(E)applicabletothefraudulentclaimsjurisdiction.

132InsuranceAct2015s.12(1)(a).133Versloot(SupremeCourt)(n59).

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A. Thejuridicalbasisofforfeiture

Followingtheenactmentofthe2015Act,thesubmissionofafraudulentclaimwillresultin

forfeiture134andrequiretheassuredtorepayanyinterimsumspaidinrespectofthetainted

claim.135Asdiscussedabove,theco-existenceofthestatutoryremedyofavoidance136and

the forfeiture rule had stymied judicial attempts to present a consistent account of the

juridical basis of the rule. 137 Accordingly, by the commencement of the LawCommission

consultationin2006,caselawindicatedthreedistinctbasesforforfeiture:138anaspectofthe

assured’spost-contractualdutyofutmostgoodfaith,139byanalogytoexturpicausa140oran

impliedtermthattheassuredshouldrefrainfromfraudintheclaimsprocess.141Theattempts

toreconcileforfeiturewiththes.17wereexaminedintheprevioussection.

Giventhattheforfeitureruleisnowenshrinedinstatute,thesearchforthejuridicalbasisof

therulebecomesalargelyacademicexercise.Indeed,theInsuranceActnotonlyremovesthe

underwriter’sliabilityfortheclaim142butalsoentitlestheunderwritertotreatthecontract

asterminatedwithprospectiveeffect.143Itshouldalsobenotedthattheassuredmayequally

forfeithisclaimasa resultofanexpress term in thepolicy.144 In thesecircumstancesthe

courts would simply give effect to the parties’ agreement.145 Indeed, this doctrinal

explanation146wouldexplainforfeiture inpolicieswhich incorporatethe InternationalHull

Clauses(01/11/03).147Expresstermstendtobecommoninnon-marinepolicies148butlessso

134InsuranceAct2015s.12(1)(a).135InsuranceActs.12(1)(b);Gottlieb(n8)[32]perManceLJ.136MarineInsuranceAct1906s.17.137LawCom353(n5)[20.37]:“uneasyjuxtapositionofsection17andthecommonlaw.”138LawComIssuesPaper7(n14)[4.18].139Forexample,Orakpo(n91)451perHoffmannLJ.140Forexample,TheStarSea(n7)[62]perLordHobhouse.141Forexample,Orakpo(n91)451perHoffmannLJ.142InsuranceAct2015s.12(1)(a).143InsuranceAct2015s.12(1)(c).144LawComIssuesPaper7(n14)[4.3];Feinman,‘Agencyandopportunism’(n1)3.145Feinman‘Agencyandopportunism’(n1)3.146Ibid3.147InternationalHullClauses(01/11/03)cl.45.3.NosuchclauseexistsinInstituteTimeClauses–Hulls(01/10/83).148NLegh-Jones,JBirdsandDOwenQC(eds.),MacGillivrayonInsuranceLaw(11thed.Sweet&Maxwell,2012),[19-055].

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inmarinepolicies.149Thismaywellexplainwhyrecentjudicialdiscussionontheextentofthe

ruleandmeaningoffraudhasoccurredlargelyinthemarinecontext.

Notwithstandingthepartialcodificationofforfeiture,thejuridicalbasisoftheruleremains

animportantconsiderationforthisproject.Indeed,freedfromthebaggageofs.17,thebasis

forjudicialinterventionbecomesmorereadilyapparent.Itisfromthisperspectivethatone

canappreciatethesignificanceofpublicpolicyconsiderations–unsurprisinggiventhemoral

opprobriumthatfraudinspires150–inthedevelopmentoftherule.Acriticalstartingpoint,

therefore,isthejudgmentofLordHobhouseinTheStarSeawhereheequatedtheforfeiture

rulewiththegenerallawofillegality,

Thisresultisnotdependentupontheinclusioninthecontractofatermhavingthat

effectorthetypeofinsurance;itistheconsequenceofaruleoflaw.Justasthelaw

willnotallowaninsuredtocommitacrimeandthenuseitasabasisforrecovering

anindemnity(BeresfordvRoyalInsuranceCoLtd[1937]2KB197),soitwillnotallow

aninsuredwhohasmadeafraudulentclaimtorecover.151

Thisisentirelyconsistentwithlogicofexturpicausa;thenotionthatfraudunravelsalland

anindicationofthejudicialreluctancetoengagewithdishonestclaimants.152

Subsequently,however,ManceLJarguedthatgeneralprinciplesofillegalitycouldnotexplain

thetotalityoftheforfeiturerule.InGottlieb,ManceLJstated,

Thelawofillegality…doesnotinmyview,however,provideacompleteanalogytoor

explanationofthecommonlawrulerelatingtofraudulentclaims.Itappliestherule

149RClift,‘Fraud:Doesthepunishmentfitthecrime?’InternationalMarineClaimsConference(24October2007)available at: http://www.marineclaimsconference.com/2007/docs/07RhysCliftHandout.pdf (accessed12/12/2016)9.150TheStarSea(n7)[72]perLordHobhouse:“fraudhasafundamentalimpactupontheparties’relationshipsandraisesseriouspublicpolicyconsiderations.”Soyer,MarineInsuranceFraud(n40)[1-21]“fraudisoftenviewedasmorallyrepugnant,especiallyinthecontextofinsurancelaw,whichisbuiltuponthefoundationsofutmostgoodfaith.”SeealsoFeinman,‘Agencyandopportunism’(n1)4whoreferstothe“moralpurpose”offorfeiture.151TheStarSea(n7)[62]perLordHobhouse.152JDaveyandKRichards,‘Deterrence,humanrightsandillegality:Theforfeitureruleininsurancecontractlaw’[2015]LMCLQ315,318.SeealsoClarke,Twenty-firstCentury(n30)207.

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that a person cannot benefit from his own wrong. It does not explain either the

forfeitureofthegenuinepartofaninsuranceclaim-thatisexplainedbythedifferent

considerationsofpolicywhichappearintheconcludingsentencesofparagraph62of

LordHobhouse’sspeechinTheStarSea-ortherecoveryofsumspaidinrespectofa

genuinelossafterafraudbutbeforeitsdiscovery.153

The“differentconsiderationsofpolicy”154towhichManceLJreferredinthisjudgmentrelate

tofrauddeterrence.Aswillbediscussedinthefollowingsection,considerationsofpolicy–

mostnotablydeterrence–havebeencriticalinsettingthelimits,andjustifyingtheeffect,of

the forfeiturerule. InGottlieb,ManceLJadvocatedthat forfeitureshouldbeexplainedas

“specialcommonlawrule”155giventhatexturpicausacouldnotexplainthetotalityofthe

rule. A further reference to this characterisationwasmade inhisdissenting judgment in

Versloot156although,forthereasondiscussedabove,thejuridicalbasisofforfeitureisnow

largelyconfinedtoacademicdiscussion.

The juridicalbasisof forfeiture isausefulstartingpoint todeterminetheextent towhich

‘fraudunravelsall’explainsjudicialinterventionincasesoffraud.Thereisnodoubtthatfraud

doesunravelallwithintheconfinesofthetaintedclaim.Indeed,insuranceclaimsfraudhas

effectswhichexceedtheordinaryinvocationofexturpicausa;theforfeitureruleisnotbound

bythearbitrarytimingofinterimpaymentsand,byvirtueoftheInsuranceAct,canbringthe

relationshiptoanend.157Viewedinthislight,theconsequencesofforfeiturearefar-reaching

and demonstrate the willingness of the courts to intervene in cases of fraud. These

consequences, as will now be discussed, are attributable to policy considerations

underpinningtherule.

B. Thepolicyrationalesofforfeiture

153Gottlieb(n8)[29]perManceLJ.154Ibid[29]perManceLJ.155Ibid[31]perManceLJ.156Versloot(SupremeCourt)(n59)[119]perLordMance.157InsuranceAct2015s.12(1)(c).

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Thejudicialapproachtofraudulentinsuranceclaimslendscredencetothenotionthatfraud

unravelsall.Thecourtshaveclearlyacceptedthescaleoftheinsurancefraudproblemand,

moreover,consideredlegalsanctionsacriticalpartofcombattingtheproblem.Accordingly,

thejudicialnarrativeinvolvestwodistinctthreads(i)theneedtoprotecttheunderwriterand

(ii)theimportanceofdeterrencebywayoflegalsanctions.Considerationsoftransactioncost

provideafurtherrationalefortheforfeiturerule(iii).

i. Protectingtheunderwriter

Theriskoffraudduringclaimsstemsprimarilyfrominformationasymmetriespresentinthe

insurancerelationship.Inparticular,theassuredwilltypicallyhavemoreinformationabout

the cause and extent of the loss than the underwriter, which creates incentives for

misrepresentationforprivategain.158Theunderwriterrequiresthisinformationtomakean

accurate assessment of the claim. The presence of these information asymmetries has

traditionallybeenusedtojustifyrulesprotectingtheunderwriter,

…thepolicywaseffectedthroughanagent,whocouldnotbesupposedtobeskilled

inthevalueofthestockinallsortsofbusinesses,ortoknowwithinahundredortwo

thevalueofstockinabusinessdifferentfromhisown.159

Similarideasareevidentinmorerecentcaselaw.InGallowayvGuardian,LordWoolfMR

held that “in themaking of the claim the facts are normally wholly within the insured’s

knowledge. The insurers are dependent on the insured exercising good faith in order to

evaluatetheclaim.”160TheCourtofAppealjudgmentinVerslootraisedsimilarconcerns,

Theimportanceofhonestyintheclaimingprocessismanifest.Mostinsuranceclaims

getnowherenearlitigationbecauseinsurersrelyontheir insured…Butinsurersare

entitledtoprotectionfromeithertypeoffraud...161

158Feinman,‘Agencyandopportunism’(n1)3.159Britton(n4)910perWillesJ.160Galloway(n8)214perLordWoolfMR.161VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG[2014]EWCACiv1349,[2015]Lloyd’sRepIR115,[113]perChristopherClarkeLJ(hereafterreferredtoasVersloot(CourtofAppeal)).

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LordSumptionendorsedthisideaintheSupremeCourt,holdingthatthefraudulentclaims

rule “reflects...the law’s traditional concern with the informational asymmetry of the

contractual relationship,and theconsequentvulnerabilityof insurers.”162 Inhisdissenting

judgment,LordMancereferredtothe“significantprotectiveeffects”163oftheforfeiturerule

which he assertedwere “entirely consistentwith the underlying philosophyof insurance,

mutualtrust.”164Thejudicialcharacterisationoftheinsurancerelationshipisoneinwhichthe

underwriterisvulnerableandmeritsprotection.Thesecondthreadofthejudicialnarrative

follows from this characterisation; the importance of deterring fraud through harsh legal

sanctions.

ii. Frauddeterrence

Thecharacterisationoftheunderwriterasinneedofprotectionsuggeststhatheispowerless

tocounterfraud.Thecorollaryofthisisthatthecourtshaveportrayedlegalsanctionsasan

importantmeansofovercomingthisvulnerability.Itisforthisreasonthattheforfeiturerule

is typically framed in instrumental terms; thedeterrenceof fraud.The judicial accountof

deterrencereliesonseverelegalsanctions165todiscourageassuredsfromtakingadvantage

of the opportunities for gain within the claims process.166 The deterrent effect of the

forfeitureruleisexplicitinthecaselaw.Arepresentativeexampleofthesefollows:

InGallowayvGuardian,MillettLJcommentedontheprevalenceandimmoralityofinsurance

fraud,

Themakingofdishonestinsuranceclaimshasbecomealltoocommon.Thereseems

tobeawidespreadbeliefthatinsurancecompaniesarefairgame,andthatdefrauding

themisnotmorallyreprehensible.Therulewhichweareaskedtoenforcetodaymay

162Versloot(SupremeCourt)(n59)[26]perLordSumption.163Ibid[127]perLordMance.164Ibid[127]perLordMance.165Versloot(CourtofAppeal)(n161)[139]perChristopherClarkeLJ;Gottlieb(n8)[31]perManceLJ.166Feinman,‘Agencyandopportunism’(n1)3.Thisisthe‘economic’rationaleinFeinman’scategorisation.

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appeartosometobeharsh,butitisinmyopinionanecessaryandsalutaryrulewhich

deservestobebetterknownbythepublic.167

LordHobhousemadeclearthattheforfeiturerulewasintendedtoinfluencetheassured’s

behaviouranddiscouragethesubmissionoffraudulentclaims,

Justasthelawwillnotallowaninsuredtocommitacrimeandthenuseitasabasis

forrecoveringanindemnity,soitwillnotallowaninsuredwhohasmadeafraudulent

claimtorecover.Thelogicissimple.Thefraudulentinsuredmustnotbeallowedto

think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose

nothing.168

In the Court of Appeal judgment in Versloot, Christopher Clarke LJ equated effective

deterrencewithsanctionseverity,

It applieseven if there isno clause in thepolicy incorporating it and isdesignedly

draconian.Itfunctionsasadeterrenttothedeceptionofinsurerswho…willhaveno,

orverylittle,knowledgeoftheincidentwhichissaidtogiverisetotheclaim.Partof

therationaleisthatiflyingtotheinsurersdidnotattractthatsanction,thedishonest

insuredwouldenjoyaone-waybet.169

In Baker’s characterisation of the insurance contract, he asserts that underwriters use

different narratives about insurance at the sales and claims stages.170 The narrative that

followsalossisdesignedtolimittheunderwriter’sexposuretosubsequentclaims.171This

focus on dishonesty and deterrence in the English case law is a clear example of Baker’s

167Galloway(n8)214perMillettLJ.168TheStarSea(n7)[62]perLordHobhouse.169Versloot(CourtofAppeal)(n161)[75]perChristopherClarkeLJ.170TBaker,‘Constructingtheinsurancerelationship:Salesstories,claimsstories,andinsurancecontractdamages’(1993-1994)72TexLRev1395.171Ibid1405.

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‘immoralinsured’narrative.172Onthisbasisitiseasytojustifyjudicialinterventiontocounter

“thedepravityofthosewhothreatenthepublicinterest.”173

Thejudicialviewofdeterrenceisthatitdependsonharshlegalsanctions.Indeed,thecases

arerepletewithreferencestothe‘draconian’and‘severe’natureoftheforfeiturerule.174

MillettLJ’sreferenceinGallowaytopublicknowledgeofforfeitureappearstosuggestthat

decision-makingaboutfraud,asconceptualisedbythecourts,involvestheassuredweighing

upthepotentialpenalty inthedecisiontooffend.175Harshsanctions,onthisanalysis,are

required to outweigh the potential financial benefits of submitting a fraudulent claim.

Characterisedinthismanner,hisLordship’sdesiretoimprovepublicknowledgeasameans

of ensuring fraud deterrence can be readily understood. Academic commentary typically

characterisesfrauddeterrenceinasimilarway.Bennett,forexample,hasarguedinfavourof

stringentsanctions–includingavoidance–tocounterfraud,

…it is important not to underplay the policing function of the doctrine…if the

consequenceof suchdeliberatenon-disclosureweremerely lossof the fraudulent

claim, the lawwouldprovideno incentive tohonestyandalmostencourage fraud

insteadofdeterringit.176

Legal sanctions are central to the judicial account of fraud deterrence. This absolves the

underwriters’responsibilitywhichisconsistentwiththenarrativeofthevulnerableinsurer.

It further carries with it the suggestion that, absent forfeiture, insureds would routinely

submitfraudulentclaims.Thisoverlooksthefactthattheexpressrequirementofgoodfaith

might have any impact on behaviour. Perhapsmost interestingly, the characterisation of

forfeitureasadeterrentaccordsthecivillawanatypicalinstrumentalpurpose.Theordinary

roleofthecivillawisnottopolicetheparties’relationshipbuttoresolvedisputesandaward

compensationforloss.177

172Ibid1411.173Ibid1412.174Versloot(CourtofAppeal)(n161)[139]perChristopherClarkeLJ;Gottlieb(n8)[31]perManceLJ.175Foracritiqueofthismodelofdecisionmaking,seeChapterThreetexttofn71etseq.176Bennett,‘Mappingthedoctrine’(n105)210.177Galloway(n8)214perMillettLJ.ThelogicofthedeterrencerationalewillbeconsideredindepthinChapterThree.

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Deterrence must also be appreciated from a broader systemic perspective178 since the

particularinsured-insurerrelationshipisbutoneofanumberofsuchrelationshipsinwhich

theunderwriterengages.Justasrisksarespreadthroughoutthepoolatinception,sotooare

thecostsoffraudbornebypolicyholdersinhigherpremiums.179Thismakesfrauddeterrence

all themore important.Not onlywill a deterrent sanctionprevent the individual assured

profitingfromwrongdoing,butitwillalsosafeguardtheinterestsofhonestassureds.180This

hasbeenrecognisedmoregenerallybyAbraham,“insurersdistributerisk,andlegalrulesthat

protectinsurersthereforeredoundtothebenefitofthecommunityofinsureds.”181If,asthe

courts presume, deterrence is dependent on harsh sanctions, this broader consideration

cementstheneedforasevereresponsetofraudwillinglyemployedbythecourts.

iii. Thetransactioncostrationale

Thejudicialaccountofinsurancefraudsuggeststhatlegalsanctionsarerequiredtoprotect

underwritersanddeterwould-befraudsters.However,issuesrelatedtotransactioncostalso

bearexaminationinthiscontext.Agooddealoftheinformationonwhichtheunderwriter

relies to make decisions about the claim will emanate from his assured. Simply, if the

underwriterwasforcedtoconfirmthevalidityofeverystatementmadetohim,theclaims

processwouldbefarlengthierandmoreexpensiveasaresult.182Thesecostswouldnodoubt

bepassedontopolicyholdersinincreasedpremiums.

A justification premised on considerations of transaction cost is not uncommon in the

insurancesetting.SimilarargumentswereusedinBrothertontoexplainthepre-contractual

disclosuredutiesoftheassured.183Iftheassuredwasnotrequiredtodiscloseallegationsof

misconduct,evenincircumstanceswheretheassuredknewthemtobefalseandwereinfact

178Feinman,‘Agencyandopportunism’(n1)4.179Versloot(SupremeCourthearing)(n3)2h16perLordSumption,Feinman,‘Agencyandopportunism’(n1)4.180Baker,‘Constructingtheinsurancerelationship’(n170)1410,1412-1413;ChapmanvPole(1870)22LT306,307perCockburnCJ.181Abraham,DistributingRisk(n19)35.182DHarris,DCampbellandRHalson,RemediesinContractandTort,(2nded.ButterworthsTolley,2001),555.183BrothertonvAseguradoraColsegurosSA[2003]Lloyd’sRep.IR746.

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laterdisproved,theunderwriterwouldbeput“tothetrouble,expenseand…riskofexpensive

litigation…incircumstanceswheninsurerswouldneverhavebeenexposedtoanyofthis,had

theinsuredperformeditsprimafaciedutytomaketimelydisclosure.”184

ThislogicwasrepeatedbyLordHughesinVersloot,

Typically,insurersmarkettheirpoliciesinpartbyadvertisingwhattheyasserttobe

theirpromptanduncomplicatedresponsetoclaims.Ifsuchistobetheresponseto

claims, insurersmust take the claiming insured to a considerable extent on trust.

Furthermore, if claims have to be investigated in detail and routinely verified by

insurers, the costs of the systems necessary to do this will fall on policyholders

generally.185

Policyconsiderationshavebeencriticalinthedevelopmentoftheforfeiturerule.Themost

significantofthese–frauddeterrence–hasbeenexplainedbythecourtsasdependenton

severe legalsanctionsandthis inturnhasbeenusedto justifytheharshconsequencesof

forfeiture. This provides philosophical support for the notion that insurance claims fraud

shouldunravelall.Thefocusnowturnstothecommonlawmeaningoffraudasthis isan

important perspective fromwhich to assess the utility of ex turpi causa in the insurance

context.

C. Theconceptionoffraud

Thedefinitionof insurancefraud isan importantconsideration intracingthescopeofthe

fraudulentclaimsjurisdiction.Themorebroadlyfraudisdefined,thegreaterscopeforcourts

topreventtheassuredreceivingtheindemnity.Thishasbeenamatterforthecourts.186The

classicdefinitionofcivilfraudistracedtothedecisioninDerryvPeek.187Inthatcase,Lord

Herschelldeterminedthatastatementwouldbefraudulentwhenitwas“made(1)knowingly,

184Ibid[31]perManceLJ.185Versloot(SupremeCourt)(n59)[55]perLordHughes.186ThisremainsthecasefollowingtheenactmentofInsuranceAct2015,seeLawCom353(n5)[1.51].187DerryvPeek(1889)14AppCas337.

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or (2)withoutbelief in its truth,or (3) recklessly, carelesswhether itbe trueor false.”188

MalcolmClarkehassuggestedthatfraudcomprisesthreedistinctelements;thefraudmust

besubstantial,wilfulandmaterial.189

Thenotionofsubstantialityrequiresanobjectiveconsiderationofthesizeofthefraud.This

is“notahighthreshold”190andeffectivelyenablesthecourtstoexcludefraudswhicharede

minimis191fromthefraudulentclaimsjurisdiction.AswasnotedatfirstinstanceinVersloot,

afraudulentexaggerationof£2000inthecontextofaclaimworth£3millionwillberegarded

assubstantialforthepurposesofforfeiture.192

The second requirement – that the fraud is wilful and deliberate – is embodied by the

definitiongiveninDerry.Thefocushereisonthemindsetoftheassured.Clarkehasnoted

that“insomedegreethefalsitymusthavebeenknowntoand,byinferenceintendedbythe

claimant.”193Thisexcludes,therefore,bothnegligence194andthe‘moralfraud’ofRedgravev

Hurd.195 This significantly narrows the range of conduct that the courts will regard as

fraudulent.

Thetestestablished inDerryhasbeenacceptedalmostwithoutquestion inthe insurance

context. An alternative test, however, was proposed and ultimately adopted in Aviva v

Brown.196Counselfortheassuredcontendedthatthe“combinedtest”197firstenunciatedin

TwinsectravYardley198whichcontainedanobjectiveandsubjectiveelementwasapplicable.

188Ibid374perLordHerschell.189Clarke(looseleaf)(n26)27-2B.190VerslootDredgingBVvHDI-GerlingIndustrieVersicherungAg(TheDCMerwestone)[2013]EWHC1666(Comm),[2013]Lloyd’sRep.IR582,[157]perPopplewellJ(hereafterreferredtoasVersloot(FirstInstance)).191Clarke(looseleaf)(n26)[27-2B1];Legh-Jones,BirdsandOwen,MacGillivrayonInsuranceLaw(n148)[19-061].InLekvMathews[1927]LlLRep141,145perViscountSumnerthefalseclaimsclausewasinterpretedtoinclude“anythingnotsoinsubstantialastomakethemaximdeminimisapplicable.”192Versloot(FirstInstance)(n190)[157]perPopplewellJ.193Clarke,looseleaf(n26)27-2B2.194BeaconInsuranceCompanyLtdvMaharajBookstoreLtd[2014]UKPC21,[26]:“errorwasagenuineoneandthatMrMaharajhadnotintendedtodeceiveanyone”,[36]:“theboundarybetweenanincompetentmistakeandaliemaybeamatterofimpression”perLordHodge.195RedgravevHurd(1881)20ChD1,seeearlierdiscussioninChapterOne.196AvivaInsuranceLtdvBrown[2012]1Lloyd’sRep.IR211,[101]butseealso[61]whereEderJdescribesDerry(n187)asprovidingthe“classicdefinitionoffraud”197TwinsectraLtdvYardley [2002]2AC164,172perLordHutton.198Ibid172perLordHutton.

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Thismeantthatdishonestywouldonlybeestablishedwherei)thedefendant’sconductwas

dishonestbythestandardsofreasonablemenandii)thedefendantknewhisconductwas

dishonestonthisbasis.199Thishasnotbeenwellreceivedinsubsequentcommentaryorcase

law. Arnould has explained the result in Aviva as “heavily influenced by the test of

dishonesty”200adoptedwithoutexpressingafirmviewonthemeritsofthecombinedtest.At

firstinstanceinVersloot,PopplewellJrestoredDerryvPeekastheappropriatetestincases

of fraud stating that “conscious dishonesty is not a separate element of the test.”201

Moreover,PopplewellJmadeclearthattheDerrystandarddidnotconstitutealowerburden

fortheunderwriterandreiteratedthedifficultyofprovingfraud.202

Thefinal,andperhapsmostcomplex,elementofthecommonlawdefinitionismateriality.

Thiscomplexityispartlyexplainedbythefactmateriality“’intheordinarysense’hasnorole

toplay”203here.Thisisbecausematerialityusuallyembodiesacausalconnectionrequiring

thecourttodeterminewhetherthefalsityimpactedtherepresentee’sconduct.Indeed,the

tortofdeceitrequiresthattherepresenteewasinfluencedbythelieindecidingtoenterthe

contract.204Bycontrast,whentheinsurerallegesfraud,hedoessopreciselybecausehehas

notbeeninducedbythelietomakepayment.205

Thishascomplicatedthecourts’approachtomaterialityandtwodistinctcharacterisationsof

thiselementofthetestareidentifiableinthecaselaw.Thefirstschoolofthoughteffectively

marginalised themateriality requirement. InRoyalBoskalis vMountain, Rix J argued that

therewas“noadditionaltestofmaterialityor,toputthesamepointperhapsinanotherway,

thetestofmaterialityisbuiltintotheconceptofafraudulentclaim.”206Thiswasaverylimited

requirementwhich,asRix J contended, responded to the“disciplinaryelementofmarine

199AvivavBrown(n196)224perEderJ.200JGilman(ed.),Arnould’sLawofMarineInsuranceandAverage(18thed.SweetandMaxwell,2013),[18-92].201Versloot(FirstInstance)(n190)[154]perPopplewellJ.202Ibid[155]perPopplewellJ.203Arnould(18thed.)(n200)[18-62].204HaywardvZurichInsuranceCo.[2016]UKSC48,[47]perLordClarke.205AswasnotedinTheAegeon(n9)[36]perManceLJ.206RoyalBoskalisWestminsterBVvMountain[1997]1LRLR523,599perRixJ.

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insurance.”207ThisconceptionhasbeensubsequentlyendorsedbyBennett208andbyMance

LJinthefollowingterms,

Andneedthefraudhaveanyeffectoninsurers’conduct?Speakinghereofaclaimfor

a loss known to benon-existent or exaggerated, the answers seem clear.Nothing

furtherisnecessary.Theapplicationoftheruleflowsfromthefactthatafraudulent

claimof this nature has beenmade.Whether insurers aremisled or not is in this

contextbesidethepoint.209

Understoodinthisway,materialityrepresentedaveryminorconstraintonthecourts’ability

tointerveneincasesoffraudandwouldbeeasilysatisfiedbytheunderwriter.

An alternative formulation ofmateriality has been suggested byMalcolm Clarke. He has

argued in favour of a decisive influence test such that fraud would be material when it

affectedtheunderwriter’sreadinesstopay.210Thisideaencompassed“eithertheamountto

bepaidorthepersontowhomitistobepaidorwhethertopayanyoneanyamountatall.”211

Thistestwouldbeeasilysatisfiedwheretheclaimwaseitherwhollyfabricatedorinvolved

anexaggeration.Thebreadthofthisformulation212isapparentinWisenthalvWorldAuxiliary

InsuranceCorporation.213Inthatcase,RocheJdeterminedthatmaterialitywouldbesatisfied

ifthe“deceithadbeenusedtosecureeasierorquickerpaymentofthemoneythanwould

havebeenobtainedifthetruthhadbeentold.”214

207Ibid598perRixJcitingPanAtlanticInsuranceCoLtdvPineTopInsuranceCoLtd[1995]1AC501,511perLordMustill.208Bennett,TheLawofMarineInsurance(n80),[22.91]:“noqualificationisneededoracknowledgedwithrespecttofraudulentclaimsstrictosensu,oralternativelyisbuiltintotheconceptofsuchafraudulentclaim.”209TheAegeon(n9)[36]perManceLJ.210Clarke(looseleaf)(n26)[27-2B4].211Ibid[27-2B4].212LawComIssuesPaper7(n14)[3.13].213WisenthalvWorldAuxiliaryInsuranceCorporation(1930)38LlLRep54.214Ibid62perRocheJ.

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Whetherthe‘noadditionalrequirement’or‘decisiveimpact’conceptionofmaterialitywere

preferred,itwasunlikelytoconstituteasignificanthurdlefortheunderwriter.AstheLaw

Commissionnoted,itwouldbeavery“rarecase”215thataliewouldnotbematerial.

Theearlierreferencetothecomplexityofmaterialityalsoreflectsthefactthattheapplicable

testwasrecentlyalteredbytheSupremeCourtinVersloot.216Atthisstage,itsufficestosay

thatthenewtestfocusessolelyonwhetherthelierelatestotheunderwriter’sliabilityunder

thepolicyandwillbeassessedretrospectively.217Thisnowmeansthatlieslikethosetoldin

Wisenthal–to“secureeasierorquickerpaymentofthemoney”218–willnotberegardedas

material.Acomprehensivediscussionofthenewmaterialitythresholdwillbeundertakenin

duecourse.219

Althoughthecourts,andindeedtheInsuranceAct2015,proceedonthebasisthatforfeiture

is the only civil sanction for fraud, the common law definition of insurance fraud can be

satisfied by several behaviours. It is appropriate, therefore, to speak of a spectrum of

insurancefraud.220Threebehavioursaretraditionallyidentifiedinthecaselaw:(i)thewholly

fraudulent claim, (ii) the exaggerated claim and (iii) the genuine claim supplemented by

fraudulent means or devices. A fourth category of fraudulent claim – the assured’s

suppressionofadefence–willalsobeconsidered(iv)followingtherecentSupremeCourt

decision in Versloot.221 The following discussion considers these behaviours in detail to

determinetheprecisescopeofthefraudulentclaimsjurisdiction.

i. Thewhollyfraudulentclaim

A wholly fraudulent claim exists when the assured fabricates the entirety of the loss or

deliberatelycausesthelosshimself.Thisisthemostserioustypeoffraudulentclaim222and

215LawComIssuesPaper7(n14)[3.15].216Versloot(SupremeCourt)(n59)[30],[36]perLordSumption,[92]perLordClarke.217Ibid[30],[36]perLordSumption,[92]perLordClarke.218Wisenthal(n213)62perRocheJ.219Seelater,texttofn319etseq.220Richards(n34)18.221Versloot(SupremeCourt)(n59).222LiverpoolVictoriaInsuranceCoLtdvBashir[2012]EWHC895(Admin),[9]perSirJohnThomas.

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willgenerallyrequiretheassuredtohaveplannedhisoffendinginadvance.Theparadigm

marineexampleofthewhollyfraudulentclaimisthescuttle;thedeliberatesinkingofavessel

to claim the indemnity. Todd has suggested that scuttling is “probably quite common”223

althoughitwillbedifficulttoproveevenwhenthereisamplesuspicionabouttherealcause

of the loss.224 This is becausebarratry – thedestructionof the vessel by the crew to the

prejudice of the owner225 – is a covered peril.226 The courts will demand considerable

evidence of the assured’s complicity in the casting away of the vessel to substantiate an

allegationofscuttling.227

The application of the forfeiture rule to the wholly fraudulent claim involves a difficult

analysis.Inthefirstplacethisisbecauseforfeituredeprivestheassuredofacauseofaction

whicharoseontheoccurrenceoftheloss.228Thisdoesnotmakesensewherethelosshas

been caused deliberately by the assured or the claim ismade in the absence of any loss

whatsoever. In the former case, the wilful misconduct defence establishes that the

underwritercannotbeliableforlossdeliberatelyoccasionedbytheassured.229Wherethe

claimismadeintheabsenceofanyloss,theassuredcouldnotrecoversimplybecausehe

wouldbeunabletodischargetheburdenofprovingthelosswascoveredbythepolicy.230

Thismakesitconceptuallydifficulttospeakofforfeitureinthecontextofwhollyfraudulent

claimsbecausethereneverwasavalidclaimfortheassuredtoforfeit.

Leaving this conceptual difficulty aside, the application of forfeiture in relation towholly

fraudulentclaimsisalsoproblematicbecausetheruleistheonlycivilsanctionforinsurance

fraud.Applyingforfeituretothistypeofclaimistheequivalentofpermittingathieftoreturn

223Todd,MaritimeFraud&Piracy(n29)[6.032].224Casesinwhichscuttlinghasbeenprovedinclude:PSamuel&CovDumas(1924)18LlLRep211;NationalJusticeCompaniavPrudentialAssuranceCo(TheIkarianReefer)[1995]1Lloyd’sRep.455;TheGoldSky(n46)[1972]2Lloyd’sRep.187.225MarineInsuranceAct1906Sched.1(11).226InternationalHullsClauses2003cl.2.2.5.227 InElfie A Issaias vMarine Insurance Co Ltd (1923) 15 Ll L Rep 186, the assured proved that the losswasbarratrous;theunderwriterwasunabletoprovethatthishadbeendonewiththeprivityoftheassured.TheCourtofAppealfoundfortheplaintiffassured.228ChandrisvArgoInsuranceCoLtd[1963]2Lloyd’sRep65,74perMegawJ;TheFanti(n25)35-36perLordGoff;Rose,MarineInsurance(n26)[26.1].229MarineInsuranceAct1906s.55(2)(a).230LawComIssuesPaper7(n14)[2.7].

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stolen propertywithout imposing any further sanction. This is, simply put, an ineffective

sanctionbecausetherewasnot,atanystage,avalidclaimandthereforenothingtolose.The

LawCommissionrecognisedtheabsenceofapenaltyintheinitialphaseofconsultation.It

wasnotedthat“thepenaltymaybearbitrary.Aninsuredwhopresentsanentirelyfictitious

claimlosesnothing(exceptaclaimwhichneverexisted).”231Itshouldalsobenotedthatthe

absence of a sanction in these circumstances cannot be reconciled with the judicial

explanationofdeterrence,namelythatitisdependentonseverelegalsanctions.232

ii. Theexaggeratedclaim

Thesecondcategoryoffraudulentbehaviouristheexaggeratedclaim.Suchaclaimoccurs

whentheassuredtakesadvantageofgenuinelosstomakealargerclaimby,forexample,

inflatingthevalueoflostitemsorclaimingitemsthatwereneverinfactowned.Thereisno

doubtthatthisbehavioursatisfiesthecommonlawrequirementofwilfulness.Thecaseof

GallowayvGuardian233isusefulhere.Gallowayinvolvedadomesticburglaryasaresultof

whichtheassuredsufferedinsuredlossesof£16,000.Theassuredthenfalselyassertedthat

he had also lost a computer worth a further £2,000 during the burglary. It is in these

circumstancesthattheforfeiturerulehasthegreatest“bite”;234MrGallowaylosttheentirety

ofhisclaim,includingthemuchlargergenuineportion.

Exaggeration is thought tobe themost common typeof insurance fraud.235 Staughton LJ

commented, rather depressingly, on the prevalence of such fraud in Orakpo v Barclays

Insurancestatingthat“ifoneexaminedasampleofinsuranceclaimsonhouseholdcontents,

Idoubt ifonewould findmanywhich stated the losswithabsolute truth.”236There isno

reasontosuggestthatthisportrayalislimitedtodomesticcontentsinsurance.

231Ibid[7.30].232Seeearlier,texttofn174etseq.233Galloway(n8).234TheAegeon(n9)[33]perManceLJ.235 MORI, ‘UK Commercial Insurance Fraud Study 2005’, available at:http://www.abi.org.uk/Publications/ABI_Publications_UK_Commercial_Insurance_Fraud_Study_2005_c6d.aspx(accessed22May2012),7.236Orakpo(n91)450perStaughtonLJ.

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The common law requirement of substantiality has been particularly problematic in the

context of exaggerated claims. This is apparent in the courts’ inability to express the

appropriatemeansofmeasuringwhetheraclaimissubstantiallyfraudulentinauniformand

consistentmanner.237InGalloway,thequestionofsubstantialitywasansweredinabsolute

terms;anexaggerationof£2,000wasnotdeminimisandcountedasfraud.238Toassessthe

exaggerationbyreferencetothevalueofthetotalclaimwould,asMillettLJrecognised,lead

to the absurd conclusion that the greater the claim, the greater the fraud that could be

practiced without fear of consequences.239 Later case law has simultaneously evaluated

exaggerationinbothabsoluteandproportionalterms,240meaningthatasmallexaggeration

ofasmallclaimcouldverywellcountasfraud.241Nevertheless,itseemssafetosaythatthe

approachofthefirstinstancecourtinTonkin,anassessmentofexaggerationinrelationto

theoverallclaim,242 is incorrectonthebasisthatitfallsfoulofMillettLJ’sconcernsabout

absurdity.243

Several cases towards theendof the twentieth centuryappeared to indicateadegreeof

tolerancetoexaggeration.Incertaincircumstances,thecourtswouldrefrainfromafinding

of fraud on the basis that the claims process, particularly when it involved commercial

assureds,oftenresembledanegotiation.244ThecaseofDiggensvSunAlliance245suggests

237GSwaby,‘Thepriceofalie:Discretionaryflexibilityininsurancefraud’[213]JBL77,83.238Galloway (n8)214perLordWoolfMR.SeealsoDirectLineInsurancevKhan [2001]EWCACiv1794,[2002]Lloyd’sRep.IR364.239Galloway(n8)214perMillettLJ.240MicroDesignGroupLtdvNorwichUnionInsuranceLtd[2005]EWHC3093(TCC),[2006]Lloyd’sRep.IR235.241RMerkin, ‘Reforminginsurancelaw: Isthereacaseforreversetransportation?’(ReportfortheEnglishandScottish Law Commissions, 2006) available at: http://www.lawcom.gov.uk/wp-content/uploads/2015/03/ICL_Merkin_report.pdf(accessed24/08/2016),[6.9];Swaby(n237)82-83.242TonkinvUKInsurance[2006]EWCA1120(TCC),[2007]Lloyd’sRepIR283[178]–[179],[189].Thiscaseinvolvedadomesticclaimexaggeratedby£2000whichconstituted0.3%ofthetotalclaim.Thejudge,HHJPeterCoulsonQC,determinedat[178]thatit“wouldbeabsurdifanentirelyinsubstantialelementofalargeclaim…couldtainttheentiretyofthatclaim.”243Forexample,JLowry,PRawlingsandRMerkin,InsuranceLawDoctrinesandPrinciples(3rded.HartPublishing,2011),312;Arnould(18thed.)(n200)[18-75];Bennett,‘Mappingthedoctrine’(n105)209:“Onehalfofonepercent.mightberegardedasdeminimisintheabstract,butonaclaimof£1,000,000thatwouldamounttothesumof£5,000.Relativeinsignificanceisnoreasontocondone,oroverlook,fraud.”244Orakpo(n91)451perHoffmannLJ;NsubugavCommercialUnionAssurance[1998]2Lloyd’sRep.682,686perThomasJ.ThenegotiationanalysisappearstohavebeenacceptedbytheLawCommissionIssuesPaper7(n14)[3.64]: “This makes it difficult to be precise about the exact boundary between fraud and, for example,exaggerationaspartofthenegotiationprocess.”245DiggensvSunAlliance[1994]CLC1146.

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somemeritinthejudicialconceptionofcommercialclaimsasnegotiation.Inthejudgment,

EvansLJreferredtothefollowingnoteintheinsurer’sfile,

Putthebalanceofouroffer ‘onthetable’andgivethepolicy-holdertheoptionof

takingthisandbackingoff,oralternativelykeepingthepolicy-holderoverthebarrel

toseeifhe[is]willingtogotherouteofarbitration/litigation.246

Thissuggeststhattheprocessismuchmoreadversarialandthatinsurersthemselvesexpect

adegreeofgiveandtakebeforetheywouldregardsuchconductasfraud.However,itisonly

possibletoregardtheclaimsprocessasanegotiationwhere“nothingismisrepresentedor

concealed,andthelossadjusterisinasgoodapositiontoformaviewofthevalidityorvalue

of the claim as the insured.”247 The degree of permitted exaggeration is also subject to

constraint;inparticular,theremustbe“somebasisforthefigure,oratleastthatthebasis

forthefigureisgiven.”248Thesefactorsovercometheinformationimbalancewhichtypically

characterises the claims process and means that the underwriter is no longer wholly

dependentoninformationprovidedbyhisassured.249

Theweightof academic commentary suggestsdifficultieswith the characterisationof the

commercialclaimsprocessasanegotiation.250TheeditorsofArnouldhavesuggestedthatthe

abilityoftheunderwritertoaccuratelyassessthelossshouldnotmakeanydifferencetoa

findingoffraud.251Itisalsodifficulttoacceptthenegotiationanalysisinlightoftheextended

246Ibid1165perEvansLJ.247Orakpo(n91)451perHoffmannLJ.248JGilmanandRMerkin,(eds.),Arnould’sLawofMarineInsuranceandAverage(17thed.Sweet&Maxwell2008),[18.76];TransthenePackingCoLtdvRoyalInsurance(UK)Ltd[1996]Lloyd’sRep.LR32,44perHHJKershawQCholdingthattheclaimforthefullreplacementcostofamachinewhichwasseriouslydefectivebeforethelosswouldconstitutefraud.SeealsoDanepointvAlliedUnderwritingInsurance[2005]EWHC2318(TCC),[2005]AllER(D)237whereanexaggeratedclaimforrepaircostswasnotregardedasmaterialbecausethefinalpaymentwassubject to authorisation by a loss adjuster, [70] per Judge Peter Coulson QC the exaggeration “would…haveultimatelymadenodifference.[becausethelossadjuster]wouldnotauthoriseanypaymentsbeyondthosethathefelt,oninspection,werejustified.”249DFoxton,‘Thepost-contractualdutyofgoodfaithinmarineinsurancepolicies:Thesearchforelusiveprinciples’inDRThomas,MarineInsurance:TheLawinTransition(InformaLaw,2006),[4.77].250 But see Soyer,Marine Insurance Fraud (n40) [1-24], [1-26] for a view recognising the judicial tolerance toexaggerationas“realistic”.251Arnould(17thed.)(n248)[18.72].

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scopeof the forfeiture rule.252 Aswill be discussed in the following section, the rulewas

extendedinTheAegeontoincludeclaimsforwhollygenuinelosswheretheassuredhadlied

aboutthecauseofthelossorusedforgedevidencetomakehiscase.253Itthereforeseems

undulylenienttooverlookexaggerationgiventhattheforfeiturerulewouldoperateagainst

theclaimantwhotolda liemerelytospeeduptheclaimsprocess.Thecase lawdoesnot

reflect this critique.Notably, the decisions inDanepoint254 andTonkin,255heard after the

extensionoftherulecontinuedtoapplythenegotiationanalysis.Afinaldifficultywiththe

negotiation analysis relates to the fact that judicial condonation of exaggeration directly

contradictsthepurposeoftheforfeiturerule;frauddeterrence.

It is difficult to find a report of exaggeration in themarine context. Soyer has suggested

severalexplanationsforthis.256Firstly,hehasattributedittotheexistenceofdeductibles,

suchasthatfoundintheInternationalHullClauses2003.257Thisisnotparticularlyconvincing.

Marinepoliciesarefarfromuniqueinrequiringassuredstopayanexcessduringtheclaims

process.Similartermsexist inbothcommercialanddomesticpolicies.Moreover,thelogic

justifyingthisfeatureofthecontract–asadevicetomitigatemoralhazard258–isnotpeculiar

tothemarinecontext.

Soyer’sotherexplanationsaremoreconvincing.Hehasarguedthatthesizeofmarineclaims

tendtojustifyinvestigationandtheemploymentofalossadjuster.259Thiswasalsotheview

252JDavey,‘Unpickingthefraudulentclaimsjurisdiction:Sympathyforthedevil?’[2006]LMCLQ223,231citingTheAegeon(n9)[45]perManceLJ.SeealsoFoxton(n251)[4.77].253TheAegeon(n9)[45]perManceLJ.254Danepoint(n248)[52],[56]perHHJCoulsonQC:“Itseemstomethatmereexaggerationofaninsuranceclaimwillnotofitselfbefraud.Ontheotherhand,exaggerationwhichiswilful,orwhichisalliedtomisrepresentationorconcealmentwill,inallprobability,befraudulent.Inaddition,Iconsiderthatexaggerationismorelikelyandmoreexcusablewherethevalueoftheparticularclaimorheadoflossinquestionisunclearoramatterofopinion.”255Tonkin(n242)[189]perHHJCoulsonQC.Thecourtheldthattheclaiminthiscasewasnotfraudulentbutanhonestandinadvertentmistake.Ifithadbeenfraudulent,“Theallegedfraudappearstobeworthnomorethan£2,000.That is,onanyview,notmorethanabout0.3percentoftheentiretyoftheclaimants’claimintheseproceedings.Idonotconsiderthatthatis"substantial"inaccordancewiththeauthorities.”ThedecisionignoresthelessonofGalloway(n8)214perMillettLJwhichcautionedagainstanarithmeticalassessmentoffraud.256Soyer,MarineInsuranceFraud(n40)[3-46].257Ibid[3-46];InternationalHullClauses2003(01/11/2003)cl.15.Seealso,InstituteTimeClausesHulls(1/10/83)cl.12.258M Pauly, ‘The economics ofmoral hazard: Comment’ (1968) 58(3)(1) Am Ec Rev 531, 535—536; T Baker,InsuranceLawandPolicyCasesMaterialsandProblems(AspenPublishers2003),16;CHeimer,ReactiveRiskandRationalAction(UniversityofCaliforniaPress,1985),47.259Soyer,MarineInsuranceFraud(n40)[3-46].

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expressedby threemembersof theSupremeCourtduringargument inVersloot.260 Soyer

goesontoexplainwhytheseeffortsreduceexaggeratedclaimsinthemarinecontext;“the

availability of such expertswould usually have a deterrent effect because their presence

would make such a deceit more risky and difficult to perpetrate.”261 While there is an

argumentthat investigationreducesthelikelihoodoffraud,262Soyer’sargumentwouldbe

morecompellingifitdependedonevidence,ratherthanmereassertion.

Soyer’sfinalcontentionconcernsthearrangementsoftheshippingindustry.Marineassureds

are generally required to keep accurate records of the equipment used on board.263 This

wouldseemtomakeitvirtuallyimpossiblefortheassuredtoassertthelossofequipmenthe

hadneverowned,aswasthecaseinGalloway.Soyeralsomakestheargumentthat,inthe

caseofarepairedvessel,asuspiciousunderwritercouldseekcorroborationinthesupposed

repairyard’srecords.264Whilethisrationaleismoreconvincing,itisdifficulttosupposethat

shipping is the only such highly regulated industry. If exaggeration is more common in

comparable industries, it would cast doubt on this explanation for an absence of similar

marineclaims.

ThecaseofGlencorevAlpinaInsurance265providesausefulillustrationofwhatexaggeration

mightlooklikeinthemarinecontext.Glencorewasoneofseveralcompanieswhichstored

oilatafloatingfacilityownedandoperatedbyMetroGroup.Theoilwasinsuredunderan

opencoverand includedperiodsof storage in the facility inFujairah.WhenMetroGroup

collapsed in1998, itwasdiscovered that therewas far lessoil in thestorage facility than

anticipated. This shortfall was attributed to withdrawals made by Metro for its own

(dishonest)purposes.266ForashortperiodfollowingMetro’scollapse,Glencoretookover

operations at the facility. Glencore then submitted a claim to its underwriter for the

differencebetweentheamountofoiltheyhaddepositedandtheamountremainingafter

260Versloot(SupremeCourthearing)(n3)1h34-35perLordMance,2h15perLordHughesand2h16perLordSumption.261Soyer,MarineInsuranceFraud(n40)[3-46].262Seelater,ChapterThreeonmoderndeterrencetheoryandtheimportanceofcertaintyofsanctions.263Soyer,MarineInsuranceFraud(n40)[3-46].264Ibid[3-46].265GlencoreLtdvAlpinaInsurance[2003]EWHC2792(Comm),[2004]1AllER(Comm)766.266Ibid[25].

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thecollapse,lesstheauthorisedwithdrawals.Priortothefirstinstancehearing,theinsurer

gavenoticeofitsintentiontorunseveraldefences,includingtheassertionthattheclaimhad

beenfraudulentlyexaggeratedtotheknowledgeoftheclaimsmanager.267Thiswasbecause

someoftheallegedshortfallrelatedtooilwhichhadbeenwithdrawnduringtheperiodthat

Glencorewasrunningthefacility.268Lossesoccasionedduringthisperiodcouldnotfairlybe

attributed toMetro. The underwriters did not pursue a defence of fraud at trial.269 It is

certainlycorrectthatexaggerationislitigatedlessofteninthemarinecontext.Itiscertainly

notinconceivable,however,thatamarineassuredmightinflatehisclaimasillustratedbythe

factsofGlencore.

iii. Fraudulentdevicesandcollaterallies

Thethirdcategoryof fraudulentclaimwaspreviouslyreferredtoasthefraudulentdevice

claim.Thisclaimexistedwhentheassuredsufferedalosswhollywithinthetermsofthepolicy

butbolsteredhis claimwith fraudulentevidence.270 Thiswould include forged receipts to

substantiatethevalueoflostitems,fabricatedwitnesstestimonyoramisleadingaccountof

theloss.Therulewasextendedtoincludedeviceclaimsin2006271andthishasprompted

significant judicial and academic discussion regarding the severity of forfeiture in these

circumstances.Thefocusofthisdiscussionhasbeentheappropriatematerialitythresholdfor

device claims and, to a lesser extent, issues relating to the substantial nature of the

wrongdoing.TherecentdecisioninVerslootchangeshowthelawapproachestheseclaimsas

wellasimposinganamechange;thefraudulentdeviceisnowreferredtoasthecollateral

lie.272

The starting point for discussion is the judgment in The Aegeon.273 The assured had

undertakenthathotworkswouldnotcommenceuntilhehadreceivedauthorisationfrom

267Ibid)[27]-[29].268Ibid[29].269Ibid[32].270TheAegeon(n9)[30]perManceLJ,“Afraudulentdeviceisusediftheinsuredbelievesthathehassufferedthelossclaimed,butseekstoimproveorembellishthefactssurroundingtheclaim,bysomelie.”271Ibid[45]perManceLJ.272Versloot(SupremeCourt)(n59)[1]perLordSumption.273TheAegeon(n9).

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theclassificationsociety.Infact,theworksbeganbeforepermissionhadbeenobtainedand

theassuredmisrepresentedtheprecisestartdateduringlitigation.ThequestionfortheCourt

ofAppealwaswhethersuchalie,toldtostrengthenanotherwisevalidclaim,wassufficient

toattractthesanctionofforfeiture.ManceLJbeganbynotingtheabsenceofauthorityinthis

area274andwentontoconductareviewoftherelevantcaselaw.Heconcludedobiterthat

the jurisdictionshouldbeextendedto includedeviceclaimswiththeadditionofa limited

materialityrequirement.Assuch,theforfeiturerulewouldapplyto

anylie,directlyrelatedtotheclaimtowhichthefraudulentdevicerelates,whichis

intendedtoimprovetheinsured'sprospectsofobtainingasettlementorwinningthe

case,andwhichwould,ifbelieved,tend,objectively,priortoanyfinaldetermination

attrialoftheparties'rights,toyieldanotinsignificantimprovementintheinsured's

prospects—whether they be prospects of obtaining a settlement, or a better

settlement,orofwinningattrial.275

Materialitywastobedeterminedatthetimetheliewastold.Thisreflectedthefactthatlies

weregenerallyemployedforapurpose-“because[theassured]believesthatitisnecessary

orexpedienttodoso.Heusessuchdevices,preciselybecausehecannotbesurethathis

claim isotherwisegood”276–andto takeaccountof the impact the liecouldhavehad, if

believed.Onthisbasis,thejudicialenquirywastoconsiderwhetherthelie,ifbelieved,would

have placed the insured in a better position during the claims process or affected the

underwriter’shandlingoftheclaim.Bywayofillustration,aliewouldbematerialifitcaused

theunderwritertosettleearlier,morefavourablyordefendtheclaimondifferentgrounds.277

In largelyendorsing this versionofmateriality inVersloot, ChristopherClarke LJheld that

dishonestywouldbematerialiftheunderwriterwas“putoffrelevantinquiriesor…drivento

irrelevant ones and he loses the opportunity to investigate the claim after an honest

presentation of the facts.”278 This was a low thresholdwhich caughtmany untruths told

274Ibid[45]perManceLJ.275Ibid[45]perManceLJ.276Ibid[20]perManceLJ.277Ibid[37]perManceLJ.278Versloot (CourtofAppeal) (n161) [132]perChristopherClarkeLJ.At [165]ChristopherClarkeLJadvocatedframing themateriality test in positive terms: “Formy part, however, I am not quite sure why the negative

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duringtheclaimsprocess.279Itisimportanttonote,however,thatthisthresholdwouldnot

besatisfiedbyliesthatcouldnotsensiblyhaveaffectedtheinsured’sprospects–suchaslies

toldtoathirdparty280ortoavoidpersonalembarrassment.281Inpractice,thisconceptionof

materiality did very little to prevent the forfeiture rule operating in device cases and

significantlyextendedthescopeofthefraudulentclaimsjurisdiction.

Thisconceptionofmaterialityechoedthetestemployedinthepre-contractualcontext. In

PanAtlantic,theHouseofLordsheldthatanunderwriterwouldonlybeentitledtoavoidfor

misrepresentationornon-disclosurewhereithadexertedaninfluenceontheunderwriter’s

decision-making process.282 This would be satisfied where themisrepresentation or non-

disclosurehad“nomorethananeffectonthemindoftheinsurerinweighinguptherisk.”283

The‘mereinfluence’testistobedistinguishedfromthe‘decisiveimpact’testwiththelatter

beingsatisfiedifthenon-disclosurecausedtheunderwritertodeclinetheriskorchargea

higherpremium.284 This correlationbetween thepre- andpost-contractual positionswith

respecttomaterialityhasbeenmodifiedbytheSupremeCourtdecisioninVersloot.285

Despite some initial uncertainty,286 due in part to the construction of the materiality

requirement,287 subsequent case law, includingaPrivyCouncil judgment,288 endorsed the

formulation was adopted, and I would prefer the requirement to demand a significant improvement in theinsured'sprospects.”279Versloot(FirstInstance)(n190)[160],[176]perPopplewellJ.280AswasthecaseinTheMercandianContinent(n97).281Versloot(SupremeCourt)(n59)[125]perLordMance.282PanAtlantic(n207)531perLordMustill;confirmedinInsuranceAct2015s.7(3).283PanAtlantic(n207)517perLordGoff.284Ibid531perLordMustill.285Seelater,texttofn326etseq.286InterpartCommerciaoeGestaoSAvLexingtonInsuranceCo[2004]Lloyd’sRepIR690;MarcRichAgricultureTradingSAvFortisCorporateInsuranceNV[2005]Lloyd’sRep.IR396;Clarke(looseleaf)(n26)[27-2B4].287Interpart(n286)[43]perHHJChambersQC,“Thequestioninthepresentcasestillconcernsthedegreeofnexusthattherehastobebetweenthefraudulentconductandpromotionoftheclaimagainstinsurers.Thatquestionlies within an area where the law remains uncertain.” A Scales (Insurance Fraud Symposium, University ofSouthamptonLawSchool,13July2016),1describesManceLJ’stestas“amasterpieceinsubjunctiveconstruction.”288StemsonvAMPGeneralInsurance(NZ)Ltd[2006]Lloyd’sRep.IR852.Itisdifficulttoassesshowmuchweighttoaccordtothisendorsementoftherule.Onthefacts,thefraudulentdevicepointwasunnecessaryastheinsurerwasabletodefendtheclaimonthebasisthattheassuredhadsetfiretohishousehimself,see[25]-[26]perLordHope.

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approachadoptedinTheAegeon.289ManceLJ’sjudgmentonthispointwas“strictlyspeaking

obiter”290 but subsequent courts did not question the correctness of the decision.291 It

appearedatthisstagethatthecontoursoftheforfeiturerulewererelativelysettled.This

feelingwastosomeextentconfirmedbythefactthattheLawCommissiondidnotsuggesta

statutorydefinitionfor fraudnorexplicitlycondemnthedirection inwhichthecourtshad

developedthelaw.292

Theapplicationoftheforfeitureruletoalltypesofinsurancefraudwascounterintuitive.293It

wasnotedabovethatforfeitureisnotaneffectivesanctionforthewhollyfraudulentclaim294

giventheabsenceofanyinsuredlossforwhichtheunderwriterwouldbeliable.Bycontrast,

forfeitureispenalwhenitoperatestodepriveanassuredofaclaimbolsteredbyafraudulent

device.ThelopsidedeffectoftherulehasnowbeenreversedbytheSupremeCourt.295

The2016SupremeCourtdecisioninVerslootDredgingvHDIGerling296fundamentallyaltered

thelegalapproachtoclaimsbolsteredbyacollaterallie.Thecaseconcernedavesselwhich

hadgot intodifficultyona voyagebetween LithuaniaandSpain. Theengine roombegan

taking on water and the vessel was towed to safety. Repairs totalling €3.2 million were

required. The underwriter instructed its solicitors to investigate. During this process the

solicitors soughtanaccountof the loss from the shipowners.Oneof the ship’smanagers

assertedthatthecrewhadfailedtorespondtoabilgealarmwhichwasknowntogivefalse

positivesinheavyweather.Thisassertionwascontainedinaletterunderaheadingmarked

‘facts’ andaccompaniedwith the suggestion that themaster corroborated this versionof

events.Thiswasincorrect;themasterwasonholidayatthetimeofthestatementandonly

subsequentlyconfirmedthathewaspreparedtosupportthisnarrative.

289EagleStarInsuranceCoLtd.VGamesVideoCoSA(TheGameBoy)[2004]EWHC15(Comm),[2004]1Lloyd’sRep.238;JosephFieldingProperties(Blackpool)LtdvAvivaInsuranceLtd[2010]EWHC2192(QB),[2011]Lloyd’sRep.IR238.290Versloot(FirstInstance)(n190)181perPopplewellJ.291SeeVersloot(SupremeCourt)(n59)[20]perLordSumption,[85]perLordHughes.292LawCom353(n5)[23.17].293SeeDaveyandRichards(n152).294Asnotedearlier,seetexttofn228etseq.295ForacomprehensivecritiqueofthisconsequenceofthelawpriortothedecisioninVersloot,seeDaveyandRichards(n152).296Versloot(SupremeCourt)(n59).

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Theliewasborneoutoffrustrationontheassured’spart.297Therepairyardwouldnotrelease

thevesseluntiltherepairshadbeenpaidforandtheassuredwasunabletodosowithout

indemnificationfromhisunderwriter.TheassuredhadreceivedadvicethattheInchmaree

clausemightaffordtheunderwriteradefenceandhewaskeentoassertthatthelosswas

caused by crew failure, a covered peril subject to his satisfaction of the due diligence

proviso,298 to divert attention away from (unfounded) suspicions about the state of the

vessel.299

Atfirstinstancetheunderwriterssoughttodefendtheclaimonseveralsubstantivegrounds,

noneofwhichwereoperative.Thelosswascausedbyaningressofwaterthroughanopen

valve.Thiswasacoveredperil,namelyalossbyperilsoftheseas.300Itmadenodifference

that the valve had been left open accidentally since negligence can supply the requisite

fortuityforalossbyperilsoftheseas.301Accordingly,“theownershadavalidclaimforsome

€3.241mwhetherornotthecrewhadfailedtoactonabilgealarmactivation.”302Popplewell

Jupheldthefraudulentdevicedefence“withregret.”303HefeltboundtofollowTheAegeon

notwithstandinghisseriousmisgivingsaboutthedisproportionateanddraconiannatureof

forfeitureinthiscase.304TheCourtofAppealrefusedthesubsequentappealintermslargely

similartoManceLJ’sjudgmentinTheAegeon,305butsuggestedthatthematerialitythreshold

shouldbeincreasedandexpressedinpositiveterms,

(a) the fraudulent devicemust be directly related to the claim; (b) the fraudulent

devicemusthavebeenintendedbytheinsuredtopromotehisprospectofsuccess;

and (c) the fraudulent device must have tended to yield a not insignificant

improvementintheinsured'sprospectsofsuccesspriortoanyfinaldeterminationof

the parties’ rights…For my part, however, I am not quite sure why the negative

297Ibid[3]perLordSumption.298InternationalHullsClauses2003cl.2.2.3299Versloot(SupremeCourt)(n59)[3]perLordSumption.300Versloot(FirstInstance)(n190)[40]perPopplewellJ.301BaxendalevFane(TheLapwing)(1940)P112,121perHudsonJ.302Versloot(SupremeCourt)(n59)[4]perLordSumption303Versloot(FirstInstance)(n190)[225]perPopplewellJ.304Ibid[146]perPopplewellJ.305Versloot(CourtofAppeal)(n161)[106]etseq.perChristopherClarkeLJ.

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formulationwasadopted,andIwouldprefertherequirementtodemandasignificant

improvementintheinsured'sprospects.306

TheCourtofAppealalsoheardargumentonwhethertheoperationofforfeitureindevice

casesconstitutedabreachoftheassured’srightsundertheEuropeanConventionofHuman

Rights.Article1,protocol1 (A1P1)guarantees individuals thepeacefulenjoymentof their

possessions. Previous case law had indicated that ‘possessions’ extended to contractual

rights.307Thiswouldencompasstherighttoindemnitywhichaccruestotheassuredonthe

occurrence of loss. A1P1 is a qualified right; states can interfere with an individual’s

enjoymentprovidedinterventionseeksalegitimateaimandisproportionateinnature.The

Court of Appeal dismissed the assured’s argument swiftly; the deterrence of fraud did

constitutealegitimateaimandforfeiturewasaproportionatemeansofachievingthataim.308

Thecourtoptedtolookattheeffectforfeitureintheround309andnotbyreferencetothe

individualcase,asearliercasesapplyingA1P1haddone.310

OnappealtotheSupremeCourt,amajorityof4:1heldthatthenewlydesignatedcollateral

liedidnotattracttheremedyofforfeiture.Thiswasalie“whichturnsoutwhenthefactsare

found tohaveno relevance to the insured’s right to recover.”311 This is a comprehensive

reversaloftheearlierposition.TheleadingjudgmentwasgivenbyLordSumption.Henoted

that the policy of deterrencewas not an appropriate explanation of sanctionswhere the

assuredsoughtnomorethanhisactualentitlementunder thecontract.312LordSumption

startedfromthepositionthattheforfeiturerulewasdesignedtoprotecttheunderwriter

frominformationasymmetries.313Inthecaseofwhollyfraudulentorexaggeratedclaims,the

ruleprotects theunderwriter frommakingpaymentswhichwouldexceedhis contractual

liability.Thesameisnottruewheretheassuredonlyseekshistruelossaswillbethecase

whereacollaterallieistold.Ifforfeitureoperatedinthesecircumstances,itwouldprotect

306Ibid[165]perChristopherClarkeLJ.307WilsonvFirstCountyTrustLtd(No2)[2003]UKHL40;[2004]AC816,[39].308Versloot(CourtofAppeal)(n161)[154]-[164].309Ibid[143]relyingonJamesvUK(1986)8EHRR123,[36].310See,forexample,AxaGeneralInsuranceLtdvTheLordAdvocate[2011]UKSC46;[2012]1AC868,[128];BarnesvTheEastendersGroup[2014]UKSC26;[2014]Lloyd’sRepFC461;[2015]AC1,[94].311Versloot(SupremeCourt)(n59)[1]perLordSumption.312Ibid[26]perLordSumption.313Ibid[26]perLordSumption.

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the underwriter from having the claims process diverted or frommaking payment at an

earlierstage.Itisclearthatforfeitureisnotdesignedtoprovidesuchsecuritytounderwriters;

“theunderwriterlosesnothingifhemeetsaliabilitythathehadanyway.”314Eveniftherule

was intended to serve thispurpose, LordSumption contended that forfeiturewouldbea

disproportionate response to a collateral lie.315 By way of analogy, Beh and Stempel’s

discussionofremediesfortheassured’sbreachofclaimsnotificationprovisionsisuseful.316

Iflatenoticehasnotprejudicedtheunderwriter,thedenialofcoveragewillonlygive“the

insureranundeservedwindfallandmake[]theinsurancepolicyfailitsintendedpurpose.”317

Thesamelogicsurelyappliesinthecaseofcollaterallies;todenytheindemnityonthebasis

of a lie irrelevant to the underwriter’s ultimate liabilitywould undermine the purpose of

insurance.Havingapproachedthematterinthisway,noneoftheirLordshipsdevotedany

realtimetotheexplicitproportionalityanalysisraisedskilfullyinargument;theapplication

ofA1P1 to fraudulentdevice claims.318 Inanyevent, adetermination thatproportionality

shouldbeassessedonacase-by-casebasiswouldinalllikelihoodhaveconstitutedahigher

thresholdthanaretrospectiveassessmentbasedontheunderwriter’sultimateliability.

ThedecisiontoalterthematerialitythresholdinVerslootfundamentallychangesthescope

ofthefraudulentclaimsjurisdiction.InTheAegeon,ManceLJconcludedthatthelieshould

beassessedbyreferencetothetimeitwastoldandtotheeffectithadontheunderwriter’s

behaviour.319Bycontrast,theVersloottestisretrospectiveinnature,andconsiderswhether

thelieboreanyrelevancetotheunderwriter’sultimateliability.320Ifthecourtanswersthis

inthenegative,theliewillbeconsidered‘collateral’andtheassuredwillescapethesanction

of forfeiture.Thisnarrowsthe fraudulentclaims jurisdiction–byexcluding from itsambit

collaterallieclaims–andclarifiestheappropriatestandardofmateriality.Thisshouldfree

314Ibid[26]perLordSumption.315Ibid[26]perLordSumption.316BehandStempel(n30)124.317Ibid124.318Versloot(SupremeCourt)(n59)[37]perLordSumption,[103]perLordHughes,[132]perLordMance.SeetheeloquentargumentsmadebyVictoriaWakefieldfortheassuredinVersloothearing(n3)from2h31andVerslootDredgingBVvHDIGerlingIndustrieVersicherung(TheDCMerwestone)(Hearingon16/03/16,afternoonsession)until 1h 04 available at https://www.supremecourt.uk/watch/uksc-2014-0252/160316-pm.html (accessed27/09/2016).Theseargumentsfollowtheacceptanceofsimilarhumanrightsconsiderationsinthepersonalinjurycontext,seeSummersvFaircloughHomesLtd[2012]UKSC26,[2012]4AllER317,[46]–[47]perLordClarke.319TheAegeon(n9)[37]perManceLJ.320Versloot(SupremeCourt)(n59)[35]perLordSumption.

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future courts from the tension between the ‘no additional requirement’ and ‘decisive

influence’standard,describedearlierinthissection.321

Thereare twonotableconsequences flowing fromthenewtestofmateriality.Firstly, the

focusonfinancialentitlementmeansthatthetestcanbeappliedtoalltypesoffraudulent

claim.322 It should follow that wholly fraudulent and exaggerated claims will always be

regardedasmaterialandthusforfeit.Thisisbecausetheassuredwillalwaysbeseekingto

recovermorethanhiscontractualentitlement.Thismaywellmakeitmoredifficultforcourts

toexcuseexaggerationbyreferencetothenegotiationanalysis.323Thenewtestrendersthe

purposeofthelieirrelevant.Goingforward,aliewhich“affect[s]hishandlingoftheclaim,or

thespeedwhichhepaysit,ortheinquirieswhichhecallsfor”324willnotbematerialsince

they“canmakenodifferencetohisliabilitytopay.”325

Secondly,thetestdistinguishesthestandardofmaterialityapplicableattheclaimsstagefrom

that employed in respect of non-disclosure and misrepresentation at inception. A pre-

contractuallieornon-disclosurepreventstheunderwriterfromassessingtheentiretyofthe

risk.326Withoutanappreciationofthewholerisk,thismaycausetheunderwritertoaccept

orpricerisksdifferentlythanheotherwisewouldhave.327Assuch,thepre-contractualtest

ofmateriality considers the impact of the lie on the underwriter’s behaviour and awards

remedies – including avoidanceab initio – accordingly.328 The position is different at the

claims stage because the underwriter is not in the same position of choice as hewas at

inception.329 If the losswas causedbya coveredperil, the insurer isprima facie liable to

indemnify the assured from the time that the loss occurred.330 The appropriate test of

materiality shouldnot considerwhether the lie affected theunderwriter’sbehaviour, but

321Seeearlier,texttofn206etseq.322Versloot(SupremeCourt)(n59)[36]perLordSumption.323Seeearlier,texttofn244etseq.324Versloot(SupremeCourt)(n59)[91]perLordHughes.325Ibid[91]perLordHughes.326Ibid[91]perLordHughes.327Ibid[91]perLordHughes.328InsuranceAct2015s.3,sched1.329Versloot(SupremeCourt)(n59)[91]perLordHughes.330TheFanti(n25)35,perLordGoff:“Iacceptthat,atcommonlaw,acontractofindemnitygivesrisetoanactionfor unliquidateddamages, arising from the failureof the indemnifier toprevent the indemnifiedperson fromsufferingdamage,forexample,byhavingtopayathirdparty.”;Rose,MarineInsurance(n26)[26.1].

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whetheritwasrelevanttohisultimateliability.ThiswastheapproachtakenbytheSupreme

CourtinVersloot.

AstrongdissentwasprovidedbyLordMance.Helargelyrestatedthepositionheadoptedin

TheAegeon,subjecttotheheightenedmaterialitythresholdasrecommendedbytheCourt

ofAppeal.331LordMancetookparticularissuewiththematerialitytestconstructedbythe

majority of the SupremeCourt, opining that assureds tells lies for a specific purpose and

reiteratingthepotentialimpactofsuchliesonclaimshandling.332Inparticular,hisconcern

was that the retrospective nature of the test cast the claims process in thewrong light,

arguing that “litigation is neither the aim nor the norm.”333 LordMance also took a firm

position that deterrence was equally applicable in the context of device claims334 and,

moreover,thatthestatutorybasisofforfeiturerepresentedparliamentaryapprovalofthis

point.335This,withrespect,overlooksthefactthattheInsuranceAct,asrecommendedby

theLawCommission,leavesthemeaningof‘fraudulentclaim’tothecourts.336

The result inVersloot returns the law to the position adopted by academics prior to the

decision in The Aegeon.337 In writings prior to the expansion of the fraudulent claims

jurisdiction,Clarkehadsuggestedthattheuseoffraudulentevidencetostrengthenavalid

claimwas“dishonestbutnotsubstantial:heisnotseekingtogetfromtheinsurermoneyto

whichheknowsthatheisnotentitled.”338ItalsomirrorsthepositiontakenbytheFinancial

Ombudsmaninconsumercases.Thepresentationofforgedevidencedidnotautomatically

resultinforfeiture;theOmbudsmansoughttodeterminewhethertheevidencewas“solely

tosubstantiatetransactionsthatreallytookplace,ordidthecustomersintendtoobtainmore

thantheywereentitledto?”339Thisisalogicaldistinctiontodrawsincethealternativecould

331Versloot(SupremeCourt)(n59)[113]citingVersloot(CourtofAppeal)(n161)[165]perChristopherClarkeLJ.332Versloot(SupremeCourt)(n59)[130]perLordMance.333Ibid[111]perLordMance.334Ibid[124]-[125]perLordMance.335Ibid[124]perLordMance.336LawCom353(n5)[23.17].337TheAegeon(n9).338Clarke,PoliciesandPerceptions(n18),171.339CitedinLowry,RawlingsandMerkin(n243)309.

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providetheunscrupulousunderwriterwithanincentivetocontinuallyquestiontheinsured

inthehopeofcatchinghiminalie.340

The foregoing discussion has traced the courts’ difficulty in establishing an appropriate

materiality threshold for device claims. Considerations of substantiality have also proved

problematicinthiscontext,341asillustratedbyAvivavBrown.342Theassuredclaimedforthe

costofremedialworksandalternativeaccommodationfollowingserioussubsidenceathis

home. Mr Brown took an active role in the search for temporary accommodation and

suggestedseveralpropertiestohisinsurer.Twooftherepresentationsmadeinconnection

withthisprocessbearparticularscrutiny.343Firstly,theassuredtoldhisinsurerthathehad

identifiedasuitablepropertyandthatitwasavailableforrent.Thiswasfalse;theproperty

washischildhoodhomewhichhenowowned.Ultimately,however,theassuredandhiswife

decidedthepropertywasunsuitable.EderJheldthatthisstatementwas“asubstantialand

materialpartof…hisclaimforalternativeaccommodation.”344Bycontrast,hisstatementthat

the landlordoftheeventualtemporaryaccommodationwaschasinghimforrentwasnot

treatedassubstantial.345ThiswasalsofalsegiventhatMrBrownwashimselfthelandlordof

thepropertyinquestion.Itisdifficulttofindanyjustificationfortreatingthesestatements

differentlyandcertainlyEderJdoesnotprovidearationaleforhisdecision.Itseemsrather

oddthatifMrBrownhadonlymadethesecondfalse,butnotfraudulentstatement,hewould

havebeenentitledtorecover.

BugraandMerkinhaveexpresseddoubtsastothesubstantialityofthefirststatementsince

itcouldnothaveaffectedtheinsurer’shandlingoftheclaim.346Thesedoubts,aswellasthe

result inBrown,demonstratethedifficultyofapplyingthesubstantialitytest inrelationto

qualitative statements, as distinct from financial exaggeration. These difficultiesmaywell

explainwhy thecourtshavepreferred to focusonmateriality todeterminewhethersuch

340LongobardivChubbInsCo560A2d68,83(NJ,1989)citedinClarke(looseleaf)(n26)[27-2B4];JHjalmarsson,‘Exit“fraudulentmeansanddevices”’[2016](July)STL(publishedonline,25July2016).341ABugraandRMerkin,'’Fraud'andfraudulentclaims’(2012)125JBritInsLawAssociation3,5.342Aviva(n196).343Avivamade21separateallegationsoffraud–only2wereprovedattrial.344Aviva(n196)[96]EderJ.345Ibid[82][118]perEderJ.346BugraandMerkin(n341)6.

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conductshouldcountasfraud.347Inanyevent,theSupremeCourt’sapproachtomateriality

inVerslootmaywellresolvetheproblemsposedbysubstantialityinthiscontext.

iv. Suppressionofadefence

The final category of fraudulent claim involves the assured’s deliberate suppression of

informationwhich,ifdisclosed,wouldaffordtheunderwriteradefenceunderthepolicy.A

usefulillustrationisprovidedbySavashvCISGeneralInsurance.348Theassuredclaimedon

his buildings and contents insurance following an alleged burglary at his home. The

underwriter successfully relied on an express clause which disclaimed liability in

circumstanceswherethepropertywasunoccupied,definedas“insufficientlyfurnishedfor

fullhabitation,ornotlivedinbytheFamily,oranyotherpersonwiththeFamily'spermission,

for more than 60 consecutive days.”349 Evidence gathered by police in the immediate

aftermathof theburglary lentcredencetotheunderwriter’ssuggestionthattheproperty

was unoccupied.350 In presenting the claim, however, the assured sought to give the

impressionthatthepropertyhadbeenoccupiedattherelevanttimeviatheproductionof

photographicevidenceandanexplanationofhispersonalcircumstances.AkenheadJheld

thattheunderwriterwasnotliablefortheclaimasthepropertyhadbeenunoccupiedand

becausetheclaimhadbeenmadefraudulently.351

Writingprior to thedecision inSavash, Bennetthadargued that knowledgeof adefence

wouldtriggertheassured’spost-contractualdutyofgoodfaithandwould,therefore,require

347Versloot(FirstInstance)(n190)[223](indicatesanoverlapbetweensubstantialityandmateriality);LawCom353(n5)[22.24]“Wethinkthereisanargumentthatthe“fraudulentdevice”employedinthatcase[Versloot]doesnotsatisfythecommonlawrequirementsforfraudofsubstantialityandmateriality.”348SavashvCISGeneralInsurance[2014]EWHC375(TCC),[2014]Lloyd’sRep.IR471.349Ibid[2]perAkenheadJ.350Ibid[5]perAkenheadJ:“Shewassurprisedattheextentofthedamagewhichhadoccurredandinrelationtosomeofthethingssaidtohavebeenstolenintheincident(whichincludedalargeamountofheavyfurniture).Shewasalsosurprisedthatnoonehadseenanyvehicleparkedoutsidethefrontgiventhesize,volumeandweightofitemssaidtohavebeenstolen,itbeingherviewthatitwouldhavetakenatleasttwopeopletocarrysomeoftheitemsoutandfrequenttripswouldneedtohavebeenmadetoandfromthehouse.Hercolleaguewentintotheloftandtoldherthatthepipeshadbeencut(fromwhichtheescapingwateremanated).Hercolleaguedidsomehouse-to-houseenquiries:theownerofNo28hadbeeninbetween13.00and15.00andhadnotseenanything,theownerofNo32hadseennothing suspiciousbuthadbeenoutbetween12.30and13.30,but laterheardbangingfromNo30whichshethoughtmightbehomeimprovements,andtheownersofNos21and36whowereinthewholetimedidnotseeanything.”351Ibid[60]perAkenheadJ.

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disclosure.352Theremovalofavoidanceastheremedyforbreachofs.17MarineInsurance

Act353meansitisnolongerproblematictoaligntheprohibitionoffraudulentclaimsandthe

duty of good faith. There is, however, a query relating to the expansiveness of the duty

suggestedinBennett’scomments.ThisisbecausehiscommentsalsoprecedetheHouseof

Lords’judgmentinTheStarSea inwhichtheassured’spost-contractualdutyofgoodfaith

waslimitedtohonesty.354Itcouldwellbethattorequiretheassuredtovoluntarilydisclose

informationamountingtoadefencewouldexceedthisdutyandresemblethewide-ranging

disclosureduties imposedat inception. ManceLJ subsequentlyendorsed theview inThe

Aegeonthatsuppressionofadefencewouldresultinthelossoftheclaim.355Itwouldappear

to be legitimate to include the suppression of a defence within the fraudulent claims

jurisdictiononthebasisthatunderwriterswill typically investigatenotonlythescopeand

quantum of liability following a loss, but alsowhether the facts enable them to assert a

defencetopayment.356ManceLJthencommentedonthedecisioninTheStarSea,noting

that“noneofthespeeches intheHouseofLordscontainanypositivesuggestionthatthe

commonlawruleorsection17cannotapplytoaknowndefence.”357ManceLJdidnotappear

to identify any tension between the post-contractual duty of honesty and information

pertainingtoadefenceknowntotheassured.

Theassured’ssuppressionofadefencehasnotyetgeneratedsignificantacademiccomment

as a distinct category of fraudulent claim. Clarke, for example, includes it as a type of

fraudulentclaimbutprovidesnofurtherdetailonthematter.358Itislikely,however,thatthis

typeofconductwillgainnewprominencefollowingthedecisioninVersloot.359Thisisbecause

the suppression of a defence would presumably meet the new standard of materiality

352Bennett,‘Mappingthedoctrine’(n105)210.353InsuranceAct2015s.14(1)(3).354TheStarSea(n7)[102],[111]perLordScott.355TheAegeon(n9)[18]perManceLJ.356GanInsuranceCoLtdvTaiPingInsuranceCoLtd[2002]EWCACiv248,[2002]CLC870,[37]perManceLJ.357TheAegeon(n9)[18]perManceLJ.358Clarke,(looseleaf)(n26)[27-2B4]:notestheexistenceofthistypeofconductasfraudulentbutprovidesnofurtherdiscussion.359Hjalmarsson,‘Exit“fraudulentmeansanddevices”’(n340).

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becauseitaffectstheunderwriter’sultimateliability.Theissuewillneedtobeconsideredat

lengthbyanappropriatelyseniorcourt.360

ThedecisioninVerslootlimitsthecircumstancesinwhichfraudwillunravelallinthecontext

ofinsuranceclaims.Thisdoesnotmean,however,thatthecommonlawdefinitionoffraud

issettled.Foronething,subsequentcourtswillneedtoascertainthepreciselimitsofthe

‘collateral lie’361 and the strength of themateriality threshold. The courts also retain the

freedomtodevelopthemeaningoffraudulentclaiminfuturecases.Notwithstandingthis

recent development, procedural matters – most notably, the standard of proof (D) and

temporallimitsofforfeiture(E)–donotundulyconstrainthecourts’abilitytointervenein

fraudcases.

D. ThestandardofproofThestandardofproofisanimportantconsiderationinassessingthescopeofthefraudulent

claims jurisdiction. The higher the burden, the more difficult it will be to explain the

jurisdictionbyreferencetothemaxim,fraudunravelsall.

Asacivilmatter,theordinaryburdenofproof–thebalanceofprobabilities–shouldapplyin

insurancefraudcases.Thiswouldsimplyrequiretheunderwritertodemonstratethatfraud

wasmore likely thannot.362Given theconcealednatureof fraud, theunderwriterwillbe

permittedtorelyon“circumstantialevidenceandinferencetodemonstrate[theassured’s]

knowledgeandintent”363tosatisfythisburden.

Acloserexaminationof thecase law,however,gives the impressionthatan intermediate

standard–somewherebetweentheordinarycivilstandardandthemoreonerouscriminal

360SeethediscussioninTheMercandianContinent(n97)[28]perLongmoreLJ:“theconductoftheassuredwhichisreliedonbyunderwritersmustbecausallyrelevanttounderwriters’ultimateliability,oratleast,tosomedefenceof the underwriters before it can be permitted to avoid the policy. This is, I think, the same concept as thatunderwritersmustbeseriouslyprejudicedbythefraudcomplainedofbeforethepolicycanbeavoided.”361Hjalmarsson,‘Exit“fraudulentmeansanddevices”’(n340).362Arnould(18thed.)(n200)[18-101].363PMacDonaldEggersandPFoss,GoodFaithandInsuranceContracts (LLP,1998),[11.11];Arnould (18thed.)(n200)[18-102].Stemson(n288)[7],[9]perLordHopeinwhichthePrivyCouncilnotedthefirstinstancecourt’srelianceoncircumstantialevidenceandinferencesithaddrawnrelatingtothecredibilityofwitnesses.

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standard – applies in the fraud context. In Hornal v Neuberger, a case on fraudulent

misrepresentation,theCourtofAppealcharacterisedtheburdenasfollows,

Themoreserioustheallegationthehigherthedegreeofprobabilitythatisrequired:

butitneednot,inacivilcase,reachtheveryhighstandardrequiredbythecriminal

law.364

More recently, inReH (Minors), LordNicholls repeated this idea in thecontextofachild

protectioncase,

Thebalanceofprobabilitystandardmeansthatacourtissatisfiedaneventoccurred

ifthecourtconsidersthat,ontheevidence,theoccurrenceoftheeventwasmore

likelythannot.Whenassessingtheprobabilitiesthecourtwillhaveinmindasafactor,

towhateverextent isappropriate in theparticularcase, that themoreserious the

allegationthelesslikelyitisthattheeventoccurredand,hence,thestrongershould

betheevidencebeforethecourtconcludesthattheallegationisestablishedonthe

balance of probability. Fraud is usually less likely than negligence…Built into the

preponderanceofprobabilitystandardisagenerousdegreeofflexibilityinrespectof

theseriousnessoftheallegation.365

Theexistenceofanintermediatestandardofproofwouldpresentagreaterchallengetothe

underwriter thanwouldbeposedby theordinarycivil standard.366Morerecentcase law,

however,hassuggestedthatReH increasestheevidentialburdenfacingunderwritersbut

doesnotdisplace theordinary civil standardofproof.367 Thismeans, inpractice, that the

courtsdemandcogentevidenceincasesinvolvingseriousallegationsandwillexaminethat

364HornalvNeubergerProductsLtd[1957]1QB247,258perDenningLJ.365 Re H (Minors) [1996] AC 563, 586-587. This standard is endorsed by a range of cases and academiccommentators,seeClarke,looseleaf(n26)[27-2A1];Arnould(18thed.)(n200)[18-101].RecentcasesendorsingtheReHapproachincludeBeachviewAviationLtdvAxaInsuranceLtd[2015]NIQB106,[32]perStephensJ;MandaliavBeaufortDedicatedNo.2Ltd[2014]EWHC4039(QB),[75]perGerardMcDermottQC.366JHjalmarsson,‘Thestandardofproofincivilcases:Aninsurancefraudperspective’(2013)17E&P47,50.367SecretaryofStatefortheHomeDepartmentvRehman[2003]1AC153,[55]perLordHoffmann(confd.InReB);R(N)vMentalHealthReviewTribunal(NorthernRegion)[2006]QB468,[62]perRichardsLJ(endorsedinReD[2008]UKHL33;1WLR1499,[27]perLordCarswell).

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evidence“inamorecriticalfashion.”368Thisistypicallyjustifiedbyreferencetotheadverse

consequencesthatafindingoffraudwillhavefortheindividual.369

Importantly, the Law Commission did not regard Re H or Hornal as establishing an

intermediatestandardofproofforinsurancecases.TheyderivedsupportfromReBinwhich

LordHoffmannheldthattherewas“onlyonecivilstandardofproofandthatisproofthatthe

fact in issue more probably occurred that not.”370 The Law Commission clarified that

“althoughthecourtsmaystartthinkingthataninnocentexplanationismorelikelythanfraud,

thisdoesnotaffectthelegalstandardofproof.”371Thesuggestionthatfraudwaslesslikely

thannegligencewas“simplysomethingtobetakenintoaccount,whererelevant,indeciding

wherethetruthlies.”372Thereis,however,noempiricalbasisforthecourtstoconcludethat

fraudis lesslikelythannegligence.373Withoutsuchdata, it isrighttoquestionthealleged

frequencyoftheseoffencesasthebasisforanincreasedevidentialburdenonunderwriters.

Evenifthecaseshadcreatedanintermediatestandardofproof,therearestrongarguments

that theordinary civil standard– thebalanceofprobabilities – should apply in insurance

cases.374Hjalmarssonhasargued that thechildprotectionandmatrimonial casesdeserve

specialprotectionduetothehumanrightsissuesthatariseinthosecontexts.375Indeed,the

laterchildprotectioncasescanbeviewedasonlyapplyingtocaseswhichariseunderthe

ChildrenAct.376Moreimportantlyforthisproject,anintermediatestandardofprooflimits

theextenttowhichtheforfeiturerulecanserveitsdeterrentpurpose.AsHjalmarssonhas

argued,

368Soyer,MarineInsuranceFraud(n40)[1-18].369Britton(n4)910perWillesJ;Hornal(n364)266-267perMorrisLJ;BeachviewAviation(n365)[32]perStephensJ;MClarke,‘Lies,damnedlies,andinsuranceclaims:Theelementsandeffectsoffraud’[2000]NZLRev233,237.370ReB(Children)(Sexualabuse:Standardofproof)[2009]1AC11,[13]perLordHoffmann.371LawCommissionIssuesPaper7(n14)[3.54].372ReB(n370)[70]perLadyHale.373EMcBride,‘Isthecivil‘higherstandardofproof’acoherentconcept?’(2009)8Law,ProbabilityandRisk323,334.374Hjalmarsson,‘Thestandardofproof’(n366)61,73.375Ibid63,71.376ReB(n370)[69]citedbyHjalmarsson,‘Thestandardofproof’(n366)62.

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A common argument is that a heightened standard of proof should be employed

wheretheconsequencesofthecaseareveryserious,particularlyinfraudcases…In

insurancecases,inparticular,thereisaclearopposingsocialorpolicyinterestwhich

isjustasvalidastheprotectionofanindividualpersonandhisorherreputation.The

opposinginterestisthelegitimatesocialneedtolimitthenumberandcombinedsize

of fraudulent insurance claims and to prevent guilty individuals getting awaywith

fraud.377

The preferable view, as endorsed by the Law Commission,378 is that the balance of

probabilitiesstandardshouldapplyininsurancefraudcases.Itisnotablethatissuesofproof

werenotincludedinthefinalproposalsforreformwhichsuggeststhatmattersarerelatively

settled.379 Ifcorrect, thismeansthatprocedural issuesdonotunduly increasetheburden

facingtheunderwriter.Thisisalsoreflectedinthenumberofcasesinwhichfraudhasbeen

successfullyestablished.Evenincaseswheretheunderwriterhasfailedtoprovefraud,this

ismoreusuallyattributedtoanabsenceof“directevidence”380thantheconstraintsofthe

evidentialburden.Thediscussionnowturnstothetemporallimitsofforfeitureandconsiders

whetherthesehindertheunravellingeffectoffraud.

E. ThetemporallimitThecourtsapproachedthetensionbetweentheforfeitureruleandthestatutoryremedyof

avoidance by consistently limiting the remedy for fraudulent claims to forfeiture.381 In so

doing,theHouseofLordsinTheStarSeaimposedatemporallimitonthepost-contractual

dutyofgoodfaith,

Oncethepartiesareinlitigationitistheproceduralruleswhichgoverntheextentof

thedisclosurewhichshouldbegiveninthelitigation,notsection17382

377Hjalmarsson,‘Thestandardofproof’(n366)70-71.378LawComIssuesPaper7(n14)[3.52]-[3.54].379Butseethecallforare-examinationoftherelevantstandardofproof:Hjalmarsson,‘Standardofproof’(n366)72-73.380YeganehvZurichPlc.[2011]EWCACiv398,[2011]Lloyd’sRep.IR540,[14]perWardLJ.381Thiswasdiscussedearlierinthischapter,seePartIV.382TheStarSea(n7)[77]perLordHobhouse.Seethemorerecentdiscussionofthemomentatwhichtheparties’relationshipiscrystallisedinthecontextofawritagreementissuedunderanoticeofabandonmentinAtlasnavios-

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ThisdictumwaslaterendorsedbytheCourtofAppealinTheAegeon.470ManceLJconsidered

thatitwouldbe“inappropriatetointroduceadistinctionbetweenthedurationoftheimpact

of the fraudulent claims rule…and of the s.17 duty.”471 The same policy argument – the

alteredcharacterof theparties’ relationshipduring litigation–dictatedthat the threatof

forfeitureshouldceaseonthecommencementoflitigation.472

The Civil Procedure Rules (CPR) govern the situation in which a claimant lies during

litigation.473Whenfacedwithadishonestlitigant,theCourtmayeitherdismisstheclaimfor

abuseofprocess474oradjudicatetheissueinthenormalway,providedthedishonestyhas

notmadethisimpossible.475Strikeoutenablesthecourtto“protect[the]legitimacyof…[its]

ownprocesses”476andis,therefore,theproceduralequivalentofexturpicausa.477Themajor

difference,however,isthatstrikeoutistobeusedproportionatelyinlinewiththeoverriding

principleoftheCPR.478Proportionalityinthiscontextrequiresthecourttousetheirdiscretion

reasonably,suchthatthejudicialresponserepresentstheminimumnecessarytoprotectthe

judicial process from abuse.479 By contrast, the operation of the forfeiture rule does not

dependonanexplicitconsiderationofproportionality.Inessence,therefore,thismeansthat

theassuredwholiesintheperiodbeforelitigationrisksafargreaterpenalty–theforfeiture

ofhisentireclaim–thanifheliesduringthetrial.480Thisiscounterintuitive;liestoldduring

NavegaçãoLDAvNavigatorsInsuranceCoLtd(TheBAtlantic)(No2)[2014]EWHC4133(Comm),[2015]1Lloyd’sRep.IR151,[343]perFlauxJ.470TheAegeon(n9)[52]perManceLJ.471Ibid[53]perManceLJ.472Ibid[52]perManceLJ;SeealsoThomas‘Fraudulentinsuranceclaims’(n79)488.473Versloot(CourtofAppeal)(n161)[78]perChristopherClarkeLJ.474CivilProcedureRulesr.3.4.(2)(b);confirmedinZahoorvMasood[2009]EWCACiv650,[2010]1WLR746,[71]perMummeryLJ.475AZuckerman,‘Mustafraudulentlitigantbeallowedtothink:ifthefraudissuccessful,Iwillgainmuch;ifitisnot,Iwillstillrecovermylegitimateclaim?’(2011)30(1)CJQ1,2.476AZuckerman,‘Courtprotectionfromabuseofprocess–themeansaretherebutnotthewill’(2012)31(4)CJQ377,378.477Ibid378.478CivilProcedureRulesr.1.1;BugraandMerkin(n341)8.479Zuckerman,‘Courtprotection’(n389)380.480Thisriskisnotreplicatedinotherareasofthecivillaw.SeeZuckerman,‘Mustafraudulentlitigant’(n388)5:recognisingthedifficultyofrespondingtofraudwithsubstantivelawasitwould“encourageadiversityofsolutionstoacommonproblem,createwasteandconfusion.Further,itwouldbringthelawintodisreputeiftheoutcomeofdeceitweredifferentdependingontherightinvoked.”SeelaterdiscussionofthetortcontextinChapterThree,texttofn312etseq.

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litigationaredesignedwithamorereprehensiblepurpose–tomisleadboththeunderwriter

andthecourt–whereasthelietoldearlierintendsonlytodeceivetheinsurer.ParkJhinted

atthisinconsistencyinTheAegeon,

Supposethatatthetrialhis liesareexposed,butthe judgetakestheviewthathe

wouldhavewonanywaywithoutthem.Doeshelosethecasebecausehelied?The

answeris:no.Ifhiscaseisagoodoneanyway,hewins.Itisdeplorablethathelied

butheisnotdeprivedofhisvictoryinconsequence.481

Liestoldbeforeandduringlitigationwillbetreateddifferentlybythecourts.Intheformer

situation,frauddeterrencepreoccupiesthecourtsandisusedtojustifythepotentiallyharsh

consequencesofforfeiture.Bycontrast,theissueoftheclaimformtriggerstheoperationof

theCPRmeaningthatconsiderationsofproportionalitywillcolourthecourt’sassessmentof

the appropriate remedy. This more punitive response to pre-litigation dishonesty

demonstratestheutilityof‘fraudunravelsall’toexplaintheeffectofinsuranceclaimsfraud.

VI. ConclusionThis chapter has examined the civil response to insurance claims fraud from a doctrinal

perspectiveandidentifiedthepolicyfactorswhichhavebeencriticalinshapingthisresponse.

Theearliertensionbetweentheforfeitureruleandthestatutoryremedyofavoidance482has

nowbeenresolvedbytheInsuranceAct2015.The2015Actconfirmsthatforfeitureisthe

appropriateresponsetoinsuranceclaimsfraud.483Viewedinisolation,therefore,thenotion

that‘fraudunravelsall’isausefulexplanationoftheoperationoftheforfeiturerule.Thisis

becausetheruleactstoretrospectivelybartheassured’srighttosucceedinaclaim.

Writing in advance of the Supreme Court decision in Versloot, Soyer suggested that the

development of forfeiture was characterised by a tension between the need to penalise

dishonest assureds and concerns about treating all frauds alike.484 This is essentially the

481TheAegeon(n9)[58]perParkJ.482MarineInsuranceAct1906s.17.483InsuranceAct2015s.12(1)(a).484Soyer,MarineInsuranceFraud(n40)[1.24]-[1.26].

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suggestionthatproportionalityhadbeenacriticalfactorinjudicialdecisionmaking.While

thistensionwascertainlyevidentintheattempttomarginaliseavoidanceinthefraudulent

claimscontext,485thereisnoevidencethatitplayedanypartinthejudicialapproachtothe

forfeiturerule.Indeed,priortoVersloot,thefraudulentclaimsjurisdictionhadbeenwidened

toincludedeviceclaims486andthecourtshadpaidnoattentiontothenuancesoffraudulent

claimswhichatrulyproportionateenquirywoulddemand.

Theabsenceofanexplicitproportionalityenquirywithintheconfinesoftheforfeitureruleis

duetotheoverriding importanceof frauddeterrence.Thecourtshaveacceptedboththe

scale of the fraud problem and the role of legal sanctions in combatting fraud. As

conceptualisedbythecourts,deterrenceisdependentonharshsanctions.Indeed,thisisno

doubttheresultwhenforfeitureisimposedinrespectofanexaggeratedclaimand,formerly

in relation to claims bolstered by fraudulent devices. A further narrative in the case law

concerns thevulnerabilityofunderwriters to fraud.This solidifiesboth the importanceof

deterrenceandlegalsanctions–asdistinctfromindustryinitiatives–torespondtothefraud

problem.

The fraudulent claims jurisdiction is no doubtmore settled following the passage of the

InsuranceActandthedecisioninVersloot.487Furtherdevelopmentsarestilllikely,however,

notleastbecausetheprecisecontoursofthecollaterallieandthenewmaterialitytestwill

need further consideration. In addition, the Supreme Court emphasised that lying during

litigationwasnotwithoutrisk.488Anylie,whethercollateralorotherwise,wouldentitlethe

court tomakeuseof procedural sanctionsduring litigation.489 It remains tobe seenhow

subsequent courts will make use of these tools. It will also be interesting to see how

underwriterscontendwithsuspiciousclaimsgiventhatthenewstatutoryregimemakesitfar

moredifficultforunderwriterstoraiseatechnicaldefenceasaproxyforfraud.490

485TheStarSea(n7)[51]perLordHobhouse.486TheAegeon(n9)[45]perManceLJ.487Versloot(SupremeCourt)(n59).488Ibid[98]perLordHughes,[108]perLordToulson.489Ibid[36]perLordSumption,[98]perLordHughes.490MacauravNorthernAssuranceCoLtd[1925]AC619.

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Thischapterhasaddressedthelimitsofthefraudulentclaimsjurisdictionandconsideredthe

policyargumentsthathaveinfluencedthedevelopmentoftherule.Thefollowingchapter

focussesonthethirdresearchquestionbysubmittingthesepolicyconsiderationstocritique.

Itwillcontend,primarily,thatthejudicialconceptionofdeterrencedependsonanoutdated

modelofdecisionmakingandthismeansthatforfeitureisanineffectivedeterrent.Research

inrelateddisciplinessuggeststhatlegalsanctionsareaminorfactorindecisionsaboutcrime

and this weakens the centrality of forfeiture in the insurance lawmodel. The remaining

discussionchallengesthecharacterisationoftheunderwriterasvulnerable.Furthermore,the

absence of proportionality in the insurance framework is compared to other fraud-prone

systemswhich have adopted nuanced remedial frameworks. The suggestion is thatwhile

deterrenceisalaudableandimportantpolicyobjective,thereisnoreasonforittooverride

everything else and thereby prevent the establishment of proportionate sanctions for

insurancefraud.

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ChapterThree

Insurance:ACritiqueoftheJudicialResponsetoFraud

Thenotionthat‘fraudunravelsall’makessenseintheinsurancecontext.Thecourtshave

fashionedanexpansivejurisdictiontodealwithfraud.Thisisaresultoftheircharacterisation

of the insurance relationship as distinctive in which the insurer merits protection from

fraudulentassureds.Thecourtsviewthemselvesasdeterringfraudthroughtheimposition

ofharshpenalties.

There is something superficially attractive about these propositions and the idea that

individualsmodifytheirbehaviourinresponsetothethreatoflegalpunishment.Acloserlook

suggests the consequentialist effects of forfeiture are not guaranteed nor is the

characterisationoftheinsurer-insuredrelationshipagiven.Thischapteraddressesthethird

researchquestionintheinsurancecontextandconsiderstheextenttowhichthesuggested

policyjustificationsarevalid.Theimportanceofsanctionstocounterinsurancefraudisnot

contestedbutit isfarfromclearthatthepolicyreasonssaidtojustifyharshsanctionsare

sufficientlycompelling.

Foreaseofexposition,theargumentschallengingthesepropositionsaresummarisedhere:

A. Theassumptionthattheforfeitureruledetersispremisedonanoutdatedmodelof

decisionmaking.Modernresearchcastsdoubtonthecentralityoflegalsanctionsin

deterrence.

B. Theforfeitureruleisnotaneffectivelegalsanctionforthewhollyfraudulentclaim.

C. Underwriters’ vulnerability and consequent need for protection from fraud is no

longerascompellinggiventechnologicalandinvestigativedevelopments.

D. Frauddeterrenceandproportionalitycanbereconciledwithinaremedialframework.

TheAustralianapproachto insurancefraudandtheEnglishresponsetofraudulent

personalinjuryclaimsandinthecriminallawreflectamorebalancedapproach.This

castsdoubtonthesupposednecessityofharshsanctions.

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I. TheDeterrenceCritiqueThenotionthatcivillawrulesplay,orhavethepotentialtoplay,asignificantroleindeterring

sociallyharmfulconductislikelytobecounterintuitivetothoseinculcatedinthetraditional

distinction between the criminal and civil spheres. And yet, this is exactly the rationale

underpinningthedraconianconsequencesofforfeitureininsurancecontractlaw.Notionsof

deterrence have traditionally been used to justify fraud rules in the insurance context

notwithstanding the absence of empirical evidence.1Without such evidence, it becomes

virtually impossible to determine whether the law has met its aim or assess the

appropriatenessofthechosenapproach.2Andyet,simpleassumptionsaboutthedeterrent

effect of legal sanctions have not troubled the insurance courts. This approach mirrors

Shand’s comment that “once, moreover, the courts are prepared to talk in terms of

deterrence,theydosoirrespectiveofanyrealitythedeterrentmayhave.”3

Thejudicialaccountofdeterrenceisfairlysimplistic;harshsanctionsdeter.Thisisnotunique

totheinsurancecontext.InSmithvCitibank,acaseonfraudulentmisrepresentation,Lord

Steynheldthat,

apolicyofimposingmorestringentremediesonanintentionalwrongdoerserves…a

deterrentpurposeindiscouragingfraud…Andinthebattleagainstfraudcivilremedies

canplayausefulandbeneficialrole.4

Thiswouldseemtomirrortheequallysimplisticassertionsofarationalchoiceconceptionof

crime.Thissectionwillarguethattherealityofdeterrenceisfarmorecomplex.Putsimply,

thelawcannothavesuchadecisiveinfluenceonindividuals’decisionslargelybecausethey

areunawareofthelawandinanyevent,areinfluencedbydifferentfactors.

1ThispointisalsomadebyPRawlingsandJLowry,‘Insurancefraud:The“convolutedandconfused”stateofthelaw’ [2016]LQR96,115: “there isnoempiricaldata to showthat the fraudulentclaimruledoesdeter,andagrowing literature throws seriousdoubtson theeffectivenessofnon-criminal (andevencriminal) sanctions indeterringbehaviour.”2JSmits,TheMindandMethodoftheLegalAcademic(EdwardElgar,2012),67.3JShand,‘Unblinkeringtheunrulyhorse:Publicpolicyinthelawofcontract’(1972)30CambridgeLJ144,155.4SmithNewCourtSecuritiesLtdvCitibankNA[1997]AC254,279-280perLordSteyn.

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Modernframeworksofdecisionmakingaboutcrimeunderminethetraditionaldeterrence

model inseveralways.Firstly,thedecision-makingprocessisaffectedbyabroadrangeof

considerations, of which the threat of legal sanctions is one (relatively minor) factor.

Secondly,humanslacktheabilitytoconductawhollyrationalanalysisandinsteadrelyon

techniques to simplify the decision-making process. These cognitive shortcuts commonly

skew the decision in favour of offending. Lastly, the objective realities of detection and

punishmentareirrelevant;insteadtheindividual’sperceptionofthesecostsisdecisive.

Thediscussionproceedsasfollows.First,thediscussionwilladdressthemajorargumentsof

rationalchoicetheoryandtheassumptionsonwhichitrelies(A).Theargumentmadehere

usesanalysisrootedinthecriminallawtoevaluatesanctionsintheprivatesphere.Economic

analysis is not unique to the criminal law and so it is important to justify the use of this

framework(B).Thediscussionwillthenturntothemodernresearchwhichhasundermined

rationalchoicetheory(C).Themajorargumentisthatiftheinsurancecourts’insistenceon

harshsanctionsdependsonanoutdatedmodelofdecisionmaking,theforfeitureruleislikely

tobeineffectiveinpractice.

A. Economicanalysisofcrime:RationalchoicetheoryAneconomicanalysisoflawseekstoanswertwoquestions;firstly,whataretheeffectsof

lawonbehaviour,andsecondly,arethoseeffectsdesirable?5Itanswersthosequestionsby

applying tools of economic theory to legal issues.6 In relation to the first question, it is

important to understand the assumed characteristics of the actor whose behaviour is

analysed.GaryBecker’ssketchoftheactorisasfollows,

[A]llhumanbehaviorcanbeviewedasinvolvingparticipantswho[1]maximizetheir

utility[2]fromastablesetofpreferencesand[3]accumulateanoptimalamountof

informationandotherinputsinavarietyofmarkets.7

5 L Kaplow and S Shavell, ‘Economic analysis of law’ (1999) available at:http://www.law.harvard.edu/programs/olin_center/papers/pdf/251.pdf(accessed01/08/16),3.6Ibid3.7GBecker,AnEconomicApproachtoHumanBehavior(UniversityofChicagoPress,1976)14.

104

This characterisation assumes rationality, namely that actors consistentlymake decisions

whichmaximisetheirexpectedutilityorself-interest.8Throughthisprocessofmaximising,

theactorranksalternativesandchoosesthecourseofactionthatmostincreaseshisutility.9

Theactorisalsopresumedtobeimmunefromthemannerinwhichchoicesarepresented.10

Thismeans that the actorwill always respond to the consequencesof a courseof action

whethertheyarecharacterisedintermsofalossoragain.11Whentheactorisfacedwith

alternatecoursesofaction,he ispresumed tohave sufficientability togatherandassess

informationtodeterminewhichalternativeconformstohispreferences.Theactoradoptsa

cost-benefitanalysistomakethisdecision.Onthisbasis,lawisregardedasasetofincentives

(benefits) and sanctions (costs) which shapes behaviour. The second question for law &

economicsscholarsisansweredbyreferencetoconsiderationsofwelfareeconomics;does

theconsequentbehaviouraccordwithideasofeconomicefficiencyandequity.12

ItispossibletotracethistypeofanalysistoJeremyBentham’seighteenthcenturyworkon

criminallawanddeterrence.13Themodernversionoftheanalysis,primarilyassociatedwith

the Chicago School of the 1950s, was initially applied to the law of competition and

monopolies.14 Theanalysis gradually becamemoreexpansive andwasused to assess the

efficiencyofalmosteveryareaoflaw.15

8RPosner,EconomicAnalysisofLaw(5thed.AspenLaw,1998),4.9RCooterandTUlen,Law&Economics(3rded,Addison-Wesley,2000),11.10MEisenberg,‘Behavioraleconomicsandcontractlaw’inEZamirandDTeichman(eds.),TheOxfordHandbookofBehavioralEconomicsandtheLaw(OUP,2014)446,447.11Eisenberg(n10)447citingATverskyandDKahneman,‘Theframingofdecisionsandthepsychologyofchoice’(1981)211(4481)Science453,457.12KaplowandShavell,‘Economicanalysis’(n5)3.13JHBurns,HLAHartandFRosen(eds),TheCollectedWorksofJeremyBenthamAnIntroductiontothePrinciplesofMoralsandLegislation(ClarendonPress,Oxford2005);KaplowandShavell,‘Economicanalysis’(n5)3.14KaplowandShavell,Economicanalysis’(n5)3;EPosner‘Valuesandconsequences:Anintroductiontoeconomicanalysisoflaw’inEPosner,ChicagoLecturesinLawandEconomics(FoundationPress,2000),189.15 Posner, ‘Values and consequences’ (n14) 189-190; Papers which are attributed with expanding the law &economicsanalysisincludedRCoase,‘Theproblemofsocialcost’(1960)3JofLandEcon1andGCalabresi,‘Somethoughtsonriskdistributionandthelawoftorts’(1961)70YaleLJ499.

105

ThepublicationofBecker’sseminalpaper,‘Crimeandpunishment:Aneconomicapproach’,

in1968extendedthisanalysistothecriminallaw.16Hecontendedthatthedecisiontocommit

crime was the same as any other decision to which the same analytical framework was

applicable.17Thiswasanassertionofconsiderablemagnitudegiventheprevailingtheories

aboutcrime.Thepositiveschoolofcriminologyhaddominatedthecrimediscoursesincethe

early1900swhichheldthatcrimewasaproductofeconomic,socialandbiologicalfactors.18

Thisresultedinpolicieswhichsoughttoincapacitateharmfuloffenders19andtocorrectthe

inequalitiesthatcausedcrime.20

Beckerrestoredtheviewthatthedecisiontocommitcrimedependedonweighing“thecosts

ofapprehensionandconviction”21againstthebenefitsofcommission.Thiswasareturnto

theutilitarianideasofclassicalcriminologywhichhaddominateddiscussionsofcrimeand

criminaljusticefromtherenaissanceuntiltheearlytwentiethcentury.Theclassicalschool,

particularly Jeremy Bentham and Cesare Beccaria, conceptualised crime as “a rational

calculationoftheriskofapainversuspotentialpleasurederivedfromanact”.22Understood

inthisway,theappropriatepurposeofpunishmentwasdeterrence.23

Themajor premise of law& economics as it relates to ideas of deterrence is the law of

demand.24 This suggests that if the price of any good increases, there will be reduced

16GBecker,‘CrimeandpunishmentAneconomicapproach’(1968)76JofPolEcon169,170intendingthattheframeworkwasapplicabletotheentirerangeofcriminaloffences,includingwhitecollarcrimesandmoretrivialoffencessuchasparkingviolations.17Ibid170,201;NMazarandDAriely,‘Dishonestyineverydaylifeanditspolicyimplications’(2006)25(1)JofPubPol&Mark.117,118.18Acomprehensiveaccountofthepositiveschoolofcriminologyisbeyondthescopeofthiswork.Thefollowingprovidearepresentativesampleofthecausesofcrime.RMerton,‘Socialstructureandanomie’(1938)3(5)Am.Soc.Rev.672,672,678;AQuetelet, ‘Of thedevelopmentof thepropensity tocrime’originallypublished inAQuetelet, A Treatise onMan (Chambers, 1842) and reprinted in EMcLaughlin, JMuncie andGHughes (eds),CriminologicalPerspectives(2nded.SAGEPublications,2003),41;EFerri,‘Causesofcriminalbehaviour’originallypublishedinEFerri,ThePositiveSchoolofCriminology;ThreeLecturesbyEnricoFerri(CharlesHKerr&Co.,1908)andpartiallyreprintedinEMcLaughlin,JMuncieandGHughes(n18)54.19JLilly,FCullenandRBall,CriminologicalTheoryContextandConsequences(5thed.SAGEPublications,2011),34.20Ibid83.21Becker,‘Crimeandpunishment’(n16)205.22RAkers,CriminologicalTheoriesIntroduction,EvaluationandApplication(3rdedn,RoxburyPublishingCompany2000),16.23Burns,HartandRosen(n13)34,158;RBellamy(ed)andRDavies(tr),Beccaria:‘OnCrimesandPunishments’andOtherWritings(CambridgeUniversityPress,1995)31.24Posner,EconomicAnalysis(n8)4.

106

consumerdemand for that good inproportion to the sizeof the initial increase. Thiswill

prompttherational,self-interestedactortoinvestigatealternativeswhichhepreferredless

whenthegoodwasatitsprevious,lowerprice.25Thishypothesisisequallyapplicabletothe

commissionofcrime,asRichardPosnerhasargued,

people act as rationalmaximizers of their satisfactions inmaking such nonmarket

decisions aswhether to…commit or refrain from committing crimes…Rules of law

operatetoimposepriceson…thesenonmarketactivities,therebyalteringtheamount

or character of the activity…The first two premises lead to such predictions as

that…increasingtheseverityaswellascertaintyofcriminalpunishmentwillreduce

thecrimerate.26

Thetheoryofthecriminalsanctionpropoundedbythelaw&economicsmovementrestson

deterrenceonthebasisthat“thestatereducesthedemandforcrimebysettinga“price”for

it in the formofanexpectedcostofhaving topaya fineorgo toprison.”27 The rational

criminalisassumedtoconductacost-benefitanalysisinwhichheweighstheexpectedcosts

againstthebenefits.Apersonrefrainsfromcrimewhenthecostsoutweighthebenefits.28In

thisequation,thecostsofcrimearetraditionallyregardedasthecertaintyandseverityof

punishment.Moreperipheralcosts,whicharenotamajorpartoftheconventionalanalysis,

includethecriminal’sopportunitycostsandtheexpensesrequiredtocommittheoffence.29

Thecriminalweighsthesecostsagainsttheexpectedbenefitsofpunishmentwhich,inthe

caseoffraud,arelargelyfinancial.

Thisidealeadstoverysimplepolicyprescriptions:increasingthecostsofcrimewillresultin

feweroffences.30Thisisnodoubtintuitivelyattractive.Aquestionremains,however,how

shouldpolicymakersincreasethecostsofcrime?Theanswerforlaw&economicsscholars

wasrootedintheideathatthesecostswereinterchangeableandinnotionsofefficiency.

25Ibid5.26RPosner,‘Thelawandeconomicsmovement’(1987)77(2)AmericanEconomicReview1,5.27Posner,EconomicAnalysis(n8)250.28Ibid242.29Ibid242.30GStigler,‘Theoptimumenforcementoflaws’inGBeckerandWLandes(eds.),EssaysintheEconomicsofCrimeandPunishment(NBER,1974),56.

107

Atraditionaleconomicanalysisoflawviewsthecertaintyandseverityoflegalsanctionsas

representingacumulativecosttotheoffender.31Forexample,afineof$10,000witha0.1

chanceofdetectionhasthesameexpectedcosttotheoffenderasafineof$1millionwhere

thechanceofdetectionis0.001.32Inbothcasestherationaloffendercalculatestheexpected

costofcrimeas$1000.33Wherethecumulativecostofthesevariablesexceedsthebenefits

ofoffending,themodelpredictsthattheindividualrefrainsfromcrime.Thissuggeststhat

the role played by each variablematters little for deterrence as long as the combination

reachesagivencostvalueinthemindoftheoffender.Thisnotionofinterchangeabilityhas

beenrecentlyconfirmedbyKaplowandShavell.34Themajorlessonofthisanalysisisthata

severesanctionwhichisunlikelytobeimposedcanhaveanidenticaldeterrenteffectasa

moretrivialsanctionwheretheoffenderisverylikelytobeapprehendedandconvicted.35

Thispresentsachoicetopolicymakers;whichcombinationofsanctionsshouldbechosento

reducecrime?Theanswertothisquestiondependedonefficiency;36policymakersshould

determine themost efficient combination of certainty and severity for each offence and

operationalisesanctionsonthatbasis.Themostefficientcombinationwouldtypicallybehigh

severity/lowcertaintysanctions.Thisisbecauseincreasingthelikelihoodofdetectionisnot

costless,but requires significant state investment in themachineryof the criminal justice

system.37BeckerandPosnerargued,onthebasisof theoreticalmodels, that thiswas the

appropriatecombinationinrelationtoprisonsentencesandfines.38

31Ibid56;AHarel,‘Behavioralanalysisofcriminallaw:Asurvey’inEZamirandDTeichman,TheOxfordHandbookofBehavioralEconomicsandTheLaw(OUP,Oxford2014),575.32Posner,EconomicAnalysis(n8)244.33Ibid244.34LKaplowandSShavell,FairnessVersusWelfare(HarvardUniversityPress,2002),362Whereanoffencehasalowprobabilityofdetection,itmaybe“desirabletoemployhigherpunishmentsthanthosecalledforundertheproportionalityprinciple.”35AHarel,‘Economicanalysisofcriminallaw:Asurvey’inAHarelandKHylton(eds.),ResearchHandbookontheEconomicsofCriminalLaw(EdwardElgar,2012),575.36Becker,‘Crimeandpunishment’(n16)183-184;RPosner,‘Aneconomictheoryofthecriminallaw’(1985)85ColumLRev1193,1206.37Posner,‘Aneconomictheory’(n36)1207.38Becker,‘Crimeandpunishment’(n16)184;Posner,‘Aneconomictheory’(n36)1206,1213;KaplowandShavell,‘Economicanalysis’(n5)[6.2.2].

108

Thissinglemetriccouldresultinveryharshpolicyrecommendations.Efficiencycoulddictate,

forexample,thattrivialoffenceswhichweredifficultorexpensivetodetectwerepunished

veryseverely.39SomeofBecker’scontemporarieshadnotedthesepotentialconsequences

ofhisanalysisandsoughttodevelopargumentstocounterhisinsistenceonseverity.40This

isnottosay,however,thatBeckerwaswhollyimmunefrombroaderconsiderations.Inhis

1968paperhehadsuggestedthatifdeterrencewassociety’sonlyconcern,offencescouldbe

reduced “at will” by rendering detection virtually certain and ensuring that punishment

exceededtheoffender’sgain.41Whilethiswouldnotmeethisefficiencycriterion,Beckerhad

a further issue with prescriptions made on this basis: it “ignore[d] the social costs of

increases”incertaintyandseverity.42Socialcostsweretheproductofthecostofpunishment

totheoffenderandtheimpactthatthispunishmenthadonsociety.43Notethatthisimpact

could be negative, as when society is forced to invest resources in prisons, or could be

positive, aswhen the sanction is a finewhich theoffenderpays to society.44Accordingly,

Beckersuggestedthatfinesshouldbeusedinpreferencetoimprisonmentasthesewould

generallyresultinlowersocialcosts.45Imprisonmentshouldbeusedtosanctionoffenders

unabletopayafine.46Thisanalysisisnotwithoutcriticism–itassumesthatthecollectionof

finesiscostless47andaggregatestheoffender’scostintotheoveralldeterminationofsocial

cost48–butitisimportanttoaddressthetotalityofprescriptionsthatBeckermade.

Rationalchoicetheoryprovidesasuperficiallyattractivemodelofcriminaldecisionmaking.

Ifcrimeistheresultofarationalbalancingofcostsandbenefits,thekeytocrimereduction

liesinincreasingthecostsofoffending.49Moreover,thesecostscanbeincreasedinamanner

whichiseconomicallyefficientforsocietywithoutcompromisingondeterrence.

39Becker,‘Crimeandpunishment’(n16)183-184;seealsoKaplowandShavell,FairnessVersusWelfare(n34)362.40Harel,‘Economicanalysis’(n35)576:“horrifiedeventhemostorthodoxadvocatesoflawandeconomicswhotried hard to provide counterarguments”; K Dau-Schmidt, ‘An economic analysis of the criminal law as apreference-shapingpolicy’(1990)1DukeLJ1,21.41Becker,‘Crimeandpunishment’(n16)180.42Ibid181.43Ibid180.44Ibid180.45Ibid193.46Ibid193.47Posner,‘Aneconomictheory’(n36)1206-1207;AHarel,‘Economicanalysis’(n35)15.48Dau-Schmidt(n40)11-12.49Becker,’Crimeandpunishment’(n16)177.

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There is a certain symmetry between rational choice theory and the approach of the

insurancecourts.The judgeshaveconsistentlyarguedthatharshpenaltiesdeterandthat

communicationofthesepenaltieswillreducefraud.True,theinsurancecourtsdonotspeak

explicitlyineconomicterms,butthisdoesnotprecludetheexplanatorypowerofeconomic

theory.50Whileintuitivelyattractive,thesemodelsarefartoosimplistic.Theyfailtorecognise

thecomplexrealitiesofdecisionmakingandtheimportanceofsocialcontextforthepotential

offender.Accordingly,sanctionspremisedonrationalchoicetheory,includingtheinsurance

forfeiturerule,arelikelytobeineffectiveindeterringoffenders.Itwillbearguedthatmodern

deterrencetheorybetterreflectsthesecomplexitiesandcanbeusedtounderpinsanctions

whicharemorelikelytodeter.

B. TheapplicabilityoftheframeworkTheforgoingdiscussionhascentredontheeconomicapproachtocriminallaw.However,the

focusofdiscussionhere–theforfeiturerule– isacivil lawsanction.Giventhateconomic

analysisisnotuniquetothecriminallaw,theapplicabilityofthecriminalframeworkwithin

thisthesismeritsexplanation.51Anexplanationisallthemorenecessarygiventhesimilarity

betweentheinsuranceapproachandtheeconomicanalysisofintentionaltortswhichalso

equates deterrencewith harsh sanctions.52 The relative size andmaturity of the criminal

literaturemeans,however,thatitprovidesamorecomprehensivebasisforcomparisonand

ispreferredinthisproject.

The critical difference between the criminal and civil settings is the purpose of the

punishmentorsanction,respectively.Thecriminallawimposespunishments“fordoingwhat

isforbidden”53andisdesignedto“dissuadetheactorfromengagingin[the]activityatall.”54

Thisisbecauseconductpunishablebythecriminallawlacksanysocialutilitywhatsoever.55

50Posner,‘Aneconomictheory’(n36)1230whereasimilarpointismadeinrelationtothecriminallaw.51IamgratefultoDrJohannaHjalmarssonforencouragingmetothinkaboutthesuitabilityofthisframeworkingreaterdepthandtoProfessorRickSwedloffforassistingmeinreachingthefinalconclusiononthispoint.52RCooter,‘Economicanalysisofpunitivedamages’[1982]56SCalLRev79,89-90.53RCooter,‘Pricesandsanctions’(1984)84ColumLRev1523,1524.54JCoffee,‘Paradigmslost.Theblurringofthecriminalandcivillawmodels’(1991-1992)101YaleLJ1875,1876.55Ibid1876.

110

The level of punishment is typically affected by two variables; the harm caused and the

offender’sstateofmind.56

Bycontrast,thecivil law,generallyconcernsconductwhichcreatessocialutilitybut, inso

doing,imposesexternalitiesonothers.Manyexamplesarecitedintheliterature57butthe

mostusefulforourpurposesisacontractwhichisbreachedbyoneparty.Asasociallyuseful

activity,thepracticeofcontractingistobeencouraged,butthelawmustmakeprovisionfor

thepossibilitythatonepartyfailstoperformasagreed.Thetaskforthecourts,therefore,is

todevelopappropriatesanctionsinthesecircumstances.Oneoptionwouldbetopunishthe

contractbreakerbutthiscouldalsohavetheunwelcomeeffectofmakingcontractingless

desirable.Amoreappropriateresponseisto‘price’thebehavioursothatthesanctionequals

the harm caused.58 This forces the actor to internalise any externalities he imposes on

others,59which in the context of breach of contract, requires the breaching party to pay

compensatory damages to his counterpart.60 This is an appropriate response since the

majorityofcontractbreachesarenotopportunisticbuteitherinvoluntary,aswouldbethe

casewherefrustrationoperates,orvoluntarybutcharacterisedasefficient.61Thisenables

theindividualtodeterminewhethertoengageintheparticularconduct62andtoundertake

anefficientlevelofprecautions.63

Thereisanoccasionalreferenceintheeconomicliteratureoncontractlawtolargedamages

awardswhich are designed to deter inefficient, opportunistic breaches.64 This is howwe

would characterise the submission of a fraudulent insurance claim. These references,

however,arenotsufficientlydevelopedtoenableacomprehensiveanalysisoftheforfeiture

rule.

56Cooter,‘Pricesandsanctions’(n53)1552.57Posner,‘Aneconomictheory’(n36)1206(theexampleofdrivingwhichcausesanaccident);Coffee(n54)1884(theexampleofamanufacturerwhocausesenvironmentalpollution).58Cooter,‘Pricesandsanctions’(n53)1554.59Coffee(n54)1876;Cooter,‘Pricesandsanctions’(n53)1525.60RobinsonvHarman154ER363(1848),365perParkeB.ButseeHCollins,RegulatingContracts(OUP,1999)121wherehearguesthat“weshouldbecautiousinassumingthatitisthelegalsanctionorapaymentequivalenttothemeasureoflegaldamagesthatsuppliesthisincentivetowardsperformanceofundertakings.”61Posner,EconomicAnalysis(n8)131.62Cooter,‘Pricesandsanctions’(n53)1552.63CooterandUlen(n9)290.64Posner,EconomicAnalysis(n8)130-131,142.

111

Wherethecivillaw‘pricing’methodworkswell,thenon-breachingpartywillbeindifferent

toperformanceorbreachplusdamages.65Thisisbecauseadamagesawardcalculatedby

reference to expectation interest will mean that the non-breaching party is in the same

positionas thoughthecontractwas fullyperformed.66Thecriticalpoint is that the ‘price’

equalstheharmcaused.67Toimposepriceswhichexceededtheharmwoulddiscouragethe

actorfromengaginginsociallybeneficialactivities,namelycontracting.68

Insurancefrauddoesnotproduceanysocialutility. Infact,asadeliberateattemptbythe

assuredtoextractmorethanhisentitlementattheexpenseoftheunderwriterandthepool

of policyholders, fraud creates disutility. This disutility increases premiums for honest

policyholdersand forces theunderwriter toexpendunnecessary costs indetermining the

validityoftheclaim.69Thisresemblesthetypeofconductproscribedbythecriminallawand,

therefore, by analogy, the appropriate legal response is to outlaw fraud. A framework

premisedon‘prices’wouldgivetheimpressionthatfraudwasalegitimateactivityprovided

theassuredwaswillingtopaytherelevantprice.Thisisclearlynotthemessagethatthelegal

systemisattemptingtosend,asevidencedbythefactthatinsurancefraudisalsopunishable

as a crime.70 Accordingly, the economic analysis of the criminal law and its associated

literatureisasuitableframeworkinwhichtodiscusstheforfeiturerule.

C. Analternativeaccountoflegalsanctions:ModerndeterrencetheoryModern deterrence theory is the result of research undertaken to test the assertions of

rational choice theory71 and developments in decision theory from the behavioural and

65Ibid133;EZamirandBMedina,Law,Economics,andMorality(OUP,2010)294.66Robinson(n60)365perParkeB.Asimilaranalysisisemployedtoexplaindamagesawardsintortlaw,seeCooterandUlen(n9)345-346.67 Cooter, ‘Prices and sanctions’ (n53) 1554. This supposes that monetary damages are capable of fullycompensatingtheaccidentvictimornon-breachingpartyinacontract,forthispointinrelationtotortseeCooterandUlen(n9)345.68MBedi,‘Contractbreachesandthecriminal/civildivide:Aninter-commonlawanalysis’(2011-2012)28GaStULRev559,583-584,588-589.Thisisthefearof‘over-deterrence’,seegenerallyPosner,‘Aneconomictheory’(n36)1206.69CooterandUlen(n9)276makethispointindiscussingwhyfraudulentmisrepresentationduringnegotiationswillrenderacontractvoid.70FraudAct2006s.2;seelaterdiscussioninpartV(ii).71RPaternoster,‘Howmuchdowereallyknowaboutcriminaldeterrence?’(2010)100(3)JofCrimL&Criminol.765,779.

112

cognitivesciences.Itpresentsamuchmorecomplexframeworkforunderstandingdecisions

aboutcrimethanthelaw&economicsapproach.Theframeworkadoptsamorerealisticactor

who is distinguishable from his rational forbear. The decision-making process too is

fundamentally different; the actor takes a broader range of factors into account when

choosingbetweenalternativesand theprocess itself is far from themethodical approach

suggestedbylaw&economics.

Before considering the ways in which modern theory diverges from the rational choice

account of crime and deterrence, it is important to provide a sketch of the actor in the

behaviouralanalysis.Themodelofmanusedinbehaviouraleconomicsdiffersconsiderably

fromtherationalactor.Theactor’spreferencesarenotconstant;decisionsdonotalways

reflectself-interestbutdemonstrateconcernforothers.72Empiricalevidencedemonstrates

thattheactorvaluesfairnessbothinhowheistreatedandhowhetreatsothers.73Thereis

considerableevidenceofaltruisticandreciprocalbehaviourinone-timeinteractionsbetween

anonymous parties,74 the paradigm case in which one would expect ‘rational’, selfish

behaviour.75 Perceptions of unfairness can also cause behaviours more spiteful than the

traditionalframeworkwouldpredict.76Ineconomicexchange,behaviourisnotdrivensolely

by financial concernsbut in somecircumstancesconsiderationsof “comfort,orpower,or

pleasure”77 may dominate decision making. Decision making, therefore, is not simply a

balanceoftherelativeeconomiccostsandbenefits.

Moderntheoryrecognisesthatpreferencesarenotsolelyshapedbyexogenousfactors78but

alsodevelop through social interaction.79 The actor’s existencewithin aparticular society

explainsagooddealofhisbehaviour.Theactor, forexample, ischaracterisedashavinga

72CJolls,CSunsteinandRThaler,‘Abehavioralapproachtolawandeconomics’[1998]50StanLR1471,1479.73Ibid1479.74MazarandAriely,‘Dishonestyineverydaylife’(n17)119citingUGneezy,‘Deception:Theroleofconsequences’(2005) 95(1) Am Ec Rev 384; J Andreoni and JMiller, ‘Analyzing choicewith revealed preference: Is altruismrational?’inCPlottandVSmith(eds.),HandbookofExperimentalEconomicsVol1(ElsevierScience,2008);JAbeler,DNosenzo and C Raymond, ‘Preferences for truth-telling’ (IZADiscussion PaperNo. 10188, September 2016)availableat:http://ftp.iza.org/dp10188.pdf(accessed15/09/2016),7,38.75EPosner,‘Law,economics,andinefficientnorms’[1996]144UPennLRev1697,1714.76Jolls,SunsteinandThaler(n72)1479.77JKidwell,‘Acaveat’(1985)WisLRev615,617.78Thisisamajorpremiseofrationalchoice,seeDau-Schmidt(n40)5;CooterandUlen(n9)18.79MazarandAriely,‘Dishonestyineverydaylife’(n17)119;Kidwell(n77)617.

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“desire toachieveapositive imageof selfbywinningacceptanceor status in theeyesof

others.”80Heachievesthissocialapprobationbybehavinginaccordancewiththenormsof

his society. Behaving in accordance with these codes of conduct also benefits the actor

intrinsically.Evidenceofthiscomesfromthefieldofneurosciencewhichdemonstratesthat

thebrainrespondsinthesamewaytobehaviourwhichaccordswithsocialnormsasitdoes

tostimuliwhichoffertheactorexternalrewards.81Thissuggeststheexistenceofaninternal

mechanismtocontrolbehaviour.Thisinternalmechanismsanctionsmisconduct,behaviour

whichcontravenesthissetofvalues,andrewardscompatiblebehaviour.82Putsimply,wefeel

goodwhenwebehave inwaysweconsidergoodeven if thismeanswesacrificeexternal

benefits associatedwith a different course of action.83 The recognition that behaviour is

shapedbyacombinationofinternalandexternalinfluencesunderminesthepredictiveability

ofamodelbasedsolelyonexternalconsiderations.

Theactor in thismodern framework alsodiffers fromhis rational forbear inhis ability to

gatherandassessrelevantinformation.Thecomplexityofdecisionmakingmeansthatthe

actor is no longer regarded as a super computer.84 Instead, the actor employs mental

shortcutstoassistwithdecisionmaking.85Theseshortcutsarepronetomisleadanddivert

the actor from ‘rational’ decisions. This again should lead us to question the predictive

accuracyoftherationalchoiceframework.Thecomplexitiesoftheactorinthebehavioural

modelrenderhimmuchmoreakintoactualhumansthanhomoeconomicus.Thefollowing

discussionofbehaviouranddecisionmakingshouldbeviewedinthislight.

80 H Grasmick and D Green, ‘Legal punishment, social disapproval and internalization as inhibitors of illegalbehavior’(1980)71JofCrimLandCriminol325,328citingDWrong,‘Theoversocializedconceptionofmaninmodernsociology’(1961)26AmSocRev183,185;Abeler,NosenzoandRaymond(n74)19.81MazarandAriely,‘Dishonestyineverydaylife’(n17)119citingJRillingetal.,‘Aneuralbasisforsocialcooperation’(2002)35(2)Neuron395;DdeQuervainetal.,‘Theneuralbasisofaltruisticpunishment’(2004)305(5688)Science1254.82NMazar,OAmirandDAriely,‘Thedishonestyofhonestpeople:Atheoryofself-conceptmaintenance’(2008)45(6)JofMark.R633,633.83Ibid634.84Jolls,SunsteinandThaler(n72)1477.85Ibid1477.

114

i. Certaintyandseveritynotinterchangeable

Amajorpremiseoftherationalchoiceconceptionofcrimewastheideathatthelegalcosts,

sanctioncertaintyandseverity,wereinterchangeable.Thecontributionofeachcostdidnot

matterprovidedthattheoverallcostvalueexceededthebenefitsofcrime.Muchoftheearly

workfollowingBecker’spapersetaboutsubjectingtheseassertionstoempiricaltesting.A

variety of methods established that certainty of detection was a far greater indicator of

deterrencethansanctionseverity.86Thisresurrectedtheviewpreviouslyheldbyrenaissance

theorists,BenthamandBeccaria.87Therelationshipbetweencertaintyandseveritywasalso

subjectedtocritique.Themodernresearchunderminedtheideaofacumulativerelationship

in which the variables were interchangeable and instead posited amodel in which both

variablesmustrepresentarealcost.Ifeithercostisperceivedtobenegligible,thethreatof

legalsanctionswillnotinhibitcrime.88

The empirical evidence makes clear that the “issues are more complex than standard

deterrenceanalysisassumes.”89Anotableabsencefromstandardtheoryisthetimeatwhich

punishment is levied inrelationtotheoffence;90 thecelerityofpunishment.Beccariahad

insisted that speedwasavital componentofdeterrenceon thebasis theoffenderwould

associateswiftpunishmentwiththeoffenceinquestion.91Moderntheoristshaverecognised

the importance of speed92 which further demonstrates the simplistic account offered by

rationalchoice.Intheinsurancecontext,punishmentsareunlikelytobeadministeredswiftly.

Theunderwriter’sassessmentofaclaimasfraudulentwilloccuraftertheclaimsprocessand

86EBlaisandJBacher, 'Situationaldeterrenceandclaimpadding:Resultsfromarandomizedfieldexperiment'(2007)3JExpCriminol337,338;SKlepperandDNagin,'Thedeterrenteffectofperceivedcertaintyandseverityofpunishmentrevisited'(1989)27Criminology721,741.Muchofthisworkfocussedonthedeathpenalty,see:AvonHirschetal,CriminalDeterrenceandSentenceSeverityAnAnalysisofRecentResearch(HartPublishing1999),11;HGrasmickandRBursik,'Conscience,significantothersandrationalchoice:Extendingthedeterrencemodel'(1990)24L&SocRev837,837.Theresearchintothedeathpenaltydemonstratednocleardifferenceintherateof capital offences between states which prescribed the death penalty and those which prescribed lifeimprisonment.87Burns,HartandRosen(n13)31.88GrasmickandGreen(n86)327.89PRobinsonandJDarley,‘Doescriminallawdeter?Abehavioralscienceinvestigation’(2004)24(2)OxfordJofLegStud173,182,186.90TLoughran,RPaternosterandDWeiss,‘Hyperbolictimediscounting,offendertimepreferencesanddeterrence’(2012)28JQuantCriminol607,611,624.91BellamyandDavies(n23)49.92RobinsonandDarley(n89)193;apreliminarystudyontheimpactofcelerityandhyperbolicdiscountingwasconductedbyLoughran,PaternosterandWeiss(n90).

115

someformofinvestigation.Theprocessmaybefurtherdelayedbyatrial.Thelossofaclaim

isthereforelikelytooccuraconsiderabletimeafterthefraudwascommitted.Asaresult,the

assuredmaynotnecessarilyassociatethesanctionwiththeoffence.

The empirical evidence undermines the deterrent effect of sanction severity. As such, it

followsthatsanctionspremisedonthisframework,suchastheinsuranceforfeiturerule,will

be relatively ineffective in deterrence terms. The construction of adequate deterrents,

therefore, depends on other factors, including ones which trigger the actor’s internal

behaviourmechanism.Thisisthefocusofthefollowingdiscussion.

ii. Informalsanctionthreatsandperception

Rationalman takes account of the objective legal costs of punishment in his decision to

offend.Theactorinthemodernframework,bycontrast,considersabroaderrangeofcosts

andthinksaboutthosecostsindifferentways.

We consider first the additional variables that affect the decision to offend. These are

generally referred toassocialor informal sanctionsbecause theyarenot imposedby the

state.93Socialsanctionsincludefeelingsofshameandembarrassmentleviedontheindividual

byhimselfasaresultofbehavinginawaywhichcontraveneshismoralcode.94Sanctionsare

also imposedby theoffender’scommunity–hemay feel shameorbeshunnedsocially–

becausehisbehaviourbreaksagreedcodesofconduct.Ifwrongdoingaffectstheindividual’s

commercial reputation, market costs will also be suffered, such as a fall in demand for

products or a reduction in parties willing to trade with the fraudulent individual.95 It is

importanttodistinguishaseparatecategoryofsanctionswhichfollowaformalsanctionbut

arenotimposedbythestate.96Thesewouldinclude,thedifficultyofobtainingprofessional

employment97andfutureinsurancecoverasaresultofacivilfindingoffraud.

93Paternoster(n71)781.94Mazar,AmirandAriely,‘Thedishonestyofhonestpeople’(n82)633-634.95AOgus,CostsandCautionaryTales(HartPublishing,2006),130.96TheauthorisgratefultoProfessorRickSwedloffforhighlightingthisdistinctionindiscussionsattheInsuranceFraudSymposium(UniversityofSouthamptonLawSchool,13July2016).97JWaldfogel,‘Theeffectofcriminalconvictiononincomeandthetrust“reposedintheworkmen”’(1994)JHumResour62,63,66,72.

116

Informal sanction threats exercise a stronger deterrent effect than traditional legal

sanctions.98Themodern framework recognises that theprecise impactof social sanctions

varies by offender and, in particular, the extent to which his social circle is engaged in

criminality. If his acquaintances themselves engage in deviant behaviour, the weight of

informal sanctionswill be considerably lower than those social sanctions leviedby a law-

abidinggroup.99Thesignificanceofsocialsanctionsconfirmthemoderncharacterisationof

decisionmakers as rooted in their community. Not only is the informal sanction amore

effective deterrent than the legal sanction, but it is also far cheaper to administer.100 In

rationalchoicetheorists’driveforefficiency,theutilityofstigmaandotherinformalsanctions

appearstohavebeenoverlooked.

Theimportanceofinformalsanctionsisnottosaythatlegalpenaltiesareirrelevant.Formal

sanctions imposed by the state will typically provide a foundation for the imposition of

informalsanctions.101Thelegalpenaltysignalstothewidercommunitythattheindividual

has contravened accepted standards of behaviour.102 There are, of course, some

circumstancesinwhichsocialsanctionswillbeleviedirrespectiveofformalsanctions.Most

notably,theindividual’sownfeelingsofguiltaretriggeredbybehaviourwhichchallengeshis

perceptionofhimselfasmorallygood.Formalsanctionswillalsobelessrelevantinmarkets

wheretheindividual’smisconductisvisibleto,andcanbesanctionedindependentlyby,other

marketparticipants.

Formalsanctionsimposedbythestatealsohaveanimportantmoralisingeffect.103Thefact

thataparticularactisprohibitedandsanctionedbythelegalsystemvalidatessocialnorms

about theparticularoffence. This can serve to strengthen society’s feelingsabout certain

typesofbehaviour.Alignmentbetweensocialvaluesandthelawrendersthelawcrediblein

98KlepperandNagin(n86)721;DKahan‘Socialinfluence,socialmeaning,anddeterrence’(1997)83(2)VaLRev349,354,357.99GrasmickandGreen(n86)329.100Dau-Schmidt(n40)30.101KlepperandNagin(n86)741;Ogus(n95)130.102Collins(n60)124.103RPaternosterandSSimpson, 'Sanction threatsandappeals tomorality:Testinga rationalchoicemodelofcorporatecrime'(1996)30L&SocRev549,577;Kidwell(n77)618.

117

theeyesofthepopulace.104Theevidencesuggestsahigherrateofcompliancewith‘credible’

lawsthanthoselawswhichdivergefromwidespreadsocialattitudes,105particularlywhere

thesesanctionsareimposedbyalawmakerregardedaslegitimate.106

There is no doubt that there is a complex interrelationship between formal and informal

sanctions.107 The evidence suggests that social sanctions have the capacity to exercise a

strongerdeterrenteffectbutanymodelmustaccountforbothtypesofsanction.Thegeneral

premise ofmodern theory continues to rely on a cost-benefit analysis; the actor will be

deterred from crime when the combination of formal and informal costs outweighs the

benefits.MazarandArielypresentamorecomplexmodelofthisinteractionandsuggestthat

itexistsasastepfunction.108Itsuggeststhatwhentheactorengagesinlow-levelornegligible

dishonesty,theinternalmechanismsofcontrolarenotactivated.109Decisionsdependsolely

on a consideration of external costs and benefits. When the dishonesty contemplated

activatestheinternalmechanism,theactor’srewardsystemexertsconsiderabledissuasive

force against misconduct.110 The actor forgoes the opportunity for dishonesty but this

decision isunconnected from theexternal sourcesof rewardandpunishment.111 In cases

wheretheexternalbenefitsofdishonestyareparticularly large,MazarandArielycontend

thattheinternalmechanismnolongerplaysarole;itisoverriddenbythepromiseofthese

materialbenefits.112Decisionsagainaremadesolelybyreferencetoexternal factors.This

latteraspectofthemodelhasnotbeenwelltested;ifcorrect,however,itwouldsuggesta

residual role for the rational cost-benefit analysis.113 This highlights the nuances of the

relationshipbetweeninformalandformalsanctionthreatsandthatthismayvaryaccording

104DKahan,‘Betweeneconomicsandsociology:Thenewpathofdeterrence’(1996-1997)95MichLRev2477,2481;TTyler,WhyPeopleObeyTheLaw(YaleUniversityPress,1990)64;ZamirandMedina(n65)77.105Kahan,‘Betweeneconomicsandsociology’(n104)2481;PRobinson,‘Thecriminal-civildistinctionandtheutilityofdesert’(1996)76BostonUni.LRev.201,213;ZamirandMedina(n65)77-78.106Tyler(n104)64-65.107GrasmickandGreen(n80)334.SeealsoPCane,‘Theanatomyofprivatelawtheory:A25thanniversaryessay’(2005)25(2)OJLS203,217“Privatelawisnotonlyasystemofnormsbutalsoasetofsocialpracticesaroundthesenormsandinstitutions.Moretheoreticalworkneedstobedoneontheinteractionoftheseelements.”108MazarandAriely,‘Dishonestyineverydaylife’(n17)120.109Ibid120.110Ibid120.111Ibid120.112Ibid120.113Seelaterdiscussion,texttofn222etseq.ButseeAbeler,NosenzoandRaymond(n74)8whosuggestthatincreasesinincentiveshavelittleimpactonbehaviour.

118

tothenatureofthedishonesty.Itisnotthegoalofthisprojecttosketchtheprecisecontours

ofthisrelationshipbuttosuggestthataccountsofdeterrencewhichexcludeawholecategory

ofsanctionthreatsarenecessarilyincomplete.Italsosuggeststhatsanctionsmustbetailored

tothedegreeofdishonestyandtothewayinwhichdecisionsaremade.

Therationalactorispresumedtobalancetheobjectivelikelihoodofdetectionandtheactual

punishmentrateinhisdecisiontooffend.Theempiricalevidencesuggestsamuchdifferent

view.Firstly,itishighlyunlikelythatpotentialoffendersknoworobtainsuchinformationas

partof theirdecision-makingprocess.114This iswhatRobinsonandDarleyhavecalledthe

“legal knowledge hurdle”.115 Knowledge of legal penalties is low even among groups for

whomaccuratestatisticswouldseemtobeuseful;thoseinvolvedinalifeofcrime.116This

doesnotmeanthatsocietyistotallyignorantoflegalrules117northattheoverarchingthreat

ofthelawhasnoeffect;ofcourseitmustdotosomeextent.Thepointisthattheindividual

willstruggletodeterminehowthelawwilldealwithhim.Issuestodowithburdensofproof,

factors influencingsentencingandjudicialdiscretioncombinetoobscuretheactualthreat

valueofthelaw.118

Ifwelookatthespecificinsurancefraudstatistics,theseideaswouldseemtohold.Datafrom

2010suggeststhatpolicyholdersaregenerallyawareoftheseverityofthefraudrule,andin

some cases identified consequences more severe than forfeiture,119 but more than half

considered that fraudwas ‘unlikely’ or ‘veryunlikely’ tobedetected.120 This goesagainst

industry-widemessagestocountertheperceptionthatoffendersareunlikelytobecaught121

andreducestheimpactofpunishmentinthedecisionprocess.

114TBrooks,Punishment(RoutledgeCavendish,Oxford2012),47;MazarandAriely,‘Dishonestyineverydaylife’(n17)120.115RobinsonandDarley(n89)175.116Ibid176.117Ibid177.118Ibid177.119 ABI, Research Brief: Deterring Opportunistic General Insurance Fraud (2010) available at:http://www.betterregulation.com/external/Research%20Brief%20Deterring%20opportunistic%20general%20insurance%20fraud.pdf(accessed30/07/16)5:almost70%ofparticipantsthoughtthewholeclaimwouldbedenied,64%consideredthatthepolicywouldbeavoidedand55%thoughttheindividualwouldgotocourt.120Ibid6:51%thoughtitwas‘unlikely’or‘veryunlikely’thatinsurancefraudswouldbedetected.121ABI,‘Insurerswilldowhateverittakestoprotecthonestcustomersagainstinsurancefraud’(18/01/16)availableat: https://www.abi.org.uk/News/News-updates/2016/01/Insurers-will-do-whatever-it-takes-to-protect-honest-customers-against-insurance-fraud(accessed13/08/16).

119

Onthebasisthatpotentialoffendersdonotknowtheactuallikelihoodofbeingcaughtand

punished, it follows thatdecisionscanonlybemadeon thebasisofperception.122This is

critical.Thedevelopmentofperceptionisstronglytiedtotheactor’sexperienceofthesystem

andthoseofhisacquaintances.123Assuch,aprioroffencewhichwentundetectedorwas

treated leniently will cause the offender to perceive a lower likelihood of detection and

sanction severity than the reality. The same logic is applicable to the severityof informal

sanctions.Punishmentwillbeperceivedasalesserthreatbythoseoffendersforwhomcrime

“mayleadtoverylittleifanylossofstatusandrespectinthecommunitieswithinwhichthey

function.”124Decisionsaboutcrime,likemanyotherdecisions,arenotmadeinavacuum;125

thereisa“strongcorrelationbetweenaperson’sobedienceandherperceptionsofothers’

behaviourandattitude toward the law.”126This suggests thatattempts to shapesociety’s

perceptionsaboutpunishment shouldbe justas important topolicymakersandcourtsas

changingthelaw.Itisnotenoughtoenactharsherpenaltieswithoutworkingtocommunicate

thatthosesanctionsexistandwillapplytoparticulargroups.Indeed,asKahanhasargued,it

is “obvious that a policy that attends only to price and not to social influence may be

ineffectiveinreducingcrime.”127

iii. Limitsonrationalityandtheuseofheuristicsandbiases

A rational choice model of crime conceptualises man as able to access and accurately

compute all the information needed to make an optimal decision. This is implicit in the

assumption that the actor knows the objective likelihood of detection and punishment.

Developments in cognitive psychology and behavioural science during the 1970s

demonstratedthesimplicityof thisassumption.128Humansdonothaveperfectmemories

norinfinitecognitivecapacity.129

122Paternoster(n71)780;RobinsonandDarley(n89)184.123RobinsonandDarley(n89)177,178.124Ibid192.Seealso,Kahan‘Socialinfluence’(n98)357.125Kahan,‘Socialinfluence’(n98)354;Kahan,‘Betweeneconomicsandsociology’(n104)2486.126Kahan,‘Socialinfluence’(n98)354.127Ibid361.128DTeichman,‘Theoptimismbiasofthebehavioralanalysisofcrimecontrol’(2011)UIll.LRev1697,1698.129Jolls,SunsteinandThaler(n72)1477.

120

Thecomplexityofmanydecisionswillmeanthatitisimpossiblefordecisionmakerstoweigh

allpossiblealternatives.130Assuch,thereareboundstohumanrationality; individualswill

tendtodemonstrateaconsistentpreferenceforparticularoutcomes131buttheirdecisions

willnotalwayscoincidewiththepredictionsofrationalchoicetheory.Thereis,forexample,

empirical evidence of ‘satisficing’132 where an individual makes decisions which meet “a

specified aspiration level” 133 but does not fullymaximise his utility. The decision is good

enough,butnotthebestitcouldbe.Intherealworld,satisficingiscommon;individualscould

notshoparoundforthebestdealadinfinitum,considerationsoftimeandneedoverriding

thoseof optimality.Of course, this behaviour couldbedescribed as rational; itwouldbe

inefficient, and in some cases, impossible, to ‘waste’ time amassing and considering all

possiblealternatives.134

Thisboundedrationalityisovercomebytheuseofmentalshortcuts,knownasheuristics,and

biases,whichsimplifythedecision-makingprocess.Assuch,theuseofheuristicsisrational,

providedthattheheuristicsarethemselvesrational.135Thefocusinthisdiscussionisonthose

biaseswhich aremost relevant to decisionmaking about crime; the availability heuristic,

hyperbolicdiscountingandtheoptimismbias.

Therationalchoicemodelreliesonpotentialoffendershavingaccesstoinformationabout

theobjectivelikelihoodofdetectionandthelikelypunishment.Thisisunrealisticparticularly

whenoneconsidersthevariablesaffectingdetectionandjudicialdiscretioninsentencing.136

Theproblemsofboundedrationalityareparticularlyacutewhendecisionmakersneedto

assesstheprobabilityofagivenoutcome,137suchasthelikelihoodofpunishment.Evidence

suggests that the availability heuristic is adopted in these circumstances. Availability is a

130 R Korobkin and T Ulen, ‘Law and behavioral science: Removing the rationality assumption from law andeconomics’[2000]88(4)CalLRev.1051,1077.131HSimon,'Altruismandeconomics'(1993)83TheAmEconRev156,156.132TheideaofsatisficingisfirstidentifiedbyHSimon,‘Rationalchoiceandthestructureoftheenvironment’(1956)63(2)Psych.Rev129,129.133KorobkinandUlen(n130)1075.134Ibid1076;Posner,EconomicAnalysis(n8)19suggestshoweverthatdecisionsmadeonthebasisofincompleteinformationare rationaland in linewitha rationalchoice theoryof lawwhenthecostsofacquiringcompleteinformationwouldexceedthelikelybenefitsstemmingfromawhollyinformeddecision.135Eisenberg(n10)446.136RobinsonandDarley(n89)177.137Jolls,SunsteinandThaler(n72)1480.

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measureofthelikelihoodofagiveneventcalculatedbyreferencetotheeasewithwhichthe

actorcancalltomindsimilarexamples.138Thiswilldependonthepersonalexperienceofthe

potentialoffenderandhisimmediatecommunityaswellasrelevantmediacoverage.139The

actoraskedtojudgetheprobabilityofeventforwhom“retrievaliseasyandfluent”140will

assumeahighlikelihoodofthegivenevent.Ingeneralterms,theavailabilityheuristicisprone

toerrorsince“actorsare…systematicallyinsensitivetosamplesizeandthereforeerroneously

take small samples as representative.”141 In relation to crime, the prior experience of

committing similar offences without being detected is likely to cause the individual to

underestimatethe likelihoodofapprehension. It followsthattheavailabilityheuristicmay

cause individuals to make decisions which the rational choice framework would not

predict.142

Asecondwayinwhichrecentresearchhasunderminedrationalchoicetheoryisrelatedto

howdecisionmakersbalancethecostsandbenefitsofagivendecision.Thetraditionalcost-

benefit analysis presumes that individuals give equal weight to each factor.143 The

behaviouralresearchdemonstratesthatthisisnotthecase.144Instead,themoreimmediate

the event, themore heavily it is weighed in the decision to act in a particular way. The

likelihood of future events is heavily discounted.145 This is the heuristic of hyperbolic

discounting.Itsexistenceexplainswhyindividualsmakedecisionswhichconflictwiththeir

long-termgoals146suchastheemployee’sinabilitytosaveforretirementorthedieterwho

succumbstoatemptingdessert.

138ATverskyandDKahneman,'Availability:Aheuristicforjudgingfrequencyandprobability'(1973)5CognitivePsychology207,208“Life-longexperiencehastaughtusthatinstancesoflargeclassesarerecalledbetterandfasterthaninstancesoflessfrequentclasses,thatlikelyoccurrencesareeasiertoimaginethanunlikelyones,andthatassociativeconnectionsarestrengthenedwhentwoeventsfrequentlyco-occur.Thus,apersoncouldestimatethenumerosityofaclass,thelikelihoodofanevent,orthefrequencyofco-occurrencesbyassessingtheeasewithwhichtherelevantmentaloperationofretrieval,construction,orassociationcanbecarriedout.”139RobinsonandDarley(n89)177-178.Thereisaconsiderableoverlapherewithissuesofperception,discussedabove.140DKahneman,Thinking,FastandSlow(Penguin,2012)129.141Eisenberg(n10)447.142KorobkinandUlen(n130)1069,1075;Jolls,SunsteinandThaler(n72)1477.143SeeZamirandMedina(n65)86whosuggestthatcertainfactorsnecessarilyhave‘lexicalpriority’overothersbutthatthesedifferentweightingsareignoredbyaconventionalcost-benefitanalysis.144TUlenandRMcAdams,‘Behavioralcriminallawandeconomics’(2008)UniversityofChicagoPublicLawandLegalTheoryWorkingPaperNo.244,23;RobinsonandDarley(n89)194.145Jolls,SunsteinandThaler(n72)1539.146Ibid1479.

122

Thisheuristicisparticularlyrelevanttodecisionsaboutcrime.Inthetypicalcase,benefitsare

likely tobeenjoyed immediatelyaftercommission147withanypunishment tobesuffered

later on.148 In the cost-benefit analysis, therefore, the immediate benefits of crime are

accordedmuchmoreimportancethanthepossiblecosts.Thelagbetweencommissionand

costsisparticularlyacuteinrelationtooffencesoffraudwhicharecharacterisedbylengthy

investigations.149Hyperbolicdiscounting is likelytoaffectmanydecisionsaboutcrimeand

will be particularly emphasised in circumstances where the offence is committed due to

emotional150orfinancialpressure.Thiswouldaccountforsomeofthecasesofexaggeration

intheinsurancecontext.Itisforthisreasonthatthecelerityofpunishmentisanimportant

factorinmoderndeterrencetheory.

The optimism bias is also relevant to questions of deterrence. The human propensity to

optimism151meansthatdecisionmakersare likelytoassumethatnegativeconsequences,

suchashavingone’scrimedetectedandsanctionedseverely,aremorelikelytohappento

someoneelse.152Thisallowsthedecisionmaker to furtherdiscount thepotentialcostsof

crime.Ifthedecisionmakerdiscountstheformalcostsofcrimeinthisway,itmayalsohave

aknock-oneffectforhisperceptionofsocialsanctionsgiventhatthesearetoalargeextent

dependentontheimpositionofsanctionsbythestate.Atthesametime,theoptimismbias

maycauseindividualstooverestimatethebenefitsofcrime.Forthoseindividualsnotsuitably

deterredbythethreatofsanctions,thecombinedeffectoftheoptimismbiasislikelytotip

thedecisioninfavourofoffending.

147RobinsonandDarley(n89)195.148Loughran,PaternosterandWeiss(n90)608.149ROgren,'Theineffectivenessofthecriminalsanctioninfraudandcorruptioncases:Losingthebattleagainstwhitecollar crime' (1972-1973)11AmCrimLRev959,969.Recent investments in thecriminalprocess,mostnotablythecreationoftheInsuranceFraudEnforcementDepartment(IFED),seekstoexpeditetheprocess,seehttps://www.cityoflondon.police.uk/advice-and-support/fraud-and-economic-crime/ifed/pages/default.aspx(accessed15/09/2017).150RobinsonandDarley(n89)179.151UlenandMcAdams(n144)5,17.152Jolls,SunsteinandThaler(n72)1524;CJolls,‘Behavioraleconomicsanalysisofredistributivelegalrules’(1998)51VandLRev1653,1659.

123

AsMcAdamsandUlenhaveargued,itisalsoimportanttoaccountforthebeneficialwaysin

which behavioural biases interact with decision making.153 The optimism bias is a prime

candidateforsuchtreatment.Theoptimisticoffenderwhounderestimatesthelikelihoodof

detectionislikelytotakefewerprecautionsincommittinghiscrime,154asfromaneconomic

standpoint,theseprecautionswouldrepresentwastedcosts.This,theyargue,“wouldbolster

the trueprobability of detection,whichpartially offsets thedilutionof deterrenceexcess

optimismcauses.”155Itiseasytoenvisagefewerprecautionsinthecontextofstreetcrime

butlesssoinrelationtocommercialfraud.Thisfurtherindicatesthecomplexityofdecision

makingandtheneedforfurtherempiricalworkontheinfluenceofthesebiases.156

Modern deterrence theory represents a significant departure from the traditional

understandingofdeterrenceandrationalchoice theory. It recognises that thedecision to

offend is taken by boundedly rational, optimistic actorswhouse rules of thumb, such as

availabilityandhyperbolicdiscounting,tosimplifytheprocess.Underthisanalysis,thereisa

much broader range of costs and benefitswhich form part of the decision. In particular,

decisionmakers accord greaterweight to social sanctions levied by themselves and their

socialcirclethanthethreatoflegalsanctions.Thelawservestoprovideafoundationforthe

impositionofinformalsanctionsandlegitimisesmoralviewsaboutcertainbehaviours.

ThecombinedimpactofthesefactorshasbeenusefullyhighlightedbyRobinsonandDarley,

Potentialoffenderscommonlydonotknowthe legal rules…Even if theyknowthe

rules,thecost-benefitanalysispotentialoffendersperceive…commonlyleadsto…

violation rather than compliance, either because the perceived likelihood of

punishmentissosmall,orbecauseitissodistantastobehighlydiscounted…And,

even if they know the legal rules and perceive a cost-benefit analysis that urges

compliance,potentialoffenderscommonlycannotorwillnotbringsuchknowledge

tobear[becauseof]avarietyofsocial,situationalorchemicalinfluences.Evenifno

153UlenandMcAdams(n144)17.154Ibid17.155Ibid17citingNGaroupa,‘Behavioraleconomicanalysisofcrime:Acriticalreview’(2003)15EuropeanJofLawandEconomics5,9.156UlenandMcAdams(n144)17-18;KorobkinandUlen(n130)1092.

124

oneofthesethreehurdlesisfataltothelaw’sbehaviouralinfluence,theircumulative

effecttypicallyis.157

The argumentmadehere is that this empirical research should change thenatureof the

debateforacademics,policymakersandthejudiciary.Policieswhichrelyontheseverityof

sanctions – such as the forfeiture rule – are out of step with modern thinking about

deterrenceand,therefore,arelikelytobeineffectiveinpreventingcrime.TheSupremeCourt

wasrecentlyinvitedtoreconsiderthescopeoftheforfeitureruleinlightofthelessonsfrom

moderndeterrencetheory.Accordingly,thediscussionnowconsidersthejudicialresponse

totheevidenceandprovidessomeillustrationsofdeterrentsalignedwithmoderntheory.

D. ModerndeterrencetheoryandtheSupremeCourtIn thecourseofargument inVersloot, counsel for theassured referred their Lordships to

moderndeterrencetheory,intheformofanarticleco-writtenbytheauthorandProfessor

James Davey.158 During the hearing itself, Lord Mance noted that set against empirical

evidencewere“theoriesofjudicialactivity[which]inviteustooperateonthebasisofrational

choicetheorywhichassumethatpeoplebehavelogicallyandthatwehaveknowledgeofthe

law.”159ThisstatementfromLordManceencapsulatestheentiredebatecontained inthis

section.

Theargumentsreceivedlittleattentioninthefinaljudgment.Thecommentsareworthciting

infull.Firstly,thecommentsmadebyLordToulsonwhichindicatetacitacceptanceofthe

importanceofinternalmoralcodesinpreventingwrongdoing,

I am not a psychologist, but I am sceptical about the idea that knowledge of this

judgmentwillincentivisepeoplewithvalidinsuranceclaimstolieinsupportoftheir

claims.Thosewhoarehonestwillnotdosobecauseitwouldnotbeintheirnature,

157RobinsonandDarley(n89)174.158JDaveyandKRichards,‘Deterrence,humanrightsandillegality:Theforfeitureruleininsurancecontractlaw’[2015]LMCLQ315.Notethattheauthorswereincontactwithcounselfortheassuredsoonafterthefirstinstancejudgment.159VerslootDredgingBVvHDIGerlingIndustrieVersicherung(TheDCMerwestone)(Hearingon16/03/16,morningsession), 2h 12 per Lord Mance available at: https://www.supremecourt.uk/watch/uksc-2014-0252/160316-am.html(accessed31/07/16).

125

whilesomewhoaredishonestmaydosoiftheythinkthattheywillgetawaywithit,

despite the risk of it having a boomerang effect on whether the court believes

anythingthattheysay.160

More generally, however, the Supreme Courtwas sceptical of the empirical evidence on

deterrenceanddidnotusemoderntheorytogroundthenewapproachtocollateralliestold

in support of an insurance claim. Lord Sumption, in giving the opinion of the majority,

commented

Therewas, itwas said, little empirical evidence that the common law rulewasan

effectivedeterrenttofraud,andnoreasontothinkthattheproblemwaspeculiarto

claimsoninsurersasopposedto,say,claimsintortforpersonalinjuries,thecostof

which also falls ultimately on insurers and policy-holderswithout there being any

equivalent common law rule. Informational asymmetry is not a peculiarity of

insurance,andinmodernconditionsmaynotevenbeastrueofinsuranceasitonce

was.Thesepointshavesomeforce.ButIdoubtwhethertheyarerelevant.Courtsare

rarelyinapositiontoassessempiricallythewiderbehaviouralconsequencesoflegal

rules.Theformationof legalpolicy inthisas inotherareasdependsmainlyonthe

vindicationofcollectivemoralvaluesandonjudicialinstinctsaboutthemotivationof

rationalbeings,notonthescientificanthropologyoffraudorunderwriting.161

During argument in Versloot, Lord Mance had commented that scepticism about the

deterrent effect of the rule was “understandable.”162 However, he too dismissed the

empiricalargumentsinthefollowingterms,

Wewerereferredtoacademiccriticismoftheoriesofdeterrenceinthiscontext,but,

asLordSumptionobserves,manylegalrulesareframedonabasiswhichassumesthat

theyarecapableofhavingandshapinglegal,socialoreconomicbehaviour,andhere

isaclassicexampleofParliamentendorsingthisapproach.163

160VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG(TheDCMerwestone)[2016]UKSC48, [108]perLordToulson(hereafterreferredtoasVersloot(SupremeCourt)).161Ibid[10]perLordSumption.162Versloot(SupremeCourthearing)(n159)2h11perLordMance.163Versloot(SupremeCourt)(n160)[124]perLordMance,referringtotheInsuranceAct2015s.12.

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This retrenches the rational choiceanalysis. It isunsurprising that theSupremeCourt–a

judiciaryinculcatedinarationalchoiceapproachtolaw-making–respondedinthiswayto

empiricalandbehaviouralevidence.ItwouldhaverequiredtheSupremeCourttolookatthe

biggerpicture,whichasLordSumptionnoted,courtsaregenerallyunabletodo.164Writing

extra-judicially,however,LordMancehasbeenreceptivetomodernevidenceaboutdecision

makingandrecognisedthatitforcesareassessmentofjudicialassumptionsinthecontextof

illegality.

Thebrocard[ofexturpicausa]…isofcourseaninvitationtofast-thinkingofthetype

thattheNobelprize-winnerDanielKahnemannhasinhisbookThinkingFastandSlow

sotellingly-and,fordecision-makerslikemyself,alarmingly-described.Itsuggests

easyanswers,butisentirelyfallaciousinsodoing.165

Hecontinued,

I doubtwhether it is realistic to try to justify it on a deterrent basis…But I doubt

whether it reallycanhavehere.Havepersonsengaging in illegal transactionsever

heardofexturpicausa?Woulditdeterthem?Gamblersmightevenrelishthechances

ofuncovenantedbenefitwhichitoffers.166

LordMance’sacceptanceoftheseargumentsinthecontextofanacademicarticlemakeshis

dismissalofthemintheSupremeCourtdisappointing.Ofcourse,thismaywellbeexplained

bythedifferentnatureofa journalarticleandajudicialspeech.Thetypical journalarticle

takes as its focus “an ideal situation rather thananactual situation”,167 asnotedby Lord

Sumption during the hearing inVersloot. This gives the authormuch greater freedom to

examinethetopicwithoutfeelingconstrainedbypracticalconsiderations,evenifthatauthor

isordinarilyaSupremeCourtjudge.Inrelationtothisspecificcase,LordMance’scomments

also appear to have been influenced by Parliament’s acceptance of the forfeiture rule as

deterrentintheInsuranceAct.168Tobeclear,however,moderndeterrencetheorydoesnot

164Versloot(SupremeCourt)(n160)bid[10]perLordSumption.165(Lord)JMance,‘Exturpicausa—WhenLatinavoidsliability’(2014)18EdinLRev175,176.166Ibid182-183.167Versloot(SupremeCourthearing)(n159)2h26perLordSumption.168InsuranceAct2015s.12;Versloot(SupremeCourt)(n160)[124]perLordMance.

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entirely relegate legal sanctions but instead views them as part of the decision-making

processaboutdishonesty.Itwouldnotbeincompatible,therefore,tosimultaneouslyendorse

theforfeitureruleasdeterrentandmoderndeterrencetheory.

Notwithstanding the effective rejection of these ideas in the Supreme Court, the role of

behavioural science in deterrence has been recognised extra-judicially. The following

discussionchartssomeoftheserecentdevelopmentsandconsiderswhatdeterrentsaligned

withthelessonsofmoderndeterrencetheorymightlooklike.

E. AligningdeterrentswithmoderndeterrencetheoryAsmallbodyofempiricalworkrelatingtotheinsuranceclaimsprocessconfirmsthepotential

of deterrents aligned with modern theory and provides inspiration for this part of the

discussion. In addition, a recent meta-analysis of 72 studies drawn from economics,

psychologyandsociologyattributedhonestbehaviourtothepersonalcostsassociatedwith

lyingandconcernsaboutreputation.169Thisprovidesfurthersupportforsocialsanctionsand

mechanismswhichseektotriggerthese‘costs’inthedevelopmentofdeterrents.170

The claim form is a critical tool in fraud deterrence as this is themoment at which the

opportunityforfraudarises.ACanadianstudyonexaggeratedclaimstrialledtheimpactof

incorporatingsocialnormsintotheclaimsprocessacrossfourinsurancecompanies.171Inhalf

oftheclaims,thepolicyholderreceivedaletterinadditiontothestandardclaimform.The

letterremindedrecipientsofthepenaltiesforfraudandcontinued,

[a]ndweknow,asarecentpollhasrevealed,thataverylargemajorityofpeoplefeel

thatboosting insuranceclaims ismorallywrong…weverywell knowthat the large

majority of insurance holders share our beliefs. And this is why we take this

opportunity to ask for yourhelp and your cooperation in completing carefully the

enclosedforms.172

169Abeler,NosenzoandRaymond(n74)38-39.170Ibid38-39.171BlaisandBacher(n86).172Ibid350.

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Onaverage,policyholdersinreceiptoftheexperimentallettersubmittedclaimsworth$300

less than claimants who were subject to the company’s standard procedure.173 This

interventioncanbeviewedasanattempttoovercomesomeofthebiasesthatresultinthe

decisiontocommitfraud.Firstly, thereminderof legalpenalties isperhapsanattemptto

overcometheeffectofhyperbolicdiscountingbybringingsanctionsintotheforefrontofthe

decisionmaker’smind.Inaddition,theappealtomoralitycanbeexplainedasanattemptto

makesalienttheindividual’sownsetofvaluestotriggertheinternalbehaviourmechanism

attherelevanttime.

Theplacementofthehonestydeclarationonclaimformsisalsocritical.Assuredsaretypically

requiredtosignatthebottomoftheclaimformtoconfirmthattheinformationprovidedis

true to thebestof theirknowledge.Thisdeclarationmayalso require thepolicyholder to

acknowledgethepossiblesanctionsofinsurancefraud.ResearchbyShuetal.suggeststhat

thisdeclarationcomestoolate;bythetimetheassuredsignstheform,theexaggerationhas

alreadyoccurred.174Theresearcherstestedtheimpactofmovingthedeclarationtothetop

of the form inboth laboratoryand real-world settings. The real-world settings includeda

policyreviewformusedbyanAmericaninsurancecompany.175Theassuredwasrequiredto

statetheircurrentmileagewhichwastobecomparedforthepurposesoftheexperimentto

theiractualmileage.Thispresentedanopportunityfordishonesty;itwasintheparticipants’

self-interest to understate mileage to attract a lower premium. Policyholders who had

declared their honesty in advance of their mileage recorded higher figures which was

associatedwith lower dishonesty.176 Thismirrored the findings of the other experiments

undertakenbyShuetal.177Theeffectofrelocatingthehonestydeclarationwasequatedto

the process of swearing an oath in court.178 In Ariely’s parlance, the honesty declaration

primestheassuredwithhisownmoralityastheopportunityfordishonestyispresented.179

173Ibid344,347.174LShuetal,‘Signingatthebeginningmakesethicssalientanddecreasesdishonestself-reportsincomparisontosigningattheend.’(2012)109(38)PNAS15197,15198.175Ibid15198.176Ibid15198.177Ibid15197-15198.178Ibid15197.179 Ibid 15198. See alsoNMazar,OAmir andDAriely, ‘(Dis)Honesty: A combination of internal and externalrewards’ (Working Paper, Sloan School of Management (MIT)) cited in D Ariely, The (Honest) Truth AboutDishonesty(Harper,2012),50-51.

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Thesesuggestionsfortheredesignoftheclaimformfocuspreventioneffortsatthemoment

thattheopportunityforfraudispresented.Theyarelikelytobecost-effective180notleast

becauseinsurerswillalreadyneedtomakeotherchangestotheirdocumentationfollowing

the2015Act.

Theindustryhasalsobeentakingstepstocounterfraudoutsideofthecourts.Theseefforts

canbeanalysedfromtheperspectiveofmoderndeterrencetheory,evenifthiswasnotthe

basisforinterventionbyinsurers.TheInsuranceFraudEnforcementDepartment(IFED)was

established in 2012 and is funded by insurers.181 It centralised police investigation into

insurance fraud within the City of London Police. Previous difficulty in detecting fraud

stemmedfromalackofexpertiseinfinancialcrime182andthecentralunitovercomesthis

difficulty.IFEDhashadconsiderablesuccesssinceitsinceptionhavingseizedorconfiscated

£1.3millionfromfraudstersandachieving200convictionstotallingmorethan100yearsin

prisonsentences.183

Continuedeffortandinvestmentshould,intime,increasethedetectionofinsurancefraud.

Anincreaseintheobjectivelikelihoodofdetectionisnot,aspreviouslydiscussed,asignificant

indicatorofcompliancewiththelaw.Whatisimportantaboutthis,however,isthepotential

forgreaterinvestigationandprosecutiontoaffectperceptionofdetectionandsocialnorms

about the immorality of insurance fraud. The greater the social costs associated with

opportunisticfraud,thelesslikelyitisthatanassuredwilltakeadvantageoftheincentives

tofraudduringtheclaimsprocess.

Therealityof insurancefraudhasalsobeenpublicisedthroughtheworkof IFED.ABBC1

daytimetelevisionshow, ‘ClaimedandShamed’, isnowin itssixthseriesandfollows IFED

investigators as they uncover and prosecute insurance fraud.184 The Insurance Fraud

180Shuetal(n174)15198.181IFED,‘AboutIFED’availableat:https://www.cityoflondon.police.uk/advice-and-support/fraud-and-economic-crime/ifed/Pages/About-IFED.aspx(accessed12/09/2017).182REmerson,‘Insuranceclaimsfraud:Problemsandremedies’(1991-1992)46UMiamiLRev907,950.183IFED,‘IFEDNews’(22/01/16)availableat:https://www.cityoflondon.police.uk/advice-and-support/fraud-and-economic-crime/ifed/ifed-news/Pages/Insurance-Fraud-Enforcement-Department-announce-new-head.aspx(accessed31/07/16).184BBC,‘ClaimedandShamed’availableat:http://www.bbc.co.uk/programmes/b071hmq0(accessed01/08/16).

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Taskforce,discussedfurtherbelow,185hascreditedtheprogrammewith“raisingtheprofile

ofinsurancefraudandactingasadeterrent.”186Fromtheperspectiveofmoderndeterrence

theory,mediacoverageshouldincreasetheeasewithwhichdecisionmakerscancalltomind

instances of detection and punishment. This taps into the availability heuristic by which

individualswould tend to underestimate the likelihoodof detection. Researchby theABI

demonstratesthatmanypolicyholdersdonotconsiderinsurancefraudacrimeorotherwise

consider it victimless.187 The television programme may help to overcome these

misconceptions by equating fraud with traditional street crimes and providing concrete

examplesofdetectionandpunishment.

FollowingtheconclusionoftheLawCommissionconsultationintoinsurancecontractlaw,the

governmentestablishedtheInsuranceFraudTaskforce(IFT).188TheIFTwaschargedwith

investigat[ing]thecausesoffraudulentbehaviourandrecommend[ing]solutionsto

reducethelevelofinsurancefraudinordertoultimatelylowercostsandprotectthe

interestsofhonestconsumers.189

TheTaskforcewasreceptivetotherolethatbehaviouraleconomicscouldplayincombatting

insurancefraud.OneoftheirkeyrecommendationswasfortheABItocommissionresearch

intotheuseofbehaviouraleconomicsandadoptusefulconclusionsasbestpracticewithin

the industry.190 The IFT also emphasised the importance of structural mechanisms to

overcomeincentivestofraud,

…goodresearchhasbeenpublishedaboutconsumersandbehaviouraleconomicsand

considers itwouldbeworthwhilefor insurerstoreviewtheirdocumentation,sales

andclaimsprocesseswithconsumerbehaviourinmind.191

185Seelater,texttofn188.186 Insurance Fraud Taskforce, Insurance Fraud Taskforce Final Report (2016) available at:https://www.gov.uk/government/publications/insurance-fraud-taskforce-final-report (accessed 13/09/2016),[4.12]187SViaeneandGDedene,‘Insurancefraud:Issuesandchallenges’(2004)29(2)TheGenevaPapersonRiskandInsurance,321.188InsuranceFraudTaskforce,FinalReport(n186)[3.47].189Ibid75.190Ibid8-9,53-54,57.191Ibid[5.17].

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Thisispromisinglargelybecauseitdemonstratesawillingnesstolookbeyondlawasameans

ofcombattinginsurancefraud.Notwithstandingtherejectionofmoderndeterrencetheory

bythecourts,therecommendationthatinsightsdrawnfrombehaviouralscienceshouldbe

establishedasbestpracticefortheinsuranceindustryisawelcomemove.

Themajorcritiqueoftheinsuranceforfeitureruleisthatitispremisedonoutdatedmodels

ofdecision-makingwhichfocusattentionontheseverityoflegalpunishment.Moderntheory,

bycontrast,accordslegalsanctionsamoremodestroleindeterrenceandinsteademphasises

the preventive power of social sanctions. The remainder of the chapter develops further

critiquesofthejudicialresponsetoinsuranceclaimsfraud.Thefirstofthesehighlightsthe

absenceofaneffectivelegalsanctionforthemostseriousfraud;thewhollyfabricatedclaim.

II. TheAbsenceofanEffectiveLegalRemedyforWhollyFraudulentClaimsTheforfeiturerulewasdesignedtodetertheexaggeratedclaim,192and,inthissense,onecan

readilyappreciatethemodelofdeterrencewhichinspiredthenineteenth-centuryjudges.A

rulewhichoperates todeprive the assuredof genuine loss (in addition to the fraudulent

portion), however, worksmuch less well in relation to wholly fraudulent and fraudulent

deviceclaims.Indeed,theargumentmadeinthissectionisthatforfeitureisanineffective

deterrenttothemostseriousfraud;thewhollyfabricatedclaim.193Applyingforfeituretothis

typeofclaimisakintoallowingthethieftoreturnstolengoodstothestorewithoutreceiving

any additional sanction. The rule has minimal impact on the wholly fraudulent claimant

becausethereisnot,andneverwas,anygenuineclaimtobeforfeited.194

The Law Commission was aware of this, noting in its 2012 consultation paper that the

forfeiturerulehad“littlepracticaleffect”195 inrelationtowholly fraudulentclaims.196The

Commissionfurtherstated,however,thatordinarycommonlawremedies–mostnotably,an

192BrittonvRoyalInsuranceCo(186)4F&F905,909perWillesJ.193Seeearlier,ChapterTwo.194PMacDonaldEggers,‘Utmostgoodfaithandthepresentationandhandlingofclaims’inBSoyer(ed.),ReformingMarineandCommercialInsuranceLaw(Informa,2008),245.195LawCommission,‘InsuranceContractLaw:PostContractDutiesandOtherIssues’(LawComCP201)[7.29],[8.20].196Ibid[7.29],[8.20].

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action in the tort of deceit197 – were available to underwriters. Two cases in which the

underwriter sought remedies inaddition to forfeituremeritdiscussionat this stage. First,

LondonAssurancevClare198inwhichtheunderwriterclaimeddamagesfortheinvestigation

ofanallegedarsoninadditiontorecoveringtheindemnityfromtheassured.Theargument

wasmadethattheassuredwasunderanimplieddutytoputforwardhonestclaimsandfraud,

therefore,entitledtheunderwritertodamagesforbreachofcontract.199GoddardJheldthat

suchdamages“werefartooremote”200andcitedthefactthatallclaimswouldneedtobe

investigatedtodetermineliabilityandquantum.Itisdifficulttofindsubsequentmentionof

damages until the 2012 case of Parker v NFU Mutual Insurance Society.201 It “was not

disputed”202 that the underwriter was entitled to damages and interest for the costs of

investigatinganallegedarsonbuttherewasnotanydiscussionofthebasisofthecauseof

actionnorthemethodofassessment.Parkerhasbeensubsequentlycitedincaselaw203and

bytheLawCommission204althoughinneithercircumstancehastheavailabilityofdamages

beenmentioned.

Despite the recent discussion of damages in Parker, it is clear that underwriters do not

routinelyseekadditionalremedies.205Tosomeextent,thisisunderstandablesinceaclaimin

deceitwouldrequiretheunderwritertosatisfyanadditionalproceduralhurdle,namelythat

ithadbeeninfluencedbythemisrepresentation.206Cognisantofthisremedialgap,theLaw

Commissioninitiallyadvocatedthecreationofastatutoryrighttodamagestomeetthecosts

of investigating fraudulent claims.207 This remedy was designed as a deterrent to wholly

197LawCommission,InsuranceContractLaw:BusinessDisclosure;Warranties;Insurers’RemediesforFraudulentClaims;andLatePayment(LawComNo353,2014),[22.30};InsuranceCorporationoftheChannelIslandsvMcHugh[1997]1LRLR94,135perManceJ:“wouldnotinitselfappearinlegaltheorytoprecludethemakingofaclaim–ifthefactsotherwisejustifiedit–basedonanypositivedeceitfulmisrepresentation.”198LondonAssurancevClare[1937]57LlLRep254.199Ibid270perGoddardJ.200Ibid270perGoddardJ.201ParkervNFUMutualInsuranceSociety[2012]EWHC2156(Comm),[2013]Lloyd’sRep.IR253.202Ibid[205]perTeareJ.203BatesvAviva[2013]EWHC1687(Comm),[2013]Lloyd’sRep.IR492.204LawCom353(n197)[22.43]discussionofParker(n201)inthecontextoffraudulentco-insureds.205LawCom353(n197)[22.30].206HaywardvZurichInsuranceCo.[2016]UKSC48,[67],[71]perLordToulson.207LawCom201(n195)[8.19].

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fraudulent claims andwould have capped damages at costswhichwere foreseeable and

reasonableinthecircumstances.208

Bythetimeofthefinalreport,theLawCommissionhadabandonedthisproposal,statingthat

“we do not consider that the recoverability of investigation costs will significantly

disincentivise policyholder fraud.”209 This was justified on the basis that insurers did not

commonlybringactionsindeceitnorattempttoincludeexpresstermsreservingtheirright

to damages,210 though this may well be due to the complexity of actions in deceit.211 A

statutorycauseofactionwouldhaveconsiderablysimplifiedmattersforunderwriters.The

Commissionalso suggested thedifficultyof recovering investigativecosts from fraudulent

policyholders212thoughthisisnotparticularlyconvincinginrelationtocommercialassureds.

Uniting both the Commission’s initial preference for a financial penalty and its eventual

rejectionisassertion,andnotevidence,aboutdeterrence.ThisisaclassicexampleofBell’s

accountof(judicial)policymakingwhichtakesplace,

onthebasisofunsupportedassertionsofsocialfactandprojectionoffuturebenefits

ordisasterswhichwouldfollowtheadoptionofanewrule,whichrestonthejudges’

appreciationofhumannature.213

To someextent, judicial relianceon suchmaterial canbe excused since the courtwill be

limitedby thematerial before it.214 This explanationdoesnot assist the LawCommission

whichcouldhavetrialledthepotentialimpactofcostsduringconsultation.215Thisleadsthe

208Ibid[8.20].209LawCom353(n197)[22.30].210Ibid[22.30].211Seeearlier,texttofn206.212LawCom353(n197)[22.30].213JBell,PolicyArgumentsinJudicialDecisions(ClarendonPress,1983)67.214Ibid68.215TheLawCommissionhasahistoryofundertaking,anddrawingon,empiricalwork,seeLawCommission,‘TheLaw Commission for England and Wales and its use of empirical research’ (09/06/2010) available at:http://www.lawcom.gov.uk/wp-content/uploads/2015/06/empirical_research_090610.pdf (accessed 22/09/16),[1.4]butnotedat[1.5]thatfinancialimplicationslimitmorewidespreadempiricalwork.Seealso,MPartington,‘Empiricallegalresearchandpolicy-making’inPCaneandHKritzer(eds.),TheOxfordHandbookofEmpiricalLegalResearch(OUP,2010),1012.

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authortospeculatethattherealreasonforabandonmentwasreallyan“apparent lackof

demand,”216 particularly given that Goriely has recently characterised the Commission as

developing“piecemealsolutionsfordemonstratedproblemswheretherewasconsensusfor

reform.”217 If this explanation is correct, this should cause us to question whether

underwriters remain as vulnerable to fraud – and therefore as necessitous of judicial

protection–as theywerewhenthe forfeiture ruleemerged.Thiswillbediscussed in the

followingsection.218Theabandonmentofproposalscouldalsobeduetoconcernthatthe

provisionswouldnotsatisfythenon-controversialprocedureforLawCommissionbills.219

It is important to recognise that there is nothing in the LawCommission’s final report to

suggest that underwriters cannot stillmake use of common law remedies in fraud cases

followingtheenactmentofthe2015Act.220Byonlyenshriningtheforfeitureruleinstatute,

however,theActgivestheimpressionthatthisisthesolecivilsanctionforfraud.Theposition

takeninthisthesisisthatthefailuretoenactastatutoryremedyforthemostseriousfrauds

isproblematicbothinconceptualandpracticalterms.

Toappreciatetheconceptualdifficulty,itisimportanttoreturntothejudicialunderstanding

ofdeterrence,namelythatitiscontingentonharshlegalsanctions.221Itiswhollyinconsistent

thatthissamelogichasnotbeenusedtodevelopasuitablesanctionforwhollyfraudulent

claims.Indeed,theabsenceofastatutoryresponseisalsodisappointinginlightofMazarand

Ariely’sworkondecisionmakingarounddishonesty.Thisresearch,discussedearlierinthis

chapter,222demonstratedthatatraditionalcost-benefitanalysishassometractionincases

where the external benefits of dishonesty are particularly large.223 Thewholly fraudulent

claim–thescuttle inthemarinecontext– fallsneatlywithinthisdescriptionbecausethe

successfulassuredstandstomakeconsiderablefinancialgain.Insuchcases,theexistenceof

216LawCom353(n197)[22.31].217TGoriely, ‘Goodfaith:Theresidual impactofs.17MarineInsuranceAct1906’(GoodFaith inContractLaw,ExeterUniversity,July2017).218Seelater,PartIII.219AHorneandRKelly,‘TheLawCommissionandLawCommissionBillProcedures’(27March2015)availableat:http://researchbriefings.files.parliament.uk/documents/SN07156/SN07156.pdf(accessed13/09/2017).220LawCom353(n197)[20.6],[22.30].221Seeearlier,ChapterTwo,texttofn174etseq.222Seeearlier,texttofn113etseq.223MazarandAriely,‘Dishonestyineverydaylife’(n17)120.

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materialbenefitsoverridesinternalmechanismsforbehaviourcontrol.MazarandArielyhave

argued,therefore,thatdecisions inthesecircumstancesmoretypicallyreflecttherational

choicemodel,224althoughpresumablythiswouldhavetobemodifiedtotakeaccountofthe

cognitivelimitationsofthedecisionmaker.225Accordingly,effectivelegaldeterrencewould

require the construction of sufficiently certain and severe sanctions which exceeded the

benefits of offending. The fact that forfeiture “provides no deterrent against complete

fabrication”226isproblematiconthisbasis.HadtheLawCommission’sproposaltocreatea

statutorybasisforrecoveringinvestigationcostsbeentakenforward,itwouldhavebeena

muchbetterfitwiththemodelsuggestedbyMazarandAriely’sresearch.Asdesignedbythe

LawCommission,thedamageswouldhavecompensatedtheunderwriterandsocannotbe

characterised as a punitive response to the wholly fraudulent claim. However, the

introductionofdamageswouldhaveprovidedatangibleexternalsanctionforthefraudulent

assured.Thiswouldhavegonesomewaytoaddressingtheabsenceofaneffectivesanction

forthemostseriousfrauds.

TheLawCommission’sabandonmentofthisproposalisalsodifficulttoreconcilewithother

areas of the civil justice system where financial penalties are considered a deterrent to

dishonesty.Recentcivil justice reforms,designedto“controlcostsandpromoteaccess to

justice,”227introducedQualifiedOne-wayCostsShifting(QOCS).228Thisprotectslitigantsfrom

adversecostsordersbyprovidingthatanyordercannotexceedtheamounttheclaimanthas

been awarded in damages.229 Thismeans that if the claimant is unsuccessful, hewill not

become liable indamagestothedefendant.Thisprotection fromcosts isnotabsolute; in

particular, a full costs order can be made where the claimant has been fundamentally

224Ibid120.225Suchasthosediscussedabove,texttofn128etseq.226LawCom201(n195)[7.29](n195).227R Jackson,ReviewofCivil LitigationCosts: FinalReport (December2009) (hereafter referred toas ‘JacksonReport’),[i].228Ibidch.19.CivilProcedureRulesr.44.13limitsQOCSto(1)(a)personalinjurycases,(b)claimsundertheFatalAccidentsAct1976,and(c)claimswhichariseoutofdeathorpersonal injuryandsurviveforthebenefitofanestatebyvirtueofsection1(1)oftheLawReform(MiscellaneousProvisions)Act1934.SeecommentaryofthisinPRawlingsandJLowry,‘Insurancefraudandtheroleofthecivillaw’(2017)80(3)MLR525,534-536.229CivilProcedureRulesr.44.14.

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dishonest.230 This is designed to deter frivolous and fraudulent claims.231 This is a

fundamentallydifferentapproachtothattakenbytheLawCommission.Ofcourse,neither

approach has been justified empirically but it is notable that opposing views about the

deterrenteffectofmonetarysanctionshavebeenadoptedinsimilarareasof lawwithina

shortspaceoftime.

ItisdisappointingthattheLawCommissiondidnotmakeuseoftheopportunitytoconsider

a remedy for wholly fraudulent claims inmore depth. Itmeans that the criticism of the

forfeitureruleascounterintuitiveremainsunresolved.Goriely’ssuggestionthattherewas

insufficientdemandforreform232causesustoreflectonthejudicialnarrativesurrounding

insurancefraud:thevulnerableunderwriteranddeceitfulassured. Itcontends, inthefirst

place,thatmodernunderwritersarenotassusceptibletofraudastheireighteenth-century

counterpartsandfurther,thatthispromptsreconsiderationofthecentralityofdeterrenceas

apolicyconsideration.

III. TheVulnerabilityofModernUnderwriters?Oneofthetraditionalhallmarksoftheinsurancerelationshipistheexistenceofinformation

asymmetriesbetweenassuredandunderwriter.Theseasymmetriesareparticularlycritical

pre-contractuallyandattheclaimsstage.This isbecausethekeyunderwritingdecisions–

whether to accept the risk and on what terms – depend on access to information. This

information isgenerallyheldby theprospectiveassured.AsLordMansfieldmadeclear in

CartervBoehm,thelawdevelopedobligationsofdisclosuresothattheinsurercouldassess

theriskproperly,

The special facts, uponwhich the contingent chance is to be computed, liemost

commonly in the knowledge of the insured only; the underwriter trusts to his

230CivilProcedureRulesr.44.16.231 Jackson Report (n227) ch.19 [4.5], [4.8]; M Porter-Bryant, ‘Fundamental dishonesty’ available at:http://www.guildhallchambers.co.uk/uploadedFiles/FundamentalDisMPB.pdf(accessed30/07/16)1.Seealso,AHiggins,‘Adefenceofqualifiedonewaycostsshifting’[2013]CivJQ198,203:“Thesearesensiblelimitationsononewaycostshifting,andwillgoalongwaytopreventinganyincreaseinhopelessorfraudulentclaims.”232Goriely(n217).

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representation, and proceeds upon confidence that he does not keep back any

circumstanceinhisknowledge…Thekeepingbacksuchcircumstanceisafraud,and

thereforethepolicyisvoid.Althoughthesuppressionshouldhappenthroughmistake,

withoutanyfraudulentintention;yetstilltheunder-writerisdeceived,andthepolicy

is void; because the risque run is really different from the risque understood and

intendedtoberun,atthetimeoftheagreement.233

Thiswas indisputable at the time theMarine Insurance Actwas drafted.234 Underwriters

wouldhavefounditverydifficulttoassesstheaccuracyofpre-contractualrepresentations

withoutinformation-forcingobligationsimposedonassureds.Thedevelopmentofrulesto

protecttheunderwriteratthatstagewaswhollyreasonable.235

Informationasymmetriesintheclaimsstagealsowarrantedrulestoprotecttheunderwriter

followingaloss.InBritton,WillesJcommentedthattheassuredhadliedto“puttheoffice

offitsguard,andintheresulttorecovermorethanheisentitledto”.236Hecontinued,“itis

of the utmost moment that insurances should be enforced fairly and protected from

fraud.”237Thecontemporarystateofscientificandinvestigativemethods238wouldhavemade

itproblematicfortheunderwritertoobtainindependentinformationaboutthelossand,in

any event, the marine context of the loss would have made information asymmetries

particularlyacute.239

Theserules,inLordMansfield’swords,designed“topreventfraudandtoencouragegood

faith”240,weresecuredwithharshsanctions.The1906Actprescribedavoidanceabinitioas

theremedyfornon-disclosure241andtheprevalentuseofbasisclausestransformedallpre-

233CartervBoehm(1766)97EngRep1162,1164perLordMansfield.234JLowry,PRawlingsandRMerkin,InsuranceLawDoctrinesandPrinciples(3rded.Hart2011)84:“Duties…havetheiroriginsinatimewhentherewasaclearlackofsymmetryintheinformationavailabletotheinsuredandtotheinsurer.”235MClarke,PoliciesandPerceptionsofInsurance(ClarendonLaw,1997),83;LawCom353(n197),[5.2].236Britton(n192)909perWillesJ.237Ibid911perWillesJ.238RClift,‘Fraud:Doesthepunishmentfitthecrime?’,InternationalMarineClaimsConference(24October2007),11.239BConway,MaritimeFraud,(LLP,1990)19,73;Versloot(SupremeCourt)(n160)[55]perLordHughes:insuredloss“mayoccuranywhereintheworldandwithorwithoutwitnesses.”240Carter(n233)1165perLordMansfield.241MarineInsuranceAct1906s.18.

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contractual statements into warranties, breach of which automatically discharged the

underwriter’s liability.242 At the claims stage, the 1906Act contained provisions onwilful

misconduct243 and the forfeiture rule had been in use for 50 years by the time of

codification.244

Similararguments,connectedtoideasofgoodfaith,areevidentinmoderncaselaw,

Idonotseewhythedutyofgoodfaithonthepartoftheassuredshouldexpirewhen

thecontacthasbeenmade.Thereasonsforrequiringgoodfaithcontinuetoexist.Just

asthenatureoftheriskwillusuallybewithinthepeculiarknowledgeoftheinsured,

sowillthecircumstancesofthecasualty:itwillrarelybewithintheknowledgeofthe

insurancecompany.Ithinkthattheinsurancecompanyshouldbeabletotrustthe

assuredtoputforwardaclaimingoodfaith.245

InVersloot,LordHughescommented,

Atthelaterstagewhentheclaimismade,thepolicyholderwillalsotypicallyknowa

gooddealmoreaboutthefactswhichgiverisetotheclaimthantheinsurerspossibly

can…Insuredlossisgenerallyadventitious.246

Despitetheserecentreferencestoideasofprotection,moderncaselawhasrestrictedthe

scopeofthepost-contractualdutyofgoodfaith.Theassuredisnotrequiredtodiscloseall

material matters during claims but is subject to a lesser duty to refrain from

misrepresentations.247MacDonaldEggersandFosshave suggested that this is thecorrect

approachduetotheadversarialnatureoftheclaimsprocess.248Itisalsodoubtfulwhether

arguments relating to protection are today as persuasive as theywere in the nineteenth

242MClarke,LawofInsuranceContracts(4thed.ServiceIssue351April2016),[20-2A1](hereafterreferredtoasClarke(looseleaf)),butnowseeInsuranceAct2015s.9(2).243MarineInsuranceAct1906s.55.244Britton(n192).245OrakpovBarclaysInsuranceServices[1999]Lloyd’sRep.LR443,451perHoffmannLJ.246Versloot(SupremeCourt)(n160)[55]perLordHughes.247ManifestShippingCoLtdvUni-PolarisCoLtd(TheStarSea)[2003]1AC469,[102],[111]perLordScott.Seeearlierdiscussion,ChapterTwo,texttofn104etseq.248PMacDonaldEggersandPFoss,GoodFaithandInsuranceContracts(LLP,1998),[11.173],[11.175].

139

century. The insurer is no longer an individualwaiting for news in a coffee house,249 but

commonly a large and sophisticated organisation which attracts custom because of its

expertiseinriskandclaimssettlement.250Inamodernageofinformationtechnology,251not

onlyhave“themeansofcollating,collecting,andrecallinginformation…improvedgreatly”,252

but insurers have dedicated anti-fraud teams comprised of forensic investigators, loss

adjustersandotherspecialists.253Theseareall tools towhich theearly twentiethcentury

underwriterdidnothaveaccess. It isnowdistinctlypossible that insurers coulddespatch

investigatorstothesceneofacasualtyinrealtimetodeterminewhetherthelossiscovered

andtoassessthecredibilityoftheassured’saccount.254Indeed,Soyerhassuggestedthatthe

sizeofmarineclaimswouldtendtojustifytheexpenseofspecialistinvestigation.255Provided

theinsurerhas“hasequalaccesstowitnesses,technicalreportsandthelike”,256heshould

bewellplacedtoinvestigatethelosswithoutrelyingonhisassured.Thissamelogicenabled

theCourtofAppealinOrakpotodeterminethatexaggerationwasnotnecessarilyfraudulent

butabargainingpositiontakenbytheassured.257

Itisdoubtful,therefore,thatthemodernunderwriterrequiresthesameprotectionastheir

earliercounterparts.Indeed,thenotionofunderwriterprotectionwasanimportanttheme

intheVersloot litigation.TheSupremeCourtrejectedthesuggestionthattheunderwriter

shouldbeprotectedfromlieswhichwouldcauseittobe“putoffrelevantinquiriesor…driven

249JHerschaft,‘Notyouraveragecoffeeshop:Lloyd’sofLondon–Atwenty-first-centuryprimeronthehistory,structure,andfutureofthebackboneofmarineinsurance’[2004-2005]29(2)Tul.Mar.LJ169,171byvirtueofLloyd’snetworkofcorrespondentslocatedinportsacrosstheglobe.250Versloot(SupremeCourt)(n160)[55]perLordHughes.251SeeJFeinman,DelayDenyDefend(Penguin,2010),121wherehecomparesthemodernandeighteenthcenturyunderwriter;“Lloyd,anticipatingStarbuck’sprovisionoffreeWi-Fibymorethantwocenturies,madeavailablepaper,pens,andshippingnewstohiscustomers.”252Clarke,PoliciesandPerceptions(n235),89.SeealsoLawCom353(n197)[5.3].253 Similar arguments have beenmade in the US context, see E Anderson, R Tuttle and S Crego, ‘Draconianforfeituresofinsurance:Commonplace,indefensible,andunnecessary’(1996)65(3)FordLR825,842:“Thenotionthat insurance companies need special assistance with respect to claims investigation is specious. Insurancecompaniestouttheirspecialexpertiseinclaimshandlingandlossinvestigation.Nearlyeveryinsurancecompanyhasaspecialunittoferretoutfalseclaimsandtheinsuranceindustryhasaplethoraofindustry-wideorganizationstocombatinsurancefraud.”254Cf.Versloot(SupremeCourt)(n160)[55]perLordHughes:“Onlysometimeswillthoroughinvestigationofthecircumstancesoftheclaimedlossbearealisticoptionforinsurers.”255BSoyer,MarineInsuranceFraud(InformaLaw,2014)[3-46].256DaveyandRichards(n158)318.257Orakpo(n245)451perHoffmannLJ.

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toirrelevantones.”258Thiswassimplybecause“wastedeffortofthiskindisnopartofthe

mischiefagainstwhichthefraudulentclaimsruleisdirected,andevenifitweretheavoidance

oftheclaimwouldbeawhollydisproportionateresponse.”259Thiscanbereadilyunderstood;

afterall,theunderwriterwillneedtoinvestigateforthepurposesofdeterminingvalidityand

quantum,whetherornottheclaimsubsequentlyturnsouttobefraudulent.260Accordingly,

thediscussionofunderwriterprotectioninVerslootwasmorenuanced;deterrentsanctions

remainimportantbecauseoftheinformationasymmetriesinherentintheclaimsprocess261

buttherearelimitstotheprotectionthelawiswillingtooffer.AsLordSumptionnoted,

Itisthereforerighttoaskinacaseofcollateralliesutteredinsupportofavalidclaim,

againstwhatshouldtheunderwriterbeprotectedbytheapplicationofthefraudulent

claimsrule?Itwould,asitseemstome,serveonlytoprotecthimfromtheobligation

topay,ortopayearlier,anindemnityforwhichhehasbeenliableinlaweversince

thelosswassuffered.262

Thedecision inVersloot limitedtheprotectionavailabletounderwritersduringtheclaims

process; the law will only offer protection against (presumably) non-collateral lies,263

exaggerationsandwhollyfraudulentclaims.Thisisanimportantlimitontheforfeiturerule

and provides some support for the argument that ideas of protection are no longer so

compellinginthemodernera.

Frauddeterrenceisnotonlyrelevantatclaimsbutalsoattheunderwritingstage;astheysay,

‘preventionisbetterthancure’.Inrecentyears,theindustryhasmadeconcertedeffortsto

facilitateinformationsharingbetweenunderwritersthroughthecreationofdatabases,such

258VerslootDredgingBVvHDI-GerlingIndustrieVersicherungAG(TheDCMerwestone) [2014]EWCACiv1349;[2015] 1 Lloyd’s Rep 32, [132] per Christopher Clarke LJ (hereafter referred to asVersloot (Court of Appeal));Versloot(SupremeCourt)(n160)[26]perLordSumption.259Versloot(SupremeCourt)(n160)[26]perLordSumption.260 LawCommission353 (n197) [22.29]: “Someargued that investigationof claims shouldbe consideredaninherentcostoftheinsurer’sbusiness.”;Versloot(SupremeCourthearing)(n159)2h02perRichardLordQCavailable at: https://www.supremecourt.uk/watch/uksc-2014-0252/160316-am.html (accessed 31/07/16);MacDonaldEggersandFoss(n248),[11.173];Clare(n198)270perGoddardJ.261Versloot(SupremeCourt)(n160)[26]perLordSumption,[114]perLordMance.262Ibid[26]perLordSumption.263Theprecisedefinitionandapplicationofthe‘collaterallie’remainsamatterforfuturelitigation.

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astheClaimsandUnderwritingExchange(CUE)264andtheInsuranceFraudRegister.265This

enablesunderwriterstodeclinecover,orelsechargeaveryhighpremium,tothosewitha

historyoffraud.Clarkehaspoeticallyreferredtotheforfeitureruleasoperating“oncethe

horsehasbolted.”266Theuseofdatabasesmeansthat“moreattentionisnowbeingpaidto

information at an earlier stage, in particular information about the ‘stable’. The key to

underwritingprofitability,whetheritbeprivateorcommercial,isoftenthemoralandother

standardsoftheinsured.”267TheexistenceofthesedatabasesisthemeansbywhichLord

Hughes’ prediction that fraudulent assuredswill struggle to obtain cover in the future268

becomes a reality. Fraud prevention does not just rely on underwriters identifying fraud-

proneassuredsattheoutset,butalsoineducatingassuredsastotheappropriatebehaviour

duringclaims.269

Itisinterestingthatthejudicialdiscussionsofinsurancefraudhavecontinuedtofocusonthe

horse; thecourtsdonotaccordanyroleto insurers toprevent fraudpre-contractually. In

someways,thisisnotsurprising;thecourtscanonlyrespondtothecasebeforethemand

havenoauthoritytodirecttheactionsofinsurancecompanies,ortheindustrymorebroadly.

However,inotherareasofthelaw,thecourtshavenothesitatedtoallocatepre-contractual

responsibilityforfraudpreventiontotheparties.Inthecontextofdocumentarycredits,to

be discussed in detail later,270 the courts have assumed that traders take sufficient

preventativemeasuresbeforecontracting.271Thisdivergenceisparticularlyinterestingifwe

consider that entities within the insurance industry, such as the ABI, Lloyd’s and the

InternationalGroupofProtection&IndemnityClubs,willtypicallybeinabetterpositionand

havegreaterresourcestotakethesestepsincomparisontothebuyerinaninternationalsale.

Thisservestocementthecharacterisationofinsurersasneedingjudicialprotectionwhich,

forthereasonsoutlinedabove,islessconvincinginthemodernera.

264MClarke,PoliciesandPerceptionsofInsuranceLawintheTwenty-firstCentury(OUP,2005)212.265 Insurance Fraud Bureau, ‘About the IFR’ available at: http://www.theifr.org.uk/en/about/ (accessed29/07/2016).266Clarke,PoliciesandPerceptions(n235)179.267Ibid179.268Versloot(SupremeCourt)(n160)[98]perLordHughes.269 W Lesch and J Brinkmann, ‘Consumer insurance fraud/abuse as co-creation and co-responsibility: A newparadigm’(2011)103(1)JofBusEthics17,18.270Seelater,ChapterFour.271Forexample,SandersvMaclean(1883)11QBD327,343perBowenLJ.Seelaterdiscussion,ChapterFour.

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Interestingly, the LawCommission recognised themodernisation of underwriters and the

changingnatureoftheinsuranceindustryinrespectoftheassured’spre-contractualdutyof

disclosure.TheCommissionnotedthat,

The 1906 Act codifies principles developed in the eighteenth and nineteenth

centuries,whencommunicationswereslowandaccesstoinformationwasdifficult.It

wasdraftedontheprinciplethattheproposerknowseverythingabouttheriskand

theunderwriterknowsnothing.Itthereforesoughttoprotectinsurers. 272

Underthe1906Act,theunderwriterwasentitledtotheremedyofavoidanceabinitioifthe

assuredfailedtomakeafulldisclosure.TheLawCommissionconsideredthatthiswenttoo

far,

[it]over-protectstheinsureragainstthelossitmighthavesufferedhadtheclaimbeen

paid,andprovidesnoincentiveforinsurerstoaskappropriatequestions.Evenwhere

avoidance isnotactually invoked, the threatof itputs the insurer inaverystrong

positiontonegotiatealowsettlement.273

The InsuranceAct 2015 reflects the contemporary insurancemarketwith respect to pre-

contractual duties of disclosure. The underwriter is given a more proactive role during

negotiationsandthenewremediescorrespondtotheimpactofbreach.274Itisnotablethen

thatthesesameideaswerenotdeemedrelevantinthecontextoffraudulentclaims.Indeed,

theLawCommissionpreferredtocharacterisetheforfeitureruleas“appropriate”.275

Thereisnodoubtthattechnologicalandinvestigativedevelopmentshavereducedinsurers’

vulnerabilitytofraudatboththeunderwritingandclaimsstages.Whileitisnotsuggested

that rules against fraud are unnecessary, these developments undermine the continued

272LawCom353(n197)[5.2].273Ibid[5.42].274InsuranceAct2015sched1,part1,ss.2,4,5.275LawCom353(n197)[20.6].

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characterisationoftheinsurerasvulnerableandinneedofjudicialprotection.Theargument

developedinthissection–thatweshouldre-examinethisrationaleofforfeiture–isfurther

supportedbythemorenuanceddiscussionofunderwriterprotectioninVersloot.Proceeding

onthebasisthattherequirementforprotection isno longerascompellingtoday,wecan

assesstheoverridingsignificanceofdeterrenceintheconstructionoffraudremedies.Tothis

end,thefinalargumentinthischapterexaminestheapproachtoinsurancefraudinAustralia

andrelatedareasofEnglishlawtosuggestthatitispossibletodeveloparemedialframework

whichbalancesthedeterrenceoffraudandproportionality.

IV. AProportionateApproachtoDeterrenceThe insurance courts have traditionally focussed on deterrence in the construction of

remedies for fraud.The recentdecision inVersloot, by contrast,highlighted theopposing

considerationofproportionality.276Thereis insufficientspaceinthisthesistoconsiderthe

philosophical arguments in favour of proportionate sanctions or to make explicit

recommendationsforaproportionateframeworkinEnglishlaw.277Accordingly,thispartof

thechapterattemptsamoremanageabletask;namely,toidentifyapproachesincomparable

jurisdictions and areas of law where considerations of proportionality have enabled the

constructionofanuancedresponsetofraudwithoutcompromisingfrauddeterrence.

Itisimportanttoprefacethisdiscussionbyaddressingthesuggestionthatconsiderationsof

proportionalityarenotappropriateintheconstructionofrulesagainstfraud.Intheeconomic

literature,forexample,Posnerhasarguedthatissuesoffairnessshouldbeirrelevantinthe

criminallaw.278Hehasarguedthatparticipationin“thecriminaljusticesystemisvoluntary:

youkeepoutofitbynotcommittingcrimes.”279ChristopherClarkeLJ’sargumentinVersloot

aboutthescopeoftheforfeiturerulehasechoesofthisrationale.Henotedthat“theruleis

276Versloot(SupremeCourt)(n160)[36]perLordSumption.277Readersaredirectedtothefollowingforaconsiderationofthisarea:JAndenaes,‘Themoralityofdeterrence’(1970)37(4)UChicagoLRev649;KCarlsmith,JDarleyandPRobinson,‘Whydowepunish?Deterrenceandjustdesertsasmotives forpunishment’ (2002)83(2) JofPersonality&SocialPsychology284;PRobinson, ‘Hybridprinciplesforthedistributionofcriminalsanctions(1987-1988)82NwULRev19;LWeinreb,‘Desert,punishment,andcriminalresponsibility’(1986)49Law&Contemp.Problems47;FZimring,‘Principlesofsentencing,plainandfancy’(1988)82(1)NwULRev73.278SeealsoKaplowandShavell,FairnessVersusWelfare(n34)352.279Posner,‘Aneconomictheory’(n36)1213.

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only applicable in the case of fraud, fromwhich no insured should have any difficulty in

abstaining.”280Thereis,however,evidenceofthesevaluesbeginningtopermeateotherareas

ofprivatelaw.TheSupremeCourthasrecognisedproportionalityasrelevanttothelawon

contractualpenalties281andasimilarargumenthasbeenmadeintheAmericancontext.282

Thesimilaritybetweenforfeitureandpenaltyclausesisthattheyarenotordinarycontractual

terms,but rathercontainadisciplinaryelement. Assuch, theseclauses“implicatevalues

otherthaneconomicefficiencyandtheparties’autonomy”283andjustifyconsiderationofthe

broaderpublicinterest.Assuch,thecallforproportionalityininsurancefraudistimelyand

wouldalsocorrespondwiththeintroductionoflikeremedieselsewhereininsurancecontract

law.284

In the context of legal sanctions, proportionality implies some relationship between

wrongdoing and punishment.285 It is not enough to speak of proportionality in abstract

terms286andwemust,therefore,considerwhetheragivenpunishmentcorrespondstothe

crime inany real sense.287As LaceyandPicardhave suggested, thepractical reflectionof

proportionalitycanonlydependon“fairandappropriatepenaltieswhicharemeaningfulto,

andregardedaslegitimateby,thepopulaceinwhosenametheyareimposed.”288Thisappeal

forproportionalitythusdependsontwofactors;i)anacceptancebythecourtsorlegislature

that some relationship between fraud and sanction is appropriate and ii) a substantive

discussionaboutwhatthiswouldmeaninpractice.Thisisevidentlynoeasytask.289Inthis

regard, the English insurance courts could draw inspiration frommorenuanced statutory

responses to fraud, namely the Australian approach to insurance fraud and the English

attitudetowardspersonalinjuryfraud(A).TheEnglishcriminalresponsetoinsurancefraud

280Versloot(CourtofAppeal)(n258)[155]perChristopherClarkeLJ.281CavendishSquareHoldingsBVvTalalElMakdessi;ParkingEyeLimitedvBeavis[2015]UKSC67,[32]perLordNeubergerandLordSumption.282SShiffrin,‘Remedialclauses:Theoverprivatizationofprivatelaw’(2015-2016)67HastingsLJ407,423.283Ibid413.284InsuranceAct2015sched.1.285NLacey,‘Themetaphorofproportionality’[2016]43(1)JLaw&Soc27,30.286Ibid28,41.287NLaceyandHPicard,‘Thechimeraofproportionality:Institutionalisinglimitsonpunishmentincontemporarysocialandpoliticalsystems’(2015)78MLR216,219.288Ibid219.289KaplowandShavell,FairnessVersusWelfare(n34)306-308wheretheauthorsnotethatthereis“nonaturalmetricfortranslatingthewrongintopunishment”andthatquestionsofproportionalityreceivedifferentanswersbetweensocietiesandovertime.

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providesafurthermodelforreconcilingdeterrenceandproportionality(B).Afinalargument,

inPartC,suggeststhatnuancedsanctionsarealsorequiredforeconomicreasons.

A. Balancingdeterrenceandproportionalityinstatute:TheAustralianInsuranceContractsAct1984andtheEnglishCriminalJusticeandCourtsAct2015

Thefirstexamplesofaproportionateapproachtofraudarestatutoryinnature;involvinga

default remedy enshrined in legislation coupledwith a judicial discretion tomitigate the

harshnessoftheremedyinappropriatecases.Thediscussioncommencesbyconsideringthe

Australianresponsetoinsurancefraud.

i. TheAustralianInsuranceContractsAct1984

TheAustralianInsuranceContractsAct(ICA)1984establishesaproportionateframeworkto

dealwithfraudulentclaimsinalllines,excludingmarine.290Forfeitureremainstheprimary

sanctionforfraud291buttheActprovidesthefollowingjudicialdiscretion;

Inanyproceedings in relation to sucha claim, thecourtmay, ifonlyaminimalor

insignificantpartoftheclaimismadefraudulentlyandnon-paymentoftheremainder

oftheclaimwouldbeharshandunfair,orderthe insurertopay, inrelationtothe

claim,suchamount(ifany)asisjustandequitableinthecircumstances.292

Thisrequirescourtstobalancefrauddeterrence,explicitlylistedasarelevantpolicyfactorin

s.56,293andtheimpactofforfeiturefortheassured.TheAustralianLawReformCommission

(ALRC)recognisedtheimportanceofdeterrencebutdeterminedthatitdidnotrequirethe

“insuredtosufferlossfarinexcessofthedamagehisfraudhascausedtotheinsurer.”294The

legislationwasexplicitlydesignedto“strikeafairbalancebetweentheinterestsoftheinsurer

andtheinsured.”295

290InsuranceContractsAct1984s.9(1)(d).291InsuranceContractsAct1984s.56(1).292InsuranceContractsAct1984s.56(2).293InsuranceContractsAct1984s.56(3).294AssistantTreasurer (Australia), ‘InsuranceContractsBill1984ExplanatoryMemorandum’ (13161/84,1983 -1984),[187](hereafterreferredtoas‘InsuranceContractsBill’).295Ibid[187].

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IftheAustralianexperienceistoprovideameaningfulexampleforEnglishlaw,weneedto

considerhowthisdiscretionoperatesinpractice.Themeaningof‘minimalorinsignificant’

wasnotimmediatelyobvioustothosedraftingthelegislationnorthecourtscalleduponto

apply it. The ALRC contended in consultation that the discretion envisaged a $200

exaggerationinaclaimworth$3000.296BythetimethattheBillreachedthelegislature,the

Explanatory Memorandum had “downplayed”297 the extent of permissible exaggeration,

suggestinginsteadthatanexaggerationof$50ina$100,000claimwouldbeallowed.298The

caselawdemonstratesthatthejudicialapproachhasalsobecomelesslenientovertime.The

firstreportedcasetoexercisethediscretionwasEntwellsvNational&GeneralInsurance.299

Therethecourtrecognisedanexaggerationof$27,000as‘relativelysmall’inthecontextof

aclaimworth$520,000.300Thisdecisionhasnotbeenwellreceivedbycommentators.301The

QueenslandCourt ofAppeal took amuch firmer approach inRicciardi v SunwayMetcorp

Insurance,recognisingthatanexaggerationof$10,000couldneverberegardedas‘minimal

or insignificant’, nomatter the size of the claim.302 This approach is to bepreferred as it

reflectsthenecessarybalancebetweendeterrenceandtheinterestsoftheassured.

Thestatutorydiscretionisnotaswell-suitedtodealingwithfraudulentdevicesorcollateral

lies.Thisisbecauses.56explicitlyreferstofraudaffectingaminorpartoftheclaimrather

thanfalsitywhichgoestotherootoftheentireclaim.303Theissuedidnotarisefordecision

296AustralianLawReformCommission,InsuranceContracts(ALRC20,1982),[243].297MKirby,‘Australianinsurancecontractlaw:Outofthechaos–Amodern,justandproportionatereformingstatute’,SpeechatAustralianInsuranceLawAssociationNationalConference2010(28October2010)availableat:http://www.michaelkirby.com.au/images/stories/speeches/2000s/2010_Speeches/2499-SPEECH-HUGH-ROWELL-LECTURE-OCTOBER-2010.pdf(accessed24/08/2016),(fn44inoriginal).298InsuranceContractsBill(n294)[187].299EntwellsPtyLtdvNationalandGeneralInsuranceCoLtd(1991)6WAR68.300Ibid.301GSwaby,‘Thepriceofalie:Discretionaryflexibilityininsurancefraud’[213]JBL77,98;RMerkin,‘Reforminginsurancelaw:Isthereacaseforreversetransportation?’(ReportfortheEnglishandScottishLawCommissions,2006) available at: http://www.lawcom.gov.uk/wp-content/uploads/2015/03/ICL_Merkin_report.pdf (accessed24/08/2016),[6.11].302RicciardivSuncorpMetwayInsurance[2001]QCA190,[36]–[37]perChestermanJ.303TiepThiThovAustralianAssociatedMotorInsurersLtd[2001]VSCA48,[25]perBuchananJ.Thedecisioninthiscasedivergedfromthepositionwhichhadexistedatcommonlawpriortothe1984Act.InGREInsurancevOrmsby(1982)29SASR498,theassuredsufferedaburglaryandincreasedthedamagetothedoorthroughwhichthethieveshadgainedaccess.At502-503perMitchellJ,thecourtheldthattheassuredwasentitledtorecoveronthebasisthatavalidclaimwouldnotberegardedasfraudulentevenif“itwereprovedthattherewasanattempttosupportthevalidclaimbyevidencewhichwasintentionallyfalse.”

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underthe1984ActuntilthecaseofThovAustralianAssociatedMotorInsurers304in2001.In

Tho,theassured’ssonhadtakentheinsuredcarwithoutconsentandcrashedit.Theassured,

unawarethatthepolicycoveredthesecircumstances,concoctedastorythatthevehiclehad

beenstolenandsubsequentlydamagedbythethief.Withoutthelie,theunderwriterwould

havebeenliableforthelossandthequestionforthecourt,therefore,waswhetherthisfalsity

waswithinthestatutorydiscretion.Thecourtheldthatthemeaningoffraud“encompasses

aliewhichcouldnotprejudicetheinsurerevenifitwerebelievedaswellasaliewhichdoes

notprejudicetheinsurerbecausetheinsurerisnotdeceived.”305Theassured’sattemptto

bringtheliewithinthediscretionins.56wasrejectedbythecourtinthefollowingterms,

“where, as here, the fraud relates to the entire sum or benefit claimed, the division

contemplatedbythesubsectioncannotbeachieved.”306Theassuredforfeitedtheentiretyof

herclaim.

Althoughthestatutorydiscretionwillnotoperateinthecaseofacollaterallie,itdoesappear

tobeworkingwellinrelationtoexaggeratedclaims.Recentamendmentstothe1984Actdid

notmakeanychangestotheframeworkforfraud307andMichaelKirbyhasremarkedthat,

mostAustralianlawyers,expertinthisfield,wouldnotnowwanttogobacktotheold

absolutelaw.AndtheAustralianinsuranceindustryappearstobeofthesameview,

takingintoaccounttheactualoperationoftheproportionateoperationoftheICAin

practice.308

The Australian approach to insurance fraud differs from the English model in both its

treatment of exaggerated and collateral lie claims. The more balanced approach to

exaggerationcouldserveasusefulguidanceshouldtheEnglishcourtswishtodevelopamore

304Tho(n303).305Ibid286perBuchananJA.ThisdefinitionwasrecentlyconfirmedinSgrovAustralianAssociatedMotorInsurers[2015]NSWCA262,[46]perBeazleyP.306Tho(n303)287perBuchananJ.307InsuranceContractsAmendmentAct2013.Seegenerally,AustralianLawReformCommission,ReviewoftheMarineInsuranceAct1909(ALRC91,2001)availableathttp://www.alrc.gov.au/inquiries/marine-insurance-act-1909(accessed27/09/2017).308 TheHonMKirby, ‘Insurance contract law reform—30yearson’ (2014) 26 ILJ 1, 17. This suggests that theconcerns of “serious conceptual and practical difficultieswith this provision” expressed in JA Tarr, ‘Dishonestinsuranceclaims’(1988)1InsLJ42,52areoverrated.

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nuancedresponsetoclaimsfraudinthefuture.309Thiswould,asGeraldSwabyhasopined,

meetthe“needforthecourtstohavesomeequitablediscretioninborderlinecases.”310In

searching for analogues for the future development of English insurance law,we are not

limitedtocomparablejurisdictions.Indeed,theprevalenceofpersonalinjuryclaimsfraud311

meansthatwecanlegitimatelyconsiderhowtheEnglishcourtshaverespondedtofraudin

thiscontext.

ii. TheEnglishCriminalJusticeandCourtsAct2015

Fraudulentpersonalinjuryclaimsariseforsimilarreasonsasopportunisticinsurancefraud;

informationasymmetrieswhichexistbetweenvictimanddefendant312andadditionally,the

subjectivenatureofpainandsuffering.313Interestingly,however,amorenuancedremedial

response topersonal injuryclaims fraudhasbeendeveloped in contrast to the rigidityof

forfeiture in first-party insurance claims. In addition to providing a further example of a

proportionate approach to deterrence, the argument made here is that there is not a

compellingreasontotreatthesetwoareasasdistinct.

ThelawapplicabletopersonalinjuryfraudiscontainedintheCriminalJusticeandCourtsAct

2015(CJCA).Thedefaultremedyforthe“fundamentallydishonest”314litigantisthedismissal

of theentireclaim, includinganygenuinepart.315This is theproceduralequivalentof the

forfeiturerule.However,theActalsocreatesajudicialdiscretionexercisableincaseswhere

309LawCom353(n197)[23.7]notingtheexistenceofthestatutorydiscretion inAustraliabutchoosingnottorecommenditonthebasisthatitcouldsignalalenientattitudetofraud.310Swaby(n301)78.311FaircloughHomesvSummers[2012]UKSC26,[32]perLordClarke;Ul-haqvShah[2010]1WLR616,[51]perToulsonLJ;AZuckerman,‘Mustafraudulentlitigantbeallowedtothink:ifthefraudissuccessful,Iwillgainmuch;ifitisnot,Iwillstillrecovermylegitimateclaim?’(2011)30(1)CJQ1,1.312WNorrisQC,‘Lookout:I’vegotapower…butIamnotgoingtouseit’(2012)3JPILaw169,171.313REricsonandADoyle,‘Themoralrisksofprivatejustice:Thecaseofinsurancefraud’inREricsonandADoyle,RiskandMorality(UniversityofTorontoPress,2003),336.314CriminalJusticeandCourtsAct2015s.57(2).Themeaningof‘fundamentallydishonest’isamatterforthecourts.Inanunreportedcase,HanifvPatel[2016](CountyCourt(Manchester)11May2016),HHJMainQCdismissedtheclaim in its entirety, satisfied that the claimanthadbeen fundamentally dishonest. As the judgmentwasnotreporteditisimpossibletoknowhowthejudgedefinedthisstandard.Infuture,itislikelythatcourtswillhaveregardtotherelatedlitigationconcerning‘QualifiedOne-wayCostsShifting’(QOCS),seeearlierdiscussion,wherecourtsbeguntodefinethisnotionundertheCivilProcedureRules.Seegenerally,BDixon,‘FundamentaldishonestyandtheCriminalJusticeandCourtsAct2015’(2015)2JPILaw108.315CriminalJusticeandCourtsAct2015s.57(2)(3).

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theclaimantwouldsuffer“substantialinjusticeiftheclaimwasdismissed.”316Thispreserves

the possibility that the fraudulent claimant will receive a measure of damages,

notwithstandinghisfraudulentexaggeration.Importantly,andcontrarytoforfeiture,317the

framework established by the CJCA covers the entirety of proceedings; the prospect of

dismissaldoesnotceasewhenthewritisissued.318

ThetriggerforlegislationwastheSupremeCourtdecisioninSummersvFaircloughHomes.319

Followinganaccidentatwork,Summersclaimed£880,000indamagesbutitlatertranspired

thathehadexaggeratedtheextentofhisinjuriestoaveryconsiderableextent.320Whenthe

fraudwasdiscovered, theunderwriterapplied tohavetheclaimstruckout.TheSupreme

Courtheldthatwhilestrikeoutwaspossible,itwouldonlybesuitablein“veryexceptional

circumstances”321 and when it constituted a “just and proportionate”322 response to the

fraud. The Court did not provide any concrete examples in which strike out would be

proportionate.323 Lord Clarke speculated, however, that dismissal might be appropriate

where the litiganthadengaged in “amassiveattempt todeceive thecourt”324where the

actuallosswas“verysmall”.325Summers’sizeableexaggeration–some90%ofthetotalclaim

–didnotmeetthistest326andhewasawardeddamagesof£88,000,toreflectthegravityof

hisactualinjuries.327Indeed,itisnotablethattheSupremeCourtdidnotregarddeterrence

as solely dependent on harsh legal sanctions and highlighted a multitude of procedural

316CriminalJusticeandCourtsAct2015s.57(2).317Seeearlier,ChapterTwo,texttofn381etseq.318CriminalJusticeandCourtsAct2015s.57(1).319Summers(n311).320Ibid[3].Thiswasaconsiderableexaggeration;thedamagesclaimwasintheregionof£838,000,hisactuallosswaslaterassessedtobeintheregionof£88,000.321Ibid[33]perLordClarke.322Ibid[61]perLordClarke.323Ibid[49]perLordClarke.StrikeouthassincebeenemployedinseveralcasesFarivHomesforHaringey(CountyCourt(CentralLondon)9October2012);ScullionvRoyalBankofScotland(CountyCourt(Exeter)24May2013)andPlanavFirstCapitalEast(CountyCourt(London)15August2013).324Summers(n311)[49]perLordClarke325Ibid[49]perLordClarke326ButseeNorris,‘Lookout’(n312)176:arguingthatitis“difficulttoimagineamoreclearcutcase”thatwouldfitLordClarke’shypotheticalsituationinwhichstrikeoutwouldbeappropriate.327Summers(n311)[63]perLordClarke.

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weapons which could contribute to deterrence,328 including adverse costs orders,329 a

reductionininterestorproceedingsincontempt.330

AlthoughtheCriminalJusticeandCourtsActmakesdismissalmorelikelyincomparisonto

thepositionpost-Summers,331 the legislationclearly continues thebalancebetween fraud

deterrenceandtheimpactontheindividual.Thisbalanceisinitiallyevidentinthejudicial

discretioncontainedins.57(2)whichentitlesthecourttoawarddamageseventhoughthe

claimanthasbehaved fraudulently. In addition, theoverriding characterof the legislation

doesnotappeartobepenal;theActrequirescriminalcourtstohaveregardtothefactof

dismissal when dealing with related proceedings in contempt or dishonesty.332 This was

explicitly incorporated to ensure that punishments were proportionate.333 This is a

commendable attempt to prevent double punishment and reflects the ideas of balance

inherentinthelegislation.Notably,asimilarcautionagainstdoublepunishmenthasnotbeen

soundedbytheinsurancecourtsnorintheInsuranceAct.

Afurtherdistinctionbetweenthepersonalinjuryandinsuranceresponsetofraudulentclaims

istemporal innature.Thethreatoftheforfeitureruleceaseswiththe issueofthewrit334

whereas the remedy of strike out is directed at dishonesty during litigation.335 This is

interesting.Ifthepersonalinjuryclaimantliesattrial,heisattemptingtodeceiveboththe

defendantandthecourt.Thisissurelyfarmoreseriousthantheliewhichonlydeceivesthe

underwriter, aswill be the casewhere the lie is toldbefore litigationbegins, andyet the

forfeitureruleprescribesamuchharsherremedythanthestatutoryresponseintheCJCA.

328Ibid[50]-[56],[61]perLordClarke.329JacksonvMinistryofDefence[2006]EWCACiv46,[16]perTuckeyLJ:“mustactasaconsiderabledisincentivetoclaimantsandtheiradvisersagainstmakingexaggeratedclaims.”330Summers(n311)[50]-[56],[61]perLordClarke.Incidentally,thesearethesametoolswhichLordsHughesandToulsonsuggestedcouldattachtofraudulentclaims,includingcollaterallies,inthefirst-partycontextinVersloot(SupremeCourt)(n160)[98][99]perLordHughes,[108]perLordToulson.Notethatproceedingsincontemptmustbeproportionate,seeRoyal&SunAllianceInsuranceCovFahad[2014]EWHC4480(QB),[25],[29]perSpencerJ.331CriminalLawandLegalPolicyUnit(MinistryofJustice),‘CriminalJusticeandCourtsAct2015Circular2015/01’(23 March 2015) available at:https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/428204/cjc-act-circular.pdf(accessed26/08/16)[175].332CriminalJusticeandCourtsAct2015s.57(7).333CriminalLawandLegalPolicyUnit(n331)[178].334TheStarSea(n247)[75]perLordHobhouse;AgapitosvAgnew(TheAegeon)[2003]QB556,[52]perManceLJ.335CriminalJusticeandCourtsAct2015s.57(9):“Thissectiondoesnotapplytoproceedingsstartedbytheissueofaclaimformbeforethedayonwhichthissectioncomesintoforce.”

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Thismeans that the relative severity of the remedies is counterintuitive since onewould

expectthelitigantwhothreatensjudicialintegritytobesanctionedmoreseverelythatthe

assuredwhomerelyattemptstodeceivehiscounterpart.

Thesedifferentapproachestofraudshouldpromptustoconsiderwhethertherearepolicy

considerationsmilitatinginfavourofdifferenttreatment.Thedifferencebetweentheseareas

istypicallyexplainedbythedirectrelationshipofgoodfaithinthefirst-partycontext.336While

there is no doubt that a requirement of good faith is not imposed in the personal injury

context,thisexplanationislessconvincingwhenoneconsidersthepracticalconsequencesof

personalinjuryfraud.AswasnotedinHaywardvZurich,“personalinjuryclaimsusuallyfall

tobemetbyinsurersandtheultimatecostisbornebyotherpolicyholdersthoughincreased

premiums.”337 The Law Commission noted the inconsistency created by the different

approachestofraudintheirfinalreport,

The reported decisions have shown no inclination to move away from the well-

establishedforfeitureruleand,althoughitisarguablyanomalous,wedonothavea

mandatetorecommendmoresubstantialchange.338

Instead of comprehensively engaging with the anomaly, the Law Commission simply

reiteratedtheabsenceofgoodfaithinthepersonalinjurycontextandsuggestedthatfirst-

partyinsurancewasparticularlyvulnerabletofraud.339Withrespect,moralhazardisasimilar

threat in the personal injury context and it is disappointing, therefore, that the Law

Commissionchosetosidesteptheissue.Intheauthor’sview,therequirementofgoodfaith

infirst-partyclaimscanonlypartiallyexplainthedifferenceinapproach.

Anotablethemeinthepersonalinjurydiscussionsistheimportanceofholdingthepartywho

hascauseddamagetothefraudstertoaccount.340InSummers,theSupremeCourtheldthat

336Summers(n311)[29]perLordClarke;Ul-haq(n311)[37]perToulsonLJ;LawCom353(n197)[21.19].337Hayward(n206)[51]perLordToulson.338LawCom353(n197)[21.20].339Ibid[21.21]-[21.22].340Summers(n311)[61]perLordClarke:“moreappropriatetopenalisesuchaclaimantasacontemnorthantorelievethedefendantofwhatthecourthasheldtobeasubstantiveliability.”

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itwas “moreappropriate topenalise sucha claimant as a contemnor than to relieve the

defendant of what the court has held to be a substantive liability.”341 By contrast, the

insurancecourtshavewhollydisregardedtheunderwriter’ssubstantiveliability.Thismakes

littlesensewhenwerecallthattheunderwriter’sobligationistoholdhisassuredharmless

againstcoveredperils.Liabilityisestablishedasfromthedateofloss342andisnotcontingent

onthebringingofanhonestclaim.343

Itisalsolikelythatthephysicalnatureofloss344hascontributedtothemorelenientapproach

inthepersonalinjurycases,thoughthisisnotexplicitlymentionedinthejudicialorlegislative

discussions.Inanyevent,theauthordoubtswhetherphysicalinjurycanadequatelyexplain

thedifferentapproachestofraudulentclaims inthesecontexts.Thenotionofholdingthe

breachingpartytoaccountissurprisinglyabsentintheinsurancedebatesand,aswasargued

above,thepresenceofgoodfaithisaninsufficientexplanationofthedivergencebetween

personalinjuryandinsurancelaw.ThediscretionintheCJCAencouragescourtstobalance

deterrenceandtherightsofthefraudulentlitigant.Asimilarbalancingexercisedoesnottake

placeinthepureinsurancecases,despiteSoyer’scontentiontothecontrary.345Instead,the

myopicfocusoftheinsurancecourtsondeterrencecausesimportantpublicvalues,suchas

proportionalityandfairness,tobeexcludedfromthedebate.

BoththeAustralianapproachtoinsurancefraudandthediscretioncontainedwithintheCJCA

enablethecourttorespondproportionatelytoexaggeratedclaims.Analternativemeansof

balancingfrauddeterrenceandproportionalityisevidentintheEnglishcriminallawresponse

to insurance fraud. This is an important comparison because the approach to sentencing

demonstratesameansofrespondingtoaspectrumofwrongdoing.

341Ibid[61]perLordClarke.342FirmaC-TradeSAvNewcastleProtectionandIndemnityAssociation(TheFanti)[1991]2AC1,35-36perLordGoff.343Versloot(SupremeCourt)(n160)[24]perLordSumption.344Ibid[63]perLordClarke.345Soyer,MarineInsuranceFraud(n255)[1.23]-[1.24].SeealsoDiggensvSunAlliance[1994]CLC1146,1165perEvansLJwhere it isnotedthat thecase lawhadnotdeterminedwhether theremedyshouldbe insomewayproportionatetothefraud.

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B. Balancingdeterrenceandproportionalityinmandatoryguidelines:Englishcriminallaw

InsurancefraudisacrimeundertheFraudAct2006.346Acomparisonwiththecriminallaw

approach to fraud iswarranted for two reasons. Firstly, theLawCommission justified the

atypicaldeterrentfunctionoftheforfeiturerulebyreferencetothehistoricallylowlikelihood

of criminal punishment.347 In addition, the insurance law narrative of sanctions is one of

severityandpunishmentand,assuch,resonateswiththepremiseofcriminallaw.

Insurancefraudstersaresentencedinthesamewayasotheroffendersbythecriminalcourts.

Sentencing isdesignedtofulfilanumberof functions includingpunishment,rehabilitation

and deterrence348 and is subject to the Sentencing Council Guidelines.349 A court must

determine the offender’s culpability and the harmfulness of the offence before taking

accountofaggravatingandmitigatingfactors.350Relevantconsiderationsincludetheactual

or intended financialharmandwhether theoffencewassophisticatedoropportunistic in

nature.351Notethatthevulnerabilityoftheunderwriter,asignificantconcerninthecivillaw

context, is irrelevant in the criminal setting. The Guidelines’ reference to vulnerability

contemplatesawhollydifferentcategoryofvictimswheretheirage,financialcircumstances

ormentalcapacityrenderthemparticularlysusceptibletodeception.352

TheGuidelinesenablethecourttorankeachoffenceonascaleofseverityand,unlikethe

forfeiturerule,respondtotheentirespectrumofwrongdoing.Thecorrespondingframework

ofsentencesislarge,comprising,atitsmostlenient,afinebasedontheoffender’sincome

and,atitsmostsevere,acustodialsentenceofsevenyears.353Theguidingprincipleoftotality

346FraudAct2006s.2.347LawCom353(n197)[19.3].348 Sentencing Council, ‘Sentencing basics’ available at: https://www.sentencingcouncil.org.uk/about-sentencing/sentencing-basics/(accessed22/08/16).349 Sentencing Council, Fraud, Bribery and Money Laundering Offences: Definitive Guideline (October 2014)available at: https://www.sentencingcouncil.org.uk/wp-content/uploads/Fraud_bribery_and_money_laundering_offences_-_Definitive_guideline.pdf (accessed22/08/2016).(Hereafterreferredtoas ‘SentencingGuidelines’)SeealsoLacey(n285)32whereshearguesthatproportionalityinthecriminallawisachievedthroughtheuseofsentencingguidelines.350SentencingCouncil,Fraud,BriberyandMoneyLaundering(n349)6-7,10.351Ibid6-7.352Ibid7.353Ibid10.

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instructsthecourttoconsiderwhetherthe“totalsentenceisjustandproportionatetothe

overalloffendingbehaviour.”354Onthisbasis, thecourtsentencingan insurancefraudster

wouldbe required toweigh the circumstancesof thewrongdoing and, inparticular, take

accountofthedegreeofplanningand intendedfinancialgain.Accordingly, theassured in

Tonkin,355whoexaggeratedhisclaimby0.3%,wouldreceiveadramaticallydifferentsentence

undertheFraudActthantheassuredinTheIkarianReefer,356whodeliberatelyscuttledhis

vessel.

The criminal response to fraud provides a practical example of how considerations of

deterrence and proportionality can be combined within a single framework. Notably,

considerations of fairness are not thought to detract from the preventive effect of the

criminallaw,asappearstobethebasisfortheinsurancecourts’resistancetoamorenuanced

approach in thecivil setting.Moreover, thecurrentabsenceofproportionality in thecivil

contextmeansthatforfeiturewillconstituteamuchgreatersanctionforlow-levelfraudsthan

theequivalentsentenceundertheFraudAct.Thisisconcerningsincethecivilcourtsdonot

extendtheevidentialandproceduralsafeguardstotheallegedfraudsterthathewouldenjoy

in criminal litigation.357 The final argument in favour of proportionality ismade from an

economicperspective;anuancedlegalresponseisrequiredtoreflectthedifferencesinfraud

offences.

C. TheeconomicargumentinfavourofproportionalityRational choice theory generally understands deterrence as being contingent on harsh

penalties.Thefirstargumentinthischaptersuggestedthefallacyofthiscontentionbasedon

moderndecision-makingtheory.Supposeforthemoment,however,thatdeterrencewasin

factcontingentonharshpenalties,itwouldnotautomaticallyfollowthatonesanctionwas

capableofdeterringa rangeof criminalor civiloffences.Fraudulent insuranceclaims, for

example, vary considerably and have been characterised in earlierwork as constituting a

354Ibid11.355TonkinvUKInsurance[2006]EWCA1120(TCC),[2007]Lloyd’sRepIR283.356NationalJusticeCompaniavPrudentialAssuranceCo(TheIkarianReefer)[1995]1Lloyd’sRep.455.357BroomevCassell [1972]AC1027,1127-1128discussed inClarke,Twenty-firstCentury (n264)276.Seealso,RawlingsandLowry,‘Insurancefraudandtheroleofthecivillaw”(n1)538.

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spectrum of wrongdoing.358 Although the Sentencing Council Guidelines make these

differencesrelevantincriminalsentencing;asitstands,theforfeitureruletreatsallfraudsin

thesameway.

An economic analysis suggests that these variations betweenoffences are important and

shouldmatterintheconstructionofcivilremedies.Tomakethisargument,itisnecessaryto

assumethatthecost-benefitanalysisofrationalchoicetheoryiscorrect.Accordingly,ifthe

costsofoffendingareheldconstant, there isaclear incentivefortheactortochoosethe

offencewhichoffershimthegreatestbenefits.359AsStiglerhasargued,“ifthethiefhashis

handcutofffortakingfivedollars,hehadjustaswelltake$5,000.”360Butthiscourseofaction

doesnotjustbenefittheactortoagreaterextent,ithasacorrespondinglyharmfulimpact

onsociety.Stiglerhasexpressedthisasan“increasingmarginaldisutilityofoffenses,soa

theftof$1000ismorethantwiceasharmfulasatheftof$500.”361Asinglepenaltytodeter

arangeofoffencesignorestheseconsequences.Theriskthenisthatasinglepenaltydeters

the least seriousoffencesbut creates additional incentives for the actor to commitmore

seriouscrimes.362 InStigler’sexample, theprospectof losingahanddetersthethief from

stealingasmallsumofmoneybutfailstodeterhimfromstealingalargersum.Bycontrast,

arangeofsanctionswhichcorrespondtotheseverityofdifferentoffencescreates,onan

economicanalysis,anadequatedeterrentforeachoffence.Thisisknownintheeconomic

literature as marginal deterrence.363 As Posner has suggested, “if it were not for

considerationsofmarginaldeterrence,moreseriouscrimesmightnotalwaysbepunishable

bymoreseverepenaltiesthanlessseriousones.”364Theforfeitureruletakesnoaccountof

theseconcerns.Thecriminalframework,outlinedabove,doesconformtotherequirements

ofmarginaldeterrenceandtherefore,onthisanalysis,wouldberegardedasamoreeffective

deterrent.

358KRichards, ‘Deterring insurance fraud:Acriticalandcriminologicalanalysisof theEnglishandScottishLawCommissions’currentproposalsforreform’(2013)24ILJ16,18-19.359Stigler(n30)57.360Ibid57.361Ibid58.362SeetheexampleofbikeandcartheftsuggestedbyPosner,EconomicAnalysis(n8)246.363Stigler(n30)57.364 Posner, ‘An economic theory’ (n36) 1207. But see Posner at 1208 where he suggests, without detailedelaboration,thatmarginaldeterrenceisnotaparticularlyusefulconsideration.

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Ontheassumptionthatrationalchoicetheoryholds,theforfeiturerulecreatesanadequate

deterrent toexaggeration.Thisechoes theconclusionreachedby theLawCommission.365

However,onceanindividualhasdecidedtocommitfraud,themarginaldeterrenceanalysis

suggeststhattheforfeitureruleservestoincentivisethemoreseriousfrauds,likethescuttle.

Thisshouldbeconcerningbothtotheindustryandthegeneralpublicwhoabsorbthecostof

thesefrauds.Theargumentthenisnotjustthattheforfeitureruleisanineffectivedeterrent

tothewhollyfraudulentclaim,asarguedinPartII,366butalsothattheexistenceofasingle

sanctionactuallyincentivisesthecommissionofthesemoreseriousoffences.Thiseconomic

argumentforproportionalityexistsalongsidetheevidenceofremedial frameworks intort

andcriminal lawwhichcombineconsiderationsofdeterrenceandproportionality. It ismy

contentionthattheseargumentsprovidestrongsupportforthedevelopmentofnuancedcivil

responsetofraudtoreplacetheuniversalruleofforfeiture.367

V. ConclusionThescaleofthefraudulentclaimsproblemacrossalllinesofinsuranceissaidtojustifythe

imposition of deterrent civil sanctions. Recent legislative activity has confirmed the

appropriateness of deterrence as a policy justification in this context.368 This expansive

approachtofraudhasdemonstratedtheextenttowhichtheassured’sfraudcananddoes

unravelall.Theparticularcontoursofthefraudulentclaimsrulearetypicallyexplainedby

reference to underwriters’ vulnerability to information asymmetries and ideas of utmost

goodfaith.Thechapterhasarguedthat,althoughcivilsanctionsforfraudarenecessary,these

justificationsareopentocritique.

Deterrenceisgenerallynotanaimofthecivillaw,whichinsteadattemptstoresolvedisputes

betweenprivatepartiesandawardcompensationforharm.Butevenifwecanacceptthe

needfordeterrenceinthiscontext,itdoesnotmandateacceptanceofdraconiansanctions.

365LawCom201(n195)[7.28]-[7.29].366Seeearlier,PartII.367There is insufficientspacetoconsideranuancedcivilregimeinmoredetailhereandtheauthor intendstoundertakesuchataskinfuturework.368InsuranceAct2015s.12;Versloot(SupremeCourt)(n160)[124]perLordMance.

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The fundamental argument of this chapter was that modern theories of deterrence and

decisionmakingunderminenotionsofsanctionseverityandinsteadprioritisesocialsanctions

andcognitivelimitations.Theforfeitureruleisanineffectivedeterrentinlightofthisrecent

empirical and theoretical research. Instead, the research calls for the recognition of the

complexity and nuance of decision making, and the development of deterrents which

correspond to these processes. While the Supreme Court was not receptive to these

argumentsinVersloot,369itwascontendedthattheseinterdisciplinaryinsightsremaincritical

to the fight against fraud. The InsuranceFraudTaskforce recommendations370 and recent

industryinitiativeswouldtendtoconfirmthis.

Theabsenceofaneffectivesanctionforthewhollyfraudulentclaimisanotableshortcoming

ofthecivilresponsetofraud.Iftheinsurancecourtstrulybelievethatdeterrenceissecured

bydraconianpenalties,itisdifficulttounderstandwhyasimilarapproachisnotadoptedto

counteralltypesoffraudintheclaimsstage.FollowingtheLawCommission’sabandonment

oftheseissues,futuredevelopmentisnowamatterforthecourts.Untilsuchtimeasthis

mantleistakenup,thelackofequivalentpenaltiesleavestheforfeitureruleonshakyground

andunderminesthejudicialconceptionofdeterrence.

Theunderwriter’svulnerabilitytofraudisacommonthemeinjudicialaccountsoffraud.The

development of modern investigative tools and resources which enable underwriters to

gatherinformationindependentlysuggestthattheseargumentsarenolongerascompelling

as they were when the forfeiture rule emerged in the mid-nineteenth century. These

developmentstendtoreducetheinformationasymmetrieswhichcreatetheopportunityfor

dishonestyintheclaimsprocess.

Differentapproachestofraudulent(insurance)claimsinotherjurisdictionsandrelatedareas

of law prompt further questioning of the English civil response to insurance fraud. In

particular, theAustralianapproachtonon-marine fraud, theEnglishapproachtopersonal

injuryfraudandthecriminalresponsetoinsurancefrauddemonstratehowdeterrencecan

369Seeearlier,texttofn158etseq.370InsuranceFraudTaskforce,FinalReport(n186)8-9,53-54.

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be reconciled within a more nuanced remedial framework. A range of penalties which

correspondtotheseverityoftheoffender’sconductrespondstonotionsoffairnessaswell

as economic arguments related tomarginal deterrence. Itwas argued that the first-party

insurance contextwas not sufficiently unique tomerit such a distinct response to claims

fraud.

In combination, these critiques highlight theweakness of the policy justifications said to

underpintheforfeiturerule.Ithasthecapacitytooperateinadraconianfashionontheone

hand,butfailstoprovideanyeffectivedeterrentforthemostseriousfraudulentclaims.This

is illogicalandnotsupportedbyevidence.There isnodoubt that thedeterrenceof fraud

remains importantbutefforts todetershouldreflectempirical researchandthedecision-

makingprocessesinvolvedindishonesty.Asophisticatedremedialregimeinformedbythese

insightswould,intheveryleast,containaneffectivepenaltyforwhollyfraudulentclaimsand

couldadoptamorenuancedapproachtoexaggerations.Thisiseffectivelyademandforthe

courtstobalancefrauddeterrencewithconsiderationsofproportionality.Thedemandfor

suchproportionality is timely;public valuesarebeginning topermeate judicialdebates in

private lawand recommendationsof the Insurance FraudTaskforce are likely to result in

somemovementinthisdirection.

The focus now moves from insurance claims fraud to fraud committed in transactions

financedbydocumentarycredit.Themaximexturpicausahasbeencentral inthejudicial

elaborationof the fraudexceptionbut inpractice, the simplicityof thisphrasebelies the

complexityof the fraudenquiry.This isbecause thedocumentarycredit raisescompeting

policyconsiderations–thedeterrenceoffraudandtheautonomyofthecreditmechanism–

and the courts have consistently prioritised the efficiency of the credit. The resulting

exception is narrow in scope which demands the satisfaction of onerous procedural

requirements.Accordingly,whileexturpicausamayunderpinthefraudexception,Chapter

Four will argue that fraud rarely unravels all in the context of transactions financed by

documentarycredit.

ChapterFour

DocumentaryCredits:ADoctrinalAnalysisoftheFraudException

I. IntroductionTheeffectivenessofinternationalsalesdependsontheavailabilityofdevicestostrengthen

andsecureeconomicexchange.Thisisbecauseoverseastransactionsareriskyandinvolvea

greaternumberofrisksthanatypicaldomesticexchange.1Thediscussionfocusesononeof

themostsignificantmechanismsdevelopedforthispurpose;thedocumentarycredit.The

creditovercomesrisksassociatedwithpaymentanddefectiveperformancebythesellerby

substitutingthebuyer’spromisetopayforthatofabankandonlyreleasingpaymentwhen

evidenceofcontractualcomplianceistendered.

Amajorriskremainsunresolvedbythecreditmechanism,however,andthatistheriskthat

thesellerwillbehavefraudulently.Thiscausestwosignificantpolicyconsiderationstocollide;

the need to facilitate international trade and the importance of discouraging fraud in

commercialtransactions.2Theconflictbetweenthesepolicies isparticularlyevident inthe

documentary credit context as the hallmarks of a system capable of identifying and

sanctioningfraud–detailedinvestigationsandsignificantexpense–areinstarkcontrastto

the commercial demand for an efficient method of payment.3 This balance is critical in

understandingthejudicialapproachtodocumentarycreditsandinappreciatinghowthelaw

relatingtofraudhasdeveloped.

TheprecisebalancethathasbeendrawnbytheEnglishcourtsisthesubjectofdiscussionin

thischapter.Itisevidentthatthecourtshaveprioritisedthepromotionofinternationaltrade

attheexpenseofamorerobustanti-fraudmechanism.Aruleagainstfrauddoesexistbutit

hasbeenframedinnarrowtermsanditsuseisconstrainedbyproceduralissuesandtherules

1MBridge(ed.),Benjamin'sSaleofGoods(9thed.Sweet&Maxwell,2015),[18-001].2BankofNovaScotiavAngelica-Whitewear[1987]1RCS59,72perLeDainJ:“differencesofvieworemphasiswithrespecttotheseissues,reflectthetensionbetweenthetwoprincipalpolicyconsiderations:theimportanceto international commerce of maintaining the principle of the autonomy of documentary credits andthe…importance of discouraging or suppressing fraud in letter of credit transactions”; N Enonchong, TheIndependencePrincipleofLettersofCreditandDemandGuarantees(OUP,2011),[1.03]-[1.04]3PTodd,MaritimeFraud&Piracy(2nded.Informa,2010),[2.022]-[2.023].

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governinglettersofcredit.Nevertheless,thephase‘fraudunravelsall’doesappearroutinely

inthecaselaw;themaximexturpicausaformingasignificantpartofthejudicialreasoning

intheelaborationofthefraudexception.4Tosimplystatethemaxim,however,istoignore

thesebroaderissueswhichhavedictatedthepreciseboundariesoftheexception.

Thechapterexploresthefirstandsecondresearchquestions;firstly,howhasthefraudrule

beenconstructedinthelawofdocumentarycreditsand,secondly,whatpolicyarguments

have been employed by the courts to justify this particular construction? By way of

introduction,thediscussioncommenceswithanaccountoftherisksinvolvedininternational

tradeandtherangeoffinancingmechanismsavailabletoparties.PartIIthenfocusesonthe

contractual framework created by the documentary credit and examines the underlying

principleswhichensureitsutilityasafinancingmechanism.5Attentionthenturnstofraudin

Part III. The discussion will first consider how the courts have conceptualised the fraud

problemandtheirroleinprevention.Thefocuswillthenshifttothelimitedcircumstancesin

whichtheEnglishcourtsarewillingtopermit fraudbythebeneficiarytodisruptpayment

underadocumentarycredit.

A. TherisksofinternationaltradeRisks in international trade arise because the contracting parties do not perform their

obligationssimultaneously,butsequentially.6Unlikethepositionininsurance,bothparties

toaninternationalcontractofsaleareexpectedtoperformsubstantivelyandperformance

isnotcontingentontheoccurrenceofaspecifiedevent.Performanceissequentialsimply

because the great distances involved make simultaneous performance impossible. The

security of economic exchange depends on overcoming these risks. From the seller’s

perspective, these risks relate primarily to payment; both the creditworthiness and the

insolvencyriskofthebuyerareatissue.Inaddition,thereisariskthatthebuyerwillbehave

opportunisticallywhenhereceivesthegoodsbyrejectingthemduetominordiscrepancies

4Forexample,UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]2Lloyd’sRep.1,6perLordDiplock(hereafterreferredtoasUnitedCityMerchants(HouseofLords)).5AconsiderationofthedoctrinalaccountofthemechanismisalsowarrantedatthisstageasdiscussioninChapterFivewilldiscussempiricalevidencewhichchallengesthetraditionalaccountofhowthemechanismoperates,seeChapterFive,PartIII.6GGundlach, ‘Exchangegovernance: The roleof legal andnonlegal approachesacross theexchangeprocess’(1994)13(2)JPubPol&Mark.246,247;RPosner,EconomicAnalysisofLaw(5thed.AspenPublishers,1998),101.

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inquality.Ifthebuyerrefusedtopayorrejectedthegoods,thesellerwouldhavetofinda

replacementbuyerpreferablylocatedinthesameplaceasthegoods,arrangeforhisgoods

tobereturnedortobringanactionforthepriceagainstthebuyer.Tradingpartieswillseek

toavoidlitigationoverseasforreasonsoftime,expenseanduncertaintyduetodifferences

inlegalsystems.7

Theriskforthebuyerliesinhislimitedabilitytoassesstheprobityofthesellerinadvance.

Hisconcernrelatestowhetherthequalityandquantityofthegoodsshippedaccordswith

theparties’ contractualagreement. If the seller fails tomeet theseobligations, thebuyer

facesthedifficultprospectofbringinganactionforbreachofcontractagainsthisseller.

Exchangescanbestrengthened,andtheserisksalleviated,bytheadoptionofmechanismsto

supportthetransaction.Severalpaymentmechanismsexistforthispurpose.Thefirst,pre-

payment, requires the buyer to pay before the goods are shipped. This reduces the risks

associatedwith insolvencyandopportunismandalsomeansthattheseller isnotwithout

workingcapitalduringshipment.8Thereverseofthismechanism,shipmentonopenaccount,

requiresthesellertoshipthegoodsandextendcredittohisbuyer.9Thisistheidealsolution

for thebuyeras itenableshimtowithholdpaymentuntilhehasexaminedthegoods for

contractualconformity.10Thesimilaritybetweenthesemechanismsisthattheyonlyassuage

one party’s concerns about the transaction. A mechanism that simultaneously provides

reassurance to both parties will often be required, particularly where the parties are

strangers11andaretradingacrossborders.

7DBischof, ‘Lettersof credit (LCs): recognizing thevalueof simple trade instruments’ (12/07/16)availableat:http://www.iccwbo.org/News/Articles/2016/Letters-of-credit-(LCs)-recognizing-the-value-of-simple-trade-instruments/(accessed15/08/16).8RMann,‘Theroleoflettersofcreditinpaymenttransactions’(1999-2000)98MichLRev2494,2516-2517;AWKatz,‘Informalityasabilateralassurancemechanism.CommentsonRonaldMann’s‘Theroleoflettersofcreditinpaymenttransactions’(1999-2000)98MichLRev2554,2556.9Mann(n8)2517;Katz(n8)2556.10Katz(n8)2556.11Todd,MaritimeFraud&Piracy(n3)[4.003]“Documentarycreditsremainwell-adaptedtotransactionswhereunfamiliarpartiesdealwitheachotheratadistance,wherethesecurityofadocumentoftitleisrequired,andwherere-salesatseaareenvisaged.”

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Themostsignificantintermediatefinancingmechanismistheletterofcredit.Itisdesignedto

allaybothparties’concernsaboutdealingoverseasbyexpandingthecontractualnetworkto

includebanksandreallocatesmanyoftherisksinherentininternationaltrade.Paymentis

arranged,andmade,throughanintermediarybankwhichhasnointerestintheunderlying

transaction,inexchangefordocumentationwhichevidencesthatthesellerhasperformedin

accordancewiththeparties’agreement.Thecreditenablesthesellertoshifttheriskofnon-

payment and insolvency to the bank and reduces the buyer’s ability to reject the goods

opportunistically.12Thesellerretainsthemarginalriskthatthepayingbankwillfailbeforehe

hasreceivedpayment.

Inastandardsale, theriskthatthesellerwill fail toperformorperforminadequatelyare

bornebythebuyer.Thefactthatpaymentiscontingentoncertaindocumentationshould

reduce these concerns in transactions financed by documentary credit. However, risks

relating to thequality andquantity of contract goodswill remainwith thebuyer as such

mattersareirrelevanttothepaymentdecisionmadebythebank.Insuchcircumstances,and

subjecttothedifficultiesandexpenseofforeignlitigation,13thebuyerwillneedtobringan

actionforbreachontheunderlyingcontracttoobtainrelief.

In comparison to other intermediate financing mechanisms, such as documentary

collection,14thedocumentarycreditisexpensive.Asanindication,thepriceisusuallyfixed

byreferencetoaquarterofonepercentoftheinvoiceprice15thoughconsiderationsofthe

buyer’sstandingwithhisbankarealsorelevant.16Whythenarepartieswillingtoadoptthe

creditifother,cheapermechanismsareavailableinthemarket?Theanswerwouldseemto

lieintheirrevocablenatureofcredit,thatistosay,thatthebank’sundertakingtopaycannot

berevokedwithouttheexpressagreementoftheseller-beneficiary.17Thismakespayment

12Thisissubjecttothepossibilityofopportunisticbehaviourduringwaiver,seelatertexttofn76.13Todd,MaritimeFraud&Piracy(n3)[4.045].14Inadocumentarycollectionarrangement,abankagreestoactasthemiddlemanbetweentheparties;collectingpaymentfromthebuyerinexchangeforthedocumentspresentedbytheseller.Thisisacheapermechanismsincethebankmakesnoobligationtomakepaymenttothesellerbutinsteadactssimplyasanintermediarybetweentheparties.Aconsiderationofthecollectionmechanismisbeyondthescopeofthisthesis.15Mann(n8)2499;Katz(n8)2559.16Mann(n8)2499.17 International Chamber of Commerce, ‘The Uniform Customs and Practice for Documentary Credits’ (2007Revision,ICCPublicationno.600)(hereafterreferredtoasUCP600),art.3:“Acreditisirrevocableevenifthereis

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virtuallycertainfortheseller,subjecttotheprovisionofcorrectdocumentation,andexplains

the popularity of themechanism.18 At one time the documentary credit was thought to

accountforthemajorityofinternationaltradefinancing,19andalthoughsuchwidespreaduse

isnolongerthecase,20themechanismhasregainedadegreeofpopularityinrecentyears,

particularly inAsia.21Thisresurgencehasbeenattributedtouncertaintyinglobalfinancial

markets.22Themostrecentdata,providedbythe2015ICCGlobalTradeandFinanceSurvey,

suggeststhatcreditsfund40%ofworldwideimportandexporttrade.23Thisrepresentssome

US$2trillionperyear.24

Althoughthecreditsolvesmanyoftheparties’concerns,itdoesnotremovealloftherisks

associatedwithinternationaltrade.Amajorrisk,andthefocusofthisthesis,isthattheseller-

beneficiarywillcommitfraudintheperformanceofhiscontractualobligations.Indeed,two

particularaspectsofthesystemprovideopportunitiesforthedishonestsellertoexploithis

buyer;theeaseofforgingdocumentsduetohighqualityreproductionmethods25andtheuse

ofcontainers.26Containerisationenablesdishonestsellerstoconcealthetruequalityofgoods

fromthemasterandobtaincleanshippingdocuments.Thisriskisusefullyillustratedbythe

factsofDiscountRecordsvBarclayswherethesellerconcealedrubbishamongafractionof

thecontractgoodsincartonsbuttenderedcleandocuments.27Theriskofbankfailurealso

remainsunmitigatedbythedecisiontouseadocumentarycredit,althoughadmittedlythisis

no indicationtothateffect.”ThisconstitutesadeparturefromthepreviousversionoftheUCPinwhichart.5recognisedthepossibilitythatthecreditcouldberevocableorirrevocableinnature.18Thelowfailureoflettersofcreditwouldtendtoconfirmtheunassailablenatureofpayment,seeBischof(n7).19 United Nations Conference on Trade And Development (UNCTAD), ‘Documentary risk in commodity trade’(1998),1:lettersofcreditsupportedtradeworthUS$100billion/yearandaccountedfor60%ofcommoditysales.20Todd,MaritimeFraud&Piracy(n3)[4.003];JUlph,‘TheUCP600:Documentarycreditsinthe21stcentury’[2007]JBL355,356;HBeale(ed.)ChittyonContracts(32nded.Sweet&Maxwell,2015),[34-446].21Chitty(32nded.)(n20)[34-446].22JMoraandWPowers, ‘Globalperspectivesinthedeclineoftradefinance’ inJPChauffourandMMalouche(eds.),TradeFinanceduringtheGreatTradeCollapse(TheWorldBank,2011)128.23 InternationalChamberofCommerce, ‘ICCGlobalTradeandFinanceSurvey2015’ (2015),40-41availableat:http://www.iccwbo.org/about-icc/policy-commissions/banking/(accessed26/07/2016).24InternationalChamberofCommerce,‘AboutICCBanking’availableat:http://www.iccwbo.org/about-icc/policy-commissions/banking/(accessed15/08/2016).25EPEllinger,‘Fraudindocumentarycredittransactions’[1981]JBL258,258;Todd,MaritimeFraud&Piracy(n3)[3.022].26Todd,MaritimeFraud&Piracy(n3)[2.047].27DiscountRecordsvBarclaysBank[1975]1WLR315,317ascitedinTodd,MaritimeFraud&Piracy(n3)[4.058].

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asmallrisk.28Theriskofbankfailurewouldbebornebythesellerinthefirstinstancewho

wouldthenseekpaymentunderthecontractofsalefromthebuyer.29

B. Independentguarantees:PerformancebondsandstandbylettersofcreditAs an intermediatemethodof financing, the documentary creditwill typically be used in

transactions where parties are unknown to each other and where the absence of trust

justifiestheexpenseofthecredit.30Atthisstage,however,referenceshouldbemadetotwo

other mechanisms, referred to broadly as ‘independent guarantees’ which share

characteristicswiththeletterofcredit.Althoughthesemechanismsservedifferentpurposes,

thelawrelatingtotheseinstruments,andparticularlyitsresponsetofraud,havedeveloped

intandem.31Assuch,abriefexplanationisrequired.

The most significant of these independent guarantees are the performance bond (used

primarily in theUnitedKingdom)and thestandby letterof credit.Thestandbycreditwas

originallydevelopedandusedprimarilyintheUnitedStates32buttodaythestandbyisbeing

usedmore broadly to facilitate international transactions.33 The similarity between these

mechanismsandtheletterofcreditistheagreementofathird-partybanktopayoneofthe

contractualpartiesinpre-determinedsituations.Thedifferenceistheintendedpurposeand

amountofthispayment.Theletterofcreditistheprimarysourceofpaymentfortheseller34

andisdesignedtofurnishhimwithanassuredrightofpaymentwhenhepresentsconforming

28ICarr,InternationalTradeLaw(5thed.Routledge,2014)476.29MBrindleandRCox,LawofBankPayments (3rded.SweetandMaxwell,2004), [8.032];RGoode, ‘Abstractpaymentundertakings’ inPCaneandJStapleton(eds.),Essays forPatrickAtiyah (ClarendonPress,1991),212(hereafterreferredtoas‘Goode,‘Abstractpaymentundertakings’);WJAlan&CoLtdvElNasrExportandImportCo[1972]2QB189,212perDenningLJwhodescribedthecreditasaconditionalpayment.Recoursetothebuyerfollowingthefailureofthebankresurrectstherisksofbuyerinsolvencyandopportunism.30Mann(n8)2498;Todd,MaritimeFraud&Piracy(n3)[4.003].31RDHarbottle(Mercantile)LtdvNatWestBankLtd[1978]QB146,156perKerrJ;HoweRichardsonScaleCoLtdvPolimex-Cekop[1978]1Lloyd’sRep.161,163perRoskillLJ;Todd,MaritimeFraud&Piracy(n3)[4.009].Itisnotunusualtoseeperformancebondcasescitedinletterofcreditdisputes,forexample,EdwardOwenEngineeringvBarclaysBankInternationalLtd.[1978]QB159,acaseonperformancebonds,isroutinelycitedinletterofcreditcasessuchasUnitedCityMerchants(HouseofLords)(n4),TukanTimbervBarclaysBankplc[1987]1Lloyd’sRep.171,MontrodLtdvGrundkötterFleischvertreibsGmbH[2002]1WLR1975.32AMalekandDQuest,Jack:DocumentaryCredits(4thed.TottelPublishing,2009)[12.14].ThestandbymechanismwasdevelopedtoenablefederalcharteredbanksintheUSAtocircumventalawwhichprohibitedtheissueofguaranteesonbehalfof thirdparties.Thestandbycredit isusedwidely indomestic transactions intheUnitedStates.Seegenerally,AMugasha,TheLawofLettersofCreditandBankGuarantees(TheFederationPress,2003)44.33Chitty(32nded.)(n20)[34-486].34Goode,‘Abstractpaymentundertakings’(n29)213.

165

documentation.Thepaymentmadeunderadocumentarycreditisthefullinvoicevalueof

thetransaction.Bycontrast,theperformancebondorstandbycreditisdesignedtocreatea

financial incentiveforthesellertoperformhissubstantiveobligations.35Theperformance

bondconstitutesasecondaryobligationwhichmayneverbedrawnuponwhenthecontract

isperformedwithoutincident.36Intheeventoftheseller’spoorperformance,suchasshort

deliveryorthedeliveryofdefectivegoods,thebuyerisabletocallonthebondandreceives

thesumofmoneystipulatedbytheparties.37Thisistypically5-10%38ofthecontractprice.

An important difference is the trigger to payment under these mechanisms. As the

documentarycredit is thesubstantivemeansofpayment, thebankrequiresdocumentary

evidence that the seller has performed his contractual obligations. These documentswill

evidence shipment of the requisite goods in the manner agreed by the parties.39 The

performancebond,bycontrast,mayonlyrequireasimplewrittenassertionoftheseller’s

breach of contract, though the bond may specify additional, but minimal, documentary

conditions.

Thecomparativeeaseofseekingpaymentunderaperformancebondmeansthatthisdevice

is particularly vulnerable to fraud.40Arguably, performancebonds couldhave formed the

basisofcomparisonwithinthisproject.Theletterofcredit,however,hasbeenchosenasthe

second example of fraud rules in commercial law. This is because the bulk of the policy

discussionandrecentdevelopmentsinthelawoccurinthecontextofdocumentarycredits.

Thelawrelatingtofraudindocumentarycreditsandperformancebondshasdevelopedin

tandem and, therefore, occasional reference will be made to bonds throughout the

discussion.Fornow,thediscussionfocusessolelyonthedocumentarycreditandexamines

themechanismfromadoctrinalperspective.

35PEllingerandDNeo,TheLawandPracticeofDocumentaryLettersofCredit(HartPublishing,2010),308.36Harbottle(n31)149perKerrJ,“Thesewereineffecttobeperformancebonds…theirpurposewastoprovidesecuritytothebuyerforthefulfilmentbytheplaintiffsoftheirobligationsunderthecontracts.”;BachmannPtyLtdvBHPPowerNewZealandLtd[1999]1VR420,436-437perBrookingJA.37EllingerandNeo(n35)306.38MalekandQuest, Jack (n32) [12.48] (inrelationtoperformancebonds);HGetz, ‘Enjoiningthe internationalstandbyletterofcredit:TheIranianletterofcreditcases’(1980)21HarvInt.LJ189,193-194(inrelationtostandbylettersofcredit).ButseeMalekandQuest,Jack(n32)[12.15]whereitissaidthatthestandbycreditisreplacingthedocumentarycreditinsomeinternationalsales.Inthesecases,thestandbycreditwouldpaytheentirecontractprice.39Thisisdiscussedfurther,seelatertexttofn99.40MalekandQuest,Jack(n32)[12.44].

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II. TheDocumentaryCreditMechanism:ANetworkofContractsAn agreement to finance a contract of sale by letter of credit creates a network of

autonomousbutinterconnectedcontracts.Theobjectofthecontract,likeanyothercontract

ofsale,isforthesellertopasscontrolandownershipofthegoodstothebuyerinexchange

for the price. The network of contracts createdunder the credit creates amechanism to

facilitatethisexchange.Thediagrambelowprovidesarepresentationofthenetwork.

Figure1:Atypicalletterofcredittransaction

Thestartingpointisthecontractofsaleinwhichthepartiesagreethatthetransactionwill

be financed by letter of credit. The partiesmust also nominate the banks throughwhich

payment is available and agree the final date on which payment can be sought. The

documentaryconditionsthatthesellerwillneedtosatisfywillalsobeagreedatthisstage.

Therequireddocumentsusuallyincludeacleanbilloflading,aninsurancepolicyandquality

certificates issuedbyathirdparty.Abriefpointonterminology. Inthecreditcontext,the

buyerisreferredtoastheapplicantandthesellerasthebeneficiary.Thesetermswillbeused

interchangeablythroughout.

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Theapplicantapproacheshisbanktoissueadocumentarycreditinfavourofthebeneficiary.

The issuing bank undertakes to pay the beneficiary when the necessary documents are

presented.Fromacontractualperspective,theopeningofthecreditwillgenerallyconstitute

aconditionprecedenttotheseller’sdutytoarrangeshipment.41

Theparticularvalueof thecredit for theseller ishisability to seekpayment fromabank

locatedinhisowncountry.42Thisisfacilitatedbytheconfirmingbank,aninstitutionlocalto

the seller,whogives an independentundertaking topaywhen complyingdocuments are

presented.Alessadvantageousarrangementisalsopossiblewherethebankmerelyadvises

theseller-beneficiarythatthecredithasbeenopened.Oncetheopeningofthecredithas

been communicated to the beneficiary, the obligations created by the credit are

irrevocable;43itwillbeimpossibletoamendthetermsofpaymentwithoutthebeneficiary’s

assent.

Thebankmustexaminethedocumentstoensurecompliancewiththetermsofthecredit

withinfivebankingdays.44Ifthedocumentsdosocomply,theconfirmingbankmustmake

payment to the beneficiary.45 The confirming bank then presents the documents to the

issuinginstitution.Iftheissuingbankdeemsthatthedocumentscomply,itwillreimbursethe

confirmingbankandthendebittheapplicant’saccountinexchangeforthedocuments.

Wherethedocumentsdonotconform,thebank“mayrefusetohonourornegotiate.”46The

factorswhichinformthisdecisionwilldependuponwhetherthebankistheconfirmingor

issuing institution. In linewiththedoctrineofautonomy,discussedbelow, theconfirming

bank’sdecisiondependssolelyonanexaminationofthedocuments.47Bycontrast,theissuing

bank may approach the applicant for permission to waive the discrepancies in the

41TransTrustSPRLvDanubiaTradingCo[1952]2QB297,304perLordDenning;BrindleandCox(n29)[8-035].RecentlyconfirmedinMenaEnergyDMCCvHascolPetroleumLtd[2017]EWHC262(Comm);[2017]1Lloyd’sRep.607,[161]perMalesJ.42HamzehMalas&SonsvBritishImexIndustries[1958]2QB127,129perJenkinsLJ.43UCP600art.2.44UCP600art.14(b).45UCP600art.8.Theprecisetimeofpaymentwilldependonthetypeofcreditchosenbytheparties,seeUCP600art.2.46UCP600art.16(a).47UCP600art.14(a).

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documents.48Ifthebankdecidestorejectthepresentation,itmustdosowithinfivebanking

daysandprovidealistofdiscrepanciesforthebeneficiary.49Providedthatthecredithasnot

yetexpired, thebeneficiarymay remedy thedefectsandmakea furtherpresentation for

payment. Finally, where the bank and beneficiary disagree about the existence of

discrepancies,thebankmayagreetomakepaymentunderreserveorsubjecttoaletterof

indemnityfromthebeneficiary.50

A. ThelawgoverningdocumentarycreditsAtitsheart,thedocumentarycreditisadeviceofcommercialoriginand,assuch,doesnot

readilyconformtoastrictcontractualanalysis.51Notwithstandingtheseanalyticalissues,the

courtshave recognised that thecredit creates thenetworkof contracts,discussedabove.

Giventhatthecreditmechanismisusedbypartiesacrossjurisdictions,adegreeofuniformity

in how these contracts are interpreted is desirable. Beginning in 1933, the International

ChamberofCommercesetaboutataskwhichhasresultedinsignificantharmonisationinthe

useofdocumentarycredits.52TheUniformCustomsandPracticesforDocumentaryCredits

(UCP)isavoluntarysetofruleswhichgaintheforceoflawthroughinclusionintheparties’

contract.53Almostalltransactionsfinancedbydocumentarycreditexpresslyincorporatethe

UCP.54

Thecurrentversionof theUCP, theUCP600,entered into force in July2007.TheEnglish

courtsinterprettheUCPpurposively55giventhatitembodies“internationalpracticeandthe

48UCP600art.16(b).49UCP600art.14(b),16(c).50 C Schmitthoff, 'Discrepancies of documents in letter of credit transactions' (1987) JBL 94, 104-108. Acomprehensiveaccountofthesemethodsofpaymentisbeyondthescopeofthisthesis.51Goode,‘Abstractpaymentundertakings’(n29)209,235;MalekandQuest,Jack(n32)[1.16];Angelica-Whitewear(n2) 82 per LeDain J, “…no completely satisfactory rationale has been found in the established categories ofcontracttheory,butthejudicialrecognitionofitslegalenforceabilityisnowbeyonddispute.”52UCP600art.1,“TheUniformCustomsandPracticeforDocumentaryCredits,2007Revision,ICCPublicationno.600("UCP")arerulesthatapplytoanydocumentarycredit…whenthetextofthecreditexpresslyindicatesthatitissubjecttotheserules.Theyarebindingonallpartiestheretounlessexpresslymodifiedorexcludedbythecredit.”SeeUCP600(Foreword):“Theobjective,sinceattained,wastocreateasetofcontractualrulesthatwouldestablishuniformityinthatpractice,sothatpractitionerswouldnothavetocopewithaplethoraofoftenconflictingnationalregulations.”53Ulph(n20)355.54FLorenzon,‘Internationaltradeandshippingdocuments’inYBaatz(ed.),MaritimeLaw(4thed.Informa,2017)116.55FortisBankSA/NVvIndianOverseasBank[2011]EWCACiv58,[2011]2Lloyd’sRep.33,[29]perThomasLJ.

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expectations of international bankers and international traders so that it underpins the

operationoflettersofcreditininternationaltrade.”56Thepartiesarefreetovarytheseterms

byagreement.57

TheUCPdoesnot,however,provideacomprehensiveguideonmattersrelatingtolettersof

credit.58 Inareaswhere theUCP is silent, and in theabsenceofanexpress choiceof law

clause,59theRomeConventiondeterminesthatthecontractwillbegovernedbythelawof

thecountrywithwhichthecontracthastheclosestconnection.60Themostsignificantfactors

forthispurposewillbethelocationofthebankfirstcheckingthedocumentsforcompliance

andtheplaceatwhichpaymentismadetothebeneficiary.61Thiswilltypicallybethecountry

in which the confirming bank and beneficiary are based, the seller-beneficiary’s home

country.62 The residual role for national law undermines the significant degree of

harmonisationwhichhasbeenachievedinmanyaspectsofdocumentarycredituse.Thisis

most notable in relation to theeffect of fraudon the letter of credit transaction,63 tobe

discussedinPartIII.

TheprovisionsoftheUCPandtheirpurposiveinterpretationbynationalcourtsensuresthat

the creditmeets the needs of the commercial community. In particular, traders desire a

paymentmechanismwhich is “asgoodascash,”64bywhich Imeanadeviceunderwhich

paymentisvirtuallyunassailableandenablesdocumentstobetransferredbetweenparties

without onerous notice requirements.65 These characteristics are highly desirable in the

commercial world and particularly useful in transactions where multiple re-sales are

56Ibid[29]perThomasLJ.Seealso,GlencoreInternationalAGvBankofChina[1996]1Lloyd’sRep.135,148perSirThomasBinghamMR: Inconstruing theUCP,courts“seek togiveeffect to the internationalconsequencesunderlyingtheUCP.”57UCP600art.1.58MalekandQuest,Jack(n32)[1.23].59Ibid[13.47]:“Itisunusualforaletterofcredittospecifyagoverninglaw,thoughthereisnoreasonwhyitshouldnotdoso.”60RomeConventionontheLawapplicabletoContractualObligations1980,art.4.161MarconiCommunicationsInternationalvPTPanIndonesiaBank[2007]2Lloyd’sRep.72,[63]perPotterLJ.62MalekandQuest,Jack(n32)[13.49].63 Carr (n28) 438. For a comparative discussionof theAmerican approach to fraud in credit transactions, seeChapterFive,PartI.64PowerCurbervBankofKuwait[1981]2Lloyd’sRep.394,398perDenningLJ;SafavBanqueduCaire[2000]2Lloyd’sRep.600,605perWallerLJ.65Chitty(32nded.)(n20)[34-001].

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envisaged.66 The importance of a commercially desirable mechanism are particularly

apparentinthedevelopmentofthetwindoctrinesofautonomyandstrictcompliance.

B. Autonomyandstrictcompliance

i. Theprincipleofautonomy

Anefficientsystemof tradefinancing issaidtodependontheautonomousnatureof the

contractscreatedbytheletterofcredit.67Theprincipleitselfisenshrinedinthefollowingtwo

provisionsoftheUCP,

Article4a

Acreditbyitsnatureisaseparatetransactionfromthesaleorothercontractonwhich

itmaybebased.Banksareinnowayconcernedwithorboundbysuchcontract,even

if any reference whatsoever to it is included in the credit. Consequently, the

undertakingofabanktohonour,tonegotiateortofulfilanyotherobligationunder

the credit is not subject to claims or defences by the applicant resulting from its

relationshipswiththeissuingbankorthebeneficiary.Abeneficiarycaninnocaseavail

itselfofthecontractualrelationshipsexistingbetweenbanksorbetweentheapplicant

andtheissuingbank.68

Article5

Banksdealwithdocumentsandnotwithgoods,servicesorperformancetowhichthe

documentsmayrelate.69

Putsimply,thedoctrineofautonomytreatsasdistincteachofthecontractscreatedbythe

letterofcredit.Thismeansthateachcontractistobeenforcedbyreferencetoitsownterms

withoutreferencetoothercontractsinthenetwork.70Autonomyismostvisibleinthebank’s

decisiontomakepaymentsinceonlyconsiderationsofdocumentarycompliancearerelevant.

66Todd,MaritimeFraud&Piracy(n3)[2.040]-[2.041].67Angelica-Whitewear(n2)70perLeDainJ“internationalcommercialutility”.68UCP600art.4(a).69UCP600art.5.70Todd,MaritimeFraud&Piracy(n3)[4-021].

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Thebankmustignorethebuyer’sassertionsthatthesellerhasshippedpoorqualitygoodsor

breachedthecontractinsomeotherway.71Theoperationofthecreditcontractistherefore

independentfromtheoperationoftheunderlyingcontractofsale.

Theeffectofautonomyistocastthebank’sroleinpurelyclericalterms.Thiscanbejustified

for two distinct reasons. Firstly, to require banks to assess the commercialmateriality of

discrepancieswouldrequireexpertiseintheparticulartransaction.Thisisunrealistic.72The

UCPconfirmsthatadeterminationofconformityisnottobeequatedwithevidenceofthe

genuinenessoraccuracyofthedocuments.73Asecondjustificationrelatestothespeedof

payment. Documentary compliance can be gauged relatively quickly, facilitating the

commercialdesireforswiftpayment.

Thecontractualnatureofthedocumentarycreditprovidesafurtherperspectivefromwhich

wecanappreciatethedoctrineofautonomy.Goodehascommentedthatthereis“nogood

reasonwhytheissuingbankshouldbeentitledtoinvoketheprotectionofthesalescontract,

towhich it is a stranger.”74 This reiterates the fact that the bank cannot have regard to

contractualdisputesbetweenbuyerandsellerindeterminingwhetherpaymentisdueunder

the credit. The contractual explanation of autonomy remains valid notwithstanding the

enactment of the Contract (Rights of Third Parties) Act 1999 which limits third party

enforceabilitytocircumstanceswherethecontractexpresslysoprovidesorconfersabenefit

onathirdparty.75Giventhatthebank’sroleistofacilitatethetransaction,theunderlying

contractofsalewillnotconferabenefitonabankforthepurposesofthe1999Act.

Ifthedoctrineofautonomywasabsolute,bywhichImeanthatinnocircumstancescould

payment be disrupted by extraneous considerations, the mechanism would offer virtual

certainty and security of payment. The standard, both that enunciatedby the courts and

containedwithintheUCP,isnotabsolute,butratherrecognisestheriskofbeneficiaryfraud

andtherealitythatdocumentsmaynotbewhollycompliantinallpresentations.

71TurkiyeIsBankasivBankofChina[1998]1Lloyd'sRep250,253,255perHirstLJ.72EquitableTrustCoofNewYorkvDawsonPartnersLtd(1926)27LlLRep49,52perViscountCave.73UCP600art.34.74Goode,'Abstractpaymentundertakings'(n29)219.75Contracts(RightsofThirdParties)Act1999s.1(1)

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Wherethepresenteddocumentscontaindiscrepancies,theUCPentitlestheissuingbankto

rejectthepresentationortoseekawaiverfromitscustomer,thecreditapplicant,tomake

payment.76 This evidently is designed to facilitate payment in the realworld of technical

discrepanciesandsoforth.Theevidencesuggeststhatbanksfrequentlytakeadvantageof

this entitlement in practice.77 The re-introduction of the buyer into the payment process

resurrectstheriskofbuyeropportunismand,moreimportantly,theriskthatfactorsother

than documentary compliance will determine payment.78 As such, although waiver

undoubtedlyenablespaymentstobemadeincasesofdocumentdiscrepancy,theprocess

itselfunderminesthedoctrineofautonomy.

Thecreationofspecificexceptionstothedoctrineofautonomyisamatterforthecommon

lawand,thereisnodoubtthattheEnglishcourtshavebeencautiousinthisregard.Theeffect

ofanyexceptiontoautonomyistomakepaymentlesscertainsincefactorsunrelatedtothe

creditcontractitselfmayoperatetodisruptorpreventpayment.Thishasbeenexpressedin

colourfullanguagebythecourts,mostnotablyintheconcernthatexceptionswouldcause

“thrombosis”tooccurinthe“lifebloodofcommerce.”79

Theresultingexceptionstoautonomyhavebeencastinnarrowtermsandtotheextentthat

publicpolicywoulddemand.Themostsignificantofthese,andthefocusoftheproject,isthe

fraudexception.Theconflictbetweenthecommercialutilityofthemechanismandtheneed

topreventfraud,identifiedintheopeningremarksofthischapter,isparticularlyapparentin

thedevelopmentofthefraudexceptiontoautonomy.

ii. Theprincipleofstrictcompliance

Thedoctrineofstrictcompliancereferstothestandardagainstwhichdemandsforpayment

and reimbursement are judged. Presentations which fail to attain this standard, due to

76UCP600art.16(b).77Mann(n8)2513.78Todd,MaritimeFraud&Piracy(n3)[4.015].79 Intraco Ltd v Notis Shipping Corporation of Liberia (The Bhoja Trader) [1981] 2 Lloyd’s Rep. 256, 257 perDonaldsonLJ.

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missing documents or documents which indicate the wrong shipment date for example,

entitlethebanktorefusepayment.Theprecisestandardofcompliancehasbeenformulated

indifferenttermsundertheUCPandbycaselawandsoadegreeofprecisionisrequired.It

isconventionaltobeginwithaconsiderationofthepositionatcommonlawandtochartthe

evolvingapproachtothequestionofcompliance.Theearlycasesfavouredastrictapproach

to compliance. The leading exposition is found in Equitable Trust of New York v Dawson

Partners,

Itisbothcommongroundandcommonsensethatinsuchatransactiontheaccepting

bankcanonlyclaimindemnityiftheconditionsonwhichitisauthorisedtoacceptare

inthematteroftheaccompanyingdocumentsstrictlyobserved,thereisnoroomfor

documentswhicharealmostthesame,orwhichwilldojustaswell.Businesscould

notproceedsecurelyonanyotherlines.80

Thisapproachwasendorsed insubsequentcase law.81The factsof JHRaynervHambro’s

Bank82provideausefulillustrationofstrictcomplianceinpractice.Theexchangeinvolvedthe

sale of Coromandel groundnuts. The bill of lading, however, listed ‘machine-shelled

groundnutkernels’thoughitwascommongroundthatthesewereidenticaltothespecified

groundnuts. The bank refused to pay. The Court of Appeal held that the rejection was

legitimateasthebankhadalimitedcontractualmandatetopayandassuch“actsatitsperil

ifitdepartsfromtheprecisetermsofthemandate.”83

Morerecentcaselawhasquestionedthelevelofstringencythatdocumentsmustattain.84In

particular, the courts will block attempts by banks to reject documents on the basis of

technicaldiscrepancies.ThiswasmadeclearbytheCourtofAppealinKredietbankAntwerp

vMidlandBank:

The requirement of strict compliance is not equivalent to a test of exact literal

compliance in all circumstances and as regards all documents, to some extent,

80EquitableTrust(n72)52perViscountCave.81Forexample,GianSinghvBanquedel'Indochine[1974]1WLR1234,1240perLordDiplock“thisoft-citedpassagehasneverbeenquestionedorimprovedon.”82JHRaynervHambro'sBank[1943]KB37,37.83Ibid37perMacKinnonLJ,42-43perGoddardLJ.84MalekandQuest,Jack(n32)[8.31].

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therefore,thebankermustexercisehisownjudgmentwhethertherequirement is

satisfiedbythedocumentspresentedtohim.85

Thissuggeststhatthebankdoesnotoccupyapurelyadministrativerolebutmustincertain

circumstancesexercisesomediscretion.Thiscounterstheimpressionofautonomydiscussed

in the preceding section. In Kredietbank, the credit required a report issued by ‘Griffith

Inspectorate’. The beneficiary tendered a document issued by ‘Daniel CGriffith (Holland)

BV…member of the worldwide inspectorate’ which the Court of Appeal determined was

compliant and ordered payment to be made.86 The authors of Jack have criticised this

approach.Theyhaveopinedthatthedocumentsmayneedtobeexactlycompliantforcertain

partiesinastringsalewhowillneverphysicallyreceivethegoods.87Theirpreferencewould

beforbankstorejectdocumentscontainingdiscrepancieslikethoseinKredietbankunless“it

is unmistakeably typographical [or] the document could not reasonably be referring to a

personororganisationdifferent from theone specified in the credit.”88 There is clearlya

balancetobestruckheretoensurethatpaymentsarenotunreasonablywithheld.Thereality,

however,isthatthisbalancewillneedtobedeterminedonacase-by-casebasis.

Thephrase‘strictcompliance’doesnotappearintheUCP;theobligationtomakepayment

insteadarisesagainsta‘complyingpresentation’judgedagainst“thetermsandconditionsof

the credit, the applicable provisions of these rules and international standard banking

practice (ISBP)”.89 There is no longer a qualification that this duty is carried out with

reasonable care90 since itwas considered that thismade little practical difference to the

processofexamination.91

85KredietbankAntwerpvMidlandBank[1999]CLC1108,[12]perEvansLJ.86 Ibid [57] The court commented further that “[i]f there is a literal requirement that the name ‘GriffithInspectorate’shallappearinthedocuments,thenitdoesso,assumingonlythatthereisaworld-wideInspectorategroupandthatthecompanybearingthenameDanielC.Griffith(Holland)isamemberofit.Thatisanassumptionwhich,asthejudgeheld,anexperiencedbankercanbeexpectedtomake”87MalekandQuest,Jack(n32)[8.37].88Ibid[8.38].89UCP600art.2.Thedutiesof the issuingandconfirmingbanks topayagainstacomplyingpresentationarecontainedinart.7(a)andart.15(a),andart.8(a)andart.15(b),respectively.Seealso,ICC,InternationalStandardBankingPractice681(2007Revision,ICCPublicationno.681),asetofbestpracticesfordocumentexaminationandaguideastohowcreditsshouldbeoperatedonaday-to-daybasis.90See,forexample,UCP500art.13(a).91MalekandQuest,Jack(n32)[8.3].

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The ISBP confirms the direction of travel in case law as to the meaning of ‘complying

presentation’.Itprovidesthat“amisspellingortypingerrorthatdoesnotaffectthemeaning

of a word or the sentence in which it occurs, does notmake a document discrepant.”92

Abbreviations in general use will also not affect a determination of compliance.93 This

approach to questions of compliance is appropriate; it should ensure that the presented

documents serve their commercial purposes without insisting on an unrealistic standard

whichcouldundulyfrustratetransactions.

The process of document examination is a complex undertaking for the banks. As banks

cannotlookbeyondthefaceofthedocumentstodeterminecompliance,itispossiblethat

payment ismadeagainstdocumentswhichappeartoconformbutare laterdiscoveredto

containdefects.Thiswouldbethecasewheredocumentshadbeenfalsifiedtoconceallate

shipmentorhadbeenauthorisedbyaforgedsignature.Thesubsequentdiscoveryofdefects

is problematic since payment will have already been made to the seller. In light of this

possibility,theUCPestablishestheruleofapparentcompliancewhichguaranteesthepaying

bank’srighttoreimbursementincircumstanceswherethedocumentsappearedtocomply

withthetermsofthecreditatthetimeofpayment.94Withoutsuchprotection,banksmay

well become unwilling to finance international transactions by documentary credit and,

therefore,theruleofapparentcomplianceistobewelcomed.

Apotentialriskassociatedwiththeprincipleofstrictcomplianceisthatitcouldopenthedoor

toopportunisticbehaviourbytheissuingbank.Opportunisminthissensewouldcontemplate

theidentificationofanydiscrepancytorefusepayment,95particularlyifthiswasaccompanied

bypressure from its customeror the suspicionof fraud.Of course, thiswouldnot be an

illegitimateresponsetodiscrepanciesonanisolatedreadingofthetermsofthecreditand

UCP.Thisisunlikelytobeasignificantriskinpractice,however,sincebankshaveavested

92ISBP681(n89)[25].93Ibid[6].94UCP600art.14(a);BrindleandCox(n29)[8-088]-[8.089].95Todd,MaritimeFraud&Piracy(n3)[4.019];SeealsoGuarantyTrustCoofNewYorkvVandenBerghs(1925)22LlLRep112,114perRocheJthatabankcouldrejectdocumentsonthebasisofminordiscrepanciesifthemarkethadfallen.Thisisofcoursesubjecttothebank’sknowledgeandinterestthatthemarkethadfallen.Thiswouldseemtocontradictthemodernviewthatbanksarenottoassessthematerialityofdiscrepanciesbutsimplytodeterminewhetherdocumentscomply.

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interestinpaymentssucceedingforreputationalreasons.96Empiricalresearchgivescredence

to this assertion. The evidence demonstrates that payments are routinely made against

discrepant presentations notwithstanding the existence of defects which would justify

rejection.97DetaileddiscussionofthisempiricalworkispostponeduntilChapterFivebut,for

now, it suffices tosay that thisevidenceundermines thepossibility thatstrictcompliance

mightoperateasaproxyforsuspicionsoffraud.

Much like thedoctrineof autonomy, theprincipleof strict complianceensures the credit

fulfils its function as an efficientmethod of trade financing. Firstly, the determination of

whetherthedocumentscomplywiththetermsofthecreditismuchmorestraightforward

than a process which demanded an assessment of the materiality of any documentary

defects.Thisenablesthebanktoexaminedocumentswithinthefivedayspermittedbythe

UCP98whichcontributestothecommercialdemandforaswiftpaymentmechanism.

Strictcomplianceshouldalsoprovideadegreeofreassuranceforthebuyer.Firstly,this is

because compliant documents should only be capable of productionwhen the seller has

performedhissubstantiveobligations.99Inaddition,thebank’sabilitytorejectdocuments

containingminordiscrepanciesshouldprovidesomeprotectionagainstfraud100sincesuch

defectsmayindicatewrongdoingbythecreditbeneficiary.101Thisshouldminimisetherisk

forthebuyerofmakingpaymentinadvanceofreceivingthegoods.

The legal framework which has developed to support documentary credit transactions

reflects the commercial desire for an efficient system of financing which cannot be

underminedbydisputesrelatingtotheunderlyingcontractofsale.Thismakessenseinan

environmentofhonesty.Ariskthatremainsunmitigatedbythecreditmechanismandalegal

framework which privileges autonomy is the risk that the beneficiary will commit fraud.

96Harbottle(n31)151perKerrJ;BolivinterOilSAvChaseManhattanBank[1984]1Lloyd’sRep.251,257perSirJohnDonaldsonMR:theinjunctionundermines“thebank’sgreatestasset…namelyitsreputationforfinancialandcontractualprobity.Furthermore,ifthishappensatallfrequently,thevalueofallirrevocablelettersofcreditandperformancebondsandguaranteeswillbeundermined.”97Mann(n8)2502–2504.98UCP600art.14(b).99Mann(n8)2505;MMoses,‘Lettersofcreditandtheinsolventapplicant:Arecipeforbadfaithdishonor’(2005-2006)57AlaLRev31,47.100DHorowitz,LettersofCreditandDemandGuarantees:DefencestoPayment(OUP,2010),[3.19];Ellinger,‘Fraudin documentary credit transactions’ (n25) 260; W Chew, ‘Strict compliance in letters of credit: The bankersprotectionorbane?’(1990)2SAcLJ70,71.101Horowitz(n100)[3.19].

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Cognisant of this gap, the English courts have crafted a fraud exception to autonomy to

respondtowrongdoingbythebeneficiary.Thisisthefocusfortheremainderofthechapter.

III. TheFraudExceptionThedevelopmentofthefraudexceptioncausesthecompetingpolicyconsiderationsofthe

autonomyof thecreditmechanismandfrauddeterrencetocollide.102This isbecausethe

demandforanefficientandunassailablepaymentmechanism,facilitatedbythedoctrineof

autonomy, iswholly opposed to the characteristics of a systemdesigned to uncover and

sanctionfraud.

Theriskoffraud–heightenedbycontainerisationandhigh-qualityreproductionmethods–

meansthatawhollyautonomousmechanismwouldbeproblematic.Ifthecreditapplicant

couldneveradduceevidenceextraneoustothedocuments,thiswouldgivethegreenlightto

the fraudulent beneficiary whose wrongdoing would be concealed by documents which

appearedtoconform.Itfollowsthatanexceptiontothedoctrineofautonomyincasesof

fraudisrequiredforreasonsofpublicpolicy.Asanexceptiontoautonomy,thisenablesthe

claimanttolookbeyondthedocumentstofurnishthenecessaryevidence103by,forexample,

introducingdocumentaryevidencerelatingtotheunderlyingcontract,evidencefromthird

partiesandevidenceofthequalityofthegoods.

TheimpactoffraudbythebeneficiaryisnotestablishedintheUCP.Instead,theICChave

takentheviewthatfraudisacontroversialissuewhichisbestlefttonationalcourtstofashion

rules in linewith local attitudes.104 In balancing the competing policy considerations, the

Englishcourtshaveconsistentlyemphasisedtheautonomyofthemechanismoveramore

robustanti-fraudrule.Theresultingexceptionisnarrowinscope,requiringtheclaimantto

provefraudbythebeneficiaryaswellasseveralotheronerouscriteria.Thismeansthatthe

Englishcourtswillonlyintervenetodisruptpaymentsunderthecreditmechanisminthemost

102Thisisthebalancingexercisereferredtointheopeningparagraphsofthischapter,seetexttofn2.103MalekandQuest,Jack(n32)[9.2].104ICCBankingCommission,‘LatestqueriesansweredbytheICCBankingCommission’(1997)3(2)DocumentaryCreditsInsight6citedinADavidson,‘Fraud,thePrimeExceptiontotheAutonomyPrincipleinLettersofCredit’(2003)8Intl.Trade&BusLAnn23,26.

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exceptional of circumstances. The limited circumstances in which the exception can be

invokedinpracticecallsintoquestiontheexplanatorypowerofthenotionthatfraudunravels

all. It also brings into focus other documentary defects unconnected to the beneficiary,

notablydocumentswhichhavebeenforgedorarenullities,andwhetherthesecanbeused

todelaypaymentunderadocumentarycredit.

ThefollowingdiscussionchartstherestrictiveapproachtofraudinEnglishlaw.Itcommences

withaconsiderationofhowthecourtshaveconceivedofthefraudproblemandtheirrolein

combattingfraud(A).Itthendiscussesthecircumstancesinwhichthefraudexceptioncanbe

employed(B).Muchliketheinsuranceforfeiturerule,thefraudexceptionindocumentary

creditsdependsinpartonexturpicausa.Aconsideredanalysisofthejuridicalbasisofthe

ruleisundertakeninpartC.Theproceduralaspectsofthefraudexception–thecriteriathe

claimantwillneedtosatisfy(D),thestandardofproof(E)andissuesrelatingtotheinterim

injunction(F)arethenconsideredinturn.

A. Settingthescene:JudicialconceptionsoffraudTherearefewstatisticswithwhichtogaugetheextentofthefraudproblemindocumentary

credits.AnabsenceoffraudcasesinEngland105hascontributedtothisobscuritybutthisis

more likely due to the chilling effect of the judicial construction of fraud, than an actual

absenceof fraud.As such, there are only very limited indications as to the extent of the

problem. One such indication appears from Langley J’s judgment in Banco Santander v

Bayferninwhichhecommentedthat,“itwascomfortingtohearfrombothexpertsthatthe

incidenceoffraudinthesesituationsisveryrareindeed…whilstwhenitarises[is]nodoubt

capableofinvolvingverylargesums.”106Referenceshouldalsobemadetothemostrecent

105MBridge,TheInternationalSaleofGoodsLaw&Practice(2nded.OUP,2007),[6.84],“failureoffraudcasestogototrialgivesrisetosomedifficultyindefiningfraudandgivinginstructiveexamples.”SeealsoESymons,‘Lettersofcredit:Fraud,goodfaithandthebasisforinjunctiverelief’(1979-1980)54TulLRev338,344whichsuggeststhatpatternsoflitigationmirroreconomiccyclesinbusiness.106BancoSantanderSAvBayfernLtd[1999]CLC1321,1332.Inthiscasetheconfirmingbankhaddiscountedtheletterofcredittothebeneficiary.Thebeneficiary’sfraudwasdiscoveredafterdiscountingbutbeforematurity.Thequestionforthecourtwaswhethertheriskoffraudshouldbebornebytheconfirmingbankortheissuingbank(andapplicant)undertheUCP500.Theriskwasdeterminedtoliewiththeconfirmingbankbecausethebankhadtakenanassignmentofthebeneficiary’srights.ThepositionhasnowbeenchangedundertheUCP600art.7(c)andart.12(b).

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TradeFinanceSurveyconductedbythe ICCwhichrecordedthe“troublesometrend[s]”of

increasingallegationsof fraudandapplications for injunctions.107Ofcourse, thisdoesnot

meanthatfraudishappeningwithanygreaterregularitythanpreviously.

Anefficientsystemoftradedependsontheabilitytosellgoodsonthebasisofdocuments

and for those documents to transfer ownership to the buyer.108 The bill of lading was

developedforthispurpose.Itwascommonpracticethatbillsofladingwereissuedinthree

sets as a safeguard for the buyer against lost documents.109 This, however, creates the

possibilityforfraud110asthesellercouldtheoreticallysellthesamecargotomultiplebuyers

andissueeachabilloflading.Billsofladingcontinuetobeissuedinthreesets111eventhough

the conditions justifying thispracticeno longerexist.112Of course, thepartiesare free to

stipulatethatthebuyershouldreceiveafullsetofbillsoflading113andthiswouldprovide

someprotectionagainstfraud.Moderndevelopmentsalsocreateopportunitiesforfraudin

asystemwheretheaccuracyofdocumentsiscritical.Theavailabilityofhighqualitymethods

ofreproductionandtheuseofcontainers114assistunscrupuloustraders.

Perhapssurprisingly,thefraudriskdoesnotappeartohaveaffectedthepopularityofthe

mechanism.Indeed,neitherdoesfraudappeartobeperceivedasamajorconcernforthe

contractingparties.115AsToddhasargued,

107 ICC, ‘Global TradeandFinanceSurvey’ (n23)37,45-46. (18.5%of respondents reportedan increase in theallegationsoffraud.)108Bridge,Benjamin'sSaleofGoods(9thed)(n1)[18-007];McKendrick,GoodeonCommercialLaw(4thed.Penguin,2010)960.109Todd,MaritimeFraud&Piracy(n3)[3.037].110SandersvMaclean (1883)11QBD327,342perBowenLJ, “Thepossibilityof its separation is intentionallydevisedfor thepurposenotof fraud,butofprotectinghonestdealing.Theseparationmayconceivablyaffordopportunitiesoffraud,iftheholderschosetobedishonest,butonthewholethecommercialworldissatisfiedtoruntheriskofthiscontingencyforthesakeofthecompensatingadvantagesandconvenienceswhichmerchantsrightlyorwronglyhave…believedtobeaffordedbythesystemoftriplicatesorquadruplicates.”SeealsoUNCTAD,‘Documentaryrisk’(n19)63:“thesetofdocumentsprovidedwithaletterofcreditisapassporttofraud.”111Todd,MaritimeFraud&Piracy(n3)[2.052];PTodd,BillsofLadingandBankersDocumentaryCredits(4thed.Informa,2007),[3.26]“oneofwhichbeingaccomplished,theothersstandvoid.”112GlynMillsCurrie&CovEastandWestIndiaDockCo(1882)7AppCas591,599perEarlCairns.113DBackusandHHarfield,‘Customsandlettersofcredit:TheDixon,Irmaoscase’(1952)52ColumLRev589,593suggestingthatcreditscommonlyrequireallthreebillstobepresented.114Todd,MaritimeFraud&Piracy(n2)[2.047].115Ibid[2.050],[4.127].

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…maritime fraud is facilitated by a trading system, deliberately developed over

decades by commercial parties, where security against fraud has been sacrificed,

apparentlydeliberately,tocommercialexpediency.Thecourtsalsotaketheviewthat

this iswhat the commercial partieswant. There are costs to security, in terms of

convenienceandspeedaswellasfinancial,andthepartiesareassumednottowant

topaythosecosts.116

Thecourtsthenhaveconceptualisedtheirroleasgivingeffecttotheneedsofthecommercial

community.Inthedocumentarycreditcontext,thisisreflectedintheimportanceofswiftand

certain payment over the constructionof a broader fraud exception.More generally, the

discussioninSandersvMacleanisusefulinthisregard,

Theobjectofmercantileusagesistopreventtheriskofinsolvency,notoffraud;and

anyone who attempts to follow and understand the lawmerchant will soon find

himself lost ifhebeginsbyassumingthatmerchantsconducttheirbusinessonthe

basisofattemptingtoinsurethemselvesagainstfraudulentdealing.Thecontraryis

thecase.117

Morerecently,LloydLJendorsedthisproposition inTheFutureExpressholdingthat“that

celebratedobservationisastruetodayasitwasahundredyearsago.”118Thisviewthatthe

lawmerchanthasnoinstrumentalpurposeinfrauddeterrenceshouldnotbeconfusedwith

a liberalattitudetowrongdoingbytraders.119Theconverseistrue. Indeed,rulesonfraud

have developed to protect the integrity of the court and to prevent the fraudster from

benefitting from his ownwrongdoing.Where these rules operate against the beneficiary

directly,hewilllosehisentirerighttopaymentwithoutanyconsiderationofproportionality

or contributory negligence.120 In addition, a claim in the tort of deceit will enable the

defraudedpartytorecovertheentiretyofitspaymentanddamagesforalldirectlossfrom

116Ibid[2.003].117Sanders(n110)343perBowenLJ.118TheFutureExpress[1993]2Lloyd’sRep.542,544.119Todd,‘Outlawingdishonestinternationaltraders’[2000]LMCLQ394,394.120StandardCharteredBankvPakistanNational ShippingCorp. (Nos.2and4) [2003]1AC959, [16]per LordHoffmanndrawingsupportat[14]-[17]fromEdgingtonvFitzmaurice(1888)29ChDiv459.

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thebeneficiary.121 Indirect actionsagainst thebeneficiary, the courtswill nothesitate to

enforcethehigheststandardsofcommercialmorality.122

Frauddeterrenceisviewedasamatterforthepartiestoresolvepre-contractually.AsBowen

LJcommentedinSanders,

Credit,notdistrust, is thebasisof commercialdealings;mercantilegenius consists

principally in knowing whom to trust and with whom to deal, and commercial

intercourseandcommunicationisnomorebasedonthesuppositionoffraudthanit

isonthesuppositionofforgery.123

This assumption that traders will only deal with honest counterparts is also apparent in

modern case law. InHIHvChaseManhattan, LordBinghamcommented that commercial

partieswillassumethe“honestyandgoodfaithoftheother;absentsuchanassumptionthey

wouldnotdeal.”124ThesamesentimentsareevidentinareportissuedbytheUnitedNations

ConferenceonTradeandDevelopment(UNCTAD).Forbuyers,suggestedUNCTAD,“thebest

protection…istomakeadequateinquiriestobeabletosatisfythemselvesastothereliability

ofthepartiestheydealwith.”125TheReportfurtherattributedfraudindocumentarycredits

toinsufficientsafeguardstoensurethatthecontractualgoodshadactuallybeenshipped.126

Thecourtsevidentlyviewcommercialtradersasabletoprotectthemselvesand,moreover,

considerthatthisisappropriate;thecourts’roleisnottorewritethecontractexpost.

The suggestion that fraud should be amatter for the parties does have some force.127 A

number of American commentators have characterised credit transactions as involving

121DoylevOlby(Ironmongers)Ltd[1969]2QB158,167perLordDenningMR.122See,forexample,StandardCharteredBankvPakistanNationalShippingCorp.(No.2)[2000]2Lloyd’sRep.511,[2]perEvansLJ.123Sanders(n110)343perBowenLJ.124HIHCasualty&GeneralInsurancevChaseManhattan[2003]2Lloyd’sRep.61,68.SeealsoYamSengPteLtdvInternational TradeCorporation Ltd [2013] EWHC111 (QB), [2013] 1 Lloyd’sRep. 526, [135]per Leggatt J: “Aparadigmexampleof a general normwhichunderlies almost all contractual relationships is anexpectationofhonesty.Thatexpectationisessentialtocommerce,whichdependscriticallyontrust.”125UNCTAD,‘Documentaryrisk’(n19)74.126 Ibid62.SeealsoUlph(n20)368whichshesuggeststhattheUCP600containsa“subtlemessage”thattherequirementofacertificatefromanindependentexpertisthebestprotectionagainstfraud.127Todd,MaritimeFraud&Piracy(n3)[2.051].

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experienced,commercialpartieswhodonotrequirejudicialprotection.128Onthisbasis,the

court’srole issimplyto interpretthecontractualagreement. InGill&DuffusvBerger, for

example,thecontracttermprovidingthattheexpert’scertificatewouldbedeterminativeof

thequalityof thegoodswas“freelynegotiatedand included in thecontractbetweenthe

partiesintheinterestsofspeed,certaintyandeconomy.”129Ifthebuyerisconcernedthata

singleexpert’scertificatedoesnotprovideadequatesafeguards,130heshouldnegotiatefor

greaterprotection.Moreover,asToddhasargued,ifthecontractdoesnotrequiredelivery

againstafullsetofbillsof lading,131theonus isonthebuyertoensurehiscounterpart is

honestandnotforthecourtstoremakethedealexpost.132

Judicial pronouncements in general do not contemplate the risk of fraud in international

trade.133Thisisnottosaythatthecourtswillpermitafraudstertogetawaywithwrongdoing,

butratherevidencejudicialassumptionsabouttheparties involvedinoverseastrade.The

courtsclearlyregardtradersassophisticatedcommercialpartieswhodonotrequiretheir

protection, in the formof amore rigorous fraudenquiry. In any event, amoreproactive

approach to fraud would diminish the speed and efficiency of payment. The following

discussion will demonstrate the prominence of these considerations in shaping the

availabilityofrelief.Itwouldseemthatinthecontextofdocumentarycredits,preventionis

regardedasbetterthancure.

B. CircumstancesinwhichthefraudexceptionisrelevantItisconventionaltobeginanydiscussionofthefraudexceptionwiththeAmericancasegiving

rise to the ruleonboth sidesof theAtlantic,Sztejn v SchroderBankingCorp.134 The case

128JDolan,TheLawofLettersofCreditCommercialandStandbyCredits(4thed.ASPratt&Sons,2007)[7-80]“thelaw should not reward novice or unknowledgeable parties at the expense of a credit device fashioned byexperienced merchants…Rather than accommodating those whomisunderstand and thus destroy the credit,courtsshouldenforcecreditsvigorouslyandhastenthelearningprocess.”;XGao,TheFraudRuleintheLawofLettersofCredit:AComparativeSurvey(KluwerLawInternational,2002)77:“acommercialtransactionbetweensophisticatedpartieswhocanandshouldlookaftertheirowninterests.”129Gill&DuffusvBerger[1984]AC382,388perLordDiplock.130UNCTAD,‘Documentaryrisk’(n19)62.131Todd,MaritimeFraud&Piracy(n3)[3.038].132Ibid[2.051].133See,forexample,MeyersteinvBarber(1866-67)LR2CP38,51perWillesJ:“allargumentsfoundeduponthenotionthattheCourtistopronounceajudgmentinthiscasewhichwillprotectthosewhodealwithfraudulentpeople,arealtogetherbesidethefactsofthiscase,andforeignfromtransactionsofthisnature.”134SztejnvSchroderBankingCorp177Misc.719(NYMisc1941).

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involvedacontractforthesaleofbristleswhichwastobefinancedbydocumentarycredit.

Thebuyerallegedthatthesellerhadsentboxesofrubbishinsteadofthecontractgoodsand

soughtaninjunctionagainsttheissuingbankandbeneficiary.Theissuingbankarguedthat

as itwasonlyconcernedwith thedocuments,apresentationwhichappearedtoconform

shouldentitleittopaythebeneficiary.

ShientagJbeganhisjudgmentbyemphasisingtheimportanceofthedoctrineofautonomy,

Itiswellestablishedthataletterofcreditisindependentoftheprimarycontractof

sale between the buyer and the seller. The issuing bank agrees to pay upon

presentationofdocuments,notgoods.Thisruleisnecessarytopreservetheefficiency

oftheletterofcreditasaninstrumentforthefinancingoftrade…Itwouldbe…most

unfortunate…ifabankwasobligedorevenallowedtogobehindthedocuments,at

therequestof thebuyer,andenter intocontroversiesbetweenthebuyerandthe

sellerregardingthequalityofthemerchandiseshipped.135

Thisconfirmsthatordinarybreachesoftheunderlyingcontractwillnotbesufficientforthe

courtstointerferewithpaymentunderadocumentarycredit.136Hecontinued,however,that

the autonomy principle “presupposes that the documents accompanying the draft are

genuineandconformintermstotherequirementsofthe letterofcredit.”137Accordingly,

wherethesellerhasactedfraudulently–by,forexample,intentionallyfailingtoshipanyof

thecontractgoods138–andthisisknowntothebank,thebankisentitledtoresistpayment.139

The protection afforded to beneficiaries by the doctrine of autonomy “should not be

extendedtoprotecttheunscrupulousseller.”140

135Ibid721perShientagJ.136Ibid721-722perShientagJ.137Ibid721perShientagJ.138Ibid722perShientagJ.139Ibid722perShientagJ.140Ibid722perShientagJ.

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Althoughthefocusofthethesisisfraudcommittedbythebeneficiary,141thefraudexception

canbe employedwithin several of the contracts createdby thedocumentary credit. It is

convenienttooutlinethesefactpatternsbeforeconsideringtherelevantcriteriaandissues

ofproof.

(1) Thebeneficiarybringsasuitfollowingthebank’srefusaltopayduetofraud.

Thefraudexceptionisinvokedbythebankasadefencetonon-payment.

(2) Theapplicantresistsaclaimforreimbursementfromtheissuingbankonthe

basisthatthebankshouldnothavepaidduetofraud.

(3) Thepayingbankseekstorecoverpaymentdirectlyfromthebeneficiary.This

actionoccurseitherasaclaimfordamagesinthetortofdeceit142oranaction

inrestitutiontoreclaimmoneypaidunderamistakeoffact.143

(4) (a)Theapplicantseeksaninterlocutoryinjunctionagainstthebanktoprevent

paymentduetofraud.

(b)Theapplicantseeksaninterlocutoryinjunctionagainstthebeneficiaryto

preventthepresentationofdocumentsonthebasisoffraud.

The consequences of the fraud exception depend upon the circumstances in which it is

employed.Usedagainstthebeneficiary,theexceptionwillpreventhimreceivingpayment

(situation 1), require him to pay damages to the bank (situation 3) or preclude the

presentation of documents (situation 4b). Where the exception is employed against the

issuingbank, itwilloperatetobarthebank’sclaimforreimbursementfromtheapplicant

(situation2)orwillpreventthebankfromhonouringthecredit(situation4a).

A successful direct action against the fraudulent beneficiary – situations 3 and 4b – is

relativelyunlikely.Thisisbecausethefraudstermaywellhavedisappearedwiththeproceeds

ofthecredit144and/ortheclaimantwillstruggletosatisfytheproceduralhurdlestosucceed

141Asopposedtofraudcommittedbytheapplicant,seeMalekandQuest,Jack(n32)[9.20];XGao,‘Theidentityofthefraudulentpartyunderthefraudruleinlawoflettersofcredit’(2001)24UNSWLS119,125-128.142StandardCharteredBank(Nos.2and4)(n120)[4]perLordHoffmann.143EdwardOwen(n31)171perLordDenningMRcitingBankRusso-Iranv.GordonWoodroffe&Co.Ltd.(3October1972,QBD)perBrowneJ(notedbyLNWilliams(1972)116SolJo921).144Todd,MaritimeFraud&Piracy(n3)[2.004],[4.041]

185

at the interim stage.By contrast, judicial intervention in situation2 requires the court to

allocatethelossbetweentwoinnocentparties;theissuingbankandthebuyer.Bridgehas

characterisedthelossestothesepartiesasfollows,

ThelosstothebuyermaybethemarketlossthatcomeswithpayingforJulygoods

wheninfactAugustgoodswereshipped,oritmaybethelossarisingonthereceipt

of goods that bear little relation to goods of the contractual description. The loss

incurredbyanissuingbank,forexample,maybethereducedvalueofitssecurityifit

istakingapledgeofthedocumentsassecurityforanadvancetothebuyer.145

Although the focus in this thesis is fraud committed by the credit beneficiary, the varied

circumstancesinwhichtheexceptionmaybeemployedrequirescarefulconsiderationofthe

legalbasisforjudicialintervention.Itisappropriatetoexaminethejuridicalbasisofthefraud

exceptionatthisstage.

C. ThejuridicalbasisoftheexceptionTheleadingcaseonfraudinEnglishlawisUnitedCityMerchantsvRoyalBankofCanada146

in which the confirming bank employed the exception to refuse payment to the credit

beneficiary(situation1).147TheHouseofLordsrecognisedanarrowfraudexceptioninthis

casewhichwaspremisedonexturpicausa.148Thisproved,however,tobean inadequate

explanation for intervention inall thecircumstances inwhich the fraudexceptionmaybe

relevant. Accordingly, subsequent case law has developed a supplementary basis for

intervention;theimpliedtermanalysis.Thediscussioninthissectionteststheseexplanations

againsteachofthesituations1-4wheretheexceptionisrelevant.Theargumentmadehere

isthatbothanalysesarerequiredtounderstandjudicialinterventionincasesoffraud.

Thejuridicalbasisofthefraudexceptiondoesnot,ingeneral,garnersignificantacademicor

judicial attention. The leading academic treatment of documentary credits, Jack:

145MBridge,‘Documentsandcontractualcongruenceininternationaltrade’inSWorthington,(ed.),CommercialLawandCommercialPractice(Hart,2003),228-229.146UnitedCityMerchants(HouseofLords)(n4).147AcomprehensivediscussionofthefactsofthiscaseandthecriteriarequiredtotriggerthefraudexceptionarepostponeduntilPartD.148UnitedCityMerchants(HouseofLords)(n4)6perLordDiplock.

186

DocumentaryCredits,confinesitsdiscussionofthejuridicalbasisoftheexceptiontoamere

twoparagraphs.149TheabsenceofdetailedconsiderationinGoodeonCommercialLaw150is

somewhatsurprisinggiventhatGoodehasdevotedsignificantattentiontootheraspectsof

thefraudexception.151Therationaleoftheexceptionisaffordedamatterofsentencesby

Ellinger and Neo in which they simply reiterate the position advocated by the House of

Lords.152Enonchong’streatmentoftheexceptionislonger–runningtosevenparagraphs153

–butfocusessubstantiallyontheimpliedtermanalysis154withlimitedattentionpaidtothe

explanationprovidedinUnitedCityMerchants.155Judicialdiscussionsoftherationaleofthe

rulearealsosimilarlylacking.156Takentogether,thislackoffocusissurprisinggiventhatthe

juridicalbasisofthefraudexceptionisnotcomprehensivelysettled.

i. Theexturpicausaanalysis

InUnitedCityMerchants,LordDiplockexplainedtheexceptionas“aclearapplicationofthe

maximexturpicausanonorituractioor, ifplainEnglish istobepreferred,fraudunravels

all.”157This immediatelypresentsaproblem.158Theusual translationofex turpi causa,or

illegality,isthefollowing,derivedfromthecaseofHolmanvJohnson,

NoCourtwilllenditsaidtoamanwhofoundshiscauseofactionuponanimmoralor

an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action

appearstoariseexturpicausa,orthetransgressionofapositivelawofthiscountry,

theretheCourtsayshehasnorighttobeassisted.159

149MalekandQuest,Jack(n32)[9.13]-[9.14].150McKendrick,GoodeonCommercialLaw(n108)1101,asingleparagraphisdevotedtothejuridicalbasis.151Forexample,Goode,‘Abstractpaymentundertakings’(n29)228-234.152EllingerandNeo(n35)141.153Enonchong,TheIndependencePrinciple(n2)[5.03]-[5.009].154Ibid[5.06]-[5.09].Thediscussionofthealternativebasisoftheexceptiondoesnotjustruntoagreaternumberofparagraphsbutalsoasignificantlyhigherwordcount.155Ibid[5.04]-[5.05].156Forexample,therecentPrivyCouncildecisioninAlternativePowerSolutionLtdvCentralElectricityBoard[2014]UKPC31,didnotconsidertheprecisejuridicalbasisoftheexception.157UnitedCityMerchants(HouseofLords)(n4)6perLordDiplock.158See,forexample,MalekandQuest,Jack(n32)253(fn5inoriginal)wheretheauthorscommentthat‘fraudunravelsall’istraditionallytranslatedfromthemaxim,frausomniacorrumpit.Bridge,‘Documentsandcontractualcongruence’(n145)229isalsoinfavourofthisalternativetranslationalthoughhenotedthat“blanketstatementsofthiskind,however,envelopebetterthantheyexplain.”159HolmanvJohnson1Cowp342(1775),343perLordMansfield.

187

Thisruleisdesignedtomaintaintheintegrityofthecourtandtopreventtheplaintiffprofiting

fromhisownwrongdoing.160Indeed,thisishowLordDiplockwentontoexplainthefraud

exceptioninUnitedCityMerchantsstating,“theCourtswillnotallowtheirprocesstobeused

byadishonestpersontocarryoutafraud.”161Giventhatthefraudexceptionwillnotalways

involve the beneficiary directly, it is questionablewhetherex turpi causa can adequately

explainjudicialinterventioninthesecases.

Todeterminethevalidityoftheexturpicausaanalysis,itisnecessarytoconsidereachofthe

circumstancesinwhichtheexceptionisemployed.

In situation 1, a claim for payment under a letter of credit by the beneficiary who has

submittedfraudulentdocumentswouldcertainlyariseexturpicausaandwouldfurnishthe

payingbankwithadefence.Insituation3,thebeneficiary’sfraudwouldentitlethepaying

banktobringadirectclaimforreimbursement.Thisrationalewouldalsoaccountforthecase

inwhichtheapplicantsoughtaninjunctionagainstthefraudulentbeneficiarytopreventhim

presentingdocumentsforpayment(situation4b).Itisthepersonalfraudofthebeneficiary

in thesecaseswhichwould justify interventiononthebasisofex turpicausa.Thecourts’

refusaltoassistadishonest litigant isevidentwhenthefraudexceptionoperates inthese

circumstancesanddeprivesthebeneficiaryofcontractualrights.

By contrast, in a claim for reimbursement by the issuing bank (situation 2) orwhere the

applicantseeksaninjunctionagainsthisbank(situation4a),thefraudulentbeneficiaryisnot

aparty to theaction. The court in these situations isnotbeingasked toaida fraudulent

claimantbutrathertoallocatelossesbetweeninnocentparties(situation2)ortoeffectively

createa causeof actionwhere theapplicant seeksan injunctionagainst the issuingbank

(situation4a).Thisistheoppositeofajudicialrefusaltobecomeembroiledinanetworkof

contracts tainted with fraud. As such, ex turpi causa provides a much less convincing

160BrindleandCox(n29)724.161UnitedCityMerchants(HouseofLords)(n4)7perLordDiplock.

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explanationofinterventioninthesecircumstances.162Foreaseofexposition,thefollowing

tabledemonstratesthosecasesinwhichexturpicausaprovidesavalidjuridicalbasisforthe

operationofthefraudexception.

Situation Exturpicausa?

(1)Bankrefusestopaybeneficiary

Yes

(2)Applicantrefusesreimbursement

No

(3)Bankseeksreimbursementfrombeneficiary

Yes

(4a)ApplicantseeksinjunctionagainstIB

(4b)Applicantseeksinjunctionagainst

beneficiary

No

Yes

Table1:Exturpicausaasjuridicalbasis

Given the inabilityofex turpi causa toexplain judicial intervention inall circumstances in

whichtheexceptionmayoperate,itbecomesrelevanttoconsiderwhetherbroaderprinciples

fromthelawofillegalitymayassistinthisrespect.Inparticular,thequestioniswhetherthe

notionoftaint–wherebyaprimafacielawfulcontractisdeclaredunenforceablebecauseit

iscollateraltoan illegaltransaction163-couldbeusedtoexplain intervention incasesnot

directlyinvolvingthefraudulentbeneficiary(situations2and4a).Theauthor’sviewisthat

thisanalysisdoesnotunderpinjudicialactivityinthesesituations.Inthefirstplace,theauthor

hasnotfoundanycasesinwhichsuchanargumenthasbeenmadeand,moreover,thecourts

do not speak in terms of ‘unenforceability’ when the fraud exception operates in these

circumstances.Interestingly,andbywayofcontrast,theseideashavebeenexplicitlyusedin

themorerecentdevelopmentofanillegalityexceptiontopaymentincredittransactions.164

162Toddhasmadethisargumentinrelationtotheclaimforreimbursement,seePTodd,‘Non-genuineshippingdocumentsandnullities’[2008]LMCLQ547,556.163Acomprehensiveaccountofthelawofillegalityisbeyondthescopeofthisproject.ReadersaredirectedtoRBuckley,IllegalityandPublicPolicy(3rded.Sweet&Maxwell,2013).164GroupJosiRevWalbrookInsuranceCoLtd[1996]1Lloyd’sRep345,354perStaughtonLJ;MahoniaLtdvJPMorganChaseBank(No1)[2003]2Lloyd’sRep.911,[66],[68]perColmanJ;MahoniaLtdvJPMorganChaseBank

189

This suggests to the author that the courts regard the fraud and illegality exceptions as

distinct.Finally,interventioninsituation4arequiresthecourttocreateacauseofactionfor

theapplicantagainsttheissuingbank.Thiswillingnessofthecourtstoinvolvethemselvesin

this situation is to be contrastedwith the typical judicial refusal to become embroiled in

contractstaintedwithfraud.

The foregoing discussion has demonstrated that ex turpi causa cannot explain judicial

interventioninallcircumstancesinwhichthefraudexceptionisemployed.Asupplementary

basisfortheexceptionhasbeensuggestedincaselaw165towhichattentionnowturns.

ii. Theimpliedtermanalysis

Morerecentcaselawhasexplainedthefraudexceptiononthebasisofanimpliedterm.166

Thisrespondstothefactthat,incertainsituations,theoperationoftheexceptiondepends

onthebank’sknowledgeoffraud.167If,forexample,thecourt’sdesirewassimplytoprevent

itsprocessesbeingusedtofacilitateafraud,thebank’sknowledgeoffraudpriortopayment

would be unnecessary.168 This, however, remains an important criterion which must be

satisfiedinsituations2and4a.169InCzarnikow-RiondavStandardBank,RixJdiscussedthe

fraud exception in light of the contractual relationships created by the letter of credit.

Drawingonpreviouscaseswhichinterpretedthesourceoftheexceptionascontractual,170

hearguedthat“paymentinthefaceoffraudcan[not]beamerematterofdiscretionbya

bank:itmustbeeitherwithinitsmandateornot,andeitheramatterofobligationornot.”171

RixJfurtherdescribedthedecisioninUnitedCityMerchantsas“anauthoritativeexpression

andWestLB[2004]AllER(D)10,[428],[432]-[433]perCookeJ.Alengthierdiscussionoftheimpactofillegalityincredittransactionsisomittedfromthisthesisforreasonsofspace.ReadersaredirectedtoHorowitz(n100)Ch7foracomprehensivetreatmentofillegalityinthiscontext.165Czarnikow-RiondavStandardBank[1999]2Lloyd’sRep.187.166MalekandQuest,Jack(n32)[9.14].ForacomprehensiveaccountofimpliedtermsunderEnglishlawsee,Chitty(32nded.)(n20)chapter14.167Thecriteriawhichmustbesatisfiedtotriggerthefraudexceptionwillbeconsideredshortly,seePartCofthischapter.168Czarnikow-Rionda(n165)203perRixJ.169Ibid205;GianSingh(n81)9perLordDiplock;MalekandQuest,Jack(n32)[9.41].Seelaterdiscussion,PartC(iv).170Czarnikow-Rionda(n165)203perRixJcitinginteraliaHarbottle(n31);TukanTimber(n31);DiscountRecords(n27).171Czarnikow-Rionda(n165)203perRixJ.

190

ofthesourceinlawoftheimpliedlimitationonabank’smandate.”172InEnglishcontractlaw,

thepurposeof implying termswasrecentlyconsideredby theSupremeCourt inMarks&

SpencervBNPParibasSecurities.173TheCourtheldthatthepurposeof implicationwasto

“discover what the parties have agreed”174 and only authorised the insertion of terms if

“without the term, the contractwould lack commercialorpractical coherence.”175 Foran

impliedtermtooperateintheletterofcreditcontext,itwouldneedtoconformtothistest.

Aswiththetaskabove,thediscussionwillnowconsiderinwhichofthesituationstheimplied

termanalysiscanexplainjudicialintervention.Duetotheautonomousnatureofthecontracts

createdby the credit, this supplementary analysis has the greatest potential in situations

wherethereisadirectrelationshipinvolvingthepayingbank.It isforthisreasonthatthe

implied term analysis cannot explain the position as between applicant and beneficiary

(situation4b).176

Itisconvenienttobeginbyconsideringthecontractbetweenthebankandbeneficiaryasthis

isthefocusoftheimpliedtermanalysisinJack177andadoptedbyBridge.178Onthisbasis,the

termwouldberelevantasadefencetonon-paymentbythebank(situation1)andasacause

of action to recover payment from the fraudulent beneficiary (situation 3). Any cause of

actionprovidedbytheimpliedterminsituation3wouldoperatealongsideanactionindeceit

orrestitution.

The authors of Jack suggest that the term would amount to a representation by the

beneficiarythatthedocumentsdidnottohisknowledgecontainmaterialmisrepresentations

norwerepartofanattempttodefraudthebankoritscustomer.179Itisnotimpossiblethat

such a term could conform to the test enunciated in theMarks & Spencer’s case. The

172Ibid203perRixJ.173Marks&SpencerplcvBNPParibasSecuritiesServiceTrustCo(Jersey)Ltd[2015]UKSC72,[22]-[32]perLordNeubergerclarifyingtheapproachinAttorneyGeneralofBelizevBelizeTelecom[2009]1WLR1988.174Marks&Spencer(n173)[69]perLordCarnwarth.175Ibid[21]perLordNeuberger.176Bridge,‘Documentsandcontractualcongruence’(n145)229.177MalekandQuest,Jack(n32)[9.14].178ThisisthefocusofthediscussioninMalekandQuest,Jack(n32)[9.14]andBridge,‘Documentsandcontractualcongruence’(n145)229.179MalekandQuest,Jack(n32)[9.14].

191

referencetothebank’scustomerdoesnotraiseanyconflictwiththedoctrineofautonomy

sincethelattergiveswaywhenthefraudexceptionoperates.

The question is whether the implied term – as formulated in Jack – can explain judicial

interventioninsituations1and3.Intheabsenceofdefinitivejudicialcommentonthematter,

acoupleofbriefcommentswillbeoffered.Itwouldberelativelystraightforwardtorecognise

an impliedterminsituation3as itwouldaugmenttheexistingpost-contractualcausesof

actionavailabletothebank.Theimpliedterminvolvesamorecomplicatedanalysisinrespect

ofsituation1becausethetermwouldneedtofunctionasadefencetonon-paymentbythe

bank.Thereisnothingtopreventthedevelopmentofsuchananalysisbutitwouldrequire

seniorjudicialconsideration.Indeed,untilsuchtimeasthecourtshaveexaminedtheimplied

termanalysisinmoredetail,theprecisecontentandutilityofanytermremainsamatterfor

academicspeculation.

Bycontrast,theimpliedtermanalysisisparticularlypromisingasbetweentheissuingbank

and the applicant. The term would provide a defence where the applicant refuses

reimbursement(situation2)andcreateacauseofactionwhenaninjunctionissoughtagainst

the bank (situation 4a). The content of the term would relate to the bank’s contractual

mandate to make payment to the beneficiary. As discussed above, the rule of apparent

compliance contained in the UCP 600 entitles the banks to pay when the presented

documentsappeartocomply.Thebank,however,willnotbeentitledtoreimbursementifit

knew at the time of payment that the documentswere fraudulent notwithstanding their

apparentcompliance.180Theimpliedterm,therefore,wouldprovideaconcretebasisforthis

qualificationtothebank’sentitlementtopay.

Support for this analysis is provided by Enonchong181 and by analogy to some case law

discussion.InTukanTimber,HirstJarguedthatanapplicantwouldhavea“cast-ironclaimfor

damages”182 against a bank which paid against apparently compliant documents in

circumstanceswhenithadknowledgeoffraud.ItisreasonabletoassumethatwhatHirstJ

180BrindleandCox(n29)[8-088]-[8-089].181Enonchong,TheIndependencePrinciple(n2)[5.06].182TukanTimber(n31)177perHirstJcitedinCzarnikow-Rionda(n165)203perRixJ.

192

hadinmindwasanimpliedcontractualtermtounderpinthisclaimsincethereisnothingto

suggestthatthepartieshadexpresslycontractedonthisbasis.

TheimpliedtermanalysisisyettobetestedbyaseniorEnglishcourt.183InAlternativePower,

acasewherethecreditapplicantsoughtaninjunctionagainsttheissuingbank(situation4a),

thePrivyCouncildidnotdiscussthejuridicalbasisofthefraudexception.184Thereferences

toex turpi causa throughout the judgment185 are disappointing given the inability of the

maxim to explain the fraud exception in these circumstances. Indeed, the implied term

analysiswouldbeparticularlyuseful incontracts involvingthecreditapplicantand issuing

bank,asisthecaseinsituations2and4a.Animpliedterminthecontractbetweenissuing

bankandbeneficiarywouldprovideafurtherdefenceinsituation1andanadditionalclaim

forreimbursementinsituation3.

Theforegoinganalysisshouldmakeclearthatexturpicausacannotconvincinglyexplainthe

variety of contexts in which the fraud exception can be utilised. This difficulty could be

rectified either by recognising fraus omnia corrumpit as the appropriate maxim or by

admitting that the contracts are more interconnected than doctrine would suggest. It is

submittedthatthislattersolutionisunlikelygiventheprimacyaccordedtoautonomybythe

courts. In addition, the contractual analysiswould strengthen the operation of the fraud

exception and would provide an additional basis for judicial intervention in certain

circumstances.Thevalidityofthecontractualanalysisremainstobesettledbysubsequent

caselaw.Assumingthisanalysisisvalid,thefollowingtablesetsoutthejuridicalbasisorbases

applicableineachofthesituationsinwhichthefraudexceptionmightbeinvoked.

183 Ithasgainedacademicsupport,however, seeMalekandQuest, Jack (n32) [9.26];KDonnelly, ‘Nothing fornothing:Anullityexceptioninlettersofcredit?’[2008]JBL316,322whodescribesitas“moreprincipled”;themajorityoftextbookscitetheimpliedtermanalysisasanalternativeoradditionalbasisforinterventionincasesoffraud,seeMalekandQuest,Jack(n32)[9.14];McKendrick,GoodeonCommercialLaw(n108)1101;BrindleandCox(n29)[8-087].184AlternativePower(n156).185Ibid[37][46][78]perLordClarke.

193

Situation JuridicalBasis/Bases

(1)Bankrefusestopaybeneficiary

Exturpicausa

Impliedterm:IBandBeneficiary

(2)Applicantrefusesreimbursement

Impliedterm:IBandApplicant

(3)Bankseeksreimbursementfrombeneficiary Exturpicausa

Impliedterm:IBandBeneficiary

(4a)ApplicantseeksinjunctionagainstIB

(4b)Applicantseeksinjunctionagainst

beneficiary

Impliedterm:IBandApplicant

Exturpicausa

Table2:Exturpicausaandimpliedtermanalysis

Asitstands,judicialinterventionislargelypremisedonthenotionthat‘fraudunravelsall’.

Thephraseitselfsuggestsafairlyexpansivejurisdiction.Broadercontextualconsiderations

related to the documentary credit as a financing device have militated against liberal

interventionbythecourts.Thisisparticularlyevidentwhenoneconsidersthewayinwhich

the criteriapertaining to the fraudexceptionhavebeen framed.The followingdiscussion

establishesthecriterianecessarytoinvokethefraudexceptionattrial,relevantinsituations

1-3,discussedabove.Thisisfollowedbytheadditionalcriteriawhichmustbesatisfiedfor

reliefattheinterlocutorystage,aswillberequiredinsituation4aandb.

D. CriteriaTheleadingcaseonthefraudexceptioninEnglishlawisUnitedCityMerchants.186Thecase

involvedthesaleofafibreglassplantbetweenEnglishsellersandPeruvianbuyerswhichwas

financedbydocumentarycredit.Thesellershadassignedtheirrightsandobligationsunder

thecredittoUnitedCityMerchants.Thecreditrequiredshipmenttobemadeby15/12/1976

from London to Callao. The first presentation of documents was rejected. A second

presentation stated that shipment had been made from London on 15/12/1976. The

documents therefore appeared to conform to the terms of the credit. The second

186UnitedCityMerchants(HouseofLords)(n4).ThisisalsotheleadingEnglishcaseonillegalityinaletterofcredit.

194

presentation was also rejected. The bank contended that it had information which

demonstratedthatshipmenthadnotbeeneffectedonthespecifieddateand,moreover,that

thiswasknowntothebeneficiarybeforethesecondpresentation.Thespecificallegationwas

that the documents had been fraudulently backdated by the loading broker tomeet the

requirementsof thecredit.Thebeneficiaryand itsassigneebroughtanactionagainst the

negotiatingbankdemandingpayment(situation1).

Atfirstinstance,MocattaJheldthatthebeneficiarywasentitledtopaymentasthefraudhad

been committed by an independent third party without the beneficiary’s knowledge or

authorisation.187TheCourtofAppealdisagreed,holdingthatthefraudulentbackdatingofthe

billbarredthebeneficiary’srighttopayment,irrespectiveoftheauthorofthefalseshipment

date.Thefocuswasonthenatureandqualityofthedocumentsratherthantheidentityof

theircreator.188Accordingly,theCourtofAppealunanimouslyallowedtheappealbecause

thebank’sobligationtopaywasonlytriggeredbythepresentationofgenuinedocuments

which conformed to the terms of the credit.189 If the bank knew, therefore, that forged

documents were presented, it had no obligation to pay; the identity of the forger was

“immaterial.”190

TheHouseofLordsrestoredthedecisionofthefirstinstancejudge.LordDiplockcommenced

hisjudgmentbyreinforcingthedoctrineofautonomy,

The whole commercial purpose for which the system of confirmed irrevocable

documentarycreditshasbeendevelopedininternationaltradeistogivetotheseller

anassuredrighttobepaidbeforehepartswithcontrolofthegoodsthatdoesnot

permitofanydisputewiththebuyerastotheperformanceofthecontractofsale

beingusedasagroundfornon-paymentorreductionordefermentofpayment.191

187UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1979]1Lloyd’sRep.267,278perMocattaJ(hereafterreferredtoasUnitedCityMerchants(FirstInstance)).188United CityMerchants v Royal Bank of Canada (The American Accord) [1981] 1 Lloyd’s Rep. 604, 623 perStephensonLJ,628perAcknerLJ,632perGriffithsLJ(hereafterreferredtoasUnitedCityMerchants(CourtofAppeal)).189Ibid628perAcknerLJ,632perGriffithsLJ.190Ibid632perGriffithsLJ.191UnitedCityMerchants(HouseofLords)(n4)6perLordDiplock.

195

Hecontinued,

To this general statement of principle…there is one established exception…that is,

wheretheseller,forthepurposeofdrawingonthecredit,fraudulentlypresentsto

the confirming bank documents that contain expressly or by implication,material

representationsoffactthattohis[theseller’s]knowledgeareuntrue.192

As the bill of lading had been backdated by a third party, without the beneficiary’s

knowledge,193 the fraud exceptiondid not operate to deprive the assuredof payment.194

Moregenerally,apartyseekingtoinvokethefraudexceptionwillneedtosatisfyeachofthe

criteriaestablishedinUnitedCityMerchants.Forclarity,thesearesummarisedhere:

i. Amaterialmisrepresentationoffactinthedocuments

ii. Fraudknowntothebeneficiary

iii. Therepresenteereliesonthefraud

iv. Fraudknowntothebank(relevantinsituations1,2and4a)

i. Materialmisrepresentationoffactinthedocuments

Thefraudmustinvolveamaterialmisrepresentationoffact,expressorimplied,withinthe

documents. Bywayof example, thedocumentswould containmisrepresentationsof fact

when apparently compliant documents were presented but the beneficiary had shipped

rubbish, as in Discount Records v Barclays.195 Equally, the presentation of apparently

compliant documentswhere nothing had been shipped, as demonstrated by the facts of

EtablissementEsefka,196wouldsatisfythiscriterion.Asafinalexample,documentswhichhad

beenalteredtoconcealabreachofthecreditcontract–thedateorplaceofshipment,for

192Ibid6perLordDiplock.193Ibid7perLordDiplock.194Ibid11perLordDiplock.Thiswassubjecttothedecisionontheillegalitypoint.TheHouseofLordsheldthatthebeneficiarywasentitledtopaymentforsumswhichdidnotconstituteamoneytransactionindisguise.195DiscountRecords(n27);Sztejn(n134)721.196EtablissementEsefkaInternationalAnstaltvCentralBankofNigeria[1979]1Lloyd’sRep.445.

196

example–wouldalsomeetthistest.197Itshouldbenoted,forclarity,thatthefraudexception

didnotoperateinanyofthesecasesbecauseofdifficultiesinestablishingtheothercriteria.

Theseexamplesareincludedtoillustrate‘misrepresentationoffact’inthiscontext.

Adifficultyarisesinrelationtothestandardof‘materiality’.Thiswasnotconclusivelyresolved

in United City Merchants in which Lord Diplock rejected two conceptions of materiality

withoutprovidingadefinitivestandard.198

TheauthorsofJacksuggestthatmaterialityshouldbeassessedbyreferencetothebank’s

obligationtopay.199AppliedtothefactsofUnitedCityMerchants,hadthedocumentsinfact

showntheactual(late)shipmentdate,thebankwouldhavehadnoliabilitytopayandcould

have rejected the documents for non-compliance. This must be the correct approach.

Notably, this standard of materiality would not embrace all documentary defects. It is

suggestedinJack,forexample,thatabillofladingwhichhadbeenfalselydatedtoconceal

therealdateofshipmentbutwhereshipmenthadnonethelessoccurredwithinthepermitted

period would be a false, but immaterial, representation.200 This suggests that some lies,

thoughfalse,wouldfallshortofthematerialitystandardtobeactionableforthepurposesof

the exception. This has echoesof the recent insurancedecision inVersloot inwhich the

collateralliewasexcludedfromthefraudulentclaimsjurisdiction.201Thefalsebutimmaterial

standardisyettobetestedbythetradefinancecourts.

Analternativestandardofmaterialitywassuggestedbycounselfortheplaintiffbeneficiaries

inRafsanjanPistachioProducersvBankLeumi.202Itwascontendedthatastatementwould

onlybematerialifitreducedthevalueofthebank’ssecurityonresale.203This,presumably,

197UnitedCityMerchants(HouseofLords)(n4).198Enonchong,TheIndependencePrinciple(n2)[5.23]-[5.25];UnitedCityMerchants(HouseofLords)(n4)7perLordDiplockrejectedamaterialitystandardthatwouldhaveentitledthebanktorefusepaymentifthedocumentsaccurately reflected the condition of the goods and information about shipment but that these statementsdemonstratedthattherehadbeenabreachofthecreditcontract,8perLordDiplockalsorejectedastandardbywhichmaterialitywouldbeassessedaccordingtotheresalevalueofthegoodswerethebankrequiredtorealiseitssecurity.199MalekandQuest,Jack(n32)[9.17].200Ibid[9.17].201Seeearlierdiscussion,ChapterTwo,texttofn296etseq.202RafsanjanPistachioProducersCooperativevBankLeumi[1992]1Lloyd’sRep.513,541.203Ibid541.

197

wasdesignedtoconfinethematerialityenquirysinceanassessmentwouldonlyberequired

when the bank needed to realise its security following the applicant’s insolvency. This

suggestionwasnotacceptedinRafsanjan.Indeed,HirstJcommentedthatsuchananalysis

“misse[d]thepoint”becausethefraudrulewasdesignedtopreventdishonestlitigantsusing

thecourts’processestoperpetrateafraud.204Itwouldbecontrarytoprinciple,therefore,if

theoperationofthefraudexceptiondependedonthebank’sabilitytosellthedocumentsat

alaterdate.

FraudinthetransactionTherequirementthatthefraudappearsinthedocumentsisasignificantrestrictiononthe

scopeoftheexceptionandcallsintoquestiontheexplanatorypowerof‘fraudunravelsall’.

Thequestioniswhetherfraudbythebeneficiary–eithermisrepresentationinrelationtothe

underlyingcontractoranintentionalfailuretoshipanyofthecontractgoods205–issufficient

topreventpaymentunderthecredit.

As a starting point, there is nothing inUnited CityMerchantswhich overtly precludes an

extension to fraud in the transaction.206 Caution is required, however, given that Lord

Diplock’sintentionwastomakejudicialinterventionpossibleonlyinthemostexceptionalof

cases.207Thisisapparentinhisconcerntosafeguardtheviabilityofthecreditmechanism,

stating that a broader fraud exceptionwould “undermine thewhole system of financing

internationaltradebymeansofdocumentarycredits.”208

Nevertheless,therearepowerfulpolicyargumentssupportingsuchanextension.Inthefirst

place,iftherationaleoftheexceptionisthatfraudunravelsall,itshouldnotmatterwhere

thebeneficiary’swrongdoingislocated.209Toconfineactionablefraudtothatlocatedinthe

documentswould,asEnonchonghasargued,furtherhinderthecourts’abilitytodiscourage

204Ibid541-542perHirstJ.Thelogicalconclusionofthisanalysiswouldsuggestthatthepurposeofthefraudruleistosecurethefullvalueofthedocumentstothebank.205Sztejn(n134)721perShientagJ.206Horowitz(n100)[2.15].207Ibid[2.15].208UnitedCityMerchants(HouseofLords)(n4)7perLordDiplock.209MalekandQuest,Jack(n32)[9.26];Enonchong,TheIndependencePrinciple(n2)[5.18];EllingerandNeo(n35)143.ThisechoestheargumentsusedtosupportthenascentdevelopmentofanillegalityexceptioninEnglishlaw:MahoniaLtd(2003)(n164)[68]perColmanJ;MahoniaLtd(2004)(n164)[431]perCookeJ.

198

fraudininternationaltransactions.210Fraudinthetransactionhasalsobeenrecognisedas

sufficientinperformancebondcases.211This,admittedly,isaweakerbasisforextendingthe

exceptiongiventheveryfewdocumentaryrequirementsinbondtransactions.212

RecentcaselawdoessuggestthatEnglishcourtswouldnowbepreparedtorecognisefraud

inthetransaction.InGroupJosiRe,thecreditapplicantsoughttodisruptpaymentonthe

basis that the underlying contract of reinsurance had been induced by fraudulent

misrepresentation and/or non-disclosure.213 Although the injunction was ultimately

refused,214thefactthattheallegedwrongdoingrelatedtotheunderlyingtransactiondidnot

concernthecourt.TheapplicantinCzarnikow-Riondaalsosoughttoinvoketheexceptionon

thebasisof fraudulentmisrepresentation.215The injunctionwasrefusedat thebalanceof

conveniencestage,butagainthecourthadnoobjectionthatthefraudwasnotdocumentary

innature.216

Theexpressrecognitionoffraudinthetransactionwouldrequireconsiderationfromasenior

court. Inparticular,thecourtwouldneedtodeterminethenecessarydegreeofproximity

betweenthefraudandthecreditcontract.217ThiswouldovercomeHorowitz’sconcernthat

anyextensiontofraudinthetransactionwouldundulycomplicatemattersforthebanks.218

Atpresent,thereappearstobeweakjudicialsupportforanexpandedconceptionoffraudto

includewrongdoingbythebeneficiaryinrelationtotheunderlyingsale.Untilsuchtimeas

the extension is confirmed, the restriction of actionable fraud to that apparent in the

documentsconstitutesa significant limitationon theextent towhich fraudunravelsall in

documentarycredittransactions.

210Enonchong,TheIndependencePrinciple(n2)[5.18].211McKendrick,GoodeonCommercialLaw(n108)1101;ThemehelpLtdvWest[1996]QB84,98-99perWaiteLJ.212Todd,BillsofLadingandBankersDocumentaryCredits(n111)[9.79].213GroupJosiRe(CourtofAppeal)(n164)358.214Ibid364perStaughtonLJ,369perSavilleLJ.215Czarnikow-Rionda(n165).216MalekandQuest,Jack(n32)[9.25];EllingerandNeo(n35)143.217Commentatorsinfavourofaconnectionbetweenthefraudandthedocumentarycredit includeMalekandQuest,Jack(n32)[9.26]andHorowitz(n100)[2.28].218Horowitz(n100)[2.28].

199

ii. Thebeneficiaryknowsthemisrepresentationtobeuntrue

Thebeneficiarymustknowatthetimeofpresentationthatthedocumentscontainmaterial

misrepresentations.219 This will be satisfied either where the beneficiary has himself

committedthefraudorwhereheadoptsthefraudofanother.220Enonchonghasarguedthat

thepositioninEnglishlawwithrespecttoagentsisnotyetclear.221Onnormalprinciples,

however,onewouldexpectthatthebeneficiarywouldberesponsibleforthefraudulentacts

of his authorised agent222 provided these were not designed to deceive the beneficiary

himself.223

Thelevelofknowledgemirrorsthatfoundinthetortofdeceit.Assuch,fraudwillbeproven

when the beneficiary presents documentswhich contain “a false representationmade (i)

knowingly(ii)withoutbelief in itstruthor (iii) recklessly,carelessofwhether itbetrueor

false.”224TheauthorsofJackhavesuggestedthepossibilityofabroaderstandard,namely

thatliabilitywouldbeimposedwhenthebeneficiaryhadsuspicionsaboutthedocument(s)

butfailedtoexaminethemproperly.225Thiswouldincreasethetypesofbehavioursufficient

toinvokethefraudexceptionaswellascreatingevidentialdifficulties.226Thishasyettobe

arguedbeforeacourtbut,giventherestrictiveapproachtofraud,theauthorsuggeststhatit

wouldbeunlikelyiftheexceptionwaswidenedinthisway.

219GroupJosiRe(CourtofAppeal)(n164)360perStaughtonLJ.220WBlair, ‘Commentaryon‘Documentsandcontractualcongruenceininternationaltrade’ inWorthington,S.(ed.),CommercialLawandCommercialPractice(Hart,2003),245(theexceptionextendstothepositionwherethebeneficiarytakesdocumentshonestlybutlaterlearnsoffraud.)221Enonchong,TheIndependencePrinciple(n2)[5.34]citingReHampshireLand[1896]2Ch743andLloydvGraceSmith[1912]AC715.ButseeGoode,‘Abstractpaymentundertakings’(n29)232,234wherethefraudexceptionincludesthefraudofthebeneficiary’sagent.222KweiTekChaovBritishTraders&ShippersLtd[1954]2QB459,470perDevlinJ,“ifSlootmakershadmadefraudulent representations toWilhelmson, theagentof theshippingcompany, inorder toprocure thebillsoflading,thedefendantswouldhavebeenliablealthoughtheyhadnotexpresslyauthorizedit,becauseSlootmakerswouldhavebeendoingimproperlytheveryactwhichtheyhadbeenauthorizedtodo;butthatisnotthequestionwhichIhavetoconsider.”223 F Reynolds (ed.), Bowstead & Reynolds on Agency (18th ed. Sweet & Maxwell, 2006), [8-064] – [8-065];Enonchong,TheIndependencePrinciple(n2)[5.35]citingKweiTekChao(n222)471perDevlinJ.224DerryvPeek(1889)14AppCas337,376perLordHerschell.225MalekandQuest,Jack(n32)[9.18].Thisstandardofknowledgeisrelevantinthemarineinsurancecontextinrelation to thedefenceof unseaworthinessunder s.39(5)MIA1906, seeCompaniaMaritima SanBasilio SA vOceanusMutualUnderwritingAssociation(Bermuda)Ltd(TheEurysthenes)[1977]QB49,68perLordDenningMR.226MalekandQuest,Jack(n32)[9.18].SeealsoEllingerandNeo(n35)142.

200

Thedecision toconfineactionable fraud to that committedby thebeneficiaryorwithhis

knowledgeplacestwoimportantlimitsonthescopeofthefraudexception.First,itmeans

that moral fraud – innocent misrepresentations of which the representor was wholly

unaware227–willnotbeactionable.Thecourtmustcontent itselfthatthebeneficiaryhas

knowinglycommittedfraud.Thesecondconsequenceisthatwrongdoingcommittedbyother

parties inthechain is irrelevantforthepurposesofthefraudexception,eventhoughthis

wrongdoingmayresultinforgedandnulldocumentsbeingpresentedtothebank.Thecourts

haveonceagainreliedonthecommercialdemandforanunassailablepaymentmechanism

tojustifytheirapproach.228Amorecompellingexplanation,intheauthor’sview,relatesto

thefactthatexturpicausaisexplicitlydesignedtopreventafraudsterprofitingfromhisown

wrongdoing.Accordingly,itisentirelylogicalthatonlyfraudbythebeneficiarytriggersthe

exception.

Thedecisiontorestrictactionablefraudtothatcarriedoutbythebeneficiaryhasforcedthe

courts to considerwhether forgery and nullity unconnected to the beneficiary constitute

independentbasesforrefusingpaymentunderacredit.229

ForgeryThe leadingdiscussionof forgery appears in theCourt ofAppeal judgment inUnitedCity

Merchants.StephensonLJdescribedaforgeddocumentinthefollowingterms,

Adocumentmaytellalieaboutitself,e.g.,aboutthepersonwhomadeit,orthetime

orplaceofmaking.Ifittellsalieaboutthemaker,itisaforgery;ifittellsalieabout

thetimeorplaceofmaking"whereeither ismaterial", it isa forgery:ForgeryAct,

1913, s.1(2)…Or the document may tell a lie about its contents. Then it is no

forgery…230

227RedgravevHurd(1881)20ChD1,seeearlierdiscussioninChapterOne,texttofn15.228UnitedCityMerchants(HouseofLords)(n4)7perLordDiplock.229Bridge,‘Documentsandcontractualcongruence’(n145)235.230UnitedCityMerchants(CourtofAppeal)(n188)618perStephensonLJ.SeealsoAcknerLJ’sjudgmentat628.

201

ThebillofladingproducedinUnitedCityMerchantstoldtwoliesaboutitself,namelythedate

andplaceofitscreation.231Itwasproperlyregardedasaforgery.Thequestion,therefore,

waswhetherforgeryofathirdparty–theloadingbroker–wassufficienttopreventpayment

underthecredit.TheCourtofAppealansweredintheaffirmative,citingthefactthataforged

document, even if the beneficiary was unaware of the defects, was not a complying

document.232AcknerLJcontinued,

Abankercannotbecompelledtohonouracreditunlessalltheconditionsprecedent

havebeenperformed,andheoughtnottobeunderanobligationtoacceptorpay

againstdocumentswhichheknowstobewastepaper…Thebuyer'sinstructionsto

thebankermustbeconstruedasrequiringtheacceptanceofvaliddocumentsonly,

andthebanker'spromisetothesellermustbesimilarlyconstrued.233

LordDiplockfirmlydisapprovedofthispositiononappealnotingthatadditionalexceptions

toautonomywouldhaveadetrimentalimpactoninternationaltrade.

This proposition which does not call for knowledge on the part of the

seller/beneficiary of the existence of any inaccuracy would embrace the fraud

exception and render it superfluous…[T]he more closely this bold proposition is

subjectedtolegalanalysis,themoreimplausibleitbecomes;toassenttoitwould,in

myview,underminethewholesystemoffinancinginternationaltradebymeansof

documentarycredits.234

Theconclusivepositionwithrespecttoforgery,therefore,isthatitdoesnotconstitutean

additionalbasisforrefusingpaymentunderthecredit.LordDiplock’sanalysismakesclear

thatthebankwillbeobligedtohonourthepresentationunlesstheforgerycanbeconnected

tothebeneficiaryatthetimeofpresentation.235

231Ibid618perStephensonLJ.232Ibid623perStephensonLJ,628perAcknerLJ.233Ibid628perAcknerLJ.234UnitedCityMerchants(HouseofLords)(n4)7perLordDiplock.235Ibid7perLordDiplock.

202

NullityWrongdoingbyapartyotherthanthecreditbeneficiarymayrenderthedocumentanullity.

Anulldocumenthasnolegalvalueandisessentiallyaworthlesspieceofpaper.236InKwei

TekChao,DevlinJconsideredthattherelevanttestwaswhetherthealterationrelated“to

thewholeortotheessenceoftheinstrumentornot.”237Thefocus,therefore,iswhetherthe

documentiscapableofservingitsintendedcommercialfunction.ThebillofladinginUnited

CityMerchants,despitethemisstatementsrelatingtothetimeandplaceofshipment,was“a

valid transferable receipt for the goods giving the holder a right to claim them at their

destination,Callao,andwasevidenceofthetermsofthecontractunderwhichtheywere

beingcarried.”238Thedocumentwasthusnotanullity.

Therearenumerousexamplesofnullityinthecaselaw.Adocumentpurportingtobeissued

by a companywhich does not existwould count as a nullity239, for example, aswould a

documentsignedbyapersonwhohonestly,butwrongly,believedhewasentitledtodoso.240

Abillof ladingeithercoveringnon-existentcargoonanon-existentship241oraforgedbill

coveringexistingcargowouldequallycountasnullities.242Incertaincircumstances,aforgery

mayadditionallyrenderadocumentanullity,suchaswhenthebillofladingwasnotissued

bythecompanypurportingtobetheissuer243andwhereacertificateofinsuranceistendered

withoutavalidpolicy.244

Nullitiescauseproblemsforpartiestakingthedocumentsassecurity;thecreditapplicantand

the issuingbank.Thedocumentsenable theultimatebuyer to takedeliveryandmaintain

subsequentactionsinrespectofdamage.245Thedocumentsalsoenablethepayingbankto

236Montrod (n31)[43]“worthless inthesensethat it isnotgenuineandhasnocommercialvalue,whetherassecurityforthegoodsorotherwise”237KweiTek(n222)476perDevlinJ.238UnitedCityMerchants(HouseofLords)(n4)9perLordDiplock.239BeamTechnology(MfG)PteLtdvStandardCharteredBank[2002]SGCA53;DNeo,‘Anullityexceptioninletterofcredittransactions’[2004]SingJLS46,68.240Montrod(n31)[56].241Todd,‘Nongenuineshippingdocuments’(n162)562;Todd,BillsofLadingandBankersDocumentaryCredits(n111)[9.152],[9.156].242 As was the case in Motis Exports Ltd v Dampskibsselskabet AF 1912 Aktieselskab andAktieselskabetDampskibsselskabetSvendborg[2000]1Lloyd’sRep.211,217perManceLJ. 243Goode,‘Abstractpaymentundertakings’(n29)231.244Ibid231.245Bridge,Benjamin(9thed.)(n1)[18-008],[18-018];Todd,BillsofLadingandBankersDocumentaryCredits(n111)[5.5].

203

recoupitslossesintheeventoftheapplicant’sinsolvencypriortoreimbursement.246These

actions are impossible where the documents are nullities.Whether nullities constitute a

furtherbasisfordenyingpaymentis,therefore,critical.

LordDiplockdidnotconclusivelyresolvethenullityquestioninUnitedCityMerchants.247The

issuesubsequentlycamebeforetheCourtofAppealinMontrodvGrundkotter.248Thecredit

stipulatedthataninspectioncertificateshouldbesignedbythecreditapplicant.Duringthe

transaction, however, thebeneficiarywasmistakenly led tobelieve that it could sign the

certificateonbehalfoftheapplicant.Itdulydidso.Thecreditapplicantarguedforanullity

exception which would enable presentations to be rejected which contained documents

whichwere“notgenuineandha[d]nocommercialvalue.”249Thiswasunanimouslyrejected

bytheCourtofAppeal,

Thecreationofageneralnullityexception,theformulationofwhichdoesnotseem

tomesusceptibleofprecision,involvesmakingundesirableinroadsintotheprinciples

of autonomy and negotiability universally recognised in relation to letter of credit

transactions…Further such an exception would be likely to act unfairly upon

beneficiariesparticipatinginachainofcontractsincaseswheretheirgoodfaithisnot

in question. Such a development would thus undermine the system of financing

internationaltradebymeansofdocumentarycredits.250

Asitstands,therefore,adocumentwhichisanullityorhasbeenforgedmustbeacceptedas

good currency unless the defect can be connected to the beneficiary in time.251 This

undermines thedoctrineof strictcompliancesince it isdifficult toseehowforgedornull

documentscouldeverberegardedasthoserequiredbythecredit.Nevertheless,thecourts

havejustifiedtheirrefusaltocreatefurtherexceptionstoautonomybytheneedtoensure

246AsrecognisedinBeamTechnology(n239)[33];Lorenzon(n54)116.247UnitedCityMerchants(HouseofLords)(n4)9perLordDiplock.248Montrod(n31).249Ibid[43].250Ibid[58]perPotterLJ.251UnitedCityMerchants(HouseofLords)(n4)7perLordDiplock.

204

that thecredit remainsanunassailablepaymentmechanism.252Thedifficultiescreatedby

thisanalysisandanalternativeapproachtonullitieswillbeconsideredinChapterFive.

Thediscussionnowrevertstothecriteriatheclaimantwillneedtoestablishtoinvokethe

fraudexception.Thethirdofthese–relianceandloss–considerstheimpactofthefraudon

theclaimant’sbehaviour.ThisisnotaparticularlydifficulthurdletomeetinEnglishlaw.

iii. Relianceandloss

Anordinaryclaiminthetortofdeceitwillrequiretheclaimanttoprovethattheyreliedon

the misrepresentation and subsequently suffered loss.253 This has to some extent been

modifiedby the recentdecision inHaywardvZurich.254TheSupremeCourtheld that this

element of the test would be satisfied where the claimant had been influenced by the

misrepresentation.255 The application of these requirements in the context of the fraud

exceptiondependsonwhetherthebankhasmadepayment.

Where payment is outstanding, the claimant – either the beneficiary (situation 1) or the

applicant(situations4aandb)-needshowonlythepotentiallossthatwouldhaveoccurred

hadthebankmadepayment.ThiswasconsideredinRafsanjanPistachiowherethebankhad

refused payment due to fraud (situation 1). The beneficiary contended that the reliance

requirementwouldonlybesatisfiedwherethebankhadactuallymadepayment.256HirstJ

swiftlydisposedofthisargumentstatingthatit“demonstrate[d]acompletemisconception

oftherelevantprinciple.”257Hefurtherheldthatthebankhadestablishedpotentialreliance

on the basis of “unanimous evidence of all the bank’s witnesses”258 and an objective

appreciationofthecircumstances.Thismustbethecorrectapproach.Ifactualreliancehad

252Ibid7perLordDiplock(forgery);Montrod(n31)[58]perPotterLJ(nullity).Seelater,ChapterFive,whereitwillbearguedthatthejudicialapproachtoforgeryandnullityunderminetherationaleforanarrowfraudexception.253StandardCharteredBankvPakistanNationalShippingCorp.(No.2)[1998]1Lloyd’sRep.684,704perCresswellJ;MJones,ADugdaleandMSimpson(eds.),ClerkandLindsellonTorts(21sted.Sweet&Maxwell,2015)[18-01].254HaywardvZurichInsuranceCo.[2016]UKSC48.255Ibid[67],[71]perLordToulson.256Rafsanjan(n202)542.257Ibid542perHirstJ.258Ibid542perHirstJ.

205

tobeestablishedpriortopayment, itwouldbe impossibleforan interim injunctiontobe

issuedinanycircumstances.259

The position is necessarily differentwhen the bank hasmade payment.Where the bank

attempts to recover fromthebeneficiary in the tortofdeceit (situation3), itwillneedto

demonstrateactualrelianceandloss.Thisisnotadifficultburdentosatisfy.260Indeed,itwas

held in Komercni Banka v Stone & Rolls that acceptance of the documents by the bank

constitutedrelianceonthebeneficiary’sfraudulentstatements.261Theissueofreliancewill

be similarly straightforward where the bank seeks reimbursement from his customer

(situation2).

Afourthcriterion–thatthefraudbepatenttothebank–isrequiredincertaincircumstances.

This requirementmust be demonstrated if the applicant wishes to resist reimbursement

(situation2).Itisalsorelevantintwocaseswherepaymentisoutstanding;wherethebank

defendsnon-paymentonthebasisoffraud(situation1)andwheretheapplicantseeksan

injunctionagainsttheissuingbank(situation4a).

iv. Fraudknowntothebank

Intheearlierdiscussion,thefraudexceptionwassaidtodependontwojuridicalbases;ex

turpi causa and an implied term. The supplementary analysis – the implied term – was

requiredtoaccountforthefactthatincertaincircumstances,thefraudexceptionrequires

proofofthebank’sknowledgeoffraudatthetimeitmadepayment.262If,forexample,the

judicial desire was simply to prevent its processes being used by dishonest litigants, the

knowledgerequirementwouldbeunnecessary.263Itappearstherefore,thatthisrequirement

servesonlytoincreasethealreadyconsiderableburdenontheclaimantandcorrespondingly

reducethelikelihoodofjudicialintervention.Accordingly,RixJproposedanamendmentto

exturpicausainCzarnikow-Rionda,

259Ibid542perHirstJ;Enonchong,TheIndependencePrinciple(n2)[5.47].260Enonchong,TheIndependencePrinciple(n2)[5.48].261KomercniBankavStone&Rolls[2003]1Lloyd’sRep.383,400perToulsonJ.262Czarnikow-Rionda(n165)203perRixJ.263Ibid203perRixJ.

206

Itwouldbelesspithybutmoreaccuratetofilloutthedictumbysayingthatfraud

unravels the bank’s obligation to act on the appearance of documents to be in

accordancewithacredit’srequirementsprovidedthatthebankknowsintimeofthe

beneficiary’sfraud.264

Thecriticalquestioninrelationtothiscriterionisoneoftiming;whenmustthebankhave

knowledgeofthefraud?Theanswerdependsonthecircumstancesinwhichfraudispleaded.

Theissuingbankisonlyentitledtoreimbursementwhereithaspaidwithoutnoticeofthe

fraud.Accordingly,toresistaclaimforreimbursement insituation(2), theapplicantmust

provethatthebankknewofthefraudbeforeitmadepayment.ThiswasestablishedinUnited

TradingvAlliedArabBank,265

wherepaymenthasinfactbeenmade,thebank'sknowledgethatthedemandmade

bythebeneficiaryontheperformancebondwasfraudulentmustexistpriortothe

actualpaymenttothebeneficiaryandthatitsknowledgeatthatdatemustbeproved.

Accordingly,ifallaplaintiffcanestablishissuchknowledgeafterpayment,thenhe

hasfailedtoestablishhiscauseofaction.Thebankwouldnothavebeeninbreachof

anydutyinmakingthepaymentwithouttherequisiteknowledge.Wedoubtthatthis

isreallyopentocontest.266

Thetimingissuehasprovedmoredifficultincircumstanceswherepaymentisyettobemade,

asinsituations1and4a.Ingeneralterms,EdwardOwenEngineeringvBarclaysisauthority

forthepropositionthatthebankcanonlyrefusepaymentwhere ithadknowledgeatthe

timeofthedemand.267Aproblemarises,however,whereabanksuspectsfraudbutcanonly

justifyrejectionofdocumentswithevidencegatheredbetweenthetimeofpresentationand

trial. The courts have struggled to determine whether subsequently acquired evidence

shouldbeadmissibleforthepurposesofthefraudexception.

264Ibid199perRixJ.265UnitedTradingCorporationvAlliedArabBankLtd[1985]2Lloyd'sRep554.266Ibid560perAcknerLJ.267EdwardOwen(n31)172perLordDenningMR,173perBrowneLJ.

207

InBolivintervChaseManhattan, itwassuggestedobiter thatevidenceacquiredafter the

bank’srefusaltopayshouldbesufficienttoinvokethefraudexception,268

…if,asLordDiplocksaid,theprincipleisthat"fraudunravelsall"andiftheissueis

whetherpaymentshouldnowbemade, it isnothingtothepointthatatanearlier

stagethefraudwasunknowntothepayerandsocouldnotbeginitsunravelling,if

fraudisnowknowntohimandhasnowunravelledhisobligations.269

When the issuewas subsequently considered inBalfour Beatty v Technical & General,270

WallerLJfeltconstrainedbythegeneralpropositionestablishedinEdwardOwen.271Hedid

concede,however,thatitwouldbeabsurdifthebankcouldnotrelyonevidenceunearthed

aftertherefusaltopayasthiswouldeffectivelyrequirethecourttoassistthefraudster.272

Toresolvethisdifficulty,WallerLJsuggestedthatifthebankwasabletoprovefraudbythe

timeofthehearing,itwouldhaveacauseofactionforfraudulentmisrepresentationagainst

the beneficiary.273 If the bank then obtained summary judgment in respect of the

misrepresentation, this would cancel out any liability which it otherwise owed to the

beneficiary.274

ThecircuityofWallerLJ’ssolution275promptedManceLJtosearchforamorestraightforward

alternativeinSoloBankvCanara.276Hesuggestedthatthecourtshouldsimplyuseitsgeneral

powertoprotectitsprocessesfromfraudinthesecircumstances.Todootherwise“would

affront good sense, and probably general principles relating to illegality, if Courts were

obligedtogivejudgmentinfavourofabeneficiarynowshowntobeactingfraudulently.”277

268Bolivinter(n96)256perSirJohnDonaldsonMR.269Ibid256perSirJohnDonaldsonMR.270BalfourBeattyCivilEngineeringvTechnical&GeneralGuaranteeCoLtd[2000]CLC252.271Ibid259perWallerLJ.272Ibid259perWallerLJ.273Ibid259perWallerLJ.274Ibid260perWallerLJ.275 See the critiquesof this analysis inNEnonchong, ‘Theautonomyprincipleof lettersof credit:An illegalityexception?’[2006]LMCLQ404,415-416;Todd,MaritimeFraud&Piracy(n3)[4.075].276SoloIndustriesLtdvCanaraBank[2001]2Lloyd’sRep.578.277Ibid[21]perManceLJ.

208

ThiswassubsequentlyendorsedinMahoniavJPMorganChaseBank.278Thesimplicityofthis

approachis,asEnonchonghasargued,“preferable”279tothesolutionadvancedinBalfour

Beatty,notleastbecauseitaccordswiththeoverarchingbasisofthefraudexception.

E. StandardsofproofAdiscussionofthestandardofproofrequiresustodistinguishwhatmustbeprovedattrial

andattheinterlocutorystage.Regardlessofthestageatwhichtheexceptionisinvoked,the

standardofproofplacesaconsiderableburdenontheclaimant.280Itisconvenienttodiscuss

standardsofprooftogetherbeforegoingon,inPartF,toconsidertheadditionalprocedural

requirementsforinjunctiverelief.

Asacivilissue,thenormalstandardofproofappliesattrial;thebalanceofprobabilities.This

issubjecttojurisprudencesuggestingthatthestandardisheightenedincasesinvolvingmore

serious allegations. The leading case is Hornal v Neuberger in which fraudulent

misrepresentationwasalleged.281Followingareviewoftheauthorities,theCourtofAppeal

concludedthatanintermediatestandardofproofwasappropriate,

Themoreserioustheallegationthehigherthedegreeofprobabilitythatisrequired:

butitneednot,inacivilcase,reachtheveryhighstandardrequiredbythecriminal

law.282

Asnotedintheinsurancediscussion,thestandardofproofwassubsequentlyconsideredin

ReH(Minors).283TheHouseofLordsdeterminedthattheordinarycivilstandardremained

applicableinseriouscases,butthatmore“cogentevidence”284wouldberequiredtoconvince

a court that the alleged event had occurred.285 This has been universally accepted as

applicableindocumentarycreditcases.286Interestingly,andunlikethepositionininsurance,

278MahoniaLtd(2003)(n164)[46]perColmanJ.279Enonchong,‘Theautonomyprinciple–illegality’(n275)415;Enonchong,TheIndependencePrinciple(n2)[5.61].280Enonchong,‘Theautonomyprinciple–illegality’(n275)413.281HornalvNeuberger[1957]1QB247282Ibid258perDenningLJ.283ReH(Minors)[1996]AC563,586-587perLordNicholls.284Ibid586perLordNichollscitingInreDellow’sWillTrusts[1964]1WLR451,455perUngoed-ThomasJ.285ReH(n283)586perLordNicholls.286MalekandQuest,Jack(n32)[9.32];McKendrick,GoodeonCommercialLaw(n108)1102.

209

the appropriateness of an intermediate standard has not been questioned in the trade

financecontext.Thisisprobablybecausefewfraudcasescomebeforethecourts.Thereisno

reason,however,thatHjalmarsson’sargumentsmadeintheinsurancecontextwouldnotbe

equallyrelevantinrespectofdocumentarycredits.287Allegationsoffraudbythebeneficiary

donotraiseanyhumanrightsissuesthatwouldmakethedefendantworthyoftheprotection

affordedbyahigherstandardofproof.288

Theposition ismore complicatedwhenan injunction is sought toprevent thebank from

making payment (situation 4a) or to prevent the beneficiary presenting documents for

payment(situation4b).Thecourtshavestruggledtoenunciatetheappropriatestandardof

proofinthesecircumstances.Variousexpressionsappearinthecaselawincludingthatthere

mustbeproofof“establishedorobviousfraud”289,a“realprospect”290ofestablishingfraud

and“agoodarguablecasethatonthematerialavailabletheonlyrealisticinference”isthat

thebeneficiarywasfraudulent.291Howeverexpressed,theburdenwillnotbedischargedby

an“uncorroboratedstatementofthecustomer.”292Thisisahighthresholdwhichisindicative

ofthetensionbetweentheautonomyprincipleandanattainablestandardofproof.293

Therehasalsobeen somediscussionaboutwhether there shouldbea lower standardof

proofwhenaninjunctionissoughttopreventthebeneficiarytenderingdocuments(situation

4b).WaiteLJfavouredalowerstandardinthesecircumstancesinThemehelp,arguingthat

wherethebeneficiarywasyettoseekpayment,aninjunctionwouldnotposethe“slightest

threat…to autonomy”.294 The Court of Appeal in Group Josi Re criticised this approach,

however,holdingthat“theeffectonthelifebloodofcommercewillbepreciselythesame

whetherthebankisrestrainedfrompayingorthebeneficiaryisrestrainedfromaskingfor

287JHjalmarsson,‘Thestandardofproofincivilcases:Aninsurancefraudperspective’(2013)17IntJE&P47.Seeearlierdiscussion,ChapterTwo,texttofn374etseq.288Ibid63,71.289EdwardOwen(n31)169perDenningLJ.290SoloIndustries(n276)1815-1816perManceLJ.291UnitedTrading(n265)561perAcknerLJ.292Bolivinter(n96)257perSirJohnDonaldsonMR.293McKendrick,GoodeonCommercialLaw(n108)1102.294Themehelp(n211)99perWaiteLJ.ThisapproachwasendorsedinCzarnikow-Rionda(n165)202perRixJ.

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payment.”295Academiccommentaryalsoappearstofavourasingletest.296Theapproachin

Themehelp isperhapsbestregardedasanaberrationgiventhatthedoctrineofautonomy

demandsthatpaymentisonlydisruptedinthemostexceptionalofcircumstances.297

InAlternativePower Supply, thePrivyCouncil reviewed theauthorities andproposed the

followingtest,

itmustbeclearlyestablishedattheinterlocutorystagethattheonlyrealisticinference

is (a) that the beneficiary could not honestly have believed in the validity of its

demandsundertheletterofcreditand(b)thatthebankwasawareofthefraud.298

The“onlyrealisticinference”299standardisnecessarilylowerthantheburdentheapplicant

wouldneedtodischargeattrial.300Thisdoesnotmean,however,thattheapplicantismore

likelytosucceedattheinterimstage.ThisisbecausetheUCPrequiresbankstodetermine

documentary compliance within five banking days301 which significantly increases the

practicalburdenofprooffortheapplicant.302 Inanyevent,theapplicantwillalsoneedto

satisfythecourtofadditionalmatters,discussedinPartF,toobtainaninteriminjunction.

ThePrivyCouncil’sinsistenceonthebank’sknowledgeisalsointerestingsincethiswouldbe

anunnecessarycriterionifthepurposeofthefraudexceptionwassimplytopreventfraud.303

The knowledge requirement perhaps further confirms the judicial preference for the

295GroupJosiRe(CourtofAppeal)(n160)361perStaughtonLJ.Seealsothejudgmentatfirstinstance,GroupJosiRe vWalbrook [1995] 1WLR1017, 1030per Phillips J stating that to establishdifferent testswould “rob thebeneficiaryofmuchofthebenefitwhichaletterofcreditisintendedtobestow.”296FavourableviewsarefoundinBrindleandCox(n29)732.ButfortheopposingviewseeMcKendrick,GoodeonCommercialLaw(n108)1099;Todd,MaritimeFraud&Piracy(n3)[4.083];MalekandQuest,Jack(n32)[9.77].297GroupJosiRe(CourtofAppeal) (n160)361perStaughtonLJ;GroupJosiRe(First Instance) (n295)1030perPhillipsJ.SeealsoSiriusInsuranceCovFAIGeneralInsuranceLtd[2003]EWCACiv470;[2003]1WLR2214,[31]perMayLJ,[34]perCarnwarthLJ.ThiswasnotdiscussedbythePrivyCouncilinAlternativePower(n156).298 Alternative Power (n156) [59] per Lord Clarke. The decision was referred to in National InfrastructureDevelopmentCompanyLtdvBancoSantanderSA[2016]EWHC2990(Comm)buttheCourtdidnotexpressanyopinionaboutthecorrectnessofthePrivyCouncil’sdiscussionoffraud.299AlternativePower(n156)[59]perLordClarke.300Czarnikow-Rionda(n165)202perRixJ.301UCP600art.14(b).302Todd,MaritimeFraud&Piracy(n3)[4.008];GMcMeel,‘Lettersofcreditandthefraudexception–thethresholdtestforinjunctiverelief’[2015]LMCLQ19,22.303Thisunderlinestheimportanceoftheimpliedtermanalysisasanadditionalexplanationofjudicialinterventionincasesoffraud.Seeearlierdiscussion,texttofn166.

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autonomy of the mechanism, expressed as the “integrity of banking contracts”304 in

Czarnikow-Rionda. Fromapracticalperspective, this additional requirement increases the

burdenonthepartywishingtoinvokethefraudexceptionandmakesitlesslikelythathewill

overcomethe“strongpresumptioninfavourofthefulfilmentoftheindependentbanking

commitments.”305

F. TheinjunctionIn situation 4, the applicant seeks an injunction against either the paying bank or the

beneficiary.Wheretheinjunctiontargetsthebeneficiary,theconclusionoftheseproceedings

willalsobeofinteresttotheissuingbank.306Thisisbecausetheoutcomewillenablethebank

toactconfidentlyinitsdecisiontohonourthecreditortorefusepayment.307Furthercriteria,

derivedfromtheHouseofLords’decisioninAmericanCynamidvEthicon,308arerelevantat

the interim stage. Claimants will be subjected to a three-stage test; i) themerits of the

evidence,ii)theadequacyofdamagesasaremedyandiii)theoverallbalanceofconvenience.

Thisisadifficulttestandmanyapplicantsfallatthefirsthurdle,failingtoprovefraudtothe

requisitestandard.

i. Themeritsoftheevidence

Aclaimof fraudat the interimstagemustbeprovedaccording to the testestablished in

AlternativePowerSupply,discussedabove.309Inrelationtothequalityofevidencerequired,

thefollowingcommentsmadebyAcknerLJinUnitedTradingareuseful,

…strongcorroborativeevidenceoftheallegation,usuallyintheformofcontemporary

documents, particularly those emanating from the buyer [the beneficiary of the

performancebond]…Fortheevidenceoffraudtobeclear,wewouldalsoexpectthe

buyertohavebeengiventheopportunitytoanswertheallegationandtohavefailed

304Czarnikow-Rionda(n165)202RixJ.305Ibid202RixJ.306MalekandQuest,Jack(n32)[9.40].307Ibid[9.40].308AmericanCynamidCovEthicon[1975]AC396.309AlternativePower(n156)[59]perLordClarke;seeearlierdiscussion,texttofn298.

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toprovideany,oranyadequateanswerincircumstanceswhereonecouldproperly

beexpected.310

Thenotionthattheallegedfraudstershouldbegiven“afairandproperopportunity”311to

rebuttheallegationshasbeenendorsedbyacademiccommentators.312

Thisplacesaconsiderableburdenontheclaimant,notleastbecausetheevidencemustbe

gatheredwithinthefivebankingdaysallowedfordocumentexamination.313Itisunsurprising,

therefore, that there are “vanishingly rare”314 examples of claimants satisfying this first

criterion for injunctive relief. Indeed, the author is aware of only one case involving a

traditional letterofcreditwheretheclaimantadducedsufficientevidence in time. In that

case–TukanTimber315-thecreditrequiredthatreceiptsweresignedbyoneofthebuyer’s

two directors and it was successfully established that signatures in respect of two

presentations were forged. The second presentation was “manifestly…crude and plainly

dishonest.”316TheCourtheldthattheseller-beneficiarycouldonlyhaveinferredthatthese

documents–whichhethenwentontopresentforpayment–werenotwhattheyappeared

to be.317 Although the injunctionwas not ultimately granted,318Tukan Timber is a useful

example of “one of those very, very rare cases wherein the strict burden of proof was

satisfied”.319

310UnitedTrading(n265)561perAcknerLJ;ItshouldbenotedthatUnitedTradingconcernedaperformancebondandnotaletterofcreditandsoitwasthesellerseekingtopreventbanksmakingpaymentunderthebond.Thejurisprudence relating to the fraudexceptionhasdeveloped in tandem in relation to theseautonomousbankundertakings.SeeUnitedCityMerchants(HouseofLords)(n4)6perLordDiplock.311UnitedTrading(n265)561perAcknerLJ.312Horowitz(n100)[5.43]describingtheapproachas“commendable’;McMeel(n302)21.313UCP600art.14(b).314McMeel(n302)21.315TukanTimber(n31).316 Ibid176perHirst J.Oneof thedocumentswaspurportedlysigned in1983butbore thenewnameof thecompanywhichhadnotbeenregistereduntilDecember1984.Thedocumentalsoborethesamedateasanearlierrejecteddocument.317Ibid176perHirstJ.318Ibid177perHirstJnotingthattheapplicanthadfailedtoprovethatthebeneficiarywouldhavemadeathirdpresentation under the credit and “I should, in the exercise ofmy discretion, have refused the order sought,applyingtheAmericanCynamidCo.v.Ethiconprinciples.”319Ibid176perHirstJ.Althoughthebeneficiarymetthenecessarystandardofproof,hewasunabletosatisfytheremainingcriteriaforthegrantofaninjunction.CasesinwhichthefirstcriterionhasbeensatisfiedinrelationtoaperformancebondincludeThemehelp(n211)91-93,100perWaiteLJandinrelationtoastandbyletterofcreditinKvaernerJohnBrownLtdvMidlandBankplc[1998]CLC446,450perCresswellJ.

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ii. Theadequacyofdamagesasaremedy

Wheresufficientevidenceoffraudhasbeenestablished,thecourtwillconsiderthesecond

limbofAmericanCynamid;whetherdamageswouldbeanadequateremedy in lieuofan

injunction.320Ifdamageswouldbeanadequateremedyfortheapplicant,theinjunctionwill

berefusednomatterhowstronghisprimafaciecasemaybe.321Damageswillveryoftenbe

considered adequate, particularly where the party to be injuncted has the capacity to

compensatetheapplicant.322Thiswillalmostcertainlybethecaseinactionsagainstthebank

asevidencedbythedecisionsinDiscountRecords323andGKNContractors.324

Ifaremedyindamageswouldnotbeadequateforthecreditapplicant,thecourtmustthen

considerthedefendant’sposition.Thecourtswillneedtodeterminewhetherdamageswould

adequatelycompensatethedefendantbankorbeneficiaryifitsubsequentlywonattrial.This

aspectofthetestmakesit“highlyunlikely”325thataninjunctionwillbeissued.Thisisbecause

reputationaldamagecausedtothebankasaresultofnon-paymentwillbedifficulttoremedy

bywayofapaymentindamages.326Indeed,thiswasthereasontheinjunctionwasrefused

in Tukan Timber; any damage to the bank was not compensable by the plaintiff’s cross-

undertakingindamages.327

iii. Theoverallbalanceofconvenience

The final element of theAmerican Cynamid test is the overall balance of convenience. It

requirescourtstoconsiderwhetherthegrantorrefusalofaninjunctionisleastlikelytoresult

in injustice.328 This is a considerable hurdle for the applicant to overcome. Reference is

320AmericanCynamid(n308)408.321Ibid408.322Enonchong,TheIndependencePrinciple(n2)[10.26].323DiscountRecords(n27)320.324GKNContractorsvLloyd’sBank(1985)30BLR48,51.325Bridge,Benjamin(9thed.)(n1)[24-31];AlternativePower(n156)[79]perLordClarke.326MBridge,Benjamin'sSaleofGoods(8thed.Sweet&Maxwell,2010)[24-028].327TukanTimber(n31)176.328Bridge,Benjamin(8thed.)(n326)24-028;MalekandQuest,Jack(n32)[9.74]“itwillbeconsideredwhethermoreharmwillbedonebygrantingorrefusingtheinjunction.”

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commonlymadetoKerrJ’sspeechinHarbottleinwhichhedescribedthistaskasconstituting

an “insuperable difficulty…[in which]…The balance of convenience would…be hopelessly

weightedagainsttheplaintiffs.”329

Indocumentarycreditdisputes,onewouldexpecttoseethesamefactorsbeingweighedby

thecourts.330Theseincludetheautonomyofthepaymentmechanismandpotentialdamage

tothebank’sreputation.331Subsequentdifficultyfortheapplicant-buyertorecoverunder

thecontractofsaleiffraudissubstantiatedattrialwillalsoberelevant,althoughthecourts

havegenerallybeenunpersuadedthatsuchdifficultyjustifiesaninjunction.InHarbottle,Kerr

J commented that “these are riskswhich themerchants take…This is unfortunate for the

plaintiffs, but it iswhat they have agreed.332 Two further factors are likely to reduce the

applicant’s chance of success, namely if the credit will expire during the currency of the

injunction333andtheavailabilityofafreezinginjunctionoverthebeneficiary’sassets.334The

lattercourseofactionisparticularlyadvantageoussinceitwillprovidesomeprotectionto

theapplicantand,asthecaselawsuggests,doesnotthreatentheautonomyofthecredit

mechanism.335

Thebalanceofthesefactorsisnotaneutralexercise,butstartsfrom“astrongpresumption

in favour of the fulfilment of the independent banking commitments.”336 Indeed, a

considerationofthesefactorsledRixJtocommentonthedifficultyofachievinginterimrelief,

IdonotknowthatitcanbeaffirmativelystatedthataCourtwouldnever,asamatter

ofbalanceofconvenience, injunctabankfrommakingpaymentunder its letterof

329Harbottle(n31)155perKerrJ.330MalekandQuest,Jack(n32)[9.75].331Ibid[9.75].332Harbottle(n31)155-156perKerrJ.333Enonchong,TheIndependencePrinciple(n2)[10.27].See,PermasteelisaJapanKKvBougesstroiBancaIntesaSpA[2007]EWHC3508(QB);Themehelp(n211)106perBalcombeLJ.334SeniorCourtsAct1981s.37;MalekandQuest,Jack(n32)[9.82];Czarnikow-Rionda(n165)203perRixJ(notingthattheavailabilityofMarevareliefwas“ahighlyimportantconsiderationandgoesveryfartounderminehis[theclaimant’s]complaintaboutthedifficultiesofhisposition.”)335ZLtdvA-Z[1982]QB558,574perLordDenningMR;Bolivinter(n96)257perSirJohnDonaldsonMR;Themehelp(n211)103perEvansLJ;Czarnikow-Rionda(n165)203-204perRixJ.ButseethemajorityreasoninginThemehelp(n211)100-101perWaiteLJand107perBalcombeLJ.336Czarnikow-Rionda(n165)202perRixJ.ConfirmedinAlternativePower(n156)[59]perLordClarke.

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credit…Allthatcanbesaidisthatthecircumstancesinwhichitshouldbedonehave

notso farpresented themselves,and that itwouldofnecessity takeextraordinary

factstosurmountthisdifficulty.337

Evenwheretheclaimanthassuccessfullyestablishedfraudtotherequisitestandard,itself

not an easy task, these concerns will generally extinguish the claim.338 The courts have

expressed concern that if interim injunctionsweremore readily attainable, it “would risk

endangering confidence in the integrity of the systemof financing international trade”339

based on autonomous undertakings. There is also concern that banks would suffer in

reputational terms if injunctions were more readily available,340 though it is difficult to

imagineanyreputationaldamageifnon-paymentresultedfromacourtorder.341Thebroader

contractualcontextofthecreditfurthercomplicatesaclaimforinjunctiverelief.InDiscount

Records,342theallegedfraudwasuncoveredinfrontofarepresentativeoftheissuingbank

butitwaslikelythatthebeneficiaryhadalreadyreceivedpaymentbydiscountingthecredit

beforethematuritydate.Aninjunctioninthesecircumstanceswouldnothaveaffectedthe

fraudster but only have prevented reimbursement of the confirming bank. Undoubtedly,

bankswouldbecomelesswillingtofinancetransactionsbydocumentarycreditifthelosses

flowingfromfraudwerebornebytheconfirminginstitution.

Applicantshaveonlybeensuccessfulinobtaininganinjunctionincasesinvolvingastandby

credit.343Itissubmittedthatalthoughtheclaimantwillneedtosatisfythesameprocedural

requirements irrespectiveof the typeof credit, the judicial appreciationof the remaining

criteriawill differ. Ellinger andNeohave argued convincingly that the critical point is the

337Czarnikow-Rionda(n165)204perRixJ.338AlternativePower(n156)[79]perLordClarke:“thereasonswhyreportedcasesofinjunctionsbeinggranted(orcontinued)underthefraudexceptionaresorareare(a)becauseitisalmostneverpossibletoestablishthetestforfraudasopposedtoamerepossibilityoffraud,butalso(b)becausethebalanceofconveniencewillalmostalwaysmilitateagainstthegrantofaninjunction.”339Bridge,Benjamin(8thed.)(n326)24-028citingDiscountRecords(n27)320,Bolivinter(n96)257perSirJohnDonaldsonMRandCzarnikow-Rionda(n165)204perRixJ.340Bolivinter(n96)257perSirJohnDonaldsonMR.SeealsoMcMeel(n302)23.341MalekandQuest,Jack(n32)[9.75].342 Discount Records (n27). See also Czarnikow-Rionda (n165) in which the beneficiary had already receivedpaymentviathenegotiatingorconfirmingbanks.RixJnotedat204-205thattheinjunctionwouldonlyservetopreventthereimbursementofthosebanksandwouldnothampertheallegedfraudster.343SeeKvaernerJohnBrown(n319);Themehelp(n211).

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relativeimportanceofpaymenttothebeneficiary.344Inadocumentarycredit,thebeneficiary

willexpectpaymentonthepresentationofconformingdocumentsanddelaymayimpacthis

ongoingabilitytotrade.345Bycontrast,promptpaymentislesscriticalforthebeneficiaryof

astandbycredit.Thisisbecausethestandbybeneficiarycannotknowattheoutsetwhether

hiscounterpartwillfailtoperformandconsequentlywhetherhewillneedtodrawonthe

credit.Accordingly,non-paymentof thecredit in thesecircumstanceswouldhaveamuch

lesserimpactforthestandbybeneficiarythanhiscounterpartunderatraditionalcredit.346

IV. ConclusionThedocumentarycreditprovidespartiestradingoverseaswithareliablepaymentmechanism

andmitigatesmany of the risks involved in international trade. The credit can serve the

purposes of the commercial community due to the principles of autonomy and strict

compliancewhichfacilitateamechanismbuiltonspeedandcertainty.Thecreditis,however,

unabletosolvealltherisksinherentininternationaltrade.Amajorunresolvedriskrelatesto

thepossibilitythatthecreditbeneficiarywillengageinfraud.Thisriskisbornebythebuyer

whichthecourtssuggestismitigatedthroughcarefulexantescreening.

TheUCPissilentastotheimpactfraudbyabeneficiarywillhaveonthecredittransaction.

TheEnglishcourtshaverecognisedafraudexceptiontoautonomywhichcanbeinvokedin

interim proceedings and at trial. This responds to public policy concerns to ensure that

fraudulentlitigantsarenotabletoprofitfromtheirdishonesty.Itisevidentthatinbalancing

theneedtopromoteinternationaltradeandthedeterrenceoffraud,theEnglishcourtshave

had the interests of the commercial community at the forefront. The result is a narrow

exception coupled with onerous procedural requirements.347 There is no doubt that the

courtshaveprioritised“considerationsofspeedandconvenience,[which]override[]thoseof

security.”348Theresult,asToddhasargued,maywellbethat“manyclaimswhichareinfact

344EllingerandNeo(n35)163.345Ibid163.346Ibid163.347Todd,MaritimeFraud&Piracy(n3)[4.008].348Ibid[4.008].

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fraudulent [will] succeed.”349 The credit applicant remains entitled to bring an action for

breachontheunderlyingcontractofsale,althoughthesuccessofthisactionwilldependon

theavailabilityandhonestyofthecreditbeneficiary.350

Thenarrowparametersofthefraudexceptionwerejustifiedbyreferencetothecommercial

importanceofaswift,unassailablepaymentmechanism.Thefollowingchaptercritiquesthe

judicialconstructionofthefraudruleandtherebyaddressesthethirdresearchquestion.In

particular, itwill suggest that thebalancedrawnbytheEnglishcourts isnot inevitable.351

SubsequentcourtshavereiteratedtheUnitedCityMerchantsanalysiswithoutconsidering

themoreexpansiveapproachesadoptedelsewhereortheunfortunateconsequencesthat

thisanalysiscreatesfor internationaltrade.Afurthercritique isbuiltuponempiricalwork

conductedintheUnitedStates.352Thisresearchdemonstratesthatcommercialpartiesuse

thecreditmechanismmoreinformallythandoctrinesuggests.Thiswillbeusedtodevelopan

argument that frauddeterrence is notmerely a pre-contractual issue, as the courts have

suggested,butthatmechanismsexistthroughouttheexchangetocontrolfraud.Asitstands,

“asuccessfulpleaoffraudappearstobeillusory.”353Thetotalityoftheargumentspresented

inChapterFivedemonstratethatadifferentpolicybalancecouldbedrawn;indeed,abalance

whichgivesgreatercredencetothenotionthat‘fraudunravelsall.’

349Ibid[4.056].350Todd,‘Outlawingdishonestinternationaltraders’(n119)394;Todd,MaritimeFraud&Piracy(n3)[4.041].351Todd,MaritimeFraud&Piracy(n3)[4.014].352Mann,‘Theroleoflettersofcredit’(n8).353WSChong,‘Theabusivecallingofperformancebonds’[1990]JBL414,416.

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219

ChapterFive

DocumentaryCredits:ACritiqueoftheJudicialResponsetoFraud

Thephrase‘fraudunravelsall’doesnotadequatelyexplaintheeffectofbeneficiaryfraudin

the documentary credit context. There are, after all, no examples of a credit applicant

successfully invoking the exception to prevent payment and the necessary procedural

requirements are particularly onerous. As the discussion in the previous chapter

demonstrated, the limitedscopeof theexception is theresultof thecourtsweighingtwo

competingpolicyconcerns;theautonomyofthecreditandfraudprevention.1

IntheEnglishcontext,thisbalancehasbeendrawninfavourofthedoctrineofautonomy.2

Thefraudexceptionisnarrow,permittingjudicialinterventiontorestrainpaymentonlyinthe

mostexceptionalofcasesandonlywhenthefraudcanbeconnectedtothebeneficiary.Given

itsdesignasaswift,unassailablepaymentmechanism,thecreditdemandsminimalinroads

intothedoctrineofautonomy.Thishasbeenusedbythecourtstojustifythelimitedconfines

ofthefraudexception.

ThestartingpointadoptedbyMacDonaldEggers inhisworkondeceitwasthesuggestion

thatrulesonfrauddevelopedtodeterlyinginthecommercialandsocialsphere.3Inthecredit

context,however,thecourtshaveconsistentlyeschewedthenotionthatthefraudexception

servesanyinstrumentalpurposerelatingtodeterrence.4Thismakessensewhenweconsider

thattheexceptionismostcommonlyinvokedtoallocatelossesbetweentwoinnocentparties

andwillonlyrarelytargetthefraudsterdirectly.5Itis,afterall,difficulttoseehowalegalrule

couldfunctionasadeterrentifitdoesnottargetthewrongdoer.Thecourtshavetherefore

allocatedresponsibility for frauddeterrencetothepartiesasanaspectofpre-contractual

1NEnonchong,TheIndependencePrincipleofLettersofCreditandDemandGuarantees(OUP,2011),[1.03]-[1.05]2ThisisthesamedecisionaswasreachedintheUnitedStates,seeAsburyPark&OceanCoveBankvNationalCityBank35NYS2d985(SupCt1942)perShientagJ:“theefficacyoftheletterofcreditasaninstrumentforfinancingtradeistheprimaryconsideration.”3PMacDonaldEggers,Deceit:TheLieoftheLaw(Informalaw,2009),[1.4].4SandersvMaclean(1883)11QBD327,343perBowenLJ.5Seeearlier,ChapterFour,texttofn144.

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negotiations.6Ifthecurrentlegalframeworkistobechargedwithanyinstrumentalpurpose,

perhapsitistoencouragepartiestotakemoreeffectiveprecautionsexante.7

Therationaleofthenarrowfraudexception–theneedsofthecommercialcommunity–isa

perfectlylegitimateguidelineforthetradefinancecourts.Therehasnot,however,beenany

considerationofwhetherthefraudexceptionactuallyservesthispurpose.Thediscussionin

thischapterfillsthisgap.Twoargumentswillbedevelopedtocontendthatcommercialneed

doesnotdictatetherestrictiveparametersimposedbytheEnglishcourts.Athirdargument

thenchallengesthejudicialviewthatfrauddeterrenceincredittransactionsisconfinedto

thepre-contractualstage.Forconvenience,theargumentsaresummarisedhere:

1. In comparison to the English rule, the fraud exception in the United States

encompassesamuchbroaderrangeofbehaviourandthecriteriaforinjunctiverelief

arelessonerous.Thismoreexpansiveapproachhasnotreducedthepopularityofthe

credit mechanism and has not adversely affected the banking system. This

underminestheEnglishinsistenceonanarrowruleforreasonsofcommercialneed.

2. Insettingthe limitsofthefraudexception inUnitedCityMerchants,8 theHouseof

Lordsmisstated the contractual basis of the credit and conflateddistinct issuesof

documentarycomplianceanddefencestopayment.Thishasresultedinconsequences

which are detrimental to commercial need which are difficult to equate with the

rationaleofthefraudexception.

3. Empiricalworkondocumentarycreditsdemonstratesthatpartiesusethecreditina

radicallydifferentmannerthanpredictedbydoctrine.Thisforcesareconsiderationof

frauddeterrenceincredittransactions.Itisarguedthatmechanismstocounterfraud

6Sanders(n4)343perBowenLJ.7Asimilarargumenthasbeenmadeinananalysisofthegeneralcontractlaw,seeEZamirandBMedina,Law,Economics,andMorality(OUP,2010),287:“ifdeceptionproducesanypositiveoutcomesatall,theseoutcomesare…: incentivizing people to ex ante obtain socially beneficial information, disseminating information in themarket,orfacilitatingefficientcontracting.”8UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]2Lloyd’sRep.1(hereafterreferredtoasUnitedCityMerchants(HouseofLords)).

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exist throughout the exchange relationship, and not simply ex ante as the courts

contend.

I. TheAmericanApproachtoFraudThewidespreaduseoftheUniformCustomsandPractice(UCP600)9has,toaconsiderable

extent, harmonised the legal framework relating to credits. TheUCP, however,makesno

provision for fraud, considering that this isa task forwhichnational jurisdictionsarebest

equipped.10Theeffectof fraudby thebeneficiarywilldepend, therefore,on the relevant

provisionsofthegoverninglaw.11Theresultingdivergenceprovidesscopeforcomparative

analysisandthepositionintheUnitedStateshasbeenchosenforthispurpose.

TheUnitedStatesprovidesagoodpointofcomparisongiventhesharedbasisforthefraud

exception12andthematurebodyoflawwhichhasdevelopedbothinrelationtofraudand

the availability of interlocutory injunctions. An indication of the scale of the American

jurisprudenceisevidentintheannualsurveyofletterofcreditcasespublishedinTheBusiness

Lawyer since1965.13 The comparison is also triggeredbyAckner LJ’s comments inUnited

TradingvAlliedArabBank,

It is interesting to observe that in America, where concern to avoid irreparable

damagetointernationalcommerceishardlylikelytobelacking,interlocutoryrelief

appearstobemoreeasilyobtainable…Moreover,theirconceptionoffraudisfarwider

than ours and would appear to include ordinary breach of contract… There is no

suggestionthatthismoreliberalapproachhasresultedinthecommercialdislocation

whichhas,by implicationat least,been suggestedwould result from rejecting the

respondent'ssubmissionsastothestandardofproofrequiredfromtheplaintiffs.14

9 The current version is ICC, ‘TheUniformCustomsandPractice forDocumentaryCredits’ (2007Revision, ICCPublicationno.600)(hereafterreferredtoastheUCP).10ICCBankingCommission,‘LatestqueriesansweredbytheICCBankingCommission’(1997)3(2)DocumentaryCreditsInsight6citedinADavidson,‘Fraud,thePrimeExceptiontotheAutonomyPrincipleinLettersofCredit’(2003)8Intl.Trade&BusLAnn23,26.11Seeearlier,ChapterFour,texttofn60.12SztejnvJHenrySchroderBankingCorp177Misc719(NYMisc1941);UnitedCityMerchants(HouseofLords)(n8)6;DHorowitz,LettersofCreditandDemandGuarantees:DefencestoPayment(OUP,2010),[2.09].13HBailey,‘Commercialpaper,bankdepositsandcollectionsandlettersofcredit’(1965)20BusLaw711.14UnitedTradingCorporationvAlliedArabBankLtd[1985]2Lloyd'sRep554,561.

222

IfAcknerLJ’scommentswereaccurate,itwouldsuggestthattheAmericancourtshavedrawn

averydifferentbalancebetweenthecompetingpolicyconsiderationsofautonomyandfraud

preventionthantheirEnglishcounterparts.ThissectionexaminesthelimitsoftheAmerican

fraudexceptionandtheavailabilityofinjunctiverelief.Thisisusedtoconsiderwhetherthe

“thrombosis”15withwhichtheEnglishcourtsarepreoccupied–andhaveusedto justifya

narrowexception–hasoccurredintheUnitedStates.

A. ConceptionoffraudintheUnitedStatesTheEnglishcourtshaverestrictedtheavailabilityofthefraudexceptiontocircumstancesin

whichthefraudisapparentonthefaceofthedocumentsandcommittedbythebeneficiary.

Bycontrast,theAmericancourtshaveembracedbothdocumentaryfraudandfraudinthe

transaction.ThisistracedtothedecisioninSztejnvJHenrySchroder.16Thefraudinthatcase

consistedoftheseller’sintentionalfailuretoshipanyofthegoodswhichhadbeenordered.

ThiswasproperlycharacterisedbyShientagJasfraudinthetransaction17but,giventhatthe

documentsappearedtoconform,alsoconsistedofmaterialmisrepresentationsoffactinthe

bill of lading. Ackner LJ further contended that ordinary breach of the underlying sales

contractwassufficienttodisruptpaymentunderacredit.18This,withrespect,overstatedthe

breadthoftheAmericanposition.Itisonlyfraudthatwilltriggertheexception.19

ThefraudexceptionhassincebeencodifiedinArticle5,UniformCommercialCode(UCC)and

thestatutehasbeenenactedinalmostallAmericanstates.20Theexceptionwasfirstdrafted

in1962andwastheversioninforceatthetimeofAcknerLJ’scomments.The1962version

madethedefenceavailablewhereadocumentwas“forgedorfraudulentorthereisfraudin

15 Intraco Ltd v Notis Shipping Corporation of Liberia (The Bhoja Trader) [1981] 2 Lloyd’s Rep. 256, 257 perDonaldsonLJ.16Sztejn(n12).Seeearlierdiscussion,ChapterFour,texttofn134.17Sztejn(n12)722perShientagJ.18UnitedTrading(n14)561perAcknerLJ.19Sztejn (n12)634perShientag J.ThiswasconsistentwithearlierAmericancase law.SeeMauriceO’MearavNationalParkBank146NE636(NYCtApp,1925),639perMcLaughlinJ:thebankwasboundtopay“irrespectiveofwhetheritknew,orhadreasontobelieve,thatthepaperwasnotofthetensilestrengthcontractedfor.”20 Uniform Law Commission, ‘UCC Article 5, Letters of Credit (1995)’ available at:http://www.uniformlaws.org/Act.aspx?title=UCC%20Article%205,%20Letters%20of%20Credit%20(1995)(accessed08/09/2017).

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thetransaction.”21ThereferencetoforgeryandfraudinthetransactionconfirmsAcknerLJ’s

viewthattheAmericanexceptionwasbroaderthanitsEnglishcounterpart.

TheIranianhostagecrisisbetween1979and1981triggeredsignificantlitigationrelatingto

standbylettersofcredit.22TherewasaconcernthattheIraniangovernmentand/orstate-

governedbankswouldmakefraudulentdemandsonstandbys,23whichhadbeenobtainedas

security for the performance obligations of American contractors. This was concerning

becausethebreakdownoftheIranianpoliticalsystemeffectivelyremovedanypossibilitythat

anAmericanapplicantwouldobtainredressfollowingpayment.24InItekCorpvFirstNational

BankofBoston,25aninjunctionwasgrantedonthebasisthataccesstoIraniancourtswas

“futile”26and“thefactthatdamagesmaybereasonablycalculablewillprovideItekwithlittle

consolationintheeventthosedamagesultimatelyproveuncollectible.”27TheCourtinItek

alsoheldthatarefusaltoissueaninjunctionincircumstancesoffraudwouldunderminethe

“fundamental purpose” of letters of credit whichwas to prevent one party enjoying the

benefitsofbothparties’performancesimultaneously.28AsimilarresultwasreachedinHarris

CorpvNational IranianRadio&Televisionwherethecourt largelyrejectedthearguments

thattheapplicantcouldhavenegotiatedforbetterprotectionexante29andwasswayedby

considerationsofthedifficultyofrecovery.30ThejudicialdesiretoprotecttheAmericancredit

applicantsinthesecircumstancesisnotdemonstratedineverycaseinvolvinganallegationof

fraudbut,isexplainedbytheexceptionalnatureoftheprevailingpoliticalsituation.31

21UCC§5-114(2)(1962).22Foracomprehensiveaccountoflitigationduringthisperiod,seeHGetz,‘Enjoiningtheinternationalstandbyletterofcredit:TheIranianletterofcreditcases’(1980)21HarvIntlLJ189.23XGao,TheFraudRuleintheLawofLettersofCredit:AComparativeSurvey(KluwerLawInternational,2002),79.24Getz(n22)212.25ItekvFirstNationalBankofBoston511FSupp.1341(D.Mass1981),1349.26Ibid1348.27Ibid1350;SimilarpointsweremadeinStromberg-CarlsonCorpvBankMelli467FSupp530(SDNY1979),533perWeinfeldJ:ifinjunctivereliefwasdenied,theapplicantwouldbelefttotakeproceedingsinIran“whichwouldmakeanyreliefquestionable.”28Itek(n25)1350.29HarrisCorpvNationalIranianRadioandTelevision(1982)691F2d1344,[55].30Ibid[48].At[55],theapplicantcouldnotbeexpectedtobear“theriskofafraudulentdemand.”31JDolan,TheLawofLettersofCreditCommercialandStandbyCredits(4thed.ASPratt&Sons,2007),[7-106];FoxboroCovArabianAmericanOilCo805F2d34(1stCir.1986),[9].

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ThejudicialwillingnesstointerveneduringtheIraniancrisiswouldsuggesttherewassome

meritinAcknerLJ’scomments,particularlyastherewasnoindicationthatcreditsdeclinedin

popularityatthistime.IntheyearsimmediatelybeforetheUCCwasrevised,however,itwas

suggestedthatinjunctivereliefwasbeingissuedtoofrequently.32TheTaskForceaddressed

thisconcernbyamendingArticle5toincludespecificcriteriaforthegrantofaninjunction.33

IntheOfficialCommenttotheUCC,itwasnotedthat“[t]hestandardforinjunctivereliefis

high, and the burden remains on the applicant to show, by evidence and not by mere

allegation, thatsuchrelief iswarranted."34Article5nowrequires that fourconditionsare

satisfiedbeforeaninjunctionwillbeissued.35Theselargelymirrortherequirementsunder

English law.36 The purpose of this discussion is not to consider in detail the judicial

interpretation of these criteria, but to considerwhether there is still force in Ackner LJ’s

commentsinrelationtotheavailabilityofinjunctiverelieffollowingtherevisionstotheUCC.

It shouldbenoted,however, that the fraudexceptionas initially codified in1962didnot

resolveallmattersrelatingtothefraudexception.Itwasunclear,forexample,whether‘the

transaction’aspectofthedefencerequiredthefraudtorelatetotheletterofcreditcontract,

aswouldbethecaseifithadbeeninducedbyfraudulentmisrepresentation,ortheunderlying

contractofsale.Thecaselawdidnotclarifymatters.ThecourtinCambridgeSportingGoods37

-acontractforthesaleofnewboxinggloveswhichweredeliveredrippedandmildewed–

32TaskForceontheStudyofUCCArticle5(LettersofCredit),‘AnexaminationofUCCArticle5(LettersofCredit)’(1989-1990)45BusLaw1521,1612(hereafterreferredtoas‘UCCTaskForce’);HHarfield,‘Code,customsandconscience in letterof credit law’ (1971)4UCC Law J 7, 8;HLAshand JL Schwartz, ‘Lettersof credit: Judicialapprehensionsmisplaced’(1983)5NatLJ13,18citedinSvanHouten,‘Lettersofcreditandfraud:Arevisionistview’(1984)62CanBarRev371,385.33TheavailabilityofaninterlocutoryorpermanentinjunctionisconfirmedbyUCC§5-109(2)(b)(1995revisions).34AmericanLawInstitute,‘[Revised]Article5.LettersofCredit.OfficialComment’availableat:http://elearn.uni-sofia.bg/pluginfile.php/91213/mod_resource/content/1/Revised_UCC_Article_5.pdf(accessed14/09/2016),[4].35UCC§5-109(b)(1995revisions):

(1)thereliefisnotprohibitedunderthelawapplicabletoanaccepteddraftordeferredobligationincurredbytheissuer;(2)abeneficiary, issuer,ornominatedpersonwhomaybeadverselyaffected isadequatelyprotectedagainstlossthatitmaysufferbecausethereliefisgranted;(3)alloftheconditionstoentitleapersontothereliefunderthelawofthisStatehavebeenmet;and(4)onthebasisoftheinformationsubmittedtothecourt,theapplicantismorelikelythannottosucceedunder its claim of forgery or material fraud and the person demanding honor does not qualify forprotectionundersubsection(a)(1).

36SeeearlierdiscussioninChapterFour,III(F).37UnitedBankLtdvCambridgeSportingGoodsCorp.392NYS2d265(NY1976)(thecaseconcernedasaleforaconsignmentofnewboxingglovesbutthosedeliveredwereold,rippedandmildewed.)

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held that Article 5 embodied a flexible approach to fraud which could be used as the

circumstancesdictated.38

Inresponsetotheseconcerns,aTaskForcerecommendedchangestothefraudexception.39

Theseweresubsequentlyadoptedin1995.Article5,UniformCommercialCodenowprovides

that, unless the presenter belongs to a protected class,40 the issuer may dishonour a

presentation41which,

appearsonitsfacestrictlytocomplywiththetermsandconditionsoftheletterof

credit,butarequireddocument is forgedormaterially fraudulent,orhonorofthe

presentation would facilitate a material fraud by the beneficiary on the issuer or

applicant42

The first trigger for the exception is fraud in the required documents.Most notably, the

statute does not explicitly require that this fraud is connected to the beneficiary.43 This

significantlybroadenstheexceptionincomparisontotheEnglishposition.Whereadocument

hasbeenforgedorismateriallyfraudulent,thecourtsareconcernedwiththenatureofthe

documentsandnotthe identityoftheircreator.44Thus,fraudperpetratedbythirdparties

unconnectedtothebeneficiarywillbecaughtbytheexception.Inthissense,therelatively

uncontroversial standard of documentary fraud is far broader than the English exception

established inUnitedCityMerchants.45ProfessorDolan,a leadingUSacademicworking in

thisarea,hassuggestedthattheHouseofLords’decisionisinconsistentwiththewordingof

38Ibid271.39Seegenerally,Article5:OfficialComment(n34);Gao,TheFraudRule(n23)82.40UCC§5-109(a)(1)(1995revision).41UCC§5-109(2)(1995revision).42UCC§5-109(a)(1995revision).43XGao,‘Theidentityofthefraudulentpartyunderthefraudruleinlettersofcreditlaw’(2001)24(1)UNSWLRev119,124.44Ibid124.Thiswasadeparturefromthepre-revisioncaselaw,seeforexample,LarsonvFirstInterstateBankofArizonaNA603FSupp467(DAriz1983),469.Foracademicsupportofthepre-revisionposition,seeJWhiteandRSummers,UniformCommercialCode(vol3)(4thed.,1995)185ascitedbyGao‘Theidentityofthefraudulentparty’(n43)123.45UnitedCityMerchants(HouseofLords)(n8).

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theUCC46and,asaresult,theEnglishpositionestablishesa“markedlyhigherhurdle”forthe

applicantseekingtoinvoketheexception.47

ThesecondpartofArticle5extendstheexceptiontocircumstancesinwhichthefraudwould

constitute a material fraud against the issuer or the applicant. This includes fraudulent

misrepresentationbythebeneficiarywhichhasinducedtheapplicanttoprocurethecredit48

andfraudconnectedtotheunderlyingcontractofsale.49Thisclarifiedtheconfusionpresent

intheinitialcodificationoftheexception,discussedabove.50Theidentityofthefraudsteris

criticaltothispartoftheprovisionmeaningthattheexceptionwillonlyoperateinresponse

tobeneficiaryfraud.Evenwiththisadditionalrequirement,therecognitionthatfraudinthe

transactionissufficienttoinvoketheexceptionismuchbroaderthantheEnglishapproachto

fraud.

AcknerLJ’scommentson thebreadthof theAmerican fraudexception, therefore, remain

validfollowingtherevisionofArticle5.TheUCCpermitspaymenttobedisruptedinmany

factualcircumstancesduetofraud.These includestraightforward incidencesofbackdated

documents,51 false assertions about the quality of the goods in documentation,52 false

documentation,53 the presentation of compliant documents where rubbish has been

shipped,54andcircumstancesinwhichfraudhasinducedtheunderlyingcontractofsale55or

issueoftheletterofcredit.56Notably,theUCCdoesnotmakethebank’sknowledgeoffraud

apre-requisitetotheoperationofthedefence.Thisbroadenstheexceptionelaboratedin

46Dolan,TheLawofLettersofCredit(n31)[7-85].47Ibid[7-93].48Forexample,Mid-AmericaTireInc.vPTZTrading768NE2d619(Ohio2002)citedinJBarnesandJByrne,‘Lettersofcredit:2002cases’(2002-2003)58Bus.Law.1605,1608(fraudulentmisrepresentationbythesellertoinducethebuyertoenterthecontract)49 See UCC Task Force (n32) 1625 for the recommendation that the revised article retains the ‘fraud in thetransaction’defence.50Seeearlier,texttofn37-38.51SideriusvWallace583SW2d852(Tex.Civ.App.,1979).52RegentCorpv International Inv&CommerceBankLtd686NYS2d24 (AppDiv1999)wherethebeneficiaryassertedthatthegoodswereofBangladeshiorigintoavoidchargesdueonPakistanigoods.53ShaffervBrooklynParkGardenApartments250NW2d172(1977)wherethepreconditionsfortheissueofacertificatehadnotbeensatisfiedbutthedocumentwasissuedanyway.54Sztejn(n12);CambridgeSportingGoods(n37).55NMCEnterprisesInc,vColumbiaBroadcastingSysInc.14UCCRep.Serv.1427(Sup.Ct.NYCounty1974)56Ibid;O’GradyvFirstUnionNationalBank296NsC212,250SE2d587(1978)ascitedinDolan,TheLawofLettersofCredit(n31)[7-112].

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SztejnwhereShientagJinsistedonthebankhavingnoticeofthefraudatthetimethedemand

for payment was made.57 The absence of this criterion further establishes Article 5 as

embodyingamoreexpansivepositionthantheEnglishfraudexception.

B. StandardofmaterialityOneofthedrivingforcesbehindthereformofArticle5wastheabsenceofastandardagainst

whichtojudgefraudulentconduct.TheproceduralhistoryofSztejnmeantthatthiswasnot

aliveissueforthecourt58andneitherwasthisdealtwithinthe1962codification.Moreover,

latercaseshadidentifiedarangeofvaryingstandardswhichhadcreatedconfusion.59

Article 5nowdemands that the fraud ismaterial.60 TheOfficial Comment to theUniform

Commercial Code made clear that materiality was to be judged against the underlying

contractandtotheimpactoffraudonthepurchaser.61ThisreflectsthefactthattheAmerican

exceptionencompassesbothdocumentaryfraudandfraudintheunderlyingtransaction.An

exampleofamaterialfraudwasprovidedintheOfficialComment.Itwassuggestedthata

shipmentof998barrelsofoilagainstdocumentationindicatingashipmentof1000barrels

would not be materially fraudulent because this shortfall was an “insubstantial and

immaterial”breachoftheunderlyingcontract.62Amaterialfraudwouldhavebeenpracticed

wherethesamedocumentationwasusedtoclaimpaymentincircumstanceswhereonlyfive

barrelshadbeenshipped.63

MaterialityisalsothestandardusedbytheEnglishcourtstodeterminewhetherthefraudis

actionable.Thefocus,however,oftheenquiryisdifferent.IntheEnglishcontext,theconcept

ofmaterialityislinkedtothebank’sobligationtomakepayment,namelywhethertruthful

57Sztejn(n12)722perShientagJ.58Dolan,TheLawofLettersofCredit(n31)[7-67].59UCCTaskForce(n32)1614.60UCC§5-109(a)(1995revision)61Article5:OfficialComment(n34)[1]ascitedinGao,TheFraudRule(n23)84.62Article5:OfficialComment(n34)[1]citedinRBuckleyandXGao,‘Acomparativeanalysisofthestandardoffraudrequiredunderthefraudruleinlettersofcreditlaw’(2003)13DukeJComp&IntlL293,317.63Ibid.

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statementsonthebillofladingwouldhaveentitledthebanktorejectthepresentation.64If

thebackdatingcouldhavebeenconnectedtothebeneficiaryinUnitedCityMerchants,the

fraudwouldhavebeenregardedasmaterialsincetheactual(late)dateofshipmentwould

haveentitled thebank to reject thepresentation. This is amuchnarrower conceptionof

materialitythanused intheUnitedStateswhichperhapsreflectsthefactthattheEnglish

courtsonlyrecognisedocumentaryfraudasactionable.

ThematerialityrequirementresultsinamuchmoreflexibleenquiryintheUnitedStatesthan

underEnglishlaw.Thisisfavourableforthecreditapplicantwherethetransactionistobe

governedbytheUCC65sincetheenquirywilltakeaccountofthecommercialrealitiesofthe

fraud.Moreover,giventhatthefraudruleexistsasanexceptiontothedoctrineofautonomy,

it is wholly legitimate that courts look beyond the credit itself to assess materiality.

Accordingly, it ismuch easier to reconcile theAmerican approach tomaterialitywith the

natureofthefraudexceptionthanitsEnglishcounterpart.

C. AvailabilityofinjunctionsInUnitedTrading,AcknerLJcontendedthatanapplicantwouldfinditfareasiertoobtain

injunctivereliefintheUnitedStatesthanunderEnglishlaw.66Itisimportanttonotethatthe

versionofArticle5inforceatthetimeofAcknerLJ’scommentsdidnotspecifyconditionsto

be satisfiedbefore reliefwouldbe granted.67 Thus, theearlyAmerican authorities donot

provideasingletestfor injunctiverelief. It ispossible,however,to identifyseveralfactors

which appear routinely in the judicial discussions. These include, for example, substantial

evidenceastothemerits(proofoffraud),thebalanceofhardshipsinfavouroftheinjunction

applicant,andaconsiderationofthebroaderpublicinterest.68Commentatorsviewedthese

factorsasameansof“prevent[ing]afloodofinjunctionsbasedupontheliberalizationofthe

64UnitedCityMerchants(HouseofLords)(n8)7-8perLordDiplock(rejectingtwostandardsofmateriality);AMalekandDQuest,Jack:DocumentaryCredits(4thed.TottelPublishing,2009)[9.17].SeeearlierdiscussioninChapterFour,III(C)(i).65SeealsoCDestréeandCSpanos,‘Sensitivitytofraud:Demandguarantees&standbylettersofcredit’(March2002)52(2)KeepingGoodCompanies94,97.66UnitedTrading(n14)561perAcknerLJ.67UCCTaskForce(n32)1534.68See,forexample,DynamicsCorpofAmericavCitizens&SouthernNationalBank356FSupp991(NDGa1973);Larson(n44).

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fraudexception.”69Thesearenotdissimilartotherequirementsanapplicantwouldneedto

satisfyunderEnglishlaw70buttheAmericancourtshavebeenpreparedtoapproachthese

considerationsinamannermorefavourabletothecreditapplicant.

Interestingly, in the cases in which the credit applicant was successful in obtaining an

injunction under the 1962 codification of the exception,71 the courts discussed the same

policyconsiderationswhichwereemployedinEnglandtorefuserelief.Indeed,thenotionof

pre-contractualduediligencehasbeenimportantwiththeAmericancourtsdeterminingthat

theriskofbeneficiaryfraudshouldfallonthecreditapplicant“whoselectedhimratherthan

[]aninnocentthirdpartyorupontheissuer.”72Despitethis,injunctionshavebeengrantedin

caseswherepaymentunderthecreditwouldcausefurtherlosstotheapplicant73andwhere

theirprospectsoflaterrecoveryagainstthebeneficiarywereslim.74Thisisadirectcontrast

tothepositioninEnglandwherecourtshaverepeatedlyinsistedthatthedifficultyoflater

actionsagainstthebeneficiarywillnotassisttheapplicantinclaimsforrelief.75

The American cases have explicitly recognised that fraud prevention is a relevant policy

concern76andthattherefusaltograntinjunctivereliefincasesoffraudwouldsendthewrong

messagetofraudsters.77ItwasstatedinLarsonthat,

the failure to issue an injunctionwhereotherwise appropriatewould send a clear

signal to those inclined toengage in fraudulentactivities that theyare likely tobe

69vanHouten(n32)387;Dolan,TheLawofLettersofCredit(n31)[7-78](notingthatcriteriaforaninjunctionshouldcounterthebroadmeaningoffraudunderUSlaw).70Seeearlierdiscussion,ChapterFour,III(E).71Forexample,Itek(n25);AmericanNationalBank&TrustCo.vHamiltonIndustriesInc.583FSupp164(NDIII1984); Paccar International Inc. v Commercial Bank of Kuwait 587 F.Supp 783 (CD Cal. 1984);Regent Corp vInternationalInvestment&CommerceBankLtd686NYS2d24(AppDiv1999).Dolan,TheLawofLettersofCredit(n31) [7-79] (arguing that even if an injunction is subsequently discharged, delay has already affected thebeneficiaryanddiminishedtheefficiencyofthemechanism.)SeealsoMMoses,‘Lettersofcreditandtheinsolventapplicant:Arecipeforbadfaithdishonor’(2005-2006)57AlaLRev31,37.72Shaffer(n53)179;Gao,TheFraudRule(n23)138.73Shaffer(n53).74Ibid;DynamicsCorp(n68).75RDHarbottle(Mercantile)LtdvNatWestBankLtd[1978]QB146,155-156perKerrJ.76Shaffer(n53)180:theroleofthecourtistobalancethe“protectionoftheconsumerfromthebeneficiary’sfraudagainstmaintenanceoftheletterofcreditasacommercialinstrumentandbusinessdevice.”77Itek(n25).

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rewarded...there is at least as much public interest in discouraging fraud as in

encouragingtheuseoflettersofcredit.78

Moreover, the refusal of injunctions in such circumstances would have “an even greater

adverseimpactuponissuingbanks,andultimatelydiscouragetheuseoflettersofcredit.”79

Thecourtsareclearlyattunedtothefactthatamechanismwhichfacilitatedfraudwouldnot

be attractive to the commercial community. These arguments have not been made in

England.

In both jurisdictions, the applicantwill need to show that hewill bewithout an effective

remedyiftheinjunctionisrefused.80Thisshouldberelativelydifficultgiventhatthecredit

expressly preserves subsequent actions on the underlying contract. Indeed, the UCC

facilitatesthisprocessasaresultofthewarrantyprovisionsinart5-110.Intheeventthatthe

presentationishonoured,thebeneficiaryistakentohavewarrantedthatthedocumentsdo

not contain forgery or fraud81 and that the presentation does not violate any agreement

betweenapplicantandbeneficiary.82Ifitlatertranspiresthatthebeneficiaryhasbreached

thewarranty,theapplicantwillbeentitledtobringanactionfordamages.Thisisdesignedto

reduceactionsforinjunctivereliefandencouragepartiestosettledisputesafterpaymenthas

beenmade.83

Despitethestatutorywarranties,Americancourtshaveinterpretedthiscriteriongenerously,

permittingapplicantstoadduceevidencethatthebeneficiarywouldbeunabletosatisfy“a

post-honordamageclaim.”84InHendricksvBankofAmerica,evidencethatthebeneficiary

wasinfinancialdistressandlikelytodissipatetheproceedsofthecreditbeforetheapplicant

78Larson(n44)470citingItek(n25)1351.79Itek(n25).80JDolan,‘Lettersofcredit,article5warranties,fraud,andthebeneficiary’scertificate’(1985-1986)41BusLaw347,356.81UCC§5-110(a)(1)(1995revisions).82UCC§5-110(a)(2)(1995revisions).83BWunnicke,DWunnickeandPTurner,StandbyandCommercialLettersofCredit(3rded.AspenLaw&Business,2000(2013Supplement))4-26.1;JBarnesandJByrne,‘RevisionofUCCArticle5’(1995)50BusLaw1449,1457.Seegenerally,RDole,‘Warrantiesbybeneficiariesoflettersofcreditunderrevisedarticle5oftheUCC:Thetruthandnothingbutthetruth’(2002-2003)39HousLRev375.84LangleyvPrudentialMortgage64UCCRepServ.2d(West661,667)(EDKy,2007).

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could obtain a remedywas sufficient for these purposes.85 Similar arguments have been

whollyrejected intheEnglishcontext.86 InHarbottle, forexample,Kerr Jcommentedthat

“theseareriskswhichthemerchantstake…Thisisunfortunatefortheplaintiffs,butitiswhat

theyhaveagreed.”87ThissuggeststhatanAmericanapplicant ismore likelytosatisfythis

criterionthanhisEnglishcounterpart.

The evidential burden on the applicant and the additional policy arguments considered

relevantbytheEnglishcourts lendscredencetoAcknerLJ’scommentsfollowingthe1995

revisions.TheEnglishapplicantmustprovideadditionalevidence,inparticularrelatingtothe

bank’sknowledgeofthefraud,88beforeaninjunctiontorestrainpaymentwillbegranted.

InjunctivereliefunderUSlawdoesnotrequiretheknowledgeofthebankasanindependent

requirement. In addition, refusals by English courts to issue injunctions are rooted in

considerationsoftheefficiencyofthemechanismandthereputationofbanks.89Bycontrast,

the American courts have focused solely on the efficiency of the mechanism90 without

consideringthereputationofUSbanksinactionsforinjunctiverelief.

In conclusion, the fraud exception ismore likely to operate in the United States than in

England.Thereareseveralreasonsforthis.TheAmericanconceptionoffraudembracesa

broader range of conduct including fraud in the transaction and documentary fraud

attributable to a third party. In addition, the applicant need not establish the bank’s

independentknowledgeatthetimeofpaymentandwillhavethebenefitofamoreflexible

standardofmateriality.Thesecriteriamake itdifficult for thecreditapplicant litigating in

Englandtoobtainrelief.91Inrelationtotheavailabilityofinjunctiverelief,the1995revisions

85HendricksvBankofAmerica398F.3d1165(9thCir,2005).Latercourtshavedeniedreliefwheretheclaimanthasbeenunabletodemonstratethis,seeDragovHolidayIsle537FSupp2d1219,1222(SDAla2007);JamesonvPineHillNo.07-0111-WSB,2007WL623807(SDAlaFeb23,2007).86 Themehelp Ltd vWest [1996] QB 84, 101 perWaite LJ noting the “appreciable risk” That assetsmight bedissipated,103perEvansLJ:“thepresentcasecriesoutforMarevarelief”butseealso107perBalcombeLJnotingthatMarevareliefmaycometoolate.Seealso,MBridge,Benjamin'sSaleofGoods(9thed.Sweet&Maxwell,2015)[24-034]wherethedifferencebetweentheUSandEnglishapproachesisnoted.87Harbottle(n75)155-156perKerrJ.88Seeearlierdiscussion,ChapterFour,III(D)(iv).89DiscountRecordsvBarclaysBank[1975]1WLR315,320perMegarryJ;BolivinterOilSAvChaseManhattanBank[1984]1Lloyd’sRep.251,257perSirJohnDonaldsonMR;Czarnikow-RiondavStandardBank[1999]2Lloyd’sRep.187,204perRixJ.90Dolan,TheLawofLettersofCredit(n31)[7-79],[7-88].91Ibid[7-93].

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havemadethepositionmoreonerousfortheAmericanapplicant.Despitethis,theAmerican

claimantremainsinafavourablepositionasagainsthisEnglishcounterpart.Thisisbecause

theAmericancourtsarewillingtointerpretthe‘irreparableinjury’criterionmorefavourably.

ItwouldalsoappearthatfewerfactorsmilitateagainstthegrantofaninjunctioninAmerica

thaninEngland.

WhatthendoesthismeanfortheargumentsbyEnglishcourtsthatthenarrowapproachto

fraud is justifiedbycommercialneed?TheAmericanexceptionwouldsuggest thatsucha

narrowapproachisnotnecessarytoensureanefficientmechanism. Inthefirstplace,the

codification of the American exception has enabled legislators to “balance competing

interests or perspectives in a manner which fairly reflects the reasonable commercial

expectationsoftheparties.”92Thisisanenviableposition93whichcannotbereplicatedinthe

Englishcommonlawsystem.Inaddition,thereisnoevidencetosuggestthatthemechanism

isanylesspopularintheUnitedStatesthaninEngland.Ifanything,thewidespreaduseof

standbycreditsindomestictransactionsinAmerica,94towhichArticle5alsoapplies,95would

suggest commercial acceptanceof the fraud standard. The volumeof litigation related to

lettersofcredithasjustifiedanannualsurveypublishedinTheBusinessLawyer.96Thishints

attherelativesizeofthemarketintheUnitedStatesbut,moreimportantly,thateventhe

possibilityoflitigationhasnothadanegativeimpactonthemarketforcredits.Accordingly,

itwouldbemoreaccuratetocharacterise theEnglishapproachasadistinctpolicychoice

connected to the judicial conception of market need rather than an inevitable balance

betweencompetingpolicyarguments.97

TheAmericanexceptiondemonstrates thatamoreexpansiveapproach to frauddoesnot

necessarilyresultinthethrombosissofearedbytheEnglishcourts.Thesecondcritiqueof

92UCCTaskForce(n32)1538:statingthatthepurposewas“topreserveandenhancetheintegrityoftheletterofcreditasavitalinstrumentofcommerce.Insodoing,ithassoughttobalancecompetinginterestsorperspectivesinamannerwhichfairlyreflectsthereasonablecommercialexpectationsoftheparties.”93JBarnesandJByrne,‘Lettersofcredit’(2005–2006)61BusLaw1591,1596:“UScourtsapplyingUSlawareuniquelyadvantagedinhavingacomprehensivecodificationoftheletterofcreditfraudexception.”94MalekandQuest, Jack (n64) [12.14];MBridge,Benjamin's SaleofGoods (8thed. Sweet&Maxwell,2010),[23.237].95Article5:OfficialComment(n34)1.96ThefirstsurveywaspublishedasBailey(n13).97Todd,MaritimeFraud&Piracy(2nded.Informa,2010),[4.014].

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theEnglishapproachtofraudarguesthatthejudicialreasoninginUnitedCityMerchantsis

flawedandthatthishassetinmotionconsequenceswhicharedetrimentaltocommercial

need.Thisseverelyunderminesthetraditionaljustificationforanarrowfraudexception.

II. ACriticalAnalysisofUnitedCityMerchantsThe narrow contours of the English fraud exception are justified by reference to the

supremacyofautonomyandcommercialneed.However, in constructing the limitsof the

fraudexception,theHouseofLordsmadeanunfortunatemisstepintheircharacterisationof

thebanks’dutiesundertheletterofcredit.Thismischaracterisationisflawedincontractual

termsandbyreferencetotheUCP(A).Analternativeanalysis,basedlargelyonarguments

madebyProfessorRoyGoode,98will thenbeofferedtodemonstratehowtheprincipleof

strictcomplianceandthefraudexceptionshouldoperate(B).Attentionwillthenturntothe

unintendedconsequencesofthisdecisionandsuggestthattheseinnowaycontributetothe

efficiencyofthedocumentarycreditasapaymentdevice(C).

A. AcritiqueofthereasoninginUnitedCityMerchantsThefundamentaldifficultywithLordDiplock’sanalysisexistsinhisaccountofwhenthebank

becomesboundtomakepaymenttothebeneficiary.ThecreditinUnitedCityMerchantswas

governed by theUCP 500which imposed a duty of reasonable care on bankswhen they

examineddocuments.99LordDiplockstatedthat,

thecontractualdutyofeachbankunderaconfirmedirrevocablecreditistoexamine

withreasonablecarealldocumentspresentedinordertoascertainthattheyappear

ontheirfacetobeinaccordancewiththetermsandconditionsofthecredit,and,if

theydosoappear,topay.100

98Forexample,RGoode,‘Abstractpaymentundertakings’inPCaneandJStapleton(eds.),EssaysforPatrickAtiyah(ClarendonPress,1991),228-243;EMcKendrick,GoodeonCommercialLaw(4thed.Penguin,2010)1105-1106.99UCP500art.13(a).ThisreferencetoreasonablecaredoesnotappearinthecurrentversionoftheUCP,theUCP600,butthisdoesnotsubstantivelyaffecttheburdenonthepayingbank,seeMalekandQuest,Jack(n64)[8.3]-[8.7].100UnitedCityMerchants(HouseofLords)(n8)7perLordDiplock(emphasisinoriginal).

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The difficulty is that Lord Diplock equated the bank’s contractual obligation to pay with

apparentcompliance.Thiswas,withrespect,incorrect.TheUCP500onlyobligedbanksto

paywhenthestipulateddocuments–asdistinctfromdocumentswhichappearedtobethose

stipulatedinthecredit–werepresented.101ThisisalsothecaseundertheUCP600wherethe

obligationtopaythebeneficiaryisonlytriggeredbyacomplyingpresentation.102Thisreflects

theimportanceofgenuinedocumentswithincredittransactions.Inthislight,thewordsfrom

EquitableTrustvDawsonPartnersbearrepeating,

Itisbothcommongroundandcommonsensethatinsuchatransactiontheaccepting

bankcanonlyclaimindemnityiftheconditionsonwhichitisauthorisedtoacceptare

inthematteroftheaccompanyingdocumentsstrictlyobserved.Thereisnoroomfor

documentswhicharealmostthesame,orwhichwilldojustaswell.Businesscould

notproceedsecurelyonanyotherlines.103

How, then, did the House of Lords come to misunderstand the respective rights and

obligationsofthepartiesinvolvedindocumentarycredittransactions?Thisisaninteresting

question,notleastbecausetheLordDiplock’sjudgmentdivergedsignificantlyfromtheCourt

ofAppealdecisiondespitecounselpresentingvirtuallyidenticalargumentstotherespective

courts.104Therewouldseemtobetwoexplanationsofthiserror.

ThefirstoftheserelatestonumerousreferencestoapparentcompliancewithintheUCP500.

Theruleofapparentcomplianceisdesignedtoprotectabankwhich,despitea(reasonable)

examinationofthedocuments,failedtouncoverdefectsinthedocumentswhichlatercome

101UCP500art.9(a)“AnirrevocablecreditconstitutesadefiniteundertakingoftheIssuingBank,providedthatthestipulateddocumentsarepresented…andthatthetermsandconditionsoftheCreditarecompliedwith.”102UCP600art.7(a)andart.15(a)(issuingbank),art.8(a)andart.15(b)(confirming/negotiationbank);UCP500art.9(a)“anirrevocableCreditconstitutesadefiniteundertakingoftheissuingBank,providedthatthestipulateddocumentsarepresentedtotheNominatedBankortotheIssuingbankandthatthetermsandconditionsoftheCreditarecompliedwith.”UCPart.9(b)setsoutthesamedutyforconfirmingbanks.103EquitableTrustCoofNewYorkvDawsonPartnersLtd(1926)27LlLRep49,52perViscountSumner.104Comparethefollowingjudgmentswherecounsels’argumentsaresummarised:UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1983]AC168,173-178;UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]QB208,213-215.ForfurtherdiscussionoftheapproachtakenbytheCourtofAppeal,seelater,texttofn139.

235

tolight.105Reimbursementisentirelyappropriateinthesecircumstancesgiventhatpayment

wasmadeingoodfaithwithoutnoticeofthefraudandthatbanksbearnoresponsibilityfor

thegenuinenessofdocuments.106Withoutreimbursement,banksmaywellbecomeunwilling

tofinanceinternationaltransactionsbywayofdocumentarycredit.Asnotedabove,however,

the UCP only imposes a contractual obligation to pay when the documents actually

conform.107TheeffectofLordDiplock’sanalysis–thatthebankowesthebeneficiaryaduty

topayagainstapparentlycompliantdocuments–wouldextendthissameprotectiontothe

beneficiary.Thisisanentirelyinappropriateuseoftheruleofapparentcompliancesincethe

UCPonlyentitlesthebeneficiarytopaymentwhenhehaspresenteddocumentsstipulated

bythecredit.Interestingly,allbutonereferencetoapparentcompliancewasremovedwhen

theUCPwasrevisedin2007.108ThisindicatesthepotentialforconfusionwithintheUCP500

andwillbeexaminedfurtherinduecourse.109

Afurtherexplanationoftheanalysis–thatthebankisobligedtomakepaymentwhenthe

documents appear to comply– lies in LordDiplock’s view that thebank shouldbeunder

identicaldutiesinitscontractwiththebeneficiaryandtheapplicant.110Hebeganbystating

that

thecontractualdutyowedbyconfirmingandissuingbankstothebuyertohonourthe

creditonpresentationofapparentlyconformingdocumentsdespitethefactthatthey

containinaccuraciesorevenareforged111

105MBridge,‘Documentsandcontractualcongruenceininternationaltrade’inWorthington,S.(ed.),CommercialLawandCommercialPractice(Hart,2003).233.ThiswastheresultinGianSinghvBanquedel'Indochine[1974]1WLR1234,1238-1239perLordDiplock:“inbusinesstransactionsfinancedbydocumentarycreditsbanksmustbeable to act promptly on presentation of the documents. In the ordinary case visual inspection of the actualdocumentspresentedisallthatiscalledfor.Thebankisundernodutytotakeanyfurtherstepstoinvestigatethegenuinenessofasignaturewhich,onthefaceofit,purportstobethesignatureofthepersonnamedordescribedintheletterofcredit.”106UCP600art.34.107UCP500art.9(a)-(b).108UCP600art.14(a);Horowitz(n12)[2.08]“Arguably,thisisallthemorethecaseundertheUCP600,wherethe‘ontheface’terminologyhasbeenremovedfromallbutonearticle.”109Seelater,texttofn218.110UnitedCityMerchants(HouseofLords)(n8)7perLordDiplock.111Ibid7perLordDiplock.

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LordDiplockthenassertedthatitwouldbe“strange”112iftherewasnotacorrespondingduty

tothecreditbeneficiaryi.e.tomakepaymentwhenthedocumentsappearedtoconform.It

isrespectfullysubmittedthatLordDiplockwasincorrecthere.Inthefirstplace,thedoctrine

of autonomydemands that each contract is enforcedby reference to itsown terms.113 It

followsthatthereisnoneedforthecontractswithinthenetworktobewrittenonidentical

terms.Itisalsoparticularlyoddthatthebankshouldoweitscustomer–thecreditapplicant

–adutytopayincircumstanceswhenitknowsthedocumentsareforgedorinaccurate.This

istantamounttosayingthatthebankowesitscustomeradutytobedefraudedor,atbest,

tobemisledbythedocuments.114 Inanyevent, itwouldbelegitimatetoassumethatthe

bankowedagreaterloyaltytoits(potentiallylongstanding)customerfromwhomitreceives

remuneration.

Thepropositionthatbanksshouldpaywhenthedocumentsappeartoconformimpactedon

thecourt’sconsiderationofthirdpartyforgeries.LordDiplockheldthatforgeddocuments,

includingcases inwhichtheforgeryrenderedthedocumentanullity,didnotconstitutea

groundforrefusingpayment.115Thiswaseventhecasewheretheforgeryornullityhadbeen

discoveredpriortopayment.116Hejustifiedhispositioninthefollowingterms,

ThisiscertainlynotsoundertheUniformCommercialCodeasagainstapersonwho

has takenadraftdrawnunder thecredit in circumstances thatwouldmakehima

holderinduecourse,andIseenoreasonwhy,andthereisnothingintheUniform

CommercialCodetosuggestthat,aseller/beneficiarywhoisignorantoftheforgery

should be in any worse position because he has not negotiated the draft before

presentation.117

112Ibid7perLordDiplock.113Todd,MaritimeFraud&Piracy(n97)[4-021].114McKendrick,GoodeonCommercialLaw(4thed.Penguin,2010)1105;Horowitz(n12)[2.11].115UnitedCityMerchants(HouseofLords)(n8)9perLordDiplock.116Ibid9perLordDiplock.117Ibid9perLordDiplock.

237

LordDiplock iscertainlycorrect that theholder induecourseenjoysaprivilegedposition

undertheUCC.118Thisisunsurprisinggiventhatthispersonhastakenthedraftforvalue,in

goodfaithandwithoutnoticeofanydefectinthedocument.119Whatisnotclear,however,

iswhytheseller-beneficiarywhocouldhavenegotiatedthecredit,butchosenotto,should

be granted equivalent protection. With respect, Lord Diplock had evidently misread the

relevantprovisionsof theUCCsince thebeneficiary isexcluded fromthe listofparties to

whomthebankmustmakepaymentincasesofforgery.120Giventhatthebeneficiary’sright

topaymenthingesonactualcompliance,itisimpossibletoseehowthemerefactthathe

couldhavenegotiatedthedocumentscouldalterthecontractualpositionbetweenhimand

thebank.121ItisnoteworthythatLordDiplock’sapproachtoforgerywasroundlyrejectedin

the Singaporean case of Lambias vHSBCon the basis that the bank’s rejection of forged

documentswouldnotextinguishthebeneficiary’sabilitytobringanactionforthepriceon

theunderlyingcontractofsale.122

Despitetheseanalyticaldifficulties,LordDiplock’sapproachhasbeenfollowedinsubsequent

case law.123 Bridge has described this position as the orthodox view.124 By contrast, the

decisionhasbeen“roundlycondemned”125bytheacademiccommunity.Themostpersuasive

argumentshavebeenmadebyProfessorGoodewhohasofferedanalternativeanalysisof

howthefraudexceptionshouldoperateinconcertwiththedoctrineofstrictcompliance.This

118TheversionoftheUCCinforceatthetimeprotectedtheholderinduecourse:UCC§5-114(2)(a).Thisisretainedintherevisedversionofarticlefive:UCC§5-109(a)(1).119UCC§3-302(a)(2).120UCC§5-109(a)(1):“theissuershallhonorthepresentation,ifhonorisdemandedby(i)anominatedpersonwhohasgivenvalueingoodfaithandwithoutnoticeofforgeryormaterialfraud,(ii)aconfirmerwhohashonoreditsconfirmationingoodfaith,(iii)aholderinduecourseofadraftdrawnundertheletterofcreditwhichwastakenafter acceptanceby the issuerornominatedperson,or (iv) anassigneeof the issuer'sornominatedperson'sdeferredobligationthatwastakenforvalueandwithoutnoticeofforgeryormaterialfraudaftertheobligationwasincurredbytheissuerornominatedperson”121Goode,‘Reflectionsonlettersofcredit–1’[1980]JBL291,294;Goode,‘Abstractpaymentundertakings’(n98)231.122LambiasvHSBC[1993]2SLR751,763perGohPhaiChengJC.123MontrodLtdvGrundkötterFleischvertreibsGmbH[2002]1WLR1975,[56]perPotterLJ:Thefraudexception“shouldnotbeavoidedorextendedbytheargumentthatadocumentpresented,whichconformsonitsfacewiththetermsoftheletterofthecredit,isnonethelessofacharacterwhichdisentitlesthepersonmakingthedemandtopaymentbecauseitisfraudulent initself, independentlyoftheknowledgeandbonafidesofthedemandingparty.”124Bridge,‘Documentsandcontractualcongruence’(n105)239.125MBridge,‘Documentsandcifcontracts’(1998)availableat:http://sas-space.sas.ac.uk/3805/1/1622-2033-1-SM.pdf(accessed16/07/2016)6.

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isacompellinganalysis,particularlyconsideringearlierdictasupportingasimilarconclusion.

WefirstconsiderGoode’salternativeanalysisbeforediscussingtheconsequenceswhichflow

fromthedecisioninUnitedCityMerchants.Itwillbecontendedthattheseconsequencesare

detrimentaltotheneedsofcommercewhichweaken,therefore,thetraditionaljustification

ofthenarrowfraudexception.

B. AnalternativeanalysisProfessorGoode’salternativeanalysismakesanimportantdistinctionbetweenpre-requisites

topaymentanddefencestopayment.126Thisenvisagesatwo-stageenquiryand,attherisk

ofdoingGoode’sargumentsadisservice,hisapproachisbrieflysummarizedhere.

Thefirststageoftheenquiryrelatestocompliance:dothedocumentsstrictlyconformtothe

termsofthecredit?Thisrequiresthecourttofocusonthenatureofthedocumentsand,if

the documents do not conform, the bank is entitled to reject the presentation.127 The

beneficiarywouldsimplyhavefailedtosatisfythepre-conditionsentitlinghimtopaymentin

thesecircumstancesalthoughhemayre-tenderdocumentssubjecttotheexpiryofthecredit.

ThestandardofstrictcompliancewhichhasbeendevelopedbytheEnglishcourtspermits

therejectionofdocumentswhichcontainminordiscrepancies,128subjecttothetypographical

errorspermittedby theUCP.129Theappropriatestandardofnon-conformityhasvaried in

Goode’sanalysisovertheyearsbut,atitsbroadest,wouldencompassdocumentswhichhave

beenforged,containfraudulentmisrepresentationsandarenullities.130Theidentityofthe

partywhoisresponsibleforthesediscrepanciesiswhollyirrelevantatthisstage.AsGoode

hasmadeclear,

The beneficiary…is only entitled to be paid if the documents are in order. A

fraudulentlycompletedbillofladingdoesnotbecomeaconformingdocumentmerely

becausethefraudisthatofathirdparty.131

126Goode,‘Abstractpaymentundertakings’(n98)228,232.127McKendrick,GoodeonCommercialLaw(n114)1106.128KredietbankAntwerpvMidlandBank[1999]CLC1108,[12]perEvansLJ.129Goode,‘Abstractpaymentundertaking’(n98)228;UCP600art.30.130McKendrick,GoodeonCommercialLaw(n114)1106.131Goode,‘Reflections–1’(n121)294.

239

Itisalsoirrelevanttoarguethatthegoodfaithofthebeneficiaryshouldmakeanydifference

to thequestionofdocumentary compliance.This isbecauseeven themost scrupulousof

behaviour could not transformnon-compliant documents into the genuine ones required

underthecredit.132

Defencestopaymentonlybecomerelevantoncethebeneficiaryhassatisfiedthenecessary

pre-conditionstopayment.Thisisthesecondphaseoftheenquiry.Paymentatthisstageis

virtuallyguaranteed–asdemandedbythecommercialcommunity–sincethedoctrineof

autonomyinsulatesthecreditfromdisputesconnectedtotheunderlyingcontract.133Indeed,

theexceptionalnatureofjudicialinterventionisappropriateatthisstagesincethebeneficiary

willhave fulfilled theobligationsentitlinghimtopayment.Accordingly, it is right that the

identity of the fraudster is critical at this stage134 and it is only when the fraud can be

connectedtothebeneficiarythatthefraudexceptionwilloperate.

Theconsequencesofthefraudexceptionfurtherdistinguishthesecondphaseoftheenquiry

fromtheinitialquestionofcomplianceaddressedbythecourts.Wherethebeneficiaryhas

engagedinconductsufficienttoinvokeadefence–forexample,thesubmissionofdocuments

he knows to containmaterial misrepresentations – the right to payment is permanently

barred.Thecourtrefusestoengagewiththebeneficiaryinthesecircumstancesasistypical

ofdefencespremisedonexturpicausa.Therewouldbenoopportunityforhimtoretender

compliantdocumentationaswouldbethecaseduringthefirstphaseoftheenquiry.

There is much to suggest that the sequential analysis is appropriate in relation to

documentarypresentationsunderaletterofcredit.Inthefirstplace,thedoctrineofstrict

compliancesupportsthisapproach;afterall,thepartieshavecontractedforthepresentation

ofactuallycompliant–andthusgenuine–documents.Inaddition,therewasconsiderable

dictasupportingasequentialapproachpriortotheHouseofLords’decisioninUnitedCity

Merchants. In Edward Owen Engineering v Barclays Bank, Denning LJ made clear that

paymentwasonlyduewhen“thedocumentsare inorderandthetermsofthecreditare

132Ibid294.133Goode,‘Abstractpaymentundertakings’(n98)233;MBrindleandRCox,LawofBankPayments(3rded.Sweet&Maxwell,2004)[8.087].134Goode,‘Abstractpaymentundertakings’(n98)232-233.

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satisfied.”135Hecontinuedthat“thebankoughtnottopayunderthecreditifitknowsthat

the documents are forged or that the request for payment is made fraudulently in

circumstanceswhenthereisnorighttopayment.”136ShortlyafterthedecisioninUnitedCity

Merchants,GutteridgeandMegrahsuggestedthat,inrespectoftheearlierEnglishcases,it

was“permissibletoassumethatwhattheyhadinmindwasfraudbyabeneficiary.”137There

is,withrespect,nobasisforthisgiventhatLordDenningMR’scommentsdonotexplicitly

requirethewrongdoingtobeconnectedtothecreditbeneficiary.138Thesameanalysiswas

employedby theCourtofAppeal inUnitedCityMerchants as the followingcommentsby

AcknerLJmakeclear,

Abankercannotbecompelledtohonouracreditunlessalltheconditionsprecedent

havebeenperformed,andheoughtnottobeunderanobligationtoacceptorpay

againstdocumentswhichheknowstobewastepaper.Toholdotherwisewouldbeto

deprivethebankerofthatsecurityfortheadvances,whichisacardinalfeatureofthe

processoffinancingcarriedoutbymeansofthecredit.139

ThesequentialanalysishasalsobeenacknowledgedinAmericancaselaw.140Thepointwas

madesuccinctly inOldColonyTrustCovLawyers’Title&TrustCo.; ifabankknowsthata

document is false or forged it “cannot be called upon to recognize such a document as

complyingwiththetermsofaletterofcredit.”141Theseearliercaseswereusedtodevelop

the fraudexception inSztejn v Schroder.142 In that case, Shientag J commented that “the

135EdwardOwenEngineeringvBarclaysBankInternational[1979]1QB159,169citingBankRusso-IranvGordonWoodroffe&Co[1972]116SolJ921,10CL296perBrowneJ.136EdwardOwen(n135)169.137HCGutteridgeandMMegrah,TheLawofBankers’CommercialCredits(7thed.EuropaPublications,1984),188.Butcf.RKing(ed.)Gutteridge&Megrah’sLawofBankers’CommercialCredits(8thed.EuropaPublications,2001)whichdoesnotcommentonthisparticular issue,169fn10whereaquotationfromEdwardOwen isprovidedwithoutfurthercomment.138EdwardOwen(n135)169perLordDenningMR:thebankoughtnottopay“ifitknowsthatthedocumentsareforgedorthattherequestforpaymentismadefraudulentlyincircumstanceswhenthereisnorighttopayment.”139UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1981]1Lloyd’sRep.604,628perAcknerLJ(hereafterreferredtoasUnitedCityMerchants(CourtofAppeal))140RBuckleyandXGao,‘Thedevelopmentofthefraudruleinletterofcreditlaw:Thejourneysofarandtheroadahead’(2002)23(4)UniofPennJofIntEcLaw663,676.141Old Colony Trust Co v Lawyers’ Title & Trust Co 297 F 152 (1924), 158. See also Buckley and Gao, ‘Thedevelopmentofthefraudrule’(n140)676.142Sztejn(n12);--,‘Decisions’(1942)42ColumLR149,150-151:“Itseemsclearthatthepresentationofforgeddocumentswouldnotsatisfytherequirementsoftheletterofcreditandthatthebankmaydefendonthegroundsofforgery.”

241

applicationofthisdoctrine[ofautonomy]presupposesthatthedocumentsaccompanying

thedraftaregenuineandconformintermstotherequirementsoftheletterofcredit.”143

AlthoughSztejnwashighlyinfluentialinLordDiplock’sjudgment,heoverlookedthefirststage

ofthesequentialanalysisandlimitedhisconsiderationofforgeryandfraudtotheoperation

ofdefences.144

Theauthortakestheviewthatthesequentialanalysisistobepreferredsinceitacknowledges

thedistinctrolesofstrictcomplianceandautonomyandreflectsthebargainthepartieshave

made. The analysis has been endorsed by a range of academic commentators.145

Unfortunately,however,Goodehasnotbeenentirelyconsistentastowhetherthesequential

analysiswouldhaveledtoadifferentresultonthefactsofUnitedCityMerchants.Hehas,on

severaloccasions,arguedthat forgery,nullityandthirdparty fraudall renderadocument

non-conforming.146Thisisabroadapproachtothecompliancequestion147andwouldhave

justifiedrejectionofthebackdatedbillofladinginUnitedCityMerchants.This,incidentally,

wastheunanimousresultreachedbytheCourtofAppeal.148Goodehasalsoexpressedthe

viewthat,despitetheflawedreasoningoftheHouseofLords,

theruling…might justpossiblybesustainableonthegroundthatthe insertionofa

falseshippingdateinthebillofladingdidnotpreventitfrombeingwhatitpurported

tobe,sothatitcouldbevalidlytenderedbyabeneficiaryingoodfaith149

This indicates a narrower approach in which non-conformity is equated with documents

whichhavenolegaleffect.Thiswouldentitlebankstorejectnullitiesfornon-compliancebut

wouldrecogniseforgeries,includingthebillsubmittedinUnitedCityMerchants,ascompliant.

143Sztejn(n12)634.144Goode,‘Abstractpaymentundertakings’(n98)232.145Horowitz(n12)[3.01],[3.10];RHooley,‘Fraudandlettersofcredit:Isthereanullityexception?’[2002]CLJ279,280;AGuestetal.,Benjamin’sSaleofGoods(7thed.Sweet&Maxwell,2006)[23-143];Neo‘Anullityexceptioninletterofcredittransactions?’[2004]SingJLS46,60;Dolan,TheLawofLettersofCredit (n31)[7-65]:“It isalsoconsistentwiththedoctrineofthestrictcomplianceruletosaythatabeneficiarywhopresentsfraudulentoffalsedocumentshasnotcompliedwiththecredit.”146Goode,‘Abstractpaymentundertakings’(n98)228-9,230,232,Goode,‘Reflections–1’(n121)294.147Horowitz(n12)[3.18],[3.20].148UnitedCityMerchants(CourtofAppeal)(n139)623perStephensonLJ,628perAcknerLJand633perGriffithsLJ.149Goode,‘Abstractpaymentundertakings’(n98)231.

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TheabovecommentsinwhichGoodeappearstofavourthenarrowerapproachalsosuggest

thatthegoodfaithofthebeneficiarycanaffectthebank’sresponsetothedocuments.This

mustbeincorrectsincetheassessmentofdocumentarycomplianceisobjectiveandshould

bedisassociatedfromthemindsetofthebeneficiary.NotwithstandingGoode’sinconsistent

approach to the appropriate standard of non-conformity, the author maintains that the

sequentialanalysisiscorrectandwillargue,induecourse,forthenarrowerconceptionof

non-compliance.150Atthisstage,itisconvenienttodiscusstheconsequenceswhichflowfrom

theflawedreasoninginUnitedCityMerchants.Theseconsequencesaredetrimentaltothe

efficiencyof,andcommercialconfidencein,thecreditmechanism.Thisisdifficulttosquare

with thepolicy constructionof the fraudexception; to preserve the credit as an efficient

systemoftradefinancing.

C. TheunintendedconsequencesofthereasoninginUnitedCityMerchantsThereasoningadoptedbytheHouseofLordsinUnitedCityMerchantsisdetrimentaltothe

efficiency of the documentary credit mechanism. This undermines the rationale of Lord

Diplock’s judgment; to ensure the credit’s continued acceptability within the commercial

community. This is not, strictly speaking, a consequence of the elaboration of the fraud

exceptionitselfbutrathertheresultofLordDiplock’sconflationoffraud,forgeryandnullity.

As Bridge has made clear, the “question of forgery and nullity is closely related to the

definitionoffraudbutshouldnotbeseenasboundupexclusivelywithfraud.”151Thepurpose

ofthissectionistoexplorethedetrimentalconsequencesofthisreasoningbynoting,inpart

i,theimpactoncommercialconfidence.Partsiiandiiithenfocusonthedifficultiesflowing

fromLordDiplock’sapproachtoforgeryandnullity,respectively.Theextenttowhichthese

consequencesmilitateinfavourofanewapproachtoforgedandnulldocumentspresented

underaletterofcreditisthenconsidered(partiv).

i. Commercialconfidenceinthedocuments

Given that the fraud exception is founded on ex turpi causa, it is not surprising that the

exceptionisonlytriggeredbythebeneficiary’swrongdoing.However,thenarrowcontours

150Seelater,PartII(C)(iv).151Bridge,‘Documentsandcontractualcongruence’(n105)230.

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ofthefraudexceptionandthecourt’srefusaltoadoptthesequentialanalysis,meansthat

forged documents, third party fraud and nullities will not constitute bases for stopping

payment.152 Thiseffectivelypermitsnon-genuinedocumentswhere thedefectcannotbe

attributedto thebeneficiary tocirculatebetweencommercialparties.153This isaconcern

becausethecreditmechanism,asalldocumentarytransactions,relytoalargeextentontrust.

Documentary transactionscanonly functionwhenthecontractingpartiesandbankshave

confidence that the requisite documents are what they appear to be.154 The relatively

unhinderedcirculationofnon-genuinedocuments,therefore,islikelytounderminefaithin

thecreditmechanism.Suchconsiderationshaveplayedasignificantroleinthedevelopment

ofthelawrelatingtobillsofexchange.155InMastervMiller,LordKenyoncommentedthat

suchinstruments“whicharecirculatedthroughoutEurope,shouldbekeptwiththeutmost

purity,andthatthesanctionstopreservethemfromfraudshouldnotbelessened.”156This

issuewascolourfullyhighlightedbyCresswellJ inhischaracterisationofantedatedbillsas

“the cancer of international trade.”157 It is surprising, therefore, that the House of Lords

delivered a judgment which permits the circulation of non-genuine documents between

traders.ItisalsonotpossibletogiveLordDiplockthebenefitofthedoubthere.Hisexpress

refusaltopermitbankstorejectdocuments“evenwherethefactthatthedocumentisforged

deprivesitofalllegaleffectandmakesitanullity,andsoworthlesstotheconfirmingbankas

security for its advances to the buyer”158 demonstrates his awareness of the potential

consequencesofhisdecision.

Giventhatthecontoursofthefraudexceptionwereconstructedwithcommercialneedin

mind, it is difficult to see how reduced confidence in the mechanism will facilitate

internationaltrade.Ifpartiesareunabletoplacetheirtrustinthedocuments,banksmaywell

152RHooley,‘Fraudandlettersofcredit,part1’(2003)3JIBFL91(onlinepublication,pagenumbersomitted).153Ibid;Horowitz(n12)[3.20].154ICarr,InternationalTradeLaw(5thed.Routledge,2014)468;Bridge,‘Documentsandcontractualcongruence’(n105)216;Gao,TheFraudRule(n23)130-131.155MacDonaldEggers(n3)11.156MastervMiller(1791)4TR320,330perLordKenyon.157StandardCharteredBankvPakistanNationalShippingCorp(No.2)[2000]1Lloyd’sRep.218,221perCresswellJ.158UnitedCityMerchants(HouseofLords)(n8)9perLordDiplock.

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become less willing to finance credit transactions159 or else demand significantly higher

compensationfortheirservices.Thebankscouldalsorequirepartiestotakeadditionalsteps

to authenticate the documentation thus increasing the expense and complexity of the

mechanism.

ii. Theissuesrelatingtoforgery

TheHouseofLordsrejectedforgeryasan independentbasis topreventpaymentundera

documentarycredit.LordDiplockheldthatadefencewhichdidnotrequirethebeneficiary

tohaveknowledgeof thewrongdoing“wouldembrace the fraudexceptionand render it

superfluous.”160Thisindicateshisconflationoftwodistinctissues;documentarycompliance

anddefencestopayment.Asdiscussedearlier,theidentityofthewrongdoeronlybecomes

relevantinrelationtodefences.Theapproachtoforgeryfailstorespecttheparties’allocation

ofrisk(a)andelevatesthedocumentarycreditaboveothernegotiableinstruments(b).This

islikelytoimpactoncommercialcertainty,exactlytheconsequencethatLordDiplocksought

toavoidinhisconstructionofthefraudexception.

a. Distortscontractualriskallocationwithrespecttoknownforgery

Theletterofcreditisproperlyregardedasacompromisemethodoftradefinancingsinceit

providesreassurancetobothbuyerandseller.161Thisisparticularlyevidentinthebalance

drawn in respectof the forgery risk. If strict compliance is analysedas apre-condition to

payment,theriskthatthirdpartydefectsarediscoveredpriortopaymentisbornebythe

beneficiary.Bycontrast,theruleofapparentcomplianceplacestheriskthatdocumentsare

subsequently discovered to be forgeries on the applicant. The applicant may of course

attempttoshiftthislossbacktohisimmediatesellerbywayofanactionontheunderlying

contract.

ThedecisioninUnitedCityMerchantsfailstogiveduerespecttothisallocationofrisk.Itputs

thewholeriskofforgery–bothknownandunknownatthetimeofpresentation–ontothe

159EPEllinger,‘Fraudindocumentarycredits’[1981]JBL258,269.160UnitedCityMerchants(HouseofLords)(n8)7perLordDiplock.161Seeearlier,ChapterFour,texttofn11.

245

credit applicant. This isbecause LordDiplock’s analysis contractuallyobligesbanks topay

unlesstheforgerycanbeconnectedtothebeneficiaryatthetimeofpresentation.

This lack of respect is surprising for several reasons. Firstly, the existence of the ICC’s

CommercialCrimeServiceenablesbankstoreferdocumentsforauthenticationwithinthe

periodpermitted forexamination.162This creates thedistinctpossibility thatbankswould

definitivelyknowthatadocumentwasnotgenuinebutwould,onLordDiplock’sanalysis,

neverthelessbecontractuallyboundtopay.163Thisisillogicalgiventhatthebank,bycontrast,

canrejectdocumentsfortechnicaldiscrepancies.Moreover,non-genuinedocuments,against

which the bank is bound to pay, aremore likely to indicate an issuewith the underlying

transactionthanthosecontainingtechnicaldefects.164 It isworthrecallingthatpartofthe

doctrine of strict compliance is fraud deterrence since discrepancies may indicate a

substantiveissuewiththebeneficiary’sperformance.165

TheexistenceoftheCommercialCrimeServicealsopointstobroaderissuesrelatingtothe

creditmechanism.Inthefirstplace,theServicefacilitatesknowledgeacquisitionbythebank

whichissurprisinggiventhatthebank’sroleisintendedtobepurelyadministrative.Itwould

be interesting,therefore,toseehowacourtwouldreconcilethebank’sdiscoveryofnon-

conformityviatheCommercialCrimeServicewithArticle34UCPwhichexpresslydisclaims

thebank’sliabilityfortheeffectivenessandgenuinenessofdocuments.166TheCommercial

Crime Service provides further support for the sequential analysis i.e. that forged or null

documentscouldberejected fornon-conformity.This isbecausetherewouldseemtobe

little role, if any, for theService if thebankwas contractuallyobliged topay, asper Lord

Diplock’sjudgment,despitethediscoveryofdefectsbeforepaymenthadbeenmade.

162 ICC Commercial Crime Services, ‘Trade Finance Documents Authentication’, https://www.icc-ccs.org/icc/imb/services/due-diligence/trade-finance-documents-authentication(accessed17/07/2016).163Aproblem identifiedbyWBlair, ‘Commentaryon ‘Documentsandcontractual congruence in internationaltrade’’inWorthington,S.(ed.),CommercialLawandCommercialPractice(Hart,2003)245;CSchmitthoff,‘Exporttrade(Casecomment)’[1982]JBL319,321.164PEllinger,‘Documentarycreditsandfinancebymercantilehouses’inBenjamin(7thed.)(n145)[23-143]ascitedinHorowitz(n12)[3.19].165Horowitz(n12)[3.19].166Thereis,totheauthor’sknowledge,noreportedcaseinwhichtheseissueshavearisenintheEnglishcourts.

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Secondly,thejudgeshaveconsistentlyfollowedtheparties’agreedriskallocationelsewhere

inthecreditnetwork.Inrelationtothefraudexception,forexample,KerrJmadeclearthat

thecourtswouldnotbeswayedbythedifficultiesoflateractionsontheunderlyingcontract

because“theseareriskswhichthemerchantstake…Thisisunfortunatefortheplaintiffs,but

itiswhattheyhaveagreed.167

Finally, the decision in United City Merchants departs from what would ordinarily be

recognisedasanefficientallocationofrisk.Theriskwouldgenerallybeplacedontheparty

closest to the potential forger as he is in the best position to prevent and uncover such

forgeries.168Applyingthislogictothecreditcontext,onewouldexpectthebeneficiarytobear

theriskinrespectofforgeriesdiscoveredpriortopresentation.Indeed,thiswasStephenson

LJ’s approach inUnited CityMerchants noting that it was the beneficiary “who put [the

loadingbroker]inthepositioninwhichhemadethebill,andmadeitfraudulently,and…itis

they…who should pay.”169 The fact that the loss does not fall on thebeneficiary in these

circumstancesissurprising,

Englishlaw…appearstoprotectshrewdsellerswhoutilisetheservicesofthirdparties

whoarediscreetenoughtokeeptheirfraudulentpracticestothemselves.Thelawin

effectencouragessellersnottoinquireintothedetailsoftheactivitiesofthirdparties

involved in their transactions so long as the bills of lading appear valid, for any

knowledgeofwrongdoingwouldjeopardisethesellers’chanceofbeingpaid.170

The judicial disregard for the parties’ agreement is likely to have consequences for

commercialcertaintyandthepopularityofthecreditmechanism.Ifnon-conformitywasto

beinterpretedbroadly,bankswouldbeabletorejectforgeddocumentsirrespectiveofthe

forger’sidentity.Thissolutionwouldtendtoreducetheincidenceoffraud171andtransferthe

167Harbottle(n75)155-156perKerrJ.168ASchwartzandRScott,CommercialTransactionsPrinciplesandPolicies(TheFoundationPress,1982)21,918;AKronman,‘Mistake,disclosure,information,andthelawofcontracts’(1978)7JLeg.Stud.1,4.169UnitedCityMerchants(CourtofAppeal)(n139)623perStephensonLJ.170GLSmith,‘Irrevocablelettersofcreditandthirdpartyfraud:TheAmericanAccord’(1983-1984)24VaJIntlL55,70-71.171Gao,TheFraudRule (n23)133(arguingthatpublicpolicyandconsiderationsoffraudpreventionmilitateinfavourofthisconstruction).

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riskofforgerydiscoveredpriortopresentationtothebeneficiary.Itwillberememberedfrom

the foregoing discussion that these documents remain effective to transfer ownership in

goods.Theauthor’sconclusionsonwhetherabroadornarrowapproach toconformity is

preferredwillbediscussedinduecourse(iv).

b. AdistinctionbetweendocumentarycreditsandnegotiableinstrumentsThe House of Lords’ approach to forgery also creates an unhelpful distinction between

documentarycreditsandnegotiableinstruments,suchasbillsofexchangeandbanknotes.172

Thecomparisonbetweenthecreditandnegotiableinstrumentsisappropriatebecausethese

mechanismsarealldesignedtobe“asgoodascash.”173Indeed,itisthischaracteristicofthe

documentarycredit thatservestoensureswiftpayment in international transactions.The

fewerwaysinwhichapaymentunderoneoftheseinstrumentscanbedisrupted,themore

itwillresemblecash.174

TheresultinUnitedCityMerchantsmeansthatthelawwillresponddifferentlytotheforgery

ofarequireddocumentunderaletterofcreditthantoaforgedbillofexchange.Inthecontext

ofdocumentarycredits,thediscoverythatarequireddocumenthasbeenforgedwillhaveno

impactonthebank’sdutytopay,unlessthatforgerycanbeattributedtothebeneficiaryin

time.Bycontrast,theBillsofExchangeAct1882provides,

whereasignatureonabillisforgedorplacedthereonwithouttheauthorityofthe

personwhose signature it purports to be, the forged or unauthorised signature is

whollyinoperative,andnorighttoretainthebillortogiveadischargetherefororto

172MBridge, ‘Documentsand contractual congruence’ (n105)231 recognises “divergence”between lettersofcreditandbillsofexchange.ItisarguablethattheEnglishcourts’refusaltorecognisenullityasaseparatedefencetopaymentinMontrodcorrespondswiththetreatmentofnegotiableinstruments.SeeMBridge,TheInternationalSaleofGoods:LawandPractice(2nded.OUP,2007)[6.82]wherehearguesthat“…nonestfactum,whichhaveaclosekinshipwithdocumentarynullities,maybeassertedevenagainstaholder induecourseofanegotiableinstrument.”173PowerCurbervBankofKuwait[1981]2Lloyd’sRep.394,398perDenningLJ;SafavBanqueduCaire[2000]2Lloyd’sRep.600,605perWallerLJ.174Bridge,‘Documentsandcontractualcongruence’(n105)231.

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enforcepaymentthereofagainstanypartytheretocanbeacquiredthroughorunder

thatsignature.175

Accordingly, theholderof abill of exchangewill beunable toobtainpaymentwhere the

signaturewasforged,eventhoughtheforgerywascarriedoutbyathirdpartyorthatthe

creditorwasunawareofthatfact.Thesamerationaleisappliedtobanknotes.176

Theapproachtoforgery inthe lawofnegotiable instrumentsmustbedesignedtoensure

confidenceinthemechanism.Therealsoappearstobeanefficiencyconsiderationatplay

here,namelythattheinstrumentbecomesinoperativeassoonastheforgeryisestablished.

Thereisnoneedtoconnectthewrongdoingwiththepersonpresentingtheinstrument.We

haveseeninthecontextofthefraudexceptionthedifficultiesassociatedwithprovingthe

mindsetofthebeneficiary.177Itisunlikelythatthecommercialcommunitywouldexplicitly

countenancethedevelopmentofapaymentmechanismwhichtookadifferent,andmore

permissive, approach to forgery in comparison to other highly liquid instruments. This is

however the bizarre, and no doubt unintended, effect of the decision in United City

Merchants.

iii. Theissuesrelatingtonullity

Although the impact of null documents on the beneficiary’s right to payment was not

conclusively settled in United City Merchants,178 there is no doubt that Lord Diplock’s

approachtonon-genuinedocuments influencedthesubsequentconsiderationofnullity in

MontrodvGrundkotter.179TheCourtofAppealrefusedtorecognisenullityasanindependent

basisforrejectionofthedocumentscitinginteraliatheunacceptablethreatthatthiswould

pose to thedoctrineofautonomy.180This isevidenceof theCourt’s refusal toaccept the

sequential analysis in which documentary compliance is considered in isolation before

defencestopaymentbecomerelevant.Thecirculationofnulldocumentscausesproblems

175BillsofExchangeAct1882s.24.176CProctor,MannontheLegalAspectofMoney(7thed.OUP2012)[1.74].177Seeearlierdiscussion,ChapterFour,PartIII(D)(ii).178UnitedCityMerchants(HouseofLords)(n8)9perLordDiplock.179Montrod(n123)[55]perPotterLJ.180Ibid[56]perPotterLJ.

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forpartiesusingdocumentarycreditstofinancetheirtransactions.Thefirstoftheserelates

tothesecuritythatthedocumentsrepresentfortheultimatebuyerandtheissuingbank(a).

TheapproachtonullityalsodistinguishesdocumentarycreditsfromCIFcontractsandthisis

notjustifiableonpolicygrounds(b).

a. ThedocumentsassecurityTransactionsfinancedbyaletterofcredit,muchlikeotherdocumentarytransactions,relyon

thefactthattheshippingdocumentstransferownershipandothercontractualrightsfrom

sellertobuyer.Inparticular,thedocumentsenabletheultimatebuyertotakedeliveryofthe

goods181andtobringasubsequentactionifthegoodshavebeendamagedintransit.182But

thedocumentsmustbegenuineforthispurpose;thebuyerwillbeunabletoasserttitleor

anyotherrightinrespectofthegoodswhenhehasreceivednullities.183Althoughthecredit

arrangementplacestheriskofpoorqualitygoodsonthefinalbuyer, it isnotdesignedto

transfertheriskofworthlessdocumentstothepersoninthisposition.Thisisbecausethe

doctrine of strict compliance should operate to screen out nullities before payment. The

judicialapproachtonullitythusexposeshimtoagreaterrisk–aninabilitytocollectthegoods

orbringlegalactioninrespectofthem–thanhewaswillingtoacceptunderthecredit.

Thedocuments,perhapsmore importantly,also representsecurity for the issuingbank in

exchangefortheadvancesitmakestothebeneficiaryontheapplicant’sbehalf.184Thisreflects

thefactthatthecreditmechanismtransferstheriskofbuyerinsolvencyfromthebeneficiary

to the issuingbank.This risk ismitigatedby two factors; firstly, that thebank retains the

documents until it has been reimbursed by the buyer and, in addition, the bank’s direct

knowledge of the applicant’s creditworthiness.185 This enables the bank to determine

181LickbarrowvMason100ER35(1787),39perAshhurstJ;Benjamin(9thed.)(n86)[18-007];RGoode,ProprietaryRightsandInsolvencyinSalesTransactions(2nded.Sweet&Maxwell,1989),59-60.182CarriageofGoodsbySeaAct1992s.2(1);Bridge,‘Documentsandcontractualcongruence’(n105)216.Ortobringanactioninnegligenceagainstthecarrier,aswasthecaseinNiruBatteryManufacturingvMilestoneTradingLtd(No.1)[2002]2AllER(Comm)705.183PTodd,BillsofLadingandBankersDocumentaryCredits(4thed.Informa,2007),[9.148].184McKendrick,GoodeonCommercial Law (n114)1106: the tenderofworthlessdocuments “undermines thesecurityoftransactionsforbankswheretheyadvancefundstotheircustomersonthesecurityofthedocuments.”185Smith(n170)94-95:“Thereplywasunanimous:thecredit-worthinessofthecustomeristheoverridingandsometimes exclusive basis onwhich banks issue letters of credit. Expenses incurred in resale and the usuallydramaticdiscountatwhichgoodsareresoldinordertorealizesecuritymakesthevalueofthegoodsasrepresentedbythedocumentsofalmostacademicsignificanceinpractice.”Seealso,KDonnelly,‘Nothingfornothing:Anullityexceptioninlettersofcredit’[2008]JBL316,357.

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whethertoissuethecreditandonwhatterms.186Intheeventofthebuyer’sinsolvencyprior

toreimbursement,theissuingbankcansellthedocumentsinthemarkettorecoupitslosses.

Thisisimpossiblewherethebankhasreceivednullities.

ThebillofladinginUnitedCityMerchantswasnotanullitysincethefraudmerelyrelatedto

thedateandplaceofshipment.Itremainedavalid,transferablereceiptforthegoods187and

didnotdiminishthebank’ssecurityinteresttoanymaterialdegree.Itisforthisreasonthat

commentators, while criticising the reasoning that the House of Lords employed, have

acceptedtheresultonthefacts.188ButtheHouseofLordsalsorefusedtorecognisethebank’s

interestasanoverridingconcernincircumstanceswherethedocumentswere“worthlessto

theconfirmingbankassecurityforitsadvancestothebuyer.”189Thisisverydifficulttojustify

since a bank in receipt of nullities will be unable tomitigate its loss in the event of the

applicant’s insolvency.190Ofcourse, thebank’sknowledgeof thebuyer’s financialposition

meansthatinsolvencyisrelativelyunlikelytooccursincethebankwouldrefusetoissuea

credittoacustomerwithapoorcredithistory.191Unexpectedinsolvenciesnodoubtoccur,

however,andinsuchcircumstancesthebankwouldhavenomeansofmitigatingitslossand

wouldnotreceiveanyconsiderationforitsperformance.Thisisawhollyunsatisfactoryresult

whichisdirectlyattributabletothecourt’srefusaltorecognisenullityasamatteraffecting

documentarycompliance.

b. AdistinctionbetweendocumentarycreditsandCIFcontractsTheresultoftheCourtofAppeal’sdecisioninMontrodisthatthepresentationofanullity

willmakenodifferencetothebank’sdutytopayifthedocumentsappeartoconform.This

distinguishes thedocumentary credit from the treatmentof nullities presentedunderCIF

contracts.

186Moses(n71)73(describingtheinsolvencyofcreditapplicantsas“rare”providedtheissuingbankhasengagedinadequatepre-contractualscreening.)187UnitedCityMerchants(HouseofLords)(n8)9perLordDiplock;Gao,TheFraudRule(n23)132.188Goode,‘Abstractpaymentundertakings’(n98)231:“theruling…mightjustpossiblybesustainableonthegroundthattheinsertionofafalseshippingdateinthebillofladingdidnotpreventitfrombeingwhatitpurportedtobe,sothatitcouldbevalidlytenderedbyabeneficiaryingoodfaith”;Gao,TheFraudRule(n23)133.189UnitedCityMerchants(HouseofLords)(n8)9perLordDiplock.190Gao,TheFraudRule(n23)129-130.RecognisedasapossibilityinUnitedCityMerchants(HouseofLords)(n8)9perLordDiplock.191Moses(n71)41;Smith(n170)94-95.

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In the context of CIF contracts, the judgment inGill&Duffus v Berger created a general

propositionthatthebuyerwasrequiredtoacceptapparentlyconformingdocuments.192To

dootherwise,LordDiplockremarked,“woulddestroytheveryrootsofthesystembywhich

internationaltrade,particularlyincommodities,isenabledtobefinanced.”193Atfirstglance,

thiswouldsuggestthattheapproachtonullitiesisidenticalinCIFanddocumentarycredit

contracts and, moreover, depends on similar policy considerations. In the CIF context,

however, this general proposition is modified by two considerations. Firstly, the seller is

required to tender genuine documents, as distinct from those which only appear to be

genuine.194Thebuyer,therefore,canrejectnon-genuinedocuments195withoutincurringany

liabilitytopaytheseller.196Itisthecharacterofthedocumentswhichisimportanthereand

notthemindsetoftheselleratthetimeofpresentation.Inaddition,caselawfollowingGill

&Duffushasconfinedtheapplicationofthegeneralpropositiontoenablethebuyertoreject

backdated197ornulldocuments198eventhoughthepresentationsmayappeartoconform.

The current position, therefore, is that nullity will enable the CIF buyer to reject the

documentswhereastheissuingbankwillberequiredtomakepaymentwherethedocuments

presentedunderacreditappeartocomply.

Thequestiontheniswhetherthisdifferenceinthetreatmentofnullitiesmatters.Ingeneral

terms,ProfessorBridgehasarguedthatCIFanddocumentarycreditcontractsneednotbe

identicalintheirapproachtothequalityoftendereddocumentsasthey“areverydifferent

contracts.”199 There is no doubt merit in this as a starting point, given that the banks’

involvement and the importance of the doctrine of autonomy in credit transactions

192Gill&DuffusSAvBerger&CoInc[1984]AC382193Ibid391-392perLordDiplock.194Hindley&CovEastIndianProduceCo[1973]2Lloyd’sRep.515,518perKerrJ“animpliedtermofacontractofthisnaturethatthebillofladingshallnotonlyappeartobetrueandaccurateinthematerialstatementswhichitcontains,butthatsuchstatementsshallinfactbetrueandaccurate.”JamesFinlay&CovKwikHooTong[1929]1KB400,416perSankeyLJholdingthatthebillofladingmustbegenuine.195Forexample,wherethebillof ladingcoversgoodsnotactuallyshipped:Hindley (n191)518;abillof ladingbearingafalseshipmentdate:JamesFinlay(n194)413perGreerLJ,KweiTekChaovBritishTradersandShippers[1954]2QB459,482perDevlinJ.196Benjamin(9thed.)(n86)[19-149].197PanchaudFrèresSAvEtablissementsGeneralGrainCo[1970]1Lloyd’sRep.53,58perLordDenningMR;Proctor&GamblevBecherGmbH[1988]1Lloyd’sRep.88,91perLeggattJ.198Hindley&Co(n194)519perKerrJ;Benjamin(9thed.)(n86)[19-035].199Bridge,‘Documentsandcontractualcongruence’(n105)239.

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distinguish the mechanisms.200 While it is true that autonomy has no application in the

contextofaCIFsale,201theoverwhelmingweightofacademiccommentary,withwhichthe

authoragrees,makesclearthatthisdistinctionisirrelevantwhenitcomestonullity.202This

isbecauseafindingthatadocumenthasnolegalvaluedoesnotinvolveanenquiryintothe

goodsortheunderlyingcontract.203Rather,theenquirywouldsimplyrelatetothequalityor

characterof thetendereddocument.Thiswould innowaythreatentheautonomyof the

contractscreatedbythedocumentarycredit.Itwouldbepreferable,therefore,forthelaw

totakethesameapproachtonullityinCIFandletterofcreditcontracts.204

The difference in treatment alsomakes little sense from the perspective of efficient risk

allocation.TheCIFsellerandthecreditbeneficiaryareboththeclosestpartytothesourceof

thenullityorbackdating,intheirrespectivetransactions.Ordinarypatternsofriskallocation,

discussed above,205would impose liability on the party best placed to identify defects at

source,eitherbecausehetakesthedocumentsdirectlyorselectsthethirdpartychargedwith

creatingthem.206Thereisnoreasonthattheapproachordinarilyregardedasefficientshould

beapplicableintheCIFcontextbutnotinrelationtolettersofcredit.Thiscreatesincentives

fortheCIFsellertotakecareinselectingthirdpartiesbutabsolvesthecreditbeneficiaryfrom

allresponsibilityinthisrespect.

Analyticaldifficultiesapart, thedivergentapproaches tonullityhaveasignificantpractical

consequenceindeterminingwhichpartyiswithoutfundsduringtheensuinglitigation.Inthe

CIF context, the buyer can shift the risk of loss immediately back onto his seller if the

documentsarenon-compliantorcontainlatentdefects,suchasafalseshippingdate.207The

onus is thenonthesellertobringanactionforwrongfulrejection.This iscontrarytothe

positioninvolvingaletterofcreditwherethebuyer-applicantmustbringanactionagainst

200Ibid239;Bridge,‘Documentsandcifcontracts’(n125)6.201PTodd,‘Non-genuineshippingdocumentsandnullities’[2008]LMCLQ547,566.202 Bridge, ‘Documents and contractual congruence’ (n105) 234; Horowitz (n12) [3.16], [3.29]; Neo, ‘A nullityexception’(n145)60.203Bridge,‘Documentsandcontractualcongruence’(n105)235;Horowitz(n12)[3.16].204Bridge,‘Documentsandcontractualcongruence’(n105)234.205Seeearlier,texttofn168.206SchwartzandScott(n168)21,918.NotethatthisisthelogicadoptedinUnitedCityMerchants(CourtofAppeal)(n139)623perStephensonLJ.207Benjamin(9thed.)(n86)[19-080].

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the seller for breach, having already reimbursed the issuing bank. This places the credit

applicantinamuchlessfavourablepositionwhichisdifficulttojustifygiventheforegoing

discussionofriskallocation.

Giventheclear judicial reluctancetorecognisenullityasabasis forrejection,208Professor

BridgehasattemptedtoreconcilethisinconsistencybetweenCIFcontractsanddocumentary

credits. His solution was to draw an analogy with the decision in Cargill International v

Bangladesh Sugar.209 In that case, the court held that a beneficiary who obtained an

overpaymentunderaperformancebondhadaduty toaccount for theexcess.210Bridge’s

suggestionwasthatthecreditbeneficiarywouldbeunderasimilarimplieddutytoaccount

forthepricewherethecreditapplicanthadrejectedthegoodsfornon-conformity.211With

respect,thissolutiononlygoessofar.Toputtheonusonthebuyertobringanactionforthe

price complicates matters and would require additional litigation. In addition, Bridge’s

solutionisonlylikelytoworkinrespectofthehonestsellerwho,asanintermediatepartyin

astringsale,hadnothingtodowiththephysicaldefectsandcouldinturnshiftthelossback

ontohisseller.Bycontrast,incircumstanceswherethenullityispartofafraudulentscheme

butthecreditapplicantisunabletoinvokethefraudexception,anactionforthepricemay

constitutenosolutionwhatsoever.Itfollowsthatthepositionmustbemodified–toequate

theapproach indocumentarycreditswiththeCIFposition–bytheappellatecourts inan

appropriatecase.

iv. Anewapproachtonullityandforgery?

ThepracticalandanalyticaldifficultiesflowingfromthedecisioninUnitedCityMerchantsare

notsomuchattributabletotherestrictiveapproachtofraud,buttoLordDiplock’sconflation

of forgery, nullity and fraud. Significantly, these consequences undermine Lord Diplock’s

justificationforanarrowapproachtofraudbythebeneficiary;tomaintainthedocumentary

credit as an efficient method of trade financing. The sequential analysis propounded by

208Montrod(n123)[58]perPotterLJ.209CargillInternationalvBangladeshiSugar&FoodIndustriesCorp[1998]1WLR461.(confirmedinTradigrainSAvStateTradingCorporationofIndia[2006]1Lloyd’sRep.216,[26]perChristopherClarkeJ.)ascitedinBridge,‘Documentsandcontractualcongruence’(n105)240.210Cargill(n209)469perPotterLJ.211Bridge,‘Documentsandcontractualcongruence’(n105)239-240.

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Goode,discussedearlierinthischapter,212providesameansofdisentanglingtheserelated

issues.ItshouldbenotedthatGoode’sanalysisisnotsimplyoftheoreticalinterest;indeed,

as founder of the Centre for Commercial Law Studies,213 he could hardly be described as

lackingreal-worldinsight.Tothisend,thispartofthediscussionconsiderstheextenttowhich

the detrimental consequences flowing from United City Merchants demand a different

approachtoforgedandnulldocuments.

Thesequentialanalysisfirstconsiderstheconformityofthedocuments.Asnotedabove,non-

conformityhasbeenconceptualisedinbothbroadandnarrowtermsintheliterature.The

broadviewofnon-conformitywouldentitle thebank to rejectdocuments containingany

known forgery, fraudulent misstatement or nullity at the time of presentation. There is

considerable academic support for this standard of non-conformity,214 including Goode

himselfinthefollowingcomments,

TheshortpointisthattheUCPandthetermsofeverycreditrequirethepresentation

ofspecifieddocuments,thatis,documentswhicharewhattheypurporttobe,and

thereisnowarrantfortheconclusionthatthisentitlesthebeneficiarytopresent,for

example, anyoldpieceofpaperwhichpurports tobeabill of lading…even if it is

forged,unauthorised,orotherwisefraudulent.215

Bycontrast,thenarrowerconceptionofnon-conformityregardsonlynulldocumentsasnon-

conforming. The focus iswhether the presented documents are capable of fulfilling their

intended purpose. Indeed, this is the approachGoode uses to justify the actual result in

UnitedCityMerchantsgiventhat“theinsertionofafalseshippingdateinthebillofladingdid

notpreventitfrombeingwhatitpurportedtobe.”216

212Seeearlier,texttofn126etseq.213 Queen Mary University of London, ‘About the Centre for Commercial Law Studies (CCLS)’ available at:http://www.ccls.qmul.ac.uk/about/index.html(accessed02/09/2016).214Hooley,‘Fraudandlettersofcredit’(n145)280;Neo,‘Anullityexception’(n145)60;Horowitz(n12)[3.21].215McKendrick,GoodeonCommercialLaw(n114)1106.216Goode,‘Abstractpaymentundertakings’(n98)231.

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Whicheverstandardofnon-conformityispreferred,itmustbeemphasisedthattorecognise

forgeryornullityasindependentbasestorejectdocumentswouldnotcreateanewdefence

topayment.Rather, itwould simply enable thebanks to fulfil their intended function; to

determineobjectivelywhetherthepresenteddocumentsarethoserequiredunderthecredit.

Furthermore,todepartfromthecurrentjudicialapproachtonullityandforgerywouldnot

underminetheprincipleofautonomy.Thisisbecause,asNeohasnoted,“afraudinrelation

toadocumentthatrendersitanullitymustsurelybedirectlylinkedtothedocumentitself

ratherthanamatterconfinedtotheunderlyingcontract.”217Thedoctrineofautonomywould

onlybethreatenedifissuesrelatingtotheunderlyingcontractwereusedtodisruptpayment

underthecredititself.

Theauthor’s view is that thenarrowapproach tonon-conformity is tobepreferred. This

reflectsthefactthatnulldocumentscannotfulfiltheirintendedcommercialfunctionwhereas

forgeddocumentsremaincapableofrepresentingthegoods.Totreatnulldocumentsasnon-

conforming would overcomemany of the difficulties associated with the current judicial

approachtonullity.Mostnotably,thecirculationofnon-genuinedocumentswouldreduce

andthiswouldsafeguardthebank’spositionintheeventofthecreditapplicant’sinsolvency.

Theauthor’spreferenceforthenarrowconceptionofnon-conformityisborneofpragmatism,

designed to reflect the importance of maintaining the credit as an efficient device for

financinginternationaltradewithoutundulyincreasingthenumberofrejectedpresentations.

The price of pragmatism, however, is a loss of conceptual clarity becausemere forgeries

wouldnotberegardedasnon-complianteventhoughtheycannotsensiblyberegardedas

thedocuments stipulatedby thecredit.Thismeans that theconsequencesof thecurrent

approachtoforgery–adistinctionbetweendocumentarycreditsandnegotiableinstruments

andthejudicialfailuretorespecttheparties’riskallocationwithregardtoforgery–remain.

Astheseissuesarelargelyproblematicfromaconceptualstandpoint,theauthor’scontention

is that the efficiency of the creditmechanism overrides these conceptual difficulties and

justifiesthenarrowapproachtonon-conformity.

217Neo,‘Anullityexception’(n145)60.

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Forthistobecomeareality,acasewouldneedtoreachtheSupremeCourttoovercomeboth

theHouseof Lords’ decision inUnitedCityMerchants and thatof theCourtofAppeal in

Montrod.Takingtheapproachtonon-conformityinUnitedCityMerchantsfirst,theUCP600

makesiteasiertorecogniseanulldocumentasnon-complyingthanitwasundertheUCP

500.218ThisisbecausethedefinitionofcomplyingpresentationinArticle2explicitlyrefersto

documents “in accordance with the terms and conditions of the credit.”219 Documents

without any legal effect could never satisfy this definition. Furthermore, the numerous

references to ‘on their face’ havebeen removedwhich serves to confirm that thebank’s

obligationtopayistriggeredbyacomplyingpresentation,andnotmerelyonewhichappears

to conform.220 These revisions to the UCP should enable a modern court to confine the

decisioninUnitedCityMerchantstocreditswhichincorporatedtheUCP500.

TheCourtofAppealfirmlyrejectedanullityexceptiontoautonomyinMontrod221without

considering the issue as a matter of non-compliance. By contrast, the approach of the

Singaporean Court of Appeal inBeam Technology v Standard Chartered Bank222provides

usefulguidanceastohowafuturecourtmightdistinguishMontrod.InBeam,thebuyerhad

notified the seller that air waybills would be issued by freight forwarders, Link Express,

although it later transpired that the named entity did not exist. The Singaporean Court

preferredthereasoningoftheCourtofAppealinUnitedCityMerchants223andadvocatedthe

sequentialanalysisinthefollowingterms,

While the underlying principle is that the negotiating/confirming bank need not

investigatethedocumentstendered,itisaltogetheradifferentpropositiontosaythat

the bank should ignore what is clearly a null and void document and proceed

nevertheless to pay. Implicit in the requirement of a conforming document is the

assumptionthatthedocumentistrueandgenuinealthoughundertheUCP500and

commonlaw,andintheinterestof internationaltrade,thebankisnotrequiredto

218Horowitz(n12)[3.26].219UCP600art.2.220Horowitz(n12)[3.26];UCParts.2,6,7.221Montrod(n123)[58]perPotterLJ.222BeamTechnology(MfG)PteLtdvStandardCharteredBank[2002]SGCA53.223Ibid[31]perChaoHickTinJA,TanLeeMengJ.

257

lookbeyondwhatappearsonthesurfaceofthedocuments.Buttosaythatabank,in

thefaceofaforgednullandvoiddocument(eventhoughthebeneficiaryisnotprivy

tothatforgery),muststillpayonthecredit,defiesreasonandgoodsense.Itamounts

tosayingthattheschemeofthingsundertheUCP500isonlyconcernedwithcommas

andfullstopsorsomemisdescriptions,andthatthequestionastothegenuineness

orotherwiseofamaterialdocument,whichwasthecausefortheissueoftheLC,is

ofnoconsequence.224

TheCourt furtherdistinguished thedecision inMontrod by reference to the fact that the

documentintheEnglishcasewas“not…essential”225inthatitrelatedonlytothequalityof

the goods. While this reasoning is tenuous – compliance depends on all documentary

conditions detailed in the credit being complied with – the decision in Beam usefully

demonstrates thedesire tomoveaway fromtheEnglishapproach. Indeed, theCourtalso

suggestedthatthedefinitionalissuesidentifiedbyPotterLJ226couldbeovercome,

…there could be difficulties in determining underwhat circumstances a document

wouldbeconsideredmaterialoranullity,suchaquestioncanonlybeansweredon

thefactsofeachcase.Onecannotgeneralise.It isnotpossibletodefinewhenisa

document a nullity. But it is really not that much more difficult to answer such

questionsthantodeterminewhatisreasonable,anexercisewhichthecourtsareall

toofamiliarwith.227

ThefactthattheSingaporeancourteasilyovercamethesupposeddefinitionalissuesmakes

itparticularlydisappointingthattheHouseofLordsrefusedleavetoappealinMontrod.228

TheapproachtonullitycontendedforheredependsonasuitablecasereachingtheSupreme

Court.Thereis,asnotedelsewhereinthisthesis,anabsenceofrecentcaselawontheproper

parametersofthefraudexception,thoughthisismorelikelyattributabletothechillingeffect

224Ibid[33]perChaoHickTinJA,TanLeeMengJ.225Ibid[31]ChaoHickTinJA,TanLeeMengJ.226Montrod(n123)[58]perPotterLJ.227BeamTechnology(n222)[36]perChaoHickTinJA,TanLeeMengJ.228Montrod(n123)1999.

258

ofUnited CityMerchants than an actual absenceof fraud.229One can readily understand

commercialparties’reluctancetolitigateseeminglysettleddoctrine.Thesituationhasnot

beenhelpedbysubsequentjudicialandacademicdiscussionwhichhascontinuedtoconflate

therelatedissuesoffraud,forgeryandnullityandtocharacterisethemasrequiringadditional

inroads into autonomy.230While the author believes the arguments in favour of viewing

nullityasamatteraffectingdocumentarycompliancearestrong,thereisnot,atthetimeof

writing,acasemakingitswaytotheSupremeCourtwhichwouldenablethemattertobe

reconsidered.

Thefinalcritiqueofthejudicialapproachtofraudisbasedinempiricalworkconductedinthe

UnitedStates.Theanalysisisusedtosuggestthatinformalmechanismstocontrolfraudexist

throughoutthelifeofexchange,andnotmerelyinthepre-contractualstageasEnglishcase

lawcontends.

III. TheEmpiricalCritiqueThe final critique of the English courts’ approach to fraud is rooted in empirical work

conducted in theUnited States in the late 1990s.231 Thiswork undermines the traditional

explanation of the creditmechanism, namely that it is a device for assuring the seller of

payment,andunderminesthesignificanceofstrictcompliance.Thissectionreflectsonthe

empiricalpictureofcredituseandreconsidersfrauddeterrencefromthisperspective.

Theempiricalwork indicates thatpartiesusecreditsmore informally thandoctrinewould

suggest. Payments were routinely made against seriously defective documentary

presentations. The assurance of payment was therefore transformed into a payment

discretion,preciselyoneoftherisksthatthesellersoughttoabrogatebyusingthecreditin

229SeeBridge,TheInternationalSaleofGoods:LawandPractice(2nded.OUP,2007),[6.84]:“failureoffraudcasestogototrialgivesrisetosomedifficultyindefiningfraudandgivinginstructiveexamples”230Montrod(n123)[58]perPotterLJ;MalekandQuest,Jack(n64)[9.23]:“sucharule[onnullity]willassisttheintegrityofthesystemofdocumentarycreditsasameansoffinancinginternationaltransactions,whereasanywideningoftheexceptionwilldetractfromit.”,[9.24];EPEllingerandDNeo,TheLawandPracticeofDocumentaryLettersofCredit(Hart,2010),168.SeealsoHorowitz(n12)[3.12].Anotableexception,otherthanGoode,isBridge,‘Documentsandcontractualcongruence’(n105)213,230:“despitelanguageusedinsomeofthecases,fraudontheonehandandforgeryandnullityontheotherhandareanalyticallyseparate,thelatterarenotvariationsoffraud.”;LChinandYWong,‘Autonomy–Anullityexceptionatlast?’[2004]LMCLQ14,18;Neo,‘Anullityexception’(n145)67.231RMann,‘Theroleoflettersofcreditinpaymenttransactions’(1999-2000)98MichLRev2494.

259

thefirstplace.Thefocusofthediscussionhereistoexaminewhatthisempiricalevidence

means for fraud and fraud prevention in documentary credits. It will be suggested that

deterrenceisnotjustapre-contractualissue,astheEnglishcourtshavetypicallysuggested,232

butonethatsurvivesthedurationoftheexchangeandismanagedbythesameforcesthat

shapetheinformaluseofthemechanism.

The empirical data is nowpresented (A). Thediscussionwill first considerwhy the credit

remains popular given that its practical operation differs considerably from the written

contract. Two explanations will be offered; firstly, Mann’s suggestion that the credit

constitutes verification by the issuing bank that the buyer has the capacity to, and will

actually, pay against discrepant documents (i) and secondly, Katz’s contention that the

mechanismcanonlybeunderstoodinthecontextofprovidingreassurancetobothparties

(ii). This analysis situates the credit mechanism in the broader relational network of the

market.Thefinalpartofthediscussionconsiderswhattheempiricaldatatellsusaboutfraud

incredittransactions(B).Thedatawillbeusedtoprovideconcretesupportforthejudicial

accountofdeterrencebeforedevelopingarelationalframeworktosuggestthatdeterrence

mechanismsarepresentthroughoutthelifeoftheexchange.

A. TheempiricalworkTheempirical studywhich forms thebasis for thediscussionwas conductedbyProfessor

RonaldManninthelate1990s.233Hesoughttotestanecdotalevidencewhichsuggestedthat

documentary credits functioned very differently in practice thanpredictedbydoctrine.234

Manngathereddatarelatingto500credittransactionsfromfiveAmericanbanksinvolving

theAmericanpartyasexporterinhalfofthetransactions,andimporterintheotherhalf.235

Healsoconductedinterviewswithtenbankmanagerswhoseinstitutionsspecialisedinletters

ofcredit.236

232Sanders(n4)343perBowenLJ.233Mann,‘Theroleoflettersofcredit’(n231).234Ibid2495.235Ibid2496-2497.236Ibid2497.

260

Themajor finding fromMann’sworkwas that documentary presentationswere typically

discrepantbutthatdiscrepancieswerenotusedasameanstorefusepayment.237Indeed,

only 27% of the 500 presentations strictly conformed to the terms of the credit.238 The

discrepancies ranged in severity from technical defects, such as issues with presentation

ratherthanperformance,239tomissingdocumentsandthosewhichindicateddefaultonthe

underlyingcontract.240Tobeclear,allofthesediscrepancieswouldhavebeensufficientfor

thebanktorefusepayment.Instead,fullpaymentwasmadeagainstallbutonediscrepant

presentation.241 In this latter case, the beneficiary received 94% of the contract price.242

Paymentwasmadeviathewaiverprocess243and,inmostcases,waiverwasobtainedwithin

onebankingday.244

Mann’sresultsindicatethattheday-to-dayoperationofthecreditdiffersconsiderablyfrom

thedoctrinalaccountofthemechanism.Thedifficultyforourpurposesisthatthedatado

notadmitofsimpleinterpretation.Theresultswerenotexplicablebyreferencetotherelative

size of the parties nor their respective location.245 Unfortunately, the data are no longer

availableforfurtherinterrogation.246

Thedatafundamentallychallengesthedoctrinalaccountofthemechanisminwhichswift,

certainpaymentisachievedbythepresentationofconformingdocuments.Whilethewaiver

mechanism did not appear to elongate the process in Mann’s study,247 the mechanism

necessarily complicates the autonomous nature of payment. This is because the waiver

processtasksthebuyerwiththepaymentdecision.Thisresurrectstheriskthatthebuyer

237Ibid2502.Thiswasdescribedas“ageneralpatternofdiscrepancy.”238Ibid2502.239Ibid2504-2505.240Ibid2503-2504.241Ibid2513.242Ibid2513.243Thesurveywasconductedinthelate1990sduringwhichtimetheUCP500wasinforce.Art.14(c)UCP500establishedthewaiverprocess.Thishasnowbeenreplacedbyart.16(b)intheUCP600.244Mann,‘Theroleoflettersofcredit’(n231)2514.245Ibid2507.246Mannofferedthedatasettootheracademicsforinterpretationandanalysis,seeibid2497(fn8inoriginal).Accordingly,IsoughttoobtainthedataduringthisthesisbutinpersonalcorrespondencewithProfessorMannhehas confirmed that they are no longer available, see statement by Professor Ronald Mann (Personal emailcorrespondence,20May2015)(onfilewiththeauthor).247Itwouldappearthatinthemajorityofcasesthattheuseofwaiverdidnotundulydelaypayment,seeibid2514.

261

might behave opportunistically, in the sense that factors unrelated to documentary

compliancemay sway the decision.However, the data revealed a total absence of buyer

opportunismduringwaiver.248Thisisinterestingbecauseitishardtoimaginethatinnoneof

thosetransactionshadmarketfluctuationsrenderedthebargain‘bad’forthebuyer.249Both

KatzandGillettehavearguedthatthebuyershouldonlybeconcernedbydiscrepancieswhich

indicatesubstantivedefaultontheunderlyingcontract.250Theproblemwiththisargumentis

thatsomeofthediscrepanciesweresubstantiveinnatureandfullpaymentwasstillmade.

This suggestionalsooverlooks thepossibility thatexact compliancemightbe required for

reasonsonlyperipherallyconnectedtothetransaction,forexamplesothatthegoodscan

clear customs.251 The data further challenged the doctrinal account of themechanism by

indicatingthatthebankdoesnotsimplyact inanadministrativecapacitybut ismoreofa

middlemanbetweenthebuyerandseller.Thebasisforthiswillbeconsideredwhenassessing

theanalysesoftheempiricalworkintheforthcomingsections.252

Forthepurposesoftheforthcominganalysis,itisassumedthattheresultsaretransferable

totheUKcontext.Inthefirstplace,Mann’ssurveyislikelytohaveincludedUKpartiestrading

withAmericancounterparts,whetherasimporterorexporter.253Ifthisisthecase,itwould

suggestthatUKpartiesarealsousingthecreditinaninformalmanner.Evidencegatheredby

SITPRO,anon-departmentalbodyfundedbytheUKDepartmentforBusiness,Innovationand

Skills254hasalsodemonstratedaveryhighrateofdiscrepanciesonfirstpresentation.255These

248Ibid2513-2514.249Eitherduetoafallinthemarketortheprospectofabetterdealwithanotherparty.250AWKatz,‘Informalityasabilateralassurancemechanism.CommentsonRonaldMann’s‘Theroleoflettersofcredit inpayment transactions’ (1999-2000)98MichLRev2554, 2566;CGillette, ‘Lettersof creditas signals.CommentsonRonaldMann’s‘Theroleoflettersofcreditinpaymenttransactions’’(1999-2000)98MichLRev2537,2539.251MalekandQuest,Jack(n64)[8.37].252Seelater,PartIII(i)and(ii).253 The data are no longer available to determine howmany transactions involved a UK party. Statement byProfessorRonaldMann(Personalemailcorrespondence,20May2015)254 SITPRO, ‘SITPRO Simplifying International Trade’http://webarchive.nationalarchives.gov.uk/20100918113753/http:/www.sitpro.org.uk/(accessed03/05/2017)255SITPROandMidlandBank,LetterofCreditManagementandControl(SITPRO1985):almosthalfof1215setsofdocumentswerediscrepantonfirstpresentation.LaterstudiesconductedbySITPROprovidefurtherevidenceofthisandaredocumentedinCSchmitthoff,'Discrepanciesofdocumentsinletterofcredittransactions'[1987]JBL94,94-95.SITPROwasanon-departmentalgovernmentbodywithresponsibilityforharmonisingproceduresanddocumentation for international tradeandadvising traders, thebusiness communityandgovernmentonbestpractice.SITPROclosedin2011anditsfunctionswerepassedtotheDepartmentforBusiness,InnovationandSkills,seehttps://www.gov.uk/government/news/cable-announces-further-quango-closures.

262

ideashavealsobeenpickeduptoalimitedextentincaselaw256andacademiccommentary.257

Where perhaps this UK data differs from that collected in the US is the idea of cure.

SchmitthoffdescribedtheSITPROdatausingthephrase“failurerate”258andthismaysuggest

thatthefirstpresentationwasrejectedbytheconfirmingbank.Regardlessoftheideaofcure,

the high rate of initial discrepancy nevertheless suggests that the practical operation of

credits intheUKdoesnotmirrorthetraditionalaccountofthemechanism.Thefollowing

analysisproceedsonthebasisthattheempiricalevidenceistransferabletotheUKcontext.

Twoexplanationsoftheempiricaldatawillnowbeprovided.Adisclaimer isrequired;the

purposeoftheseanalyseswastoadvancedebatesurroundingdocumentarycreditsbasedon

theempiricalevidencerathertoprovidea‘onceandforall’accountoftheiruse.259

i. Mann’sanalysis:Documentarycreditasverificationinstitution

Thewaythatcreditsareusedinpracticedoesnotguaranteepaymenttotheseller.Thisis

contrary to the doctrinal account of the mechanism. As such, it becomes necessary to

considerwhypartiesoptforanexpensivemechanism260butthenuseitinawaythatdeprives

itof itsuniquequality.Mannhimselfprovidedonesuchanalysis for thecontinueduseof

documentarycredits.

Mannfirstdiscreditedthenotionthatpartiesusingcreditshadapoorunderstandingofthe

mechanismorchosethedeviceoutofhabit.261Thoseusingcreditsaresophisticatedmarket

actors and it was “implausible that [they]…would organize such a large number of

transactions inawaythatsystematically, repeatedly,andpointlessly increases thecostof

256BankersTrustCovStateBankofIndia[1991]2Lloyd'sRep443,449perLloydLJ.257JUlph,‘TheUCP600:Documentarycreditsinthe21stcentury’[2007]JBL355,356suggests70%ofdocumentsarediscrepantonfirstpresentation.258Schmitthoff,‘Discrepanciesofdocuments’(n255)95.ThenotionthatdiscrepantpresentationsarecuredintheUKisstrengthenedbyRBergami,'WilltheUCP600providesolutionstoletterofcredittransactions?'(2007)3IntlRevofBusResearchPapers41,42whereitissaidthatdiscrepanciescost£133million/yeartocureintheUKalone.259Mann,‘Theroleoflettersofcredit’(n231)2533.Indeed,Katz(n250)2573andMann(n231)2533bothimploredotheracademicstogatherfurtherdatatotesttheseassumptions.Theauthorhasfoundnoevidencethatanyonehasyettakenupthischallenge.260Lettersofcredittypicallycostonequarterof1%ofthevalueofthegoodssoldi.e.inatransactionworth£1million,theletterofcreditwouldcost£2500,seeMann,‘Theroleoflettersofcredit’(n231)2499.261Ibid2515-2516.

263

transactions.”262Insteadtheevidencesuggestedthatcreditswerenotthedefaultchoiceinall

internationalexchanges263butwereemployedinexchangeswheretherewasanabsenceof

relational ties.264 This suggests a degree of discrimination in their use265 which makes it

possibletodisposeoftheideathatpartiesareusingcreditsoutofhabit.

Mann then suggested that the traditional understanding of themechanism – guaranteed

paymenttotheseller–wasincompletesince,inpractice,thecreditdidnotprovidesellers

withalegalrighttopayment.266Thedataalsosuggestedthedefectswerenotcured,evenin

casesinwhichcurewouldhavebeenstraightforward,267whichledManntoarguethatthe

presentation of strictly complying documents was less important than suggested in the

doctrinalaccount.268

AbaselineassumptioninMann’sanalysiswasthatcommercialpartiesoptedforaletterof

credit because they believed it strengthened the underlying transaction. The doctrinal

accountwouldsuggestthatthisstrengthisthevirtualguaranteeofpaymenttotheseller.If

the practical usage of the credit does not provide this guarantee i.e. because strictly

conforming documents are not routinely presented, the letter of creditmust bolster the

underlyingtransactioninsomeotherwayandbyprovidingsomethingthatthepartiescannot

(easily)obtainthemselves.269Mannarguedthattheveryissueofthecreditprovidedtwotypes

ofinformation:firstly,thatthebuyercanandwillpaynotwithstandingdocumentarydefects

andsecondly,thatthetransactionislegitimate.270Thisdiscussionfocusesonthefirsttypeof

information, a signal of the buyer’s creditworthiness and non-opportunistic behaviour

directedtotheseller.

262Ibid2516.263Ibid2518.264Ibid2518.265Ibid2518.266Ibid2519.267Ibid2535:“thedefectswerecurableinabout62%ofthe341casesinwhichtherewasadefect…overall,thedefectswerecuredin35%ofthe193casesforwhichthedefectswerecurable.”268Ibid2519.269Ibid2521.270Ibid2521.

264

InMann’sanalysis,theissuingbankactsasareputationalintermediaryforthebuyer.271The

feasibilityofsystemsinwhichathirdpartystandsforthebehaviourofanotherdependson

theexistenceofasanctionshouldthatthirdpartyprovidefalse information.272Thiswould

typically be a reputational sanction. The effectiveness of such sanctions demands that

credibleinformationaboutaparty’sbehaviourisavailableandthatitcanbetransferredto

othersconsideringdealingwiththatparty.273Manncontendedthatareputationalsanction

existedinthecreditcontextinthatabank’songoingbusinesswouldsufferifpaymentswere

unsuccessful.274Manndidnotconsiderhownoticeofdefaultwouldbecirculatedamongst

thepotentialtradingcommunity.

Asystemofreputationalintermediationmakessenseinthecontextoflettersofcredit.Firstly,

thesellercanassessthereputationofaforeignbankfareasierthanitcanaforeignbuyer.275

Thismaybeduetotheexistenceofinformationlocaltotheseller276orsimplybecausethere

arefewerspecialistdocumentarycreditbanksthantherearepotentialtradingpartners.277In

thiswaythentheletterofcreditminimisestransactioncosts.Assumingthistobethecase,

the bank can provide information about the buyer that the seller would otherwise find

difficulttoobtain.Thisinformationrelatestothebuyer’screditworthiness,namelyhisability

topay,andthathewillnotopportunisticallyrefusepaymentduringthewaiverprocess.The

bank’s information is built on ex ante screening,278 actual knowledge of the buyer from

previous interactions and its ability to monitor the buyer’s behaviour throughout the

transaction.279 The interview evidence confirmed the banks’ dislike for opportunistic

rejections, with one interviewee noting that the bank would cease to act on behalf of

opportunisticclients.280

271Ibid2521.Seemoregenerallyonthistopic:RMann,‘Verificationinstitutionsinfinancingtransactions’(1998-1999)87GeoLJ2225,2258etseq.272Gillette,‘Lettersofcreditassignals’(n250)2541.273Ibid2544.274Mann,‘Theroleoflettersofcredit’(n231)2521-2522,2525.275Ibid2522.276Ibid2533.277Ibid2533.278Ibid2526.Screeningbythebanktoensurethecreditworthinessoftheapplicantalsomakessenseaspartofthedoctrinalstory.Forexample,Moses(n71)62arguesthatitisparticularlyimportantintheeventoftheapplicant’sinsolvencysincethebankwillbecomeobligedtomakepaymentagainstacomplyingpresentation.279Mann,‘Theroleoflettersofcredit’(n231)2529.280Ibid2526-2527.

265

It is important to note that the use of a letter of credit goes beyond reputational

intermediation; it displaces the buyer as the primary obligor for payment under the

contract.281Ofcourse,thereisthepossibilitythattheunderlyingcontractwillrevive,where,

forexamplethebankfailsorthecreditexpires,andwithitthebuyer’sdutytopayunderthe

original contract.282 In these circumstances the creditworthiness of the buyer would be

importanttotheseller.Ingeneralterms,however,thisisnothowthecreditisdesignedto

work;itisintendedthatthebankmakespaymentinthefirstinstanceandisthenreimbursed

bythebuyer.Theabsenceofstrictcompliancecreatesapotentialdifficultyforthebeneficiary

if the applicant subsequently goes insolvent.283 Once the issuing bank (or trustee in

bankruptcy)hasbecomeawareofthe insolvency,theywillnotpermitdiscrepanciestobe

waived,eveniftheapplicanthadalreadysanctionedpayment.284Notably,theUCPdoesnot

bindthepayingbanktotheapplicant’sdecisiononwaiver285andintheserare286circumstances

theriskofinsolvencywillbebornebythebeneficiary,muchlikeinatransactionwithoutthe

supportofadocumentarycredit.

ForMann,thecontinueduseofcreditswasexplainedbytheinformationthattheissuingbank

providedtotheseller.Thisinformationservedtoreassurethesellerthatthebuyerwouldpay

against discrepant documents and was secured by the threat of a reputational sanction

againstthebank.

ii. Katz’sanalysis:Documentarycreditsandbilateralincentives

An alternative analysis of the empirical datawas provided by Professor Avery Katz.287 He

contendedthatMann’saccountwasincompletebecauseitfailedtorecognisethatcreditsare

281Gillette,‘Lettersofcreditassignals’(n250)2541-2542.282Theideaoftheletterofcreditas‘conditionalpayment’isevidentinWJAlan&CovElNasrExportandImportCo[1972]2QB189,210perLordDenningMR.283Moses(n71)34.Thisisnotaprobleminthedoctrinalaccountofthemechanismsinceseller’sroutinelypresentstrictly compliant documents which assure them of payment from the bank, irrespective of the applicant’ssubsequentinsolvency.284Ibid34.285UCP600art.16(c)(iii)(b).286Moses(n71)73.287Katz,‘Informalityasabilateral’(n250).

266

designedtoreassurebothparties.288Moreover,hesuggestedthatthecreditcouldnotsimply

beabouttheflowofinformationfrombanktosellerassimilarinformationwasavailablemore

cheaplyfromothersources.289Ofcourse,ifsellerssimplywantedanassuranceofpayment,

thebankcouldsendastrongersignalbyopeningitselftolegal,andnotsimplyreputational,

liability.290Theroutinepresentationofdiscrepantdocumentsmeansthatthebankdoesnot

becomelegallyboundtomakepayment.

In Katz’s analysis, the role of the creditwas to provide both partieswith an incentive to

perform.291Todemonstratehowthecreditfulfilledthisfunction,Katzdistinguishedtwosets

of actions which were undertaken in the period before documents were presented for

payment.Theseactionsprovideconcreteinformationtothepartiesabouteachother.

The first category isobservablebehaviourwhichcannotbeeasilyorcheaplyverifiedbya

third-partyenforcer,suchasacourt.292Thesearetheactionsthatthepartiestakesoonafter

agreeingtotradeanddependinlargepartonthebroadernetworkinwhichtheagreement

islocated.Examplesofthesebehavioursincludetheexchangeofpreliminarydocumentation

inwhichtheprecisespecificationofthegoodsisconfirmed,amendmentstotheunderlying

agreementaswellasinformationobtainedthroughconversationswithothermarketactors

andgossip.293Thisprovidesinformationabouteachparty’scharacterandindicateshowthey

are likely to perform over the course of the exchange. Indications of cooperation and

flexibilityinthisphasewouldsuggestthatthepartyiscommittedtothetransaction.Parties

canrelyonthisinformationbecauseitcomesdirectlyfromtheirexperienceandfromother

marketparticipants.294Asthesesoftsignalscannotbeverifiedbyacourt,theseactionscannot

formthebasisoflegalobligations.295Incidentally,theexistenceofsuchinformationchannels

288Ibid2555-2556.289Ibid2557-2558.290Ibid2555.291Ibid2555-2556;ThebilateralassuranceprovidedbythemechanismisalsorecognisedbyGillette,‘Lettersofcreditassignals’(n250)2539.292Katz(n250)2564.293Ibid2564.294OWilliamson,‘Transaction-costeconomics:Thegovernanceofcontractualrelations’(1979)22(2)JLaw&Ec233, 248;GGundlach, ‘Exchange governance: The role of legal andnonlegal approaches across the exchangeprocess’(1994)13(2)JofPubPol&Mark.246,253.295Katz,‘Informalityasabilateral’(n250)2564-2565.

267

wouldconstitutethemeansbywhichthereputationalsanctioninMann’sanalysiscouldbe

transmitted.296

The second type of actionwhich occurs before the presentation of documents is directly

relatedtotheparties’substantiveobligationsunderthecontract.297Assuch,theyareeasily

and cheaply verifiable by a court and can therefore form the basis of legally enforceable

duties.298 These include the completion and procurement of detailed documentation

evidencingperformancesuchasthecommercialinvoice,billofladingandcertificatesissued

by third parties.299 The completion of these tasks provides a strong signal of a party’s

willingnesstoperformtheirsubstantiveobligationsbutareexpensiveandtimeconsuming

forthepartiestocomplete.300

Onthisanalysis,theperiodpriortothepresentationofdocumentsprovidesinformationto

bothbuyerandsellerabouttheircounterpart’swillingnesstoperformandcommitmentto

thetransaction.Katzfurthercontendedthattheexchangeofinformationduringthisphase

determinedwhetherpresentationandpaymentwouldbedealtwithstrictlyoronamore

informalbasis.301Katzdistinguishedtwoscenariosforthispurpose.

If the buyer received sufficient soft signals indicating substantive performance, Katz

suggested that hewould be less concerned about exact documentary compliance.302 The

buyer,assuredofsubstantiveperformanceinthisway,wouldbelikelytowaivedefects.This

wouldreducethecostsassociatedwithstrictcompliancefortheseller.303Thebuyermayalso

receiveindicationsofdeficientperformanceintheearlyphasesofexchange.304Ifthiswasthe

case, the buyer would be unwilling to accept discrepant documents and, in these

296Seeearlier,texttofn271etseq.;Gillette,‘Lettersofcreditassignals’(n250)2544.297Katz,‘Informalityasabilateral’(n250)2565.298Ibid2565.299Ibid2565.300 Gillette, ‘Letters of credit as signals’ (n250) 2540: strict compliance is expensive because it requiresmoreeffectivemonitoringofthirdpartiesandagentsand,intheeventofrejection,thecostsofcureandre-tenderarehigh.301Katz,‘Informalityasabilateral’(n250)2565.302Ibid2565,2567.303Ibid2565.304Ibid2565.

268

circumstances,onewouldexpectpartiestobehaveinaccordancewiththewrittentermsof

thecredit.305

Pre-presentation information has the potential to reassure the buyer that substantive

performanceisforthcoming.Theopportunitytominimisetheexpenseofstrictcompliance

providesanincentiveforthesellertoperformhissubstantiveobligationswithoutadhering

strictlytothedocumentaryconditions.306Thisisonlyhalfofthestory.Toreassurebothparties

thattheircounterpartwillperform,themechanismalsoneedstoprovideanincentiveforthe

buyer.ThisiswheretheissuingbankbecomessignificantinKatz’sanalysis.307Byissuingthe

credit,thebankreassuresthesellerthatthebuyerwillnotbehaveopportunisticallyduring

waiver.308The informationcomes fromthesamesourcesas inMann’sanalysis,namelyex

antescreeningandmonitoringduringperformance.309Itisimportanttonotethattheissuing

bank has amore limited role in Katz’s analysis; the information provided relates only to

whether the buyer will pay (opportunism) and not to whether the buyer can pay

(creditworthiness).310Thiscomportswiththedoctrinalaccountofthemechanism;oncethe

credithasbeenissued,thesellershouldhavenoregardforthebuyer’screditworthinesssince

hewillordinarilylooktothebankforpayment.311

MuchlikeMann,Katzreliedonthenotionofreputationalintermediationbytheissuingbank

onbehalfofitscustomer,thecreditapplicant.Inorderthatsuchintermediationiseffective,

theremustbeasanctionimposedonthebankifthebuyerbehavesopportunistically.Katz

recognisedbothreputationalandlegalpenaltiesforthispurpose.312Thisgoesfurtherthan

Mann’sanalysiswherethepenaltywaslimitedtoareputationalsanction.AccordingtoKatz,

abankwhichrejectedsubstantiallycomplyingdocumentswouldsufferareputationalpenalty

becauseitanditscustomerswouldgarnerareputationfornit-picking.313Sellersdealingwith

305Ibid2565,2567.306Ibid2566.307Ibid2566.308Ibid2566.309Ibid2567.310Ibid2566.311Gillette‘Lettersofcreditassignals’(n250)2542.Thisignoresthepossibilitythatthesellermayneedtoseekpaymentdirectlyfromthebuyeraswherethecredithasexpiredorthebankhasitselfgoneinsolvent.312Katz,‘Informalityasabilateral’(n250)2566-2567.313Ibid2567.

269

thatbankinthefuturewouldknowthatstrictcompliancewasrequiredwhichwouldincrease

thepriceofdealingthroughthatbank.314Thiswouldrenderthebankanditscustomersaless

attractiveproposition.InKatz’sestimation,however,areputationalpenaltyisinsufficientto

support the bank’s signal alone.315 As such, he suggested that the threat of legal liability

strengthenedthebank’ssignalandcreatedanincentiveforeffectivemonitoring.316Thethreat

oflegalliabilityexistsbecauseasellerwhohadperformedsubstantivelycouldsubsequently

procurestrictlycomplyingdocuments,317albeitatgreaterexpense,atwhichpointthebank

wouldbecome legallyobligedtopay.Thecombinationof thesesanctions incentivisedthe

banktomonitorthebuyereffectively.318

Contractualarrangementswhichareunderpinnedbya strict legal frameworkbutoperate

informallyarecommonintheempiricalcontractliterature.319Indeed,Katzhimselfmakesthis

link.320ToadoptProfessorLisaBernstein’slanguage,thestrictlegalframeworkconstitutesa

seriesof‘endgame’normswhichareemployedwhentherelationshiphasbrokendown.321

Theflexibleandinformaloperationofthecreditareexplicableas ‘relationship-preserving’

normswhichdictatetheday-to-dayinteractionsbetweentheparties.322Wheretheparties

are engaged in a successful ongoing relationship, documentary discrepancies may not

warrant asserting one’s legal rights by demanding strict conformity of the presented

documents.323 If this is correct, one would expect to see a greater insistence on strict

complianceinoneshottransactionsthaninexchangesbetweenrepeatplayers.324Thedata

314Ibid2567.315Ibid2560-2562(thereasonsarenotparticularlyrelevantforthisanalysis).316Ibid2566-2567317Ibid2566.318Ibid2567.Katzdoesnotsuggesthowtheseincentivesmotivatethebankinthisway.319Forexample,LBernstein,‘Privatecommerciallawinthecottonindustry:Creatingcooperationthroughrules,norms,andinstitutions’(2000-2001)99MichLRev1724;SMacaulay,‘Non-contractualrelationsinbusiness:Apreliminary study’ (1963) 28(1) Am Soc Rev 55; R Ellickson, ‘Of Coase and cattle: Dispute resolution amongneighborsinShastaCounty’(1986)38StanLR623.320Katz,‘Informalityasabilateral’(n250)2569.321LBernstein, ‘Merchant law inamerchantcourt:Rethinkingthe law’ssearchfor immanentbusinessnorms’(1996)144UPaLRev1765,1796-1797.Thismaynotbethefullpicture.SeeDCampbell,‘ArcosvRonaasenasrelationalcontract’inDCampbell,LMulcahyandSWheeler(eds.),ChangingConceptsofContract:EssaysinHonourofIanMacneil(PalgraveMacmillan,2013)(arguingthataninsistenceonstrictlegalobligationsmaybeperfectlyacceptablewithincompetitivemarkets.)322Bernstein,‘Merchantlaw’(n321)1796-1798.323Gillette‘Lettersofcreditassignals’(n25)2540.324Seealsoibid2546wherehemakesasimilarpointinrelationtothetypesofexchangeinwhichtheletterofcreditisemployed.

270

wasnotdifferentiatedinthiswayand,asnotedabove,325arenolongeravailableforfurther

analysis.

Adegreeofprecisionisrequiredhere.326Thestudieswhicharetraditionallyusedtoexemplify

the power of reputational sanctions involve economic exchange between ethnically

homogenous communities327 or in geographically closed spaces.328 The efficiency of

reputationalsanctionsinthesesettingsdependsonthesharednormsofmarketparticipants

and thedirect channels throughwhich sanctions canbe levied.By contrast,documentary

creditcontractstypicallyinvolvestrangers,separatedbothgeographicallyandculturally.Itis

important to consider, therefore, whether the characteristics indicative of reputational

penaltiesexistinthecreditcontext.

Tobeginwiththegeographicaldistanceseparatingpartiestoacredittransaction,thestudies

of internet sales provide support for reputational sanctions in long distance contracts

betweenanonymousparties.Thisrequiresasmalldiversionfromthemainargument.These

transactionsarguablybeargreater similarity to letterof credit contracts329 thanstudiesof

closedcommercialsocieties.Thescaleofinternet-basedcommercewouldtodaysuggestthat

mechanisms have evolved to counter the natural absence of trust between anonymous

parties.Rietjens’workprovidesausefulexampleofhoweBay,theonlineauctionwebsite,

has created a community of traders providing publicly-available feedback after each

transaction.330This reputationsystem“collects,distributesandaggregates feedbackabout

participants’pastbehaviour”331whichcanbeusedtopredictfuturebehaviour.332Thecostof

poorperformanceisprimarilyreputational inthesemarketswhich,as inthecaseofeBay,

325Seeearlier,texttofn246.326ThiselementoftheanalysiswasdevelopedasaresultofaquestionandanswersessionwithProfessorSallyWheelerat‘MainCurrentsintheContemporarySociologyofLaw’(CentreforLawandSocietyConference,CardiffSchoolofLawandPolitics,10June2016)327LBernstein,‘Optingoutofthelegalsystem:Extra-legalcontractualrelationsinthediamondindustry’(1992)21JLS115.328Bernstein,‘Privatecommerciallaw’(n319);Macaulay,‘Non-contractualrelations’(n319).329BRietjens,‘TrustandreputationoneBay:Towardsalegalframeworkforfeedbackintermediaries’(2006)15(1)Info&CommTechL55,60:transactions“conductedwithpeopleororganizationswhoarestrangerstoeachotherandoftenhaveanunknownrecordofpastbehaviour.”330Ibid58-59.331Ibid59citingPResnicketal.,‘Reputationsystems’(2000)43CommunicationsoftheACM45,46.332CGillette, ‘Reputationand intermediaries inelectroniccommerce’(2002)62(4)LouisianaLRev1165,1167;Mann,‘Verificationinstitutions’(n271)2230;CWeizsacker,BarrierstoEntry(FarrarStrausGiroux,1981)72-73.

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may also be underpinned by a formal enforcement structure.333 Although enforcement

mechanismsinconsumerinternetcontractsareof littledirectinteresttotheproject,they

demonstratethatreputationcanconstrainbehaviourinlongdistance,anonymousexchanges

providedaneffectivefeedbackloopexists.

Thesecondissuetoconsideristheculturaldistancewhichmayexistincredittransactions.

Thestudiesinvolvingethnicallyidenticaltradersdemonstratethatsharedcommunitynorms

moderatebehaviour.Itis,ofcourse,virtuallyimpossibletoattributeasimilargroupofshared

normstoallcommercialpartiesusingdocumentarycredits.Thereis,however,evidenceto

suggestthatcommonnormsexistwithinindustries.334AsBealeandDugdalefoundintheir

study of engineeringmanufacturers, for example, “certain terms and certain customs or

“unwrittenlaws”werewidelyaccepted.”335Thesetacitunderstandingsenabledtheparties

toeconomiseoncontractualplanning336andprovidedafoundationforhowpartieswould

behave during the transaction. The ability of norms tomoderate behaviour in the credit

contextwillbeconsideredindetailinduecourse.Atthisstage,however,thereisnothingto

suggestthatsimilarunwrittenrulesdonotexistbetweenthepartiestoacredittransaction

whichconstrainharmfulbehaviour.

Themain thrust of Katz’s analysis is that the creditmechanismmotivatesbothparties to

performsubstantivelyandprovidesreassuranceoftheircounterpart’sperformance.Thisis

achieved,fromthebuyer’sperspective,fromknowledgeheacquiresaboutthesellerinthe

pre-contractualphase.Theissuingbankprovidesreassurancetothesellerthatthebuyerwill

notseizeontrivialdiscrepanciesduringwaiver.Reputationalandlegalsanctionsunderpinthe

role of the issuing bank in this analysis. This is a more comprehensive, and therefore

preferable,analysisthanthatofferedbyProfessorMann.

333Rietjens(n329)62,73.334Macaulay,‘Non-contractualrelations’(n319)62-63;HBeale,andTDugdale,‘Contractsbetweenbusinessmen:Planningandtheuseofcontractualremedies’(1975)2(1)BritJLaw&Soc45,47;RLewis,‘Contractsbetweenbusinessmen:Reformofthelawoffirmoffersandanempiricalstudyoftenderinginthebuildingindustry’(1982)9JLaw&Soc153,169.335BealeandDugdale(n334)47.336Ibid47,59.

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Theempiricalworkchallengestheorthodox,doctrinalaccountofthecreditmechanism.Itis

my contention that the empirical work can lead us to a different view about fraud in

transactionsfinancedbydocumentarycredit. Indeed,theremainderofthechapterargues

thatfrauddeterrenceisnotsimplyamatterforpartnerselectionexante,butabackground

matterforthedurationoftheexchange.

B. Empiricalevidenceofdocumentarycredits:ImplicationsforfraudUnlikeothercommercialfraudrules,thetradefinancecourtsdonotcharacterisethefraud

exceptionasadeterrent.This isbecausethecontractingpartiesaredeemedtoundertake

sufficient pre-contractual screening to combat the risk of fraud. This is not routinely

questioned.Itisarguedherethatthejudicialaccountofdeterrencelacksdetailwithregard

to themechanicsofpre-contractual screeningandalso fails toexplainhow incentives for

fraudduringperformancearemitigated.Afterestablishingtheshortcomingsofthejudicial

account(1), theempiricalevidence–and inparticular,Katz’sanalysisthereof– isusedto

suggest a more comprehensive account of fraud deterrence in documentary credit

transactions. It is argued, firstly, that reputational sanctions functionexante to constrain

fraudacrosstransactions(2).Theempiricalevidenceisthenusedtodeveloptwoarguments

abouthowincentivestofraudduringperformancearemitigated(3).

i. Limitationsofthejudicialaccount

Asfarasthetradefinancecourtsareconcerned,deterrenceisamatterforthecontractual

parties and depends on the selection of an appropriate counterpart.337 Lord Bingham’s

comments inHIH Casualty usefully summarise the judicial view; “parties entering into a

commercialcontract…willassumethehonestyandgoodfaithoftheother;absentsuchan

assumptiontheywouldnotdeal.”338Despitetheapparent logicofthisassertion,thereare

severalshortcomingswiththisjudicialaccountofdeterrence.

337Sanders(n4)343perBowenLJ.338HIHCasualty&GeneralInsurancevChaseManhattanBank[2003]2Lloyd’sRep.61,[15]perLordBingham.

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Firstly,andmuchlikethepositionininsurance,339thereisnoempiricalevidenceunderpinning

thisassertion.340Thecourtsarereliant,assooften,onjudicial intuitionandspeculation. It

remainsthecasethatwedonotknowforsurewhetherpartieswouldrefusetodealwitha

partywhosehonestywasindoubt.341

Second, the courts are silent about howpre-contractual screening operates and onwhat

calibreof information it relies. There is an implicit assumption that sufficient information

aboutaparty’scharacterandpropensitytofraudiseasilyandcheaplyavailableinthemarket.

Thisisdifficulttoacceptatfacevalue.Ifwerememberthatthecreditischosentocompensate

forthelackofinformationaboutaparty’screditworthiness,342onewouldassumethatsimilar

difficultieshamperdiscoveryaboutaparty’spropriety.Theargumentmadein(2)isthatthe

empirical data can be used to overcome this shortcoming of the judicial account of

deterrence.

Thejudicialaccountfurtherassumesthattheentirefraudriskcanbemitigatedexante.This

whollyignoresthepossibilitythatincentivestofraudariseduringperformance,eitherdueto

structuralweaknessesofthemechanismortotheunderlyingcharacterorfinancialposition

ofthetrader.Giventhatthefraudexceptionisnotcharacterisedasadeterrent,343itappears,

fromthecourt’sperspective,thatthereisnomechanismtodeterfraudinperformance.The

geographical separation of trading parties, economic fluctuations and containerisation344

make fraudbothpossibleanddifficult todetectduring thisphaseof the transaction.The

courts’failuretoconsiderdeterrenceatthisstageisanotableshortcoming.Inpart(3),the

empiricaldataisusedtosuggestthatdeterrentsdoexistinthisphaseofthetransactionand

relylargelyonnormswhichhavedevelopedbetweentheparties.

339Seeearlierdiscussion,ChapterThree,texttofn1.340JDavey,‘Honesty&therelationalcommercialcontract:Towardsalawofpost-contractualmisrepresentation’,(InsuranceFraudSymposium,UniversityofSouthamptonLawSchool,13July2016),11.341Ibid11:notingtheabsenceofworkconcerningwhethercommercialparties“genuinelyexpecthonestyor‘else[they]wouldnotdeal’forallaspectsofperformance.”342Mann,‘Theroleoflettersofcredit’(n231)2522.Seealso,Moses(n71)36.343Sanders(n4)343perBowenLJ;Todd,BillsofLadingandBankersDocumentaryCredits(n183)[6.2],[6.49].344Todd,MaritimeFraud&Piracy(n97)[4-058].

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ii. Anempiricalexplanationofpre-contractualscreeningandfraud

Thecourtsconfinedeterrencetothepre-contractualstage.Whilethereisacertainlogicto

the contention that sophisticated parties would take steps to ensure the reliability of

potentialcounterparts,thecourtsdonotspecifythemechanicsofpre-contractualscreening

northetypeofinformationonwhichitdepends.Theempiricaldataisusedheretoexpand

uponthejudicialaccountanddemonstratehowpre-contractualscreeningmaypreventfraud

incredittransactions.

Inhisanalysis,Katzhypothesisedtheexistenceofinformationchannelswhichconnectedthe

individualpartiesandwidermarketparticipants.345Thesechannelsconveyed“softsignals”;346

informationwhichwassufficientforthepartiestodeterminehowtobehavebutwhichcould

notformthebasisforlegalobligationsnorbeverifiedbyacourt.347Thequalityofinformation

conveyedintheearlyphasesofperformancedictatedtheformalityoftheparties’exchange.

Where,forexample,softsignalsofcompliantperformancewereconveyed,thebuyerwas

willingtowaivestrictdocumentarycompliance.Conversely,Katzsuggestedthatindications

ofdeficient,andbyextensionfraudulent,performancewouldcausethecreditapplicantto

insistonstrictcompliance.348Tobeclear,itisnotsuggestedthatthisoptionwasexercisedby

anyofthecreditapplicantsinMann’sstudysincethedocumentarydefectswerewaived,and

fullpaymentmade,inallbutoneofthediscrepantpresentations.349

Strict documentary compliance has several consequences for the beneficiary. Firstly, the

transactioncostsoftheinstantexchangewillincreaseashewillberequiredtomonitorthird

partiesmorecloselyandmayincurcoststocuredefectsandretenderdocuments.350More

broadly,signalsoffraudulentbehaviourinonetransactionwillhaveconsequencesforfuture

business.351Assomeofthesesoftsignalsaregeneratedbyothermarketactors,evidenceof

fraudwillimpactthetrader’sreputation.Thiswillreducethequantityofpositivesoftsignals

345Katz,‘Informalityasabilateral’(n250)2564.346Ibid2564.347Ibid2564-2565.348Ibid2565,2567.349Mann,‘Theroleoflettersofcredit’(n231)2513.350Katz,‘Informalityasabilateral’(n250)2565;Gillette,‘Lettersofcreditassignals’(n250)2540.351THawkins,CMWittmannandMBeyerlein,‘Antecedentsandconsequencesofopportunisminbuyer-supplierrelations:Researchsynthesisandnewfrontiers’(2008)37Ind.Mark.Man.895,907.

275

hecansendinfuturetransactionswhichinturnwillmakethoseexchangesmoreexpensive.

On this basis, it is argued here that the reputational and associated financial costs of

fraudulentperformancehavethecapacitytoconstrainmisconduct.

This argument depends on the recognition in the business management and economics

literatures that reputation is able to exercise amoderating effect on behaviour.352 These

literaturesdemonstratethatreputationcanplaythisrolewheretherearechannelsthrough

which informationof poor performance canbe circulated to othermarket participants.353

Providedthesechannelsexist,reputationovercomesthefactthatpartiescannotpredictwith

certaintyhowtheircounterpartwillbehaveoverthecourseoftheexchange.Weizsacker’s

‘extrapolationprinciple’explainshowreputationfunctions,

…the phenomenon that people extrapolate the behavior of others from past

observations and that this extrapolation is self-stabilizing, because it provides an

incentiveforotherstoliveuptotheseexpectations...Byobservingothers'behaviorin

the past, one can fairly confidently predict their behavior in the future without

incurringfurthercosts.354

In the credit context, Katz’s analysis provides clear support for the existence of channels

through which reputational information can flow.355 The precondition for reputational

sanctionstoconstrainbehaviour,assuggestedinthebusinessmanagementliterature,ismet.

Accordingly,thesuggestionisthattheriskofsuchsanctionsencouragespartiestobehavein

accordance with the express terms and informal norms of their agreement to minimise

transactioncostsinthecurrentexchangeandattractfuturebusiness.356Thisreinforcesthe

judicialaccountofdeterrenceasanexantematteranddemonstratesmorespecificallyhow

pre-contractualscreeningcanpreventfraud.

352RCoase,‘Thenatureofthefirm:Influence’(1988)4JofL,Ec&Org33,44:opportunismis“effectivelycheckedbytheneedtotakeaccountoffutureactionsonbusiness”;GGundlachandRAchrol,‘Governanceinexchange:Contractlawanditsalternatives’(1993)12(2)JofPubPol&Mark.141,143.353 For example, Gillette, ‘Reputation and intermediaries’ (n332) 1169;Mann, ‘Verification institutions’ (n271)2256;HCollins,RegulatingContracts(OUP,1999)114.354vonWeizsacker(n332)72-73.355Katz,‘Informalityasabilateral’(n250)2564.356JAbeler,DNosenzoandCRaymond,‘Preferencesfortruth-telling’(IZADiscussionPaperNo.10188,September2016)availableat:http://ftp.iza.org/dp10188.pdf(accessed15/09/2016),7,19.

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iii. Mitigatingthefraudriskduringperformance

The judicial suggestion that the fraud risk is mitigated ex ante through careful partner

selectionignoresthefactthatopportunitiesforfraudmayariseduringperformance.Such

opportunitiesmaystemfromeconomicormarket fluctuationsordifficulties linked to the

shipmentofthegoodswhicharebeyondthebeneficiary’scontrol.Acomprehensiveaccount

ofdeterrencenecessarily requires considerationofhow theseopportunities for fraudare

managed.TheremainderofthechapterusesMann’sempiricaldatatodeveloptwonovel

suggestions as to how fraud ismitigated during performance. The first contends that an

exchangeofpositivesoftsignalsintheearlyphasesoftheexchangereducestheforceofany

subsequent opportunities for fraud (a). The second contention suggests that a relational

modelof governancedevelops to constrainopportunisticbehaviourbecauseof the social

normswhichevolvebetweenthepartiesintheinitialphasesoftheexchange(b).

a. PositivesoftsignalsreduceincentivesforfraudThefirstargumentreliesonthesoftsignalsexchangedbetweenthepartiesintheearlyphases

ofperformance.Thefollowingexampleillustratestheposition.Imaginethatthebeneficiary

hasshippedthecorrectgoodsbutcannotobtainstrictlycompliantdocumentationbecause,

dueto issuesbeyondhiscontrol, theshipmentwas lateor fromadifferentport. In these

circumstances, the seller has three options: (i) to tender non-conforming documents and

hopethebuyerwaivesthedefects,(ii)toseekanamendmenttothecreditor(iii)toprocure

falsifieddocumentationsothat thepresentationappearstocomplywiththetermsof the

credit.Noneoftheseoptionsisentirelyriskfree.Inoption(i)thebuyermayrefusewaiver.357

In (ii), amending the credit involves delay, additional expense358 and requires the buyer’s

agreement.Theriskofoption(iii)isobvious;shouldthefraudbediscovered,thebeneficiary

riskshisrighttopayment.359

357Thisisonthebasisthatitisnotpossibletoobtainconformingdocumentationoncethegoodshavebeenshippedlateorfromthewrongplace.358MalekandQuest,Jack(n64)[3.37].359Providedthattheapplicantcanestablishthenecessarycriteriaforaninjunction,seeearlierdiscussioninChapterFour,III(E).

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Adopting the analysis suggestedbyKatz, the sellerwhohas sent sufficient soft signals of

substantivecomplianceneednotbeconcernedinthishypotheticalillustration.Heshouldbe

confidentthathisbuyerwillwaivethedefectsandpermitpayment.Thistheoreticallyreduces

theincentivesforhimtobehavefraudulently.Accordingly,thebeneficiarywhohasshipped

thecorrectgoodsbutisunabletoobtainconformingdocumentationshouldchooseoption

(i),providedsufficientsoftsignalsofreliabilityhavebeencommunicatedtohisbuyer.

b. TherelationalgovernanceargumentThe final argument is more complex and makes use of literatures in contract theory,

economicsandbusinessmanagement.ThestartingpointistheactivitiesthatKatzsuggested

took place in the time between agreement and document presentation. These activities

includedfinalisingthedetailoftheproducts,specifyingthepracticalaspectsofshipmentand

thecompletionofpreliminarydocumentation.360

The suggestion that the exchange evolves after the written contract is signed adopts a

relationalviewofcontract.Relationalcontracttheoryviewseconomictransactionsandthe

wayinwhichexchangehazardsaremitigatedinfundamentallydifferenttermsthanclassical

andneo-classicaltheory.361Thesearesignificantdistinctionswhichwillnowbediscussed.

1. ModelsofcontractingbehaviourClassicalandneo-classicalcontractlawregardedeconomictransactionsas“simple,one-time

bargainingbetweenindividualactorspursuingindividualoutcomes.”362Thischaracterisesthe

contractingpartiesasself-interestedactorswhopursueoutcomestomaximisetheirowngain

fromthetransaction.363Thismaymean,therefore,thatasellerwouldtakeadvantageofa

rise in themarket to extract a higher price from his buyer. The classical analysis further

consideredthatthepartiesdiscussedtheentiretyoftheirexchangeduringnegotiationsand

360Katz,‘Informalityasabilateral’(n250)2564.361Muchhasbeenwrittenon relational contract theoryand its intricaciesarenotat issuehere.An indicativeselectionofsourcesnotcitedhereincludeDCampbell,LMulcahyandSWheeler,ChangingConceptsofContract:Essays inHonour of IanMacneil (PalgraveMacmillan, 2013);D Campbell, ‘Good faith and the ubiquity of the‘relational’contract’(2014)77MLR475;RScott,‘Thecaseforformalisminrelationalcontract’(1999)94(3)NwULRev847;IMacneil,‘Relationalcontract:Whatwedoanddonotknow’(1985)WisLRev483;IMacneil,‘Themanyfuturesofcontract’(1973-1974)47SCalLRev691.362Gundlach,‘Exchangegovernance’(n294)246.363RBrownsword,‘Fromco-operativecontractingtoacontractofco-operation’inDCampbellandPVincent-Jones(eds.),ContractandEconomicOrganisation(DartmouthPublishingCo.,1996),15.

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committedthisagreementtopaper.Theresultingcontractsetouttheparties’substantive

obligationsaswellastheirrightsintheeventofbreachbytheotherparty.364Sincetheentire

agreement was contained within the written contract, the wider context in which the

exchange took placewas considered irrelevant. The contractwas self-contained, isolated

fromallpriorandfutureevents.365

Bycontrast,arelationalapproachrecogniseseconomicexchangeasasocialendeavour366and

explicitly takes account of the social, economic andmarket context inwhich the specific

exchangeisembedded.367Thisisanimportantdistinctionbecauseitmovesawayfromthe

view that economic exchange is an isolated, singular event and instead recognises

transactions as a spectrum of behaviour.368 This is usefully demonstrated by Macneil’s

relational-discreteaxis.Ontheleft-handsideoftheaxisisthe“as-if-discrete”transaction;the

one-shot exchange between strangerswhose shared context perhaps consists solely of a

commonlanguageandcurrency.369Anexampletypicallycitedintheliteratureis“purchasing

localspiritsfromashopkeeperinaremoteareaofaforeigncountrytowhichoneneveragain

expects to visit nor refer his friends.”370 At the other end of this spectrum is the highly

relationalexchangewhichdevelopsovertimetoaccommodatetheneedsofthepartiesand

tochangesintheworldbeyondtherelation.371Suchexchangesare“usuallyassociatedwith

long-term,flexibleandopen-endedagreementsthatdisplayahighdegreeofrelianceontrust

andongoingco-operation inperformance, ratherthan law.”372Therelationalanalysisalso

movesawayfromthepropositionthatcontractingpartiesareinherentlyself-interested.The

364Thisisknownaspresentiation–theprocessofbringingallpotentialmattersintothepresentforthepurposesofcontractualplanning.SeeIMacneil,‘Economicanalysisofcontractualrelations:Itsshortfallsandtheneedforarich classificatory apparatus’ (1981) 75NwU L Rev 1018, 1019, 1039; CMitchell,Contract Law and ContractPractice:Bridgingthegapbetweenlegalreasoningandcommercialexpectations(HartPublishing,2013),173.365Gundlach,'Exchangegovernance'(n294),246.SeealsoPAtiyah,EssaysonContract(ClarendonPress1986)5-6wheretheneoclassicalconceptionofexchangeisexplainedas“the(1)discrete,(2)two-party,(3)commercial,(4)executory,(5)exchange.”366DCampbell(ed.),TheRelationalTheoryofContract:SelectedWorksofIanMacneil(SweetandMaxwell,2001)130;IMacneil,‘Valuesincontractlaw:Internalandexternal’(1983)78NwULRev340,341-342“allcontractsarerelational.Nevertheless,somecontracts…arefarmorerelationalthanothers.”(emphasisinoriginal).367IMacneil,'Reflectionsonrelationalcontracttheoryafteraneo-classicalseminar'inDCampbell,HCollinsandJWightman(eds),ImplicitDimensionsofContract(HartPublishing2003),217.368IMacneil,Contracts:ExchangeTransactionsandRelations(2nded.FoundationPress,1978),12.369Macneil,‘Values’(n366)343;Mitchell(n364)175.370Williamson,‘Transaction-costeconomics’(n294)247.371IMacneil,‘Contracts:Adjustmentoflong-termeconomicrelationsunderclassical,neoclassical,andrelationalcontractlaw’(1977-1978)72NwULRev854,889-890.372Mitchell(n364)175-176.

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model instead recognises the nuances of human behaviour and provides for both the

competitiveandcooperativeaspectsofbehaviour.

The social and market context is significant in the relational analysis of contract. This

conceptualisesexchangeasanembeddedactivitywhich isnot isolated from theworld in

which it takesplace. This is important because thiswider contextwill inform theparties’

expectations about the transaction.373 Indeed, a relational analysis regards economic

exchange as having the “propensity to generate norms, define or inform parties’

expectations, provide sources of reassurance, facilitate co-operation, [and] create

interdependence.”374 These norms and expectationsmay develop as a result of personal

interaction375 and by virtue of specific trade or industry practices.376 These norms and

understandings are typically unspoken and do not formpart of thewritten contract. The

result is that thewrittenagreement is likely tobe incomplete sincepartieswill avoid the

expenseofdetailedplanningincircumstanceswherethesenormsareasufficientguidefor

conduct.377

2. ThemitigationofcontractualhazardsInternational trade is risky because the parties do not perform their obligations

simultaneously.Thismeansthatmarketfluctuationsmayincentiviseoneorbothpartiesto

breach,oract inamanner inconsistentwith, the termsof theoriginaldeal.These risks–

broadly referred to as exchange hazards – need to be mitigated to safeguard economic

exchange.Inthecontextofinternationalsales,theseller’sprimaryconcernisthatthebuyer

willbeunableorunwilling topaywhen thegoodsaredelivered.Thebuyer’s concern,by

contrast, relates to the probity of the seller. These risks explain the use of documentary

creditstosupportinternationalsalestransactions.Thecredit,however,isunabletoprevent

the beneficiary engaging in fraudulent conduct. The discussion draws on literatures in

373Ibid172.374DKimel,‘Thechoiceofparadigmforthetheoryofcontract:Reflectionsontherelationalmodel’(2007)27OJLS233,236.375DiscussedinMitchell(n364)175;SWheeler, 'Contractsandcorporations' inPCaneandHKritzer(eds),TheOxfordHandbookofEmpiricalLegalResearch(OUP2010),127.376IMacneil,TheNewSocialContract(YaleUniversityPress,1979),37.BealeandDugdale(n334)47.377BealeandDugdale(n334)47-48.

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contracttheoryandbusinessmanagementtoconsiderhowthefraudriskismitigatedduring

credittransactions.

Before considering how classical and relational contract theory explain the mitigation of

hazards, it is important to define ‘opportunism’ and ‘governance’. A party who takes

advantageofoneofthesehazardsforprivategainwouldbecharacterisedasopportunistic.

Theliteraturedefinesopportunismas“self-interestseekingwithguile.”378Thereferenceto

‘guile’heredistinguishesopportunismfromordinarycompetitivebehaviour,acceptable in

themarket. It includes“lying,stealing,cheating,andcalculatedeffortstomislead,distort,

disguise,obfuscate,orotherwiseconfuse.”379Thisembracesthedeliberatebreachofexpress

contractualterms380–whichwouldtypicallymeetthelegaldefinitionoffraud381–aswellas

conductwhichcontravenestheparties’ownsetofnorms.382

Governance mechanisms are required to combat the risks of opportunism and preserve

economicexchange.AsDixithasdescribed,

…ifmarketeconomiesaretosucceed,theyneedafoundationofmechanismstodeter

suchprivatelyprofitablebutsociallydysfunctionalbehaviors,andtherebytosustain

adequateincentivestoinvest,produce,andexchange.Inotherwords,marketsneed

theunderpinningofinstitutionsofeconomicgovernance.383

Giventhefundamentaldifferencesbetweenclassicalandrelationalcontracttheory,itshould

come as no surprise that the governance mechanisms required to safeguard exchange

similarlydifferbetweenthesecompetingtheories.

378OWilliamson,MarketsandHierarchies(TheFreePress,1975),6.379OWilliamson,TheEconomicInstitutionsofCapitalism(TheFreePress,1985)47.380KWathneandJHeide,‘Opportunismininterfirmrelationships’(2000)64JofMarketing36,38.381DerryvPeek(1889)14AppCas337.382OWilliamson,‘Opportunismanditscritics’(1993)14(2)ManagandDecisionEcon97,101;Macneil,‘Economicanalysis of contractual relations’ (n364) 1023 defining opportunism as “self-interest seeking contrary to theprinciplesoftherelationinwhichitoccurs.”383ADixit,LawlessnessandEconomics(PrincetonUniversityPress,2004),2.

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Classicalandneo-classicaltheory,asdiscussedabove,considerthatthecontractingparties

commiteverythingtopaperinadvanceofperformance.Thismeansthatthecontractsetsout

legalsanctionstorespondtobreach.Withthecertaintyofthisframeworkinmind,classical

theorypresumesthatadecisiontobehaveopportunisticallyistakeninfullcognisanceofthe

resulting legal penalty. It further presumed that an individual only decides to act

opportunistically where the gains from fraud exceeded the legal penalty. In the classical

analysis, therefore, the law provided a disincentive to opportunism – the threat of legal

sanctions–whichwasdesigned tokeep theexchangeoncourse. Followingabreach, the

courtswouldsimplygiveeffecttothepenaltiescontainedinthecontract.384

Bycontrast,relationalscholarsdonotviewthecontractasacomprehensiveaccountofthe

exchange.Thismeansthatitwillbeunabletoconstitutethesinglesourceofguidanceforthe

parties or the courts in dealing with disputes. This does not remove the law from the

governanceequationentirelybutitdoesmeanthatanadditionalgovernancemechanismis

required. The relational model suggests that tacit understandings and industry norms

generatedbyeconomicexchangefunctionasagovernancemechanism.Normsareeffectively

anunwrittencodeofconductwhich“circumscribe[s]acceptablebehaviorbetweenexchange

partners.”385

Thebalanceofthesemechanisms–legalsanctionsandrelationalgovernance–willdepend

on the characteristics of the specific transaction under discussion. As a general guide,

exchanges appearing towards the ‘as-if-discrete’ end ofMacneil’s axis would typically be

reliantonlegalsanctionsforgovernance.386Bycontrast,onewouldexpecthighlyrelational

transactions to display evidence of relational governance in the parties’ response to

difficultiesduringperformance.387Itmayalsobethecasethatexchangestowardstheright

of the spectrum display relational governance in some areas but rely on comprehensive

384JFeinman,‘Criticalapproachestocontractlaw’(1982-1983)30UCLALRev829,832.385SSheng, JBrown,CNicholsonandLPoppo, ‘Doexchangehazardsalways foster relationalgovernance?Anempiricaltestoftheroleofcommunication’(2006)23Intl.JofResearchinMarketing63,65.386Mitchell(n364)173.387RSpeidel,‘Thecharacteristicsandchallengesofrelationalcontracts’(1999-2000)94NwULRev823,827,829.

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contractual planning andpre-agreed legal sanctions inothers.388Of course, theparticular

balanceofgovernancewilldependonthetransactionunderdiscussion.

Thesuggestionmadehereisthatexchangehazardsincredittransactionsmaybegoverned

relationally.Todevelopthisargument,thehallmarksoftransactionsdemonstratingrelational

governancewillbeexamined(3)beforeconsideringwhetherthesearereplicatedincredit

transactions(4).ThisismadepossiblebyKatz’sanalysisoftheempiricaldata,mostnotably

thattheexchangeevolvesafterthewrittenagreementissigned.

3. ThehallmarksofrelationalgovernanceRelational governance has been used extensively in the fields of economics and business

management toexplainbehaviour ineconomicexchange.389Thediscussion in this section

identifies the norms typically found in these relations and explains how norms constrain

opportunisticconduct.

Transactions which display relational governance are characterised by norms of trust,390

flexibility391 and commitment.392 These exchangeswill be less susceptible to opportunism

because these norms encourage exchange-sustaining behaviour. When confronted by

economicconditionswhichcreateanincentiveforopportunism–suchasariseorfallinthe

market–apartywithinarelationalexchangewilllikelyforgothisopportunityforprivategain

and instead be willing to renegotiate or offer a concession to his counterpart. In these

circumstances,normsconstitutea“generalprotectivedeviceagainstdeviantconduct.”393

388BealeandDugdale(n334)47,51.389SourcesnotcitedelsewhereinthisthesisincludeGBaker,RGibbonsandKMurphy,‘Relationalcontractsandthetheoryofthefirm’(2002)FebQuart.JEconomics39;RGulati,‘Doesfamiliaritybreedtrust?Theimplicationsof repeated ties for contractual choices in alliances’ (1995) 38(1) Acad.Man. J 85;M Paulin, J Perrien and RFerguson,‘Relationalcontractnormsandtheeffectivenessofcommercialbankingrelationships’(1997)8(5)IntJofServiceInd.Man435;MYaqubi,‘Antecedents,consequencesandcontrolofopportunisticbehaviorinstrategicnetworks’(2009)7(2)JofBus&Ec.Research15.390AZaheerandNVenkatraman,‘Relationalgovernanceasaninterorganizationalstrategy:Anempiricaltestoftheroleoftrustineconomicexchange’(1995)16(5)Strat.Man.J373,378;JJarillo,‘Onstrategicnetworks’(1988)9(1)Strat.Man.J31,36.391LPoppoandTZenger,'Doformalcontractsandrelationalgovernancefunctionassubstitutesorcomplements?'(2002)23StrategicManagementJournal707,710.392RScott, ‘A relational theoryofdefaultof rules forcommercial contracts’ (1990)19 J LegStud.597,614;GGundlach,RAchrolandJMentzer,‘Thestructureofcommitmentinexchange’(1995)59(1)JofMark.78,78,85-86.393BHeideandGJohn,‘Donormsreallymatter?’(1992)56(2)JofMarketing32,35.

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Theabilityofnormstoshapebehaviourinawaywhichsafeguardseconomicexchangehas

beenexplainedinbotheconomicandsociologicalterms.Theeconomicexplanationrelieson

thefactthattheexpectationoffutureexchangeencouragescooperationinthepresent.394In

short,theriskofreputationaldamagekeepspartieshonest.395Thissuggeststhatcooperation

is a rational, deliberate choice396 inwhich the long-term commercial gains are considered

greaterthanthosewhichwouldbeachievedthroughshort-termopportunism.397

Thesociologicalexplanation,bycontrast,reliesontheideaofcontrolfromwithintherelation.

Laietalhavesuggestedthatbehaviouriscontrolledintwoways;throughtheinternalisation

ofrelationalnormsandself-control.398Wherethenormsmirrortheindividual’sownsetof

values,wewoulddescribethenormsashavingbeeninternalised.399Subsequentbehaviourin

accordancewithsharednormsoccursbecausetheactorhasacceptedthemascorrectand

gainsanintrinsicbenefitfromcompliance.400Inaddition,appropriatebehaviourisachieved

throughself-discipline.Macaulay,forexample,arguedthatsocialtiescreated“pressuresfor

conformity to expectations.”401 As a result of these pressures, parties refrain from

opportunistic conduct by exercising self-discipline and moral control.402 Parties may also

conformdueto thesocialconsequencesofopportunism.Theearlierdiscussionsuggested

that a poor reputation makes exchange expensive and risks future business.403 These

reputationaleffectsmay,incertaincommunities,extendintothesocialandpersonallifeof

394PoppoandZenger(n391)710.395BRichman,‘Firms,courtsandreputationmechanisms:Towardsapositivetheoryofprivateordering’(2004)104ColumLRev2328,2335.396PoppoandZenger(n391)710.397OWilliamsonandSWinter,TheNatureoftheFirmOrigins,EvolutionandDevelopment(OUP,1993)71;BKleinandKLeffler,'Theroleofmarketforcesinassuringcontractualperformance'(1981)89JofPolEcon615,616-7.Thelanguageadoptedintheseaccountsimpliesalaw&economicsunderstandingofrationality;KleinandLeffler,forexample,speakintermsofwealthmaximisation.Itisnoteworthythatthemodernbehaviouralunderstandingofbehaviourhasnotpermeatedthesediscussions.398CLaietal.,'Governancemechanismsofopportunism:Integratingfromtransactioncostanalysisandrelationalexchangetheory'(2005)5台灣管理學刊1,2.399HKelman,‘Compliance,identificationandinternalization:Threeprocessesofattitudechange.’(1958)2(1)JofConflictResolution51,53.400Ibid53.ThisechoestheworkofNMazarandDAriely,‘Dishonestyineverydaylifeanditspolicyimplications’(2006)25(1)JofPubPol&Mark.117,discussedinChapterThree,seetexttofn110etseq.401Macaulay,‘Non-contractualrelations’(n319)63.402ALarson,‘Networkdyadsinentrepreneurialsettings:Astudyofthegovernanceofexchangerelations’(1992)37(1)AdminScienceQuarterly76,90.403Seeearlier,texttofn314etseq.

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opportunistic market participants.404 In Bernstein’s studies of the cotton and diamond

industries,sheidentifiedthatindividualswhohadnotmetappropriatestandardsofconduct

incommerciallifewouldalsobeshunnedinsocialsituations.405

Inboththeeconomicandsociologicalaccounts,repeatexchangeisconsideredvaluable.This

isbecauseitprovidespartieswithconcreteandvaluableinformationaboutwhototrust.406

Thisovercomesparties’lackofknowledgeaboutthefuturebehaviouroftheircounterpart407

andreducestheneedtoinvestinexpensivecontractualsafeguards.408

Themarketing literatureconfirmstheexistenceofrelationalgovernance in jointventures,

strategicalliancesand licensingagreements.409Whatthese ‘exchanges’have incommonis

theirextendedduration410anda relativelyequalbalanceofpowerbetween theparties.411

Efficientcommunicationchannelsinthesesettingsenablethepartiestorespondtoproblems

whichariseduringthetransaction412andformpersonalrelationships.413Itisthecombination

ofthesefactorswhichfosterthedevelopmentofrelationalnorms.

4. ApplicationtothedocumentarycreditcontextThe critical question iswhether transactions financedbydocumentary credit embody the

factorsindicativeofrelationalexchange.Thepositionadvancedhereisthat,ingeneralterms

404Richman(n395)2344-2345.405Bernstein,‘Optingoutofthelegalsystem’(n327)138—140,157;Bernstein,‘Privatecommerciallaw’(n319)1748-1750.406 Poppo and Zenger (n391) 710; M Granovetter, ‘Economic action and social structures: The problem ofembeddedness’ (1985) 91(3) American J of Sociology 481, 490; R Gulati, ‘Does familiarity breed trust? Theimplicationsofrepeatedtiesforcontractualchoiceinalliances’(1995)38(1)AcademyofManagementJ85,86,107.407Seeearlier,vonWeizsacker(n332).408EPosner,‘Law,economics,andinefficientnorms’[1996]144UPennLRev1697,1705.409 R Kingshott, ‘The impact of psychological contracts upon trust and commitment within supplier-buyerrelationships:Asocialexchangeview’(2006)35Ind.Mark.Man.724;YLeeandSCavusgil, ‘Enhancingallianceperformance:Theeffectsofcontractual-basedversusrelation-basedgovernance’(2006)59JofBusRes.896;Gulati(n353).Seealsotheworkon ‘vestedoutsourcing’ i.e.KVitasekandKManrodt, ‘Vestedoutsourcing:Aflexibleframeworkforcollaborativeoutsourcing’(2012)5(1)StrategicOutsourcing4,6whichpromotesamodelinwhichparties are “mutually committed to each other’s success, creating a long-termwin-win relationship based onachievingmutualdeterminedgoals.”410GundlachandAchrol(n352)141,144;PoppoandZenger(n391)717,719.411Shengetal(n385)72.412 Ibid 64, 67;Williamson also recognises that communication can encourage parties to develop “sensitive”,cooperativeproblemsolving,seeWilliamson,‘Transaction-costeconomics’(n294)240.413Shengetal(n385)67-68.

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atleast,credittransactionsarecapableofdisplayingthemoreinformalrelationalmodelof

governance.

InKatz’sanalysis,thephasebetweenagreementandperformanceenabledtheexchangeof

softinformationaboutwhethereachpartywouldperformtheirsubstantiveobligations.414I

wouldsuggest,however,thatthisphaseoftheexchangealsoenablesthedevelopmentof

relationalnorms.Thisisbecausetheearlytaskswillcommonlyrequiretheinvolvementand

collaborationofbuyerandsellerandotherpartiesinthesupplychain.Assuch,indicationsof

flexibilityandcooperationatthisstagewillbegintodevelopnormstogoverntheremainder

oftheexchange.Thisisalsothestageatwhichpartieswillinteracttofinalisethedetailsof

theexchange.Asdiscussedabove,socialinteractionfosterspersonalrelationshipswhichin

turnsolidifiesnormslikelytosustaintheexchange.

Itwasnotedabovethatthepotentialforrepeatbusinesswouldencouragepartiestoforgo

opportunitiesforprivategain.Whilebuyerandsellermaybeunknowntoeachotheratthe

outsetofthetransaction–whichitselfjustifiestheuseofacredit415–otherpartiesinthe

contractual network may have had prior dealings. This includes the buyer and seller’s

relationships with their respective banks, dealings between the issuing and confirming

institutionsaswellasotherpartiesonlyperipherallyconnectedtothetransaction,suchas

agents of the buyer and seller, loading brokers and shipping line employees. These

connectionsfacilitatetheflowofinformationbetweenbuyerandsellerandprovidesources

ofconcreteinformationabouttheircounterpart.Theselayersofrepeatbusinessarelikelyto

depend on (some) industry-specific norms and this is likely to influence and support the

relationathand. Indeed, it ispossibleto interpretthe informaloperationofdocumentary

credits, despite the rigid contractual framework, as a norm of these transactions.

Furthermore,Mannsuggestedthattheacceptabilityofcertaindocumentarydiscrepancies

would depend on the particular market.416 This adds credence to the relational analysis

because it suggests differences in market context affect the understanding of a given

exchange.

414Katz,‘Informalityasabilateral’(n250)2564.415Mann,‘Theroleoflettersofcredit’(n231)2518.416Ibid2527.

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The literature also establishes that a relatively equivalent balance of power aids the

developmentofrelationalgovernance.417Theargumenthereisthattheuseofadocumentary

creditovercomes,orat leastreduces,anypowerasymmetrywhichwouldhaveotherwise

existedbetweenbuyerandseller.Thisanalysisholdsbothbyreferencetothedoctrinaland

empiricalaccountsof thecreditmechanism.Onthedoctrinalviewof themechanism, the

creditmakespaymentcontingentonthepresentationofstrictlyconformingdocuments.This

envisagesanobjectiveassessmentbythebankwhich limitsthepressureapowerfulseller

could imposeonhisbuyer.Thecredit removes theriskofbuyeropportunismatpayment

sincethisisdependentondocumentarycompliancealone.Undertheempiricalviewofthe

creditmechanism,thepaymentdiscretionisreturnedtothebuyer.Thisdoesnotcausean

imbalanceinpowerbetweentheparties,however,sincethebuyer’sbehaviourduringthe

paymentphasewillbecloselymonitoredbytheissuingbank,asdescribedabove.418These

analysessuggestthatthecreditcreatesamoreequalbalanceofpowerthanifthepartieshad

chosentoarrangethetransactiondifferently,forexampleonopenaccount.Thisaccordswith

thecharacterisationofthecreditasacompromisemechanism.419

Thepositionadvancedhereisthatrelationalgovernanceisaplausibleaccountofdeterrence

in the performance phase of transactions financed by documentary credit. If correct, the

relational mechanism reduces the likelihood of fraud by the beneficiary and explains,

alongsidetheroleoftheissuingbank,theabsenceofbuyeropportunismduringwaiver.420

There is undoubtedly scope for further empiricalwork to determine the accuracy of this

contentionandthenormsatworkinthiscontext.

It is importanttonotethatrelationalnormsdonotguaranteethatcontractingpartieswill

forgoeveryopportunity formisconduct. Inparticular,normswill be ineffectivewhenone

partystandstomakeaconsiderablegainfromfraud,especiallywherethesegainsexceedthe

417Shengetal(n385)72.418Mann,‘Theroleoflettersofcredit’(n231)2529;Katz,‘Informalityasabilateral’(n250)2567.419Seeearlier,ChapterFour,texttofn11.420Thiswasnotadequatelyexplainedbyeitheroftheanalysesdiscussedabove.

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valueoffuturebusiness.421Inthosecircumstances,thedefraudedparty–typicallythecredit

applicant–wouldneedtorelyoncontractualmechanismsandthefraudexceptiontodeter,

and subsequently sanction, the beneficiary.Given the difficulties involved in invoking the

fraudexception,422 it ishighlyunlikely that theexceptionwilleveroperate todeprive the

fraudulentbeneficiaryofpayment.Onthisbasis,itbecomesdifficulttocharacterisethefraud

exceptionasaneffectivedeterrent.Tothisextent,therefore,theempiricaldatacanbeused

tosupportthejudicialassertionthatthefraudexceptiondoesnotfunctionasadeterrent.423

IV. ConclusionThelimitsofthefraudrulearetraditionallyjustifiedbyreferencetocommercialneed.Thisis

alaudableobjective,butreflectionisrequiredtoensuretheruleservesitsintendedpurpose.

Accordingly,thischapterhascriticallyexaminedthepolicybalanceunderpinningtheEnglish

fraudexceptionfromwhichthreecritiqueshaveemerged.

TheEnglishcourtshaveconsistentlyrejectedabroaderfraudexceptionduetofearsthatit

wouldparalyse international trade.Acomparisonwith theAmericanapproachto fraud in

PartIdemonstratedthatsuchfearsareunfounded.Thecreditmechanismremainspopular

intheUnitedStatesnotwithstandingabroaderconceptionoffraudandgreateravailabilityof

injunctiverelief.Inaddition,theAmericanexceptionistheresultoflegislativereformwhich

enabled policymakers to balance competing considerations and construct a rule in

consultationwiththecommercialcommunity.Thisispreferabletothepiecemeal,common

lawdevelopmentof theEnglish fraudexception.424There is,ofcourse,noreasonthat the

response to fraud should be identical in all jurisdictions but the English courts should

recognisethattheirapproachtofraudisadistinctpolicychoice,ratherthanthemanifestation

ofbestcommercialpractice.

421EPosner,LawandSocialNorms(HarvardUniversityPress,2000)160;RScott,‘Conflictandcooperationinlong-termcontracts’(1987)75CalLRev2005,2030;Scott,‘Arelationaltheory’(n392)615.Seealso,MazarandAriely(n400)asdiscussedearlier,ChapterThree,texttofn112.422Seepreviousdiscussion,ChapterFour,texttofn343.423Sanders(n4)343perBowenLJ.424Dolan,TheLawofLettersofCredit(n31)[7-94]describingthedecisioninUnitedCityMerchantsinthefollowingterms,“onegetsthefeelingthatsucharesultisexactlywhattheEnglishjudgesdesire.”

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TheHouseofLords’judgmentinUnitedCityMerchantswasexaminedindetailinPartII.In

hisattempttoconfinethefraudenquiry,LordDiplockheldthattheexceptionwouldonly

operatewhen the fraudwas attributable to thebeneficiary.425 This is perfectly legitimate

giventhattheexceptionisunderpinnedbyexturpicausa.However,insodoing,LordDiplock

conflated–therelatedbutdistinct–issuesofforgeryandnullity.426Theresultwasthatbanks

arecontractuallyobliged topaywhenthedocumentsappear toconformnotwithstanding

thatthetendereddocumentsareknowntobeforgedornull.Thiswhollyunderminesthe

doctrineofstrictcomplianceandresultsinconsequenceswhicharedetrimentaltothecredit

mechanism. These consequences challenge LordDiplock’s justification for a narrow fraud

rule; theefficiencyof thedocumentary credit as adevice for international financing. This

prompts a reconsideration of the proper approach to null and forged documents. The

author’spreferencewouldbeforthecourtsandUCPtoendorsethenarrowapproachtonon-

compliance. This would enable banks to reject nullities as non-compliant but permit the

continued acceptance of known forgeries as good tender. This distinction is justified by

referencetothefactthatnullitiescannotservetheirintendedcommercialpurposeswhereas

forgeriesremaincapableoftransferringownershipandprovidingsecuritytothepayingbank.

Thisisapragmaticsolutionwhichwouldnotthreatentheautonomyofthecreditnorextend

thefraudexception.

A significant new analysis of fraud deterrence in documentary credit transactions was

presented in Part III. It was rooted in empirical work427 which indicated a more flexible

standardofdocumentarycomplianceinpractice.Thedatawasinitiallyemployedtosupport

thejudicialaccountofdeterrencebysuggestingsourcesofinformationwhichmightenable

partiestoundertakepre-contractualscreening.Moresignificantly,thedatawasthenusedto

developanaccountoffrauddeterrenceduringtheperformanceofcredittransactions.Itfirst

contended that the informality of the mechanism in practice reduced the need for the

beneficiarytoengageinfraud.Thisisaplausibleanalysisincircumstanceswhenthegoods

havebeenshippedbutcomplyingdocumentationcannotbeobtainedforreasonsbeyondthe

beneficiary’scontrol.Thediscussionthenconsideredincentivestofraudwhicharisebecause

425UnitedCityMerchants(HouseofLords)(n8)7perLordDiplock.426Bridge,‘Documentsandcontractualcongruence’(n105)230.427Mann,‘Theroleoflettersofcredit’(n231).

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ofmarketoreconomic fluctuationsduringperformance.Thedevelopmentof cooperation

and interaction between the parties in the early phases of the exchange prompted

considerationoftherelationalgovernanceliterature.Exchangesgovernedinthismannerrely

on norms developed between the parties and derived from the broader context of the

exchange to limitopportunisticbehaviour. Itwasargued thatcredit transactionsbear the

hallmarksofrelationalexchangeandthatthisformofgovernancemayexplainwhyparties

aredeterredfrombehavingfraudulentlyduringperformance.Thecombinationofarguments

putforwardinPartIIIprovidesacomprehensiveaccountofdeterrenceincredittransactions.

Thisisawhollynovelanalysiswhichchallengesthejudicialviewthattheentirefraudriskis

mitigatedbycarefulpartnerselectionexante.

Thisthesisconsiderstheextenttowhich‘fraudunravelsall’accuratelyexpressesthelegal

responsetoinsuranceclaimsfraudandfraudbythebeneficiaryinatransactionfinancedby

documentary credit. The foregoing chapters have critiqued the judicial construction and

respectivepolicyargumentsoftheserulesfromadoctrinalandcomparativeperspective,and

inlightofabodyofevidencedrawnfromrelateddisciplines.Thefinalchapter,ChapterSix,

unifiesthediscussionandconcludestheproject.

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ChapterSix

Conclusion

I. IntroductionThisprojectcommencedbynotingthesimplicityofthemaximexturpicausawhichproclaims

thatfraudunravelsall.Asingular–andpossiblypunitive–approachtofraudwassimilarly

employedasthestartingpointinMacDonaldEggers’excellentworkondeceit,

Ourcivillawofdeceittheoreticallydealswithallliesinthesameway,nomatterwhy

theyweretold,providedofcoursethattheycommittedthedeceivedtoacourseof

action that they would not have undertaken but for the deception and that they

causeddamage.1Theexistenceandformulationofaparticularruleoflawmayhave

its genesis in utility, certainty or fairness. The law concerning fraud and deceit,

attested to by such ancient advocates as Hyperides, Aristotle and Cicero, is

underpinned by our moral duty to tell the truth and the social and commercial

necessityofdeterringuntruthsdrawingtheinnocenttotheirharm.2

MacDonaldEggersconcludeshiscomprehensiveanalysisofdeceitbyrecommendingamore

nuancedframeworkwhichwouldenablethe lawtooperate flexiblyand“mirror the law’s

contemporarypolicyormoraljudgment.”3Theexaminationoftworelatedbutdistinctareas

of law – fraudulent insurance claims and fraud in documentary credit transactions –

undertaken in this thesis has similarly demonstrated the fallacy of the simplistic account.

Whenfraudarises,thecourtsarenotautomaticallyledtotheeasyanswersimplicitinthe

maximbecausenotionsofdeterrencemustoftenbeweighedagainstcountervailingpolicy

considerations.Importantly,thesecompetingconcernsdependonthenatureofthespecific

mechanism and the contractual context in which the fraud has occurred. This means,

1ItwasnotedintheIntroductionthattheresponsetoinsuranceclaimsfraudandfraudintransactionsfinancedbydocumentarycreditsdonotcontainanyelementofcausation.Thisisbecausethefraudruleis(typically)designedtooperatebeforetheunderwriterorapplicanthasbeendeceived.TherequirementsforaclaimindeceithavealsobeenmodifiedbythedecisioninHaywardvZurichInsuranceCo.[2016]UKSC48,[67],[71]perLordToulson,seeearlierdiscussion,ChapterTwo,texttofn204.2PMacDonaldEggers,Deceit:TheLieoftheLaw(InformaLaw,2009),[1.4].3Ibid[9.2],[9.4].

292

therefore, that theextent towhich fraudunravelsalldependsonhowthecourtsbalance

thesecompetingissueswithinthebroadercontractualcontext.Ashasbeendemonstratedin

theforegoingdiscussionoffraudinmarineinsuranceanddocumentarycredits,thisleadsthe

courtstoconceiveoffrauddifferentlyandtoproposesolutionsalignedwiththejudicialview

ofthespecificmechanism.Thedivergentaccountsoffrauddevelopedbytheinsuranceand

tradefinancecourtsexplaintheabsenceofasingletheoreticalframeworkwithinthisthesis.

Thischaptersummarisesthemainfindingsofthisresearch.Accordingly,itisconvenientto

recalltheresearchquestionsestablishedattheoutsetofthisproject:

1. Howisthefraudruleconstructedindoctrinalandproceduralterms?4

2. Whatpolicyargumentshavebeenusedbythecourtstojustifythescopeofandtheproceduralcriteriarequiredtoinvokethefraudrule?5

3. Towhat extent are these policy justifications valid in light of comparative andempiricalevidence?6

Thisdiscussionpromptsaconsiderationofwhatthesefindingsmeanforthefutureshapeof

the fraud rule and the accompanying judicial narratives in these contexts. This task is

undertakeninPartII(C)andPartIII(C),respectively.Thediscussionisthenwidenedinthe

finalpartofthechaptertoconsider,moregenerally,whatthisresearchtellsusaboutEnglish

commerciallaw’sresponseto,andconceptionof,fraud.ThemajorcallinPartIVisforcourts

andacademicstoresistthelureofinstinctiveanswerstohardpolicyquestions,inpreference

for a context-specific, empirically-informed response to fraud which overcomes the

idiosyncrasiesofthecommonlawsystem.

II. InsuranceA. Thejudicialresponsetoinsuranceclaimsfraud

Atfirstglance,thejudicialresponsetoinsuranceclaimsfraudisanexemplarofthesimplistic

modelpropoundedbythecourtsandinitiallyidentifiedbyMacDonaldEggers.7Thejudicial,

4ThiswasaddressedinChapterTwo(insurance)andChapterFour(documentarycredits).5ThiswasaddressedinChapterTwo(insurance)andChapterFour(documentarycredits).6ThiswasaddressedinChapterThree(insurance)andChapterFive(documentarycredits).7MacDonaldEggers(n2)[1.4].

293

and now statutory,8 emphasis on the forfeiture rule gives the impression of a singular

response9whichappliestoalltypesoffraudulentconduct.Forfeitureoperatestodeprivean

assuredoftheentiretyoftheclaimtowhichthefraudrelates,includinganygenuineloss.The

rule,moreover,isunderpinnedbyexturpicausaandonlyoperatesinresponsetowrongdoing

by the assured. In some circumstances, however, forfeiture responds more harshly than

wouldthecommonlawof illegality;removingtheassured’srighttoclaimforgenuineloss

andrequiringtherepaymentofinterimsums.10Thepunitivecharacteroftheforfeiturerule

isparticularlyapparentinthesecircumstances.

Thefar-reachingconsequencesofforfeitureareroutinelyjustifiedbyreferencetopolicy;the

deterrenceoffraud.Indeed,thecourtsoftenrefertoindustrystatisticsontheprevalenceof

claimsfraud11andhaveclearlyacceptedtheroleoflegalsanctionsindeterrence.Indeed,in

thetraditionofrationalchoicetheory,theinsurancecourtshaveconceptualiseddeterrence

asdependentonharshlegalsanctionsanddevelopedtheforfeitureruleaccordingly.

The dominance of deterrence in the judicial discourse can be attributed to the relative

absence of competing policy objectives. Issues of proportionality, though critical in

overcomingthetensionbetweenforfeitureandavoidanceabinitiointhissetting,havenot

generallyaffectedthedevelopmentoftheforfeiturerule. Itmustofcoursebenotedthat

considerationsofproportionalitywereattheheartoftherecentdecisioninVerslootwhich

ring-fencedcollateralliesfromthethreatofforfeiture.12Thisjudgmentis,however,thesole

occasioninwhichproportionalityhasbeenusedtoalterthescopeoftheforfeitureruleinits

almost200-yearhistory.Inaddition,thenarrativepropoundedbythecourts–thevulnerable

underwriter and deceitful assured – dovetails with the importance of deterrence and

underpinstheimportanceofjudicialinterventiontopreventfraud.

8InsuranceAct2015s.12.9Thereare,however,otherremediesavailabletotheunderwriter,see,forexample,theearlierdiscussionontheavailabilityofdamagesinParkervNFUMutualInsuranceSociety[2012]EWHC2156(Comm),[2013]Lloyd’sRep.IR253. 10AxaGeneralInsuranceLtdvGottlieb[2005]EWCACiv112,[2005]1AllER(Comm)445,[29]perManceLJ.11VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG[2016]UKSC48,[56]perLordHughes(hereafterreferredtoasVersloot(SupremeCourt));Royal&SunAllianceInsuranceCovFahad[2014]EWHC4480(QB),[24]perSpencerJ;DirectLineInsuranceplcvKhan[2002]Lloyd’sRep.IR364,[38]-[39]perArdenLJ;KhanvHussain(16May2007,HuddersfieldCountyCourt)[9]perJudgeHawkesworthQC.12Versloot(SupremeCourt)(n11)[26]perLordSumption.

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B. ThecritiqueofthejudicialresponsetofraudWhilethereisnodoubtthatfraudshouldbedeterredandsanctionedappropriately,thisdoes

notmeanthatthejudicialapproachtoinsurancefraudshouldbeleftunquestioned.Three

keyfindingsemergedfromthiscritiqueandaresummarisedhere:

i. The forfeiture rule is, in effect, the only civil sanction for claims fraud. This ruleoperatescounterintuitivelygiventhespectrumoffraudulentbehaviour.

ii. Thejudicialunderstandingofdeterrencedependsonanoutdatedmodelofdecision

makingwhichresultsinineffectivepolicyprescriptions.

iii. Thecharacterisationoftheunderwriterrequiresmodernisationtoreflecttheinsurer’s

abilitytotakeproactivestepstopreventfraudintoday’smarket.

i. Thecounterintuitivenatureofforfeiture

Theforfeiturerulewasdevelopedinthecontextofexaggeratedclaimsandhereonecansee

the judicial logic; the threat of losing the entire claim would dissuade an assured from

committing fraud.Over time,however, forfeiturewaspresumed tobe the remedy for all

types of fraud irrespective of the fact that claims appear on a spectrum of increasing

culpabilityandseverity.Thishas resulted ina rulewhichoperatescounterintuitively.Asa

response to the most serious wrongdoing – the wholly fraudulent claim – forfeiture is

ineffectivebecausethereneverwasanygenuineclaimtosacrifice.Atthelowestendofthe

culpabilityscale,however,forfeiturewasdraconiangiventhatitdeprivedtheassuredofan

insured loss.Thecounterintuitiveoperationof forfeituremakes little sensegiven that the

courts have constructed the rule on the basis that harsh sanctions deter. Despite the

theoretical availability of damages13 and actions in deceit,14 the fact that forfeiture is, in

practice,thesolesanctionforinsurancefraudcannotbereconciledwiththisconceptionof

deterrence.

13Parker(n9)[205]perTeareJ.14InsuranceCorporationoftheChannelIslandsvMcHugh[1997]1LRLR94,135perManceJ;LawCommission,Insurance Contract Law: Business Disclosure; Warranties; Insurers’ Remedies for Fraudulent Claims; and LatePayment(LawComNo353,2014),[22.30].

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TheSupremeCourthavetosomeextentcorrectedthecounterintuitivenatureofforfeiture

inVersloot;therulenolongerappliestoclaimsembellishedbyacollaterallie.15Thisistobe

broadly welcomed16 and would probably encompass some lies which would also find

mitigationinMacDonaldEggers’justificatoryanalysisinthetortofdeceit.17However,ifthe

positionpriortoVersloot18wascriticisedforbeingpro-underwriter,itissurelynobetterfor

the law to develop in an equally simplistic, albeit pro-fraudster, direction. In reality, the

judgmentmaygotoofarandsimplyshifttheproblemtooneofdefinition–whatexactlyisa

collaterallie?–andfocusattentiononclaimswheretheassuredhassuppressedadefence.19

TheAssociationofBritishInsurershasalsoexpressedconcernthattherulinginVerslootmay

givetheimpressionthatlyingisacceptable20andcontradictrecentpublicinformationefforts

undertakenbytheindustry.21Ifunderwritersareconcernedaboutthejudgment,theyshould

simplymakeuseofstandardtermswhichalreadyprovideremediesforclaimstaintedwith

thepre-Verslootequivalentofacollaterallie.22WhilethepreciseimpactofVerslootremains

tobeseen,theearlierdiscussionofmoderndeterrencetheory23leadstheauthortoagree

withthelateLordToulsonthatthedecisionwillprobablynottriggerawaveoffraudulent

claims,

I am not a psychologist, but I am sceptical about the idea that knowledge of this

judgmentwillincentivisepeoplewithvalidinsuranceclaimstolieinsupportoftheir

claims.Thosewhoarehonestwillnotdosobecauseitwouldnotbeintheirnature,

whilesomewhoaredishonestmaydosoiftheythinkthattheywillgetawaywithit,

15Versloot(SupremeCourt)(n11)[26]perLordSumption.16SeePRawlingsandJLowry,‘Insurancefraudandtheroleofthecivillaw’(2017)80(3)MLR525,531wherethejudgmentisdescribedasachieving“mixedreviews”.17MacDonaldEggers(n2)[5.32]-[5.46],[5.57]-[5.64],[9.7].18Versloot(SupremeCourt)(n11).19JHjalmarsson,‘Exit“fraudulentmeansanddevices”’[2016](July)Shipping&TradeLaw(publishedonline,25July2016).20JDalton,‘Liesarelies:SupremeCourtrulingsendsoutthewrongmessagetocustomers’(27/07/2016)availableat: https://www.abi.org.uk/news/blog-articles/lies-are-lies-supreme-court-ruling-sends-out-the-wrong-message-to-customers/(accessed12/09/2017).21Forexample,ABI,‘FromMrWhippytogigglingconmennoletupasinsurersturnuptheheatoninsurancecheats’(13/09/2016) available at: https://www.abi.org.uk/news/news-articles/2016/09/from-mr-whippy-to-giggling-conmen-no-let-up-as-insurers-turn-up-the-heat-on-insurance-cheats/(accessed12/09/2017).22ThisisthesuggestionmadebyRawlingsandLowry,‘Insurancefraudandtheroleofthecivillaw’(n16)532.Inthemarinecontext,underwriterscouldcontractonthebasisofInternationalHullsClauses(01/11/03),cl.45.3.1.23See,inparticular,ChapterThree,PartI(C).

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despite the risk of it having a boomerang effect on whether the court believes

anythingthattheysay.24

InsteadofVerslootandthestatutoryprovisionsinthe2015Actsettlingthecivilresponseto

claimsfraud,itisnothardtoimaginefurtherlitigationtoprobethepreciselimitsofthenew

regime.AsRichardAikens,formerLordJusticeofAppealhasarguedrecently,“wehavenot

heardthelastinthe“fraudulentclaims”saga.”25

Whatever the future holds for the notion of the collateral lie, neither Versloot nor the

InsuranceAct2015doesanythingtocorrecttheimbalanceinrespectofthewhollyfraudulent

claim.Ofcourse,itwouldbeinappropriatetocastigatetheSupremeCourtinthisregardgiven

thenarrow factsof thecasebefore them. Theabsenceofa further remedy in theAct is

particularlynoticeablegiventhattheLawCommissionhadinitiallyproposedastatutorycause

of action which would have entitled underwriters to recover costs incurred in the

investigationoffraudulentclaims.26AswasdiscussedinChapterThree,theproposalwasnot

taken forward despite the broad support of consultees.27 The fact thatwholly fraudulent

claimsarenotaddressedbythe2015Actmeansthatthereisstillnotaneffectivesanction

for the most serious wrongdoing. This is conceptually problematic given the court’s

explanationofhowlegalsanctionsdeter.

ii. Anoutdatedmodelofdecisionmaking

Thesecondmajorfindingrelatestotheoutdatedmodelofdecisionmakingwhichunderpins

thejudicialaccountoftheforfeiturerule.Theinsurancecourtshaveassumedthatharshlegal

sanctionsdeterandhave constructed forfeitureon thisbasis. Thismirrors rational choice

theory. However, modern deterrence theory suggests that harsh legal penalties are less

effectivedeterrentsbecausedecisionmakersdonotweighuptheprospectofpunishmentin

theobjectivemannerassumedinarationalframework.Focussingsolelyonlegalsanctions,

24Versloot(SupremeCourt)(n11)[108]perLordToulson.25RAikens,‘Whenisa“fraudulentclaim”onlya“collaterallie”?’[2017]LMCLQ340,345.26LawCommission,InsuranceContractLaw:PostContractDutiesandOtherIssues(LawComCP201),[8.19].27Seeearlier,ChapterThree,texttofn207.

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modernresearchondeterrenceindicatesthatsanctioncertaintyisamuchmoresignificant

indicator of compliancewith the law than sanction severity. The key to deterrencemore

broadly,however,liesbeyondlaw.Decisionstoengageindishonestyareinsteadshapedby

socialorinformalsanctionssuchasguiltassociatedwithcontraveningone’sownmoralcode,

embarrassmentandlossofreputation.Incomparisontolegalsanctionsimposedbythestate,

informalpenaltiesareleviedbytheoffenderhimselfandhisimmediatecommunity.Modern

deterrence theory demonstrates that these informal sanctions exercise a much stronger

deterrenteffectthanlegalsanctions.Thisisnottosaythatlegalsanctionsareabsentfrom

themoderndeterrencemodel;indeed,formalsanctionthreatsprovideafoundationforthe

imposition of informal sanctions28 and confirm social attitudes towards wrongdoing.29

Accordingly,ChapterThreeconcludedthattheforfeiturerulecouldonlyfunctionasaweak

deterrenttoopportunisticclaimsfraud.

Anarticle co-writtenby theauthorandProfessor JamesDavey30whichdiscussedmodern

deterrence theory in the context of forfeiture was presented to the Supreme Court in

Versloot.31 Indeed, LordMance requested the empirical literature onmodern deterrence

theorytoreadwhilewritinghisjudgment.Whiletheseinsightswereultimatelynotusedto

reversetheapproachtocollaterallieclaims,32theauthorsuggeststhatmoderndeterrence

theory resulted in the SupremeCourt undertaking amuch deeper analysis of the correct

approachtosuchclaimsthanwouldotherwisehavebeenthecase.Twoconsiderationslead

to this conclusion. Firstly, it is interesting to note the considerable degree to which the

SupremeCourtdepartedfromTheAegeon informulatingthenewtest.This isdespitethe

“severalpowerfulreasons”33whichledChristopherClarkeLJtoapplyTheAegeonasamatter

ofratioattheCourtofAppeal.Thisindicatesthedegreetowhichthelawapplyingtodevice

claimswasregardedassettledpre-Versloot. Inaddition,theLawCommissionsuggestedin

28SKlepperandDNagin,'Thedeterrenteffectofperceivedcertaintyandseverityofpunishmentrevisited'(1989)27Criminology721,741;AOgus,CostsandCautionaryTales(HartPublishing,2006),130.29 R Paternoster and S Simpson, 'Sanction threats and appeals tomorality: Testing a rational choicemodel ofcorporatecrime'(1996)30L&SocRev549,577;JKidwell,‘Acaveat’(1985)WisLRev615,618.30JDaveyandKRichards,‘Deterrence,humanrightsandillegality:Theforfeitureruleininsurancecontractlaw’[2015]LMCLQ315.31Versloot(SupremeCourt)(n11).32Ibid[10]perLordSumption,[108]perLordToulson,[124]perLordMance.33VerslootDredgingBVvHDIGerlingIndustrieVersicherungAG[2014]EWCACiv1349,[2015]Lloyd’sRepIR115,[106]perChristopherClarkeLJ(hereafterreferredtoasVersloot(CourtofAppeal)).

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their finalreportthatthe lie inVersloot failedtosatisfythecommonlawrequirementsof

substantialityandmateriality.34TheSupremeCourtcouldhavetakenasimilarapproachon

the facts of Versloot to permit the assured to recover without making any significant

amendmentstothetestestablishedinTheAegeon.Thedegreeofdepartureis,intheauthor’s

view,indicativeofthelevelofreconsiderationpromptedbymoderndeterrencetheory.

Afinalpointshouldbenotedinrelationtorationalchoicetheory.MazarandAriely’sworkon

decisions around dishonesty suggested that harsh legal penalties can serve to deter an

offender when he stands to gain considerable external – often financial – benefits from

dishonesty.35 In these circumstances, informal sanction threats are no longer an effective

deterrent.ItwasarguedinChapterThreethatthewhollyfraudulentclaimwasanexample

of dishonesty which promised considerable external benefits. Accordingly, the argument

madehereisthataharshlegalsanctionwouldconstituteaneffectivedeterrenttothistype

ofclaim.Thisisafurtherreasonwhytheabsenceofaneffectivelegalsanctiontopenalise

thewhollyfraudulentassured,asnotedabove,cannotbesupported.

iii. Modernisingtheportrayaloftheunderwriter

It was argued in Chapter Three that the judicial characterisation of the underwriter as

vulnerablewasoutdatedanddoesnotreflectthemodernstateofthe insurance industry.

Today’sinsurerisnolongerrequiredtowaitfornewsofacasualtyinariversidecoffeehouse

as was his eighteenth-century counterpart. Instead, the modern underwriter is a

sophisticatedentity,comprisingsignificantexperienceandexpertiseinlosspreventionand

risk reduction. It has access to databases enabling a pre-contractual assessment of the

assured’s propensity for fraud and has access to loss adjusters and investigators in the

immediate aftermath of a loss. These modern developments mitigate many of the

informationasymmetrieswhichwouldotherwiseimperiltheclaimsprocess.

34LawCom353(n14)[22.24]“Wethinkthereisanargumentthatthe“fraudulentdevice”employedinthatcase[Versloot]doesnotsatisfythecommonlawrequirementsforfraudofsubstantialityandmateriality.”35NMazarandDAriely,‘Dishonestyineverydaylifeanditspolicyimplications’(2006)25(1)JofPubPol&Mark.117,120.

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Themodernisation of the underwriter is not reflected in the Insurance Act 2015. This is

problematic since it further entrenches the narrative of judicial responsibility for fraud

deterrence and wholly ignores the proactive steps taken by the industry to reduce such

claims.Thisshouldalsobecontrastedwiththeupdatedportrayalof theunderwriterwith

respecttotheassured’spre-contractualdisclosureobligations.TheActrequiresunderwriters

to take a more active role during the disclosure process36 which reflects the insurer’s

knowledgeofwhatinformationismaterialforunderwritingpurposes.Theremediesforthe

assured’sfailuretomakeafairpresentationarealsoalignedwiththeimpactofnon-disclosure

ontheinsurer.37

The suggestion that themodern underwriter is less susceptible to fraud undermines the

centralityofdeterrenceinthejudicialexplanationofforfeiture.Indeed,itsuggeststhatthe

developmentofaremedialframeworkwhichcombinesdeterrenceandproportionalitywould

beappropriateinthiscontext.Itisdisappointing,therefore,thattheLawCommissiondidnot

recommendamorenuancedregimethroughtheintroductionofajudicialdiscretiontomirror

the position in Australia38 and the English Criminal Justice and Courts Act.39 The limited

considerationofthesealternativesappearstobeattributabletoMerkin’sswiftdismissalof

thesameinhis2006reportfortheCommissioninwhichhenotedthatadiscretion“would

sendthewrongmessage.”40This,withrespect, failedtogivedueweighttothesuccessful

operationofthediscretioninpractice41andbroadacceptancebytheinsuranceindustryin

Australia.42

C. LookingforwardIt remains to consider what these findings mean for the future of the civil response to

insuranceclaimsfraud.Thereisnodoubtthattheabovediscussionmilitatesinfavourofa

36InsuranceAct2015s.3(4)(b).37InsuranceAct2015Sched.1(2),(4)-(6).38AustralianInsuranceContractsAct1984s.56(2)(3).39CriminalJusticeandCourtsAct2015s.57(2)(3).40RMerkin, ‘Reforming insurance law: is thereacase for reversetransportation?Areport for theEnglishandScottish Law Commissions on the Australian experience of insurance law reform’ (2006) available at:http://www.lawcom.gov.uk/app/uploads/2015/03/ICL_Merkin_report.pdf(accessed24/09/2017),[6.9].41TheHonMKirby,‘Insurancecontractlawreform—30yearson’(2014)26ILJ1,17.42Merkin(n40)[6.9].

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remedytodeterthewhollyfraudulentclaim.Thepreciseshapeofthisremedyisbeyondthe

scopeofthisthesis43althoughitshouldbenotedthataslidingscaleofremedieswouldbetter

reflecttherealityofinsurancefraud.ItispleasingtoseethatMacDonaldEggersreacheda

similarconclusioninhisrestatementofthetortofdeceit,

…aliabilityindeceitshouldbeanswerablebyabroadrangeofremediesavailableto

theclaimant,subjecttothecourt’sdiscretionarycontroltoensureaflexibleresponse

tothedeceitanditsseriousness.44

Partiesarefreetocontractoutofthestatutoryprovisionsonfraudulentclaims,subjectto

thetransparencyrequirementscontainedintheAct.45Thisentitlesunderwriters,therefore,

tocontractexpresslyforinvestigationcostsand/orpunitivedamagesintheeventofawholly

fraudulentclaim.Marketappetite,asever,willdictatewhetherpolicieswillbewrittenon

suchtermsinthefuture.Fromapracticalperspective,underwritersshouldbeencouragedto

seekadditionalfinancialpenalties.Certainly,thecourtsdonotappearaversetomakingsuch

orders,aswasevidentinParker46andtheseveralmotorinsuranceclaimsinwhichpunitive

damageshavebeenawarded.47

S.12InsuranceAct2015wasnotdesignedasa‘onceandforall’restatementofthelawon

fraudulent claims. Indeed, the express purpose of the Law Commission was to develop

“piecemealsolutionsfordemonstratedproblemswheretherewasconsensusforreform.”48

Indeed,the2015Acthasalreadybeenamendedtoincludeprovisionsondamagesforlate

43 The author has begun work on the shape of a suitable remedy, see K Richards, ‘Redressing the balance:Fabricated insurance claims and (harsh) civil remedies’ (American Society of Comparative LawYounger Comparativists Committee Conference, Koç University (Istanbul), April 2017). Paper on file with theauthor.44MacDonaldEggers (n2) [9.7].Seealso the foreword to thisbook inwhichRixLJ comments ‘Hiswell-arguedprescriptionisforthelawtorestrainitsopprobriumforthereallydeservingcasesofdeliberatedishonestyandforamorecarefuldelineationofremediestomatchtheseriousnessofthecase.’(atvii).45InsuranceAct2015s.17.46Parker(n9).47 Churchill Insurance v Shajahan (11 September 2015, Birmingham County Court); Tasneem v Morley (30September2013,CentralLondonCountyCourt);VasilevPopLoan(17November2015,WillesdenCountyCourt);LiverpoolVictoriavGhadhda(30June2010,CentralLondonCountyCourt).48TGoriely,‘Goodfaith:Theresidualimpactofs.17MarineInsuranceAct1906’(GoodFaithinContractLaw,ExeterUniversity,July2017).

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payment.49 Unlike the position for breaches of fair presentation under the Consumer

Insurance(DisclosureandRepresentations)Act2012,50thereisnosuggestioninthe2015Act

thats.12constitutes“theonlysuchremedies”51forfraudulentclaims.Thereissomescope,

therefore,forfurtheramendmentstotheActtoestablishadistinctremedyforthewholly

fraudulent claim.A statutory remedy for this typeof conduct, thoughunlikelydue to the

constraintsonparliamentary time,wouldbring conceptual clarity to the judicialmodelof

deterrence. The imposition of harsh legal sanctions in these circumstanceswould further

accordwithmodern research intodishonesty involving largeexternalbenefits. In short, a

statutorycauseofactionorstructuralincentivestoencourageunderwriterstomakeuseof

commonlawremediesalreadyinexistencewouldcreateaneffectivelegaldeterrentwhere

nonecurrentlyexists.

Modern deterrence theory offers a wealth of insights which could be operationalised to

developacomprehensiveanti-fraudframework.Ingeneralterms,theinsightsdiscussedin

thisthesisshouldcautionjudgesagainstrelyingsolelyoninstincttoconstructlegalpenalties.

ItisworthreiteratingthatLordMance,writingextra-judicially,reachedthesameconclusion

inrespectofthelawonillegality.52Tothisend,theauthor’srecommendationisthatsuch

insights remain an important frame of reference for any future judicial or parliamentary

responsetothecollaterallieandforfeiture,moregenerally.

Thelessonsofmoderndeterrencetheoryshouldalsocausetheinsuranceindustrytoreflect

on the structural opportunities for fraud within the claims process. From a practical

perspective,thiscouldinitiatethedevelopmentofabehaviourally-informedclaimformand

claimshandlingprocessesdesignedtotriggerthedeterrenteffectofsocialsanctions.53This

wouldalsobeanopportunitytochallengethebiasesandheuristicsbyremindingtheassured

of the potential sanctionswhen the opportunity for fraud arises. This is significant since,

unchallengedthesementalshortcutsmightotherwiseleadanassuredtocommitfraud.The

49EnterpriseAct2016ss.28-30insertingss.13A,16AintoInsuranceAct2015.50ConsumerInsurance(DisclosureandRepresentations)Act2012s.4(3).51ConsumerInsurance(DisclosureandRepresentations)Act2012s.4(3).52(Lord)JMance,‘Exturpicausa—WhenLatinavoidsliability’(2014)18EdinLRev175,176.53 See also BBC, ‘Insurance fraud tops £1bn a year for the first time’ (27/07/2013) available at:https://www.abi.org.uk/globalassets/sitecore/files/documents/publications/public/2016/fraud/effective-counter-fraud-practices-checklist-for-insurers-and-partners.pdf(accessed23/07/2017).

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examples discussed in Chapter Three demonstrate that simple administrative tweaks

informedbybehaviouralsciencecanreduceclaimsfraud.54ThefinalreportoftheInsurance

FraudTaskforceispromisinginthisregard.OneoftheTaskforce’scentralrecommendations

wasfortheABItocommissionresearchintobehaviouraleconomicstodetermineitsutilityin

relation to fraud deterrence. At the time of writing, it remains to be seen what

recommendationswillemergefromthisbut,asadirectionoftravel,itistobewelcomed.

Industry reflection would also serve an important conceptual purpose. At present, the

characterisation of forfeiture as a deterrent and the importance of judicial intervention

creates the impression that underwriters are distanced from efforts to deter fraud. The

recognition thatunderwriters canenact structuralmechanisms todeter fraudwould shift

responsibilityforfraudprevention.Amorebalancednarrativeinwhichtheindustryandthe

courtshavearoletoplayindeterrencewouldbetterreflectthecharacteristicsofthemodern

underwriterandtherealityofdeterrence.Importantly,thiswouldalsomirrorindustryefforts

beyond the courtroom, most notably the funding of the Insurance Fraud Enforcement

Department,55industry-widedatasharingviatheInsuranceFraudBureau56andthecreation

oftheInsuranceFraudRegister.57

Thecritiqueundertakeninthisthesishasthepotentialtoshapethefuturedevelopmentof

theforfeitureruleandofamorecomprehensiveandefficientdeterrenceregime.Thefocus

nowshiftstoconsiderthejudicialconstructionofthefraudexceptionindocumentarycredits.

III. DocumentaryCredits

54Seeearlierdiscussion,ChapterThree,texttofn171etseq.55 IFED, ‘About IFED’ availableat: https://www.cityoflondon.police.uk/advice-and-support/fraud-and-economic-crime/ifed/Pages/About-IFED.aspx(accessed12/09/2017).56InsuranceFraudBureau,‘Aboutus’availableat:https://www.insurancefraudbureau.org/about-us/supporting-the-insurance-industry(accessed23/07/2017).57 Insurance Fraud Register, ‘About the IFR’ available at: http://www.theifr.org.uk/en/about (accessed23/07/2017).

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A. ThejudicialresponsetofraudThe fraud exception to autonomy in the law of documentary credits shares some of the

characteristicsofthesimplisticaccountoffraudrules.Theexception,forexample,hasbeen

describedas“aclearapplicationof…exturpicausa”58andissingularinnature,respondingto

all instances of fraudulent conduct in the sameway. The development of the exception,

however,hasrequiredthecourtstoovercomethetensionbetweentwocompetingpolicy

considerations;theautonomyofthecreditandfrauddeterrence.Theseconsiderationsstand

indirectoppositiontooneanothersincetherequirementsofanautonomousmechanism–

swift,efficientpaymentwithminimaljudicialintervention–wouldbefataltoaruledesigned

to uncover and deter fraud.59 The trade finance courts have repeatedly demonstrated a

preferenceforautonomyandhaverefusedtointerveneindisputesrelatingtotheunderlying

transaction.Theresulting fraudexception isnarrow inscopeandrequires theclaimantto

satisfyonerousproceduralcriteriatoinvoketheexception.Thecourts,importantly,willnot

permittheexceptiontobeusedasaproxyforairingconcernsabouttheunderlyingcontract

of sale.Assuming foramoment thatanapplicanthasestablishedevidenceofbeneficiary

fraudintime,theimpactoftheexception–todenythebeneficiaryanyrighttopayment–

hasthepenalcharactertypicallyassociatedwithcivillawrulesagainstfraud.

The fact that the fraud exception has never been successfully established in English law

reflectsthepracticaldifficultyoftheproceduralcriteriaaswellasjudicialadherencetothe

autonomyofthecredit.Fraudmaywellunravelallinhypotheticaltermsbutthisisnotthe

caseinpractice.Accordingly,thecharacterisationofthedocumentarycreditasa‘paynow,

argue later’ device’ is apt; parties are left to settle any disputes subsequently under the

contract of sale. As for deterrence, the courts have not regarded this as a matter for

commerciallawandhaveinsteadassumedthatpartiesmitigatethefraudriskthroughcareful

partnerselection.

The distinctiveness of the fraud exception is also attributable to the broader contractual

networkcreatedbythecredit.Thefraudruledoesnotjustariseasameansofpreventing

58UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]2Lloyd’sRep.1,6perLordDiplock(hereafterreferredtoasUnitedCityMerchants(HouseofLords)).59PTodd,MaritimeFraud&Piracy(2nded.Informa,2010),[2.022]-[2.023].

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paymenttothefraudulentbeneficiary,butisalsoemployedbythecreditapplicantagainst

theissuingbank.Inthesecircumstances,theapplicantemploysthefraudexceptiontorefuse

reimbursement to the issuing bank or to prevent the bank frommaking payment to the

beneficiary.Thefraudulentbeneficiaryisexcludedfromtheseactionsandthefraudexception

instead functions as a loss allocation device between two innocent parties. It is

understandable that deterrence is much less relevant where the action excludes the

fraudster. The inclusion of the banks within the contractual network is also critical in

understandingthejudicialresponsetofraud.Thelimitedopportunityforjudicialintervention

enablesthebankstomakepaymentwithconfidence.Thisincreasesthecertaintyofpayments

whichthecourtshaveregardedasvitalfortheglobalreputationofUKbanks.60

B. ThecritiqueofthejudicialresponsetofraudItisdifficulttodisagreewiththepropositionthatcourtsshoulddeveloplawwithcommercial

needinmind.Indeed,thisnotionunderpinnedLordIrvine’scharacterisationofcommercial

law in his 2001Modern LawReview article.61 To focus solely on commercial need in the

context of documentary credits, however, overlooks another, equally significant policy

consideration;thedeterrenceoffraud.ThediscussioninChapterFivecriticallyexaminedthe

tradefinancecourts’constructionofthefraudexceptionandclearpreferenceforthedoctrine

ofautonomy.Threekeyfindingsemergedfromthisdiscussion:

i. Thebalancebetweencompetingpolicyobjectivessurroundingthefraudexceptionisnotfixedbycommercialneed.

ii. The conflation of three distinct issues – fraud, forgery and nullity – inUnited City

Merchants has had consequences which impact on the efficiency of the credit

mechanism. These contradict the policy rationale of the narrow English fraud

exception.

iii. Deterrenceisnotmerelyanexanteissueforthepartiesbutratherisaprocesswhich

continuesthroughoutthetransaction.

60Forexample,BolivinterOilSAvChaseManhattanBank[1984]1Lloyd’sRep.251,257perSirJohnDonaldsonMR: the injunctionundermines “thebank’s greatest asset…namely its reputation for financial and contractualprobity.Furthermore,ifthishappensatallfrequently,thevalueofallirrevocablelettersofcreditandperformancebondsandguaranteeswillbeundermined.”61(Lord)DIrvine,‘Thelaw:Anenginefortrade’(2001)64(3)MLR333.

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i. Thebalancebetweencompetingpolicyobjectivesisnotinevitable

The fraudexception requiresnational jurisdictions tobalance the autonomyof the credit

mechanismandfrauddeterrence.TheInternationalChamberofCommerce’sdetermination

that fraud is controversial62 suggests that there is not a simple answer and creates the

conditions inwhich divergent responses to fraud have emerged. The English courts have

consistently presented this policy balance as dictated by the needs of the commercial

community.Putsimply,autonomyhasbeenpreferredtodeterrenceandthishasledtothe

constructionofanarrowfraudexception.Thepositiontakeninthisthesisisthatadifferent

balancecouldbedrawnbetweenthesecompetingpolicyobjectives.63

TheAmericanapproachtofraudisausefulstartingpoint.Thefraudexception,embodiedin

UCCart5-109,adoptsamoreexpansivedefinitionoffraudwhichincludesforgeryandfraud

intheunderlyingtransaction.64InjunctivereliefisalsoeasiertoobtainintheUnitedStates.

Significantly, this more expansive approach to fraud has not resulted in the commercial

dislocationsofearedbytheEnglishcourts.

Ofcourse,differentjurisdictionsareentitledtoreachdifferentconclusionsonpolicygrounds.

ThismuchisexplicitintheICC’sdecisiontoleavefraudtonationalcourts.However,thefraud

exceptionhasdevelopeddifferentlyinthejurisdictionsunderdiscussion.TheEnglishfraud

rule is a product of the common law and largely of Lord Diplock’s speech inUnited City

Merchants.Fewfraudcaseshavesincereachedthehighestcourts–nodoubtinpartdueto

thechillingeffectcausedbythenarrowconfinesoftherule–meaningthattherulehasnot

undergoneadequatejudicialscrutiny.WhiletheAmericanexceptionwasinitiallydeveloped

62ICCBankingCommission,‘LatestqueriesansweredbytheICCBankingCommission’(1997)3(2)DocumentaryCreditsInsight6citedinADavidson,‘Fraud,thePrimeExceptiontotheAutonomyPrincipleinLettersofCredit’(2003)8Intl.Trade&BusLAnn23,26.63ThisviewissimilartothatexpressedinCanada,seeBankofNovaScotiavAngelica-Whitewear[1987]1RCS59,72perLeDainJ:“differencesofvieworemphasiswithrespecttotheseissues,reflectthetensionbetweenthetwoprincipal policy considerations: the importance to international commerce ofmaintaining the principle of theautonomyofdocumentarycreditsand the…importanceofdiscouragingorsuppressing fraud in letterofcredittransactions”.64UniformCommercialCode§5-109(a)(1995revisions).

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bythecourts,65itisnowenshrinedintheUniformCommercialCode.66The1995revisionsto

theUCC followeda lengthyconsultationprocesswhichpermitted theTaskforce to takea

comprehensiveviewofthemechanismwiththebenefitofparticipationofawiderangeof

marketactors.67ThepiecemealapproachoftheEnglishcommonlawsystemmeansthatsuch

oversightisimpossible.

ThebroaderdefinitionoffraudintheUCCdoesnotmeanthatfrauddeterrencehasbeen

prioritised at the expense of autonomy. Concerns about unnecessarily disrupting

international trade are equally relevant in theAmerican context. This is apparentboth in

judicialdiscussion68andinthestatutorycauseofactionfacilitatingpost-presentationactions

againstafraudulentbeneficiary.69Indeed,theverypurposeofthesewarrantiescontainedin

art 5-110was to reduce theactions for injunctive relief andencourageparties to resolve

disputesfollowingpayment.70Thisdemonstratesthatamorepermissiveapproachtofraud

doesnotnecessarilyjeopardiseinternationaltradeasfearedbytheEnglishjudiciary.

It is important to comment on thewidespread use of standby credits in America and to

consider specificallywhether the greater use of standbys has dictated the policy balance

drawn in theUCC.Asa startingpoint, the caseunderpinning the fraudexception inboth

jurisdictions–SztejnvSchroder71–involvedanordinarydocumentarycreditasdistinctfrom

astandby.True,ShientagJdidnotreferencefrauddeterrenceexplicitlybutitisimplicitinhis

judgmentthatthelawshouldnotbeusedtoassistthefraudster.Indeed,hecommentedthat

therewouldbe “nohardship”72 if thebank could refusepayment to a fraudster andwas

unwillingtoextendtheprotectionoftheautonomydoctrinetoafraudulentbeneficiary.73It

65SztejnvJHenrySchroderBankingCorp.177Misc.719(N.Y.Misc.1941).66UCCart.5-109(1995Revisions).67TaskForceontheStudyofUCCArticle5(LettersofCredit),‘AnexaminationofUCCArticle5(LettersofCredit)’(1989-1990)45BusLaw1521.(Hereafterreferredtoas‘UCCTaskForce’).68Sztejn(n65)721perShientagJ.SeealsoJDolan,TheLawofLettersofCreditCommercialandStandbyCredits(4thed.ASPratt&Sons,2007),[7-79],[7-88].69UniformCommercialCode§5-110(a)(1995revisions).70BWunnicke,DWunnickeandPTurner,StandbyandCommercialLettersofCredit(3rded.AspenLaw&Business,2000(2013Supplement))4-26.1;JBarnesandJByrne,‘RevisionofUCCArticle5’(1995)50BusLaw1449,1457.Seegenerally,RDole,‘Warrantiesbybeneficiariesoflettersofcreditunderrevisedarticle5oftheUCC:Thetruthandnothingbutthetruth’(2002-2003)39HousLRev375.71Sztejn(n68).72Ibid723.73Ibid722.

307

wouldappear,therefore,thatthestandbymechanismisnotattherootofthepolicybalance

drawnintheUnitedStatesbutthattheAmericanpositionsimplyreflectsamoreevenbalance

betweenthecompetingpoliciesthanunderEnglishlaw.

TherepeatedentrenchmentoftheEnglishpositionbysubsequentcourtsandacademicsmay

appeardauntingtoacourtaskedtodivergefromtheorthodoxapproach.Bywayofanalogy,

itshouldalsoberememberedthatpriortotheSupremeCourtdecisioninVersloot,74itwas

widelythoughtthatthelawoninsurancefraudwas“relativelysettled”.75 Theoutcomein

that case– anarrowingof the scopeof the forfeiture rule – indicates that courtswill be

preparedtoengageinaconsideredanalysisofanorthodoxposition,notwithstandingitsage

orelucidationbyanexpertjudge.76

ii. Thedetrimentalconsequencesofconflation

InUnitedCityMerchants,LordDiplockconfirmedtheexistenceofanarrowfraudexception

butinsodoing,mischaracterisedthecontractualbasisofthecreditandconflatedthedistinct

issuesoffraud,forgeryandnullity.Thishasresultedinseveraldetrimentalconsequencesfor

theefficiencyofthecreditmechanism,whichundermineLordDiplock’sveryrationalefora

restrictiveapproachtofraud.

Thedifficultystems fromthecircumstances inwhichLordDiplockheld that thebankwas

contractuallyobligedtomakepayment.Heheldthatthebank’sdutytopaywasengagedby

thepresentationofapparentlycomplyingdocuments.77Incircumstanceswhenthepresented

documents were fraudulent, forged or null, the bank would only be entitled to refuse

paymentwhen the defect could be attributed to the beneficiary. The fact that the fraud

exception can only be triggered by the personal wrongdoing of the beneficiary correctly

reflectsthejuridicalbasisoftherule;exturpicausa.However,theconsequenceofobliging

74Versloot(SupremeCourt)(n11).75LawCom353(n14)[20.6];[22.22]-[22.24];LawCom201(n26)[8.10].76NotethatManceLJ,ashethenwas,whoiswidelyacknowledgedtobetheleadinginsurancelawjudgeextendedtheforfeitureruletofraudulentdeviceclaimsinAgapitosvAgnew(TheAegeon)[2003]QB556,[45]andwaspartofthecourtinVersloot(SupremeCourt)(n11).77UnitedCityMerchants(HouseofLords)(n58)7perLordDiplock.

308

bankstopayagainstapparentlycompliantdocumentsisthatitmustpayforknownnullities

and forgeriesunless thesecanbeattributedto thebeneficiary.Theproceduralhurdles to

provingfraud,discussedinChapterFour,meanthatthefraudexceptionwillonlyveryrarely

operatetodisruptpayment.This is,accordingtothecourts,thehallmarkofamechanism

developedwithcommercialneedinmind.78

ItwaswhollylegitimateforLordDiplocktofocusontheauthorofthedocumentarydefectto

determine whether the fraud exception should operate. However, this meant that his

Lordshipoverlookedapriorquestion:didthedocumentscomplywiththetermsofthecredit?

Documents which, at the time of presentation, were known forgeries or nullities should

properly be regarded as non-compliant. Since compliance requires banks to assess the

documents objectively, the identity of the person responsible for the defect is wholly

irrelevantatthisstageoftheenquiry.79Indeed,theidentityofthewrongdoeronlybecomes

relevantwhenthedocumentshavebeendeemedcompliantandthefocusshiftstowhether

there is a legitimate basis for the bank to refuse payment. This two-stage enquiry treats

questionsofcomplianceasathresholdinthatconsiderationsoffrauddonotariseuntiland

unlessthisthresholdhasbeensatisfied.80 It isunclearwhytheHouseofLordsoverlooked

earlierdictaestablishingthetwo-stageanalysis81anddivergedsoconsiderablyfromtheCourt

ofAppeal judgment,particularlysincetheargumentsmadebycounselforthebuyerwere

virtually identicalonappeal.82Theruleofapparentcompliance isalsomischaracterised in

Lord Diplock’s analysis. The rule was established to safeguard the bank’s right to

reimbursementwhenfraudwassubsequentlydiscovered.Theruledoesnot,andwasnever

intendedto,establishthecircumstancesinwhichthebank’sobligationtopayarises.

ThedecisioninUnitedCityMerchantscannotbereconciledwiththeexpresstermsoftheUCP

andthishasresultedinseveralpracticaldifficultiesforthecreditmechanism.Mostnotably,

78Ibid7perLordDiplock.79RGoode,‘Abstractpaymentundertakings’inPCaneandJStapleton(eds.),EssaysforPatrickAtiyah(ClarendonPress,1991),232.80Ibid233-234.81EdwardOwenEngineeringvBarclaysBankInternational[1979]1QB159,169perDenningLJcitingBankRusso-IranvGordonWoodroffe&Co[1972]116SolJ921,10CL296perBrowneJ.82Comparethefollowingjudgmentswherecounsels’argumentsaresummarised:UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1983]AC168,173-178;UnitedCityMerchantsvRoyalBankofCanada(TheAmericanAccord)[1982]QB208,213-215.

309

thecourt’sapproachtonullitieshaseffectivelymeantthatdocumentsdevoidofcommercial

orlegalvaluecanstandasgoodcurrency.Thisistroublingsincedocumentarytransactions

dependontrust.83Afurtherpracticaldifficultyrelatingtothecirculationofnulldocuments

relatestothebank’sroleinfinancingcredittransactions. Indeed,banksareonlywillingto

financesuchtransactionsbecausetheytakethedocumentsassecuritytoguardagainstthe

riskofapplicantinsolvencypriortoreimbursement.84Itgoeswithoutsayingthatnullitieswill

notenablebankstorecouplossessufferedbecauseoftheircustomer’s insolvency.Similar

issuesstemfromtheacceptanceofforgeddocumentsasgoodcurrency,mostnotablythat

the approach to forgery differs between documentary credits and other negotiable

instruments.

Thedoctrinalanalysisofthecreditmechanismvaluestheprinciplesofautonomyandstrict

complianceequally.ThisisnotreflectedinthedecisioninUnitedCityMerchantssincethe

court demonstrated a preference for the doctrine of autonomy. This is not merely of

conceptual interest since the principle of strict compliance performs several important

commercial functions.85 These are inevitably undermined by the judgment inUnited City

Merchants.

Theconsequencesofthisdecisionarealsoapparentinsubsequentcaselawconcerningthe

circumstancesinwhichbankscanrefusepayment.Thefailuretotreatcomplianceandfraud

as distinct elements of the enquiry has meant that subsequent discussions about

documentarydefectshavebeenmischaracterisedasexceptionstoautonomyratherthanas

aninstanceofabeneficiaryfailingtosatisfythepreconditionstopayment.Thisisparticularly

apparent in the Court of Appeal’s discussion in Montrod v Grundkotter.86 Subsequent

discussionshavebecomeundulydominatedbyfraudattheexpenseoflegitimateenquiries

focussingondocumentarycompliance.

83ICarr,InternationalTradeLaw(5thed.Routledge,2014)468;MBridge,‘Documentsandcontractualcongruenceininternationaltrade’inWorthington,S.(ed.),CommercialLawandCommercialPractice(Hart,2003),216;XGao,TheFraudRuleintheLawofLettersofCredit:AComparativeSurvey(KluwerLawInternational,2002),130-131.84EPEllinger,‘Fraudindocumentarycredits’[1981]JBL258,269.85Seeearlier,ChapterFour,texttofn98etseq.86MontrodLtdvGrundkötterFleischvertreibsGmbH[2002]1WLR1975,[56]perPotterLJ.

310

Thisthesishasarguedthattheconflationneedstobecorrectedinamannerthatgivesdue

considerationtothecommercialneedforanefficientmechanism.Thesuggestionmadein

ChapterFivewastoreinstatethethresholdanalysissuggestedinearliercaselaw.87Thiswould

focustheinitialenquiryondocumentaryconformityandenablebankstorejectnullitiesas

non-compliant. This reflects the fact that the documents will be required to function as

securityfortheultimatebuyerandthebankintheeventofitscustomer’sinsolvency.This

would not unduly hinder the payment process, however, as the beneficiary can resubmit

documentationbeforethecreditexpires.Thisdiffersfromtheimpactofthefraudexception

whereby the beneficiary’s right to payment is permanently barred. Although forged

documentsarestrictlyspeakingnon-compliant,thepositionadvocatedinthisthesiswould

entitle banks to make payment against forgeries. This is a pragmatic approach to the

compliancequestionwhich,intheauthor’sview,canbejustifiedbecauseforgeddocuments

remaincapableofservingtheircommercialpurpose.

iii. Deterrenceindocumentarycredittransactions

The courts have repeatedly asserted that traders bear responsibility for mitigating fraud

throughthecarefulpre-contractualselectionofhonestcounterparts.Theviewisthatabsent

honesty,therewouldbenodeal.88Thereisnothinginthejudicialaccounttosuggesthow

such information isgatheredorcirculatedbetweenparties.Thetradefinancecourtshave

furthercharacterisedcommerciallawasofferingprotectionfrominsolvencyandnottoguard

againstfraud.89Intandem,thisviewofthelawperhapsexplainstheabsenceofanyjudicial

or academic discussion of fraud deterrence in credit transactions. The approach to

documentarycreditfraud,therefore,divergessignificantlyfromboththeinsuranceapproach

todeterrenceandthegeneralshapeandfunctionoffraudrulesinEnglishlaw.Thisthesis,

therefore,representsasignificantandmorecomprehensiveanalysisoffraudindocumentary

credit transactions.Thediscussion reliedonempiricalevidenceof credituse,gatheredby

87EdwardOwen(n81)169perDenningLJ.88JDavey,‘Honesty&therelationalcommercialcontract:Towardsalawofpost-contractualmisrepresentation’,(InsuranceFraudSymposium,UniversityofSouthamptonLawSchool,13July2016),11.89SandersvMaclean(1883)11QBD327,343perBowenLJ,

311

Professor Mann in the late 1990s.90 The data diverged considerably from the doctrinal

account of credit use, demonstrating that paymentwas achieved via thewaiver process,

notwithstanding serious documentary discrepancies. This data is not routinely cited or

considered in the English context.91 It was used in this thesis to develop two specific

argumentsaboutdeterrence.

The first argument used the empirical data to strengthen the judicial account of fraud

prevention;exantescreening.Itwascontendedthattheinformationchannelsidentifiedin

Katz’sanalysisof thedataprovideda framework inwhichpre-contractualscreeningcould

occur.Thesechannelsprovidedthestructureinwhichinformationaboutaparty’sreputation

andpropensityforwrongdoingcouldbedispersedamongthecommunity.Thisaddscolour

anddepthtothejudicialexplanationofdeterrence.

Thesecondargumentconsideredthemitigationof incentives for fraudwhichariseduring

performanceofthecreditcontract.Thiswasanovelanalysisgiventhatthejudicialaccount

confinesdeterrencetothepre-contractualperiod.Inparticular,opportunitiesforfraudarise

duringperformancewhenthebeneficiaryshipsthecontractualgoodsbutcannotcomplywith

thetermsrelatingtoshipmentorencountersfinancialdifficulty.Itwassuggestedherethat

relational governance operates during credit transactions tomitigate incentives for fraud

duringperformance.Thisisaninformalmechanismofgovernancewhichdependsonnorms

oftrust,flexibilityandcooperationandindustry-specificnormstoguidebehaviourwithinthe

transaction. A relational mechanism constrains misconduct in commercial transactions

becauseofthecommercialimportanceattachedtoagoodreputation.Itwascontendedin

ChapterFive that thesenormscouldplausiblydevelop incredit transactions followingthe

conclusionofthewrittencontract.Theprocessoffinalisingthedetailsoftheexchangewill

typically require parties to cooperate and engage in personal interaction. These are the

hallmarksofatransactionunderpinnedbyrelationalgovernance.

90RMann,‘Theroleoflettersofcreditinpaymenttransactions’(1999-2000)98MichLRev2494.91Theauthorhasidentifiedthefollowingtworeferencestotheempiricalwork:Bridge,‘Documentsandcontractualcongruence’(n83)227(fn68inoriginal);JUlph,‘TheUCP600:Documentarycreditsinthe21stcentury’[2007]JBL355,362 (fn29 inoriginal).Neitheraccountdiscusses thedata indetailorwhat itmightmean for theuseofdocumentarycredits,ashasbeenundertakeninthisthesis.

312

Readers will note that neither of these arguments about deterrence refers to the fraud

exception.Inthisway,thethesislendssupporttothejudicialaccountthatthefraudexception

toautonomyisnotdesignedtodeterfraud.92Instead,deterrenceisexplainedbyreference

toextra-legalmechanisms,namelyduediligenceinthepre-contractualphaseandrelational

governanceduringperformance.

C. LookingforwardItisconvenientatthisstagetoconsiderwhatthesefindingsmeanforthefuturedevelopment

ofthefraudexceptionindocumentarycredits.

The first, and perhaps overarching, impact of these findings is conceptual in nature. The

research undertaken in this thesis demonstrates that English courts could broaden their

approach to fraudand theavailabilityof injunctive reliefwithout risking theutilityof the

credit mechanism or the reputation of UK banks. In short, the English courts have been

incorrect to suggest that the particular contours of the rule are fixed by reference to

commercialneed.Tothisend,amoreflexibleandreflectiveapproachtothepolicyquestions

surroundingdocumentarycreditswouldensurethatthelawachievesitsaimoffacilitating

trade.

Thepracticalimpactofthesefindingsisdependentonasuitablecasereachingtheappellate

courtsoronlegislativeintervention.Thelattercourseofactionishighlyunlikelygiventhe

constraintsonparliamentarytime.Inrelationtojudicialaction,acasewouldneedtocome

beforetheSupremeCourtinordertore-examinetheHouseofLords’decisioninUnitedCity

Merchants.Asargued inChapterFive,amoderncourtcouldsimplydistinguishtheearlier

decisionon thebasis that the transaction incorporated theUCP500, asdistinct from the

revisedUCP600incommonusagetoday.AmorecourageousSupremeCourtwouldalsohave

groundsforoverrulingthedecisioninUnitedCityMerchants.Firstly,thecourtcouldargue

that theHouse of Lords fundamentallymisunderstood that the beneficiarywas under an

express contractual duty to present strictly compliant documents to gain payment. The

92Sanders(n89)343perBowenLJ.

313

SupremeCourt could alsodemonstrate the flawedunderstandingof the ruleof apparent

complianceandreinstatethatruleasaprotectivedeviceforbanksandnotastandardfor

establishing thebank’sduty tomakepayment. Irrespectiveofwhichcourseofactionwas

taken–todistinguishoroverrulethedecisioninUnitedCityMerchants–theSupremeCourt

would,ingeneralterms,beentitledtoalterthepolicybalancebetweenfrauddeterrenceand

autonomy.Morespecifically,ajudicialrestatementoftheproperroleofapparentcompliance

andthedoctrineofstrictcompliancewouldenablebankstorespondtonullitiesintheway

suggestedabove,namely to legitimately reject suchdocumentsasnon-compliantwithout

consideringthepartyresponsibleforthedefects.Theapproachadvocatedheredependson

asuitablecasereachingtheSupremeCourtalthough,atthetimeofwriting,thereisnosuch

caseonthehorizon.This,itshouldagainbenoted,isattributabletothechillingeffectofthe

HouseofLords’decisioninUnitedCityMerchants.

Atthetimeofwriting,theInternationalChamberofCommercearedraftinganewversionof

theUCP.ThisisunlikelytodealwithfraudgiventheICC’srepeatedinsistencethatthisisa

matterfornationaljurisdictions.However,tocontinuethedriveforclarityandfurtherreduce

defectivepresentations,93theUCP700couldclarifythedefinitionof‘complyingpresentation’

inlinewiththefindingsofthisthesis.Inparticular,theICCcouldconfirmthatnullitiesarenot

complying for the purposes of the UCP. This would firmly distinguish documentary

compliance and fraudwithout encroaching on national courts’ jurisdiction to legislate for

fraud. A workable definition of nullity would be required for these purposes. This issue

troubledtheEnglishCourtofAppealinMontrodandwasusedtorejectthedevelopmentof

anullityexceptiontopaymentinEnglishlaw.94Thesolutiontothedefinitionproblemcould

be easier than the English courts have suggested. The ICC offer banks a document

authenticationservice95whichpresumablyreliesonaworkingdefinitionofnullitytoassess

documents.ThiswouldbeafruitfullineofenquiryshouldtheICCwishtoenshrinenullities

asnon-compliant in theUCP700. Inanyevent, asa voluntary setof guidelines for credit

93ICC,‘TheUniformCustomsandPracticeforDocumentaryCredits’(2007Revision,ICCPublicationno.600)(seeintroductorycommentsbyGCollyer).94Montrod(n86)[58]perPotterLJ.ButseetheapproachinBeamTechnology(MfG)PteLtdvStandardCharteredBank[2002]SGCA53,[36]perChaoHickTinJA,TanLeeMengJwherethematter“canonlybeansweredonthefactsofeachcase.”95 ICC Commercial Crime Services, ‘Trade Finance Documents Authentication’, https://www.icc-ccs.org/icc/imb/services/due-diligence/trade-finance-documents-authentication(accessed17/07/2016).

314

transactions,iftheUCP700–completewithastrengtheneddefinitionofcompliance–was

unacceptabletotraders,partiescouldsimplyincorporateanearlierversionoftheUCP.The

authorwouldsuggest,however,thatthelikelihoodofanewversionbeingunacceptableto

tradersisrelativelyslimgiventhatthedraftingprocessincludesbothbanksandtraders.

If the recommendations detailed above were reflected in the UCP 700 and English

jurisprudence, a further issue would arise; the singularity of the remedy. Much like the

simplisticoverviewofdeceitfirstidentifiedbyMacDonaldEggers,96theremedyforfraudin

credittransactionsoperateslikeaswitchtodeprivethefraudulentbeneficiaryofhisentire

righttopayment.There is,astherule iscurrentlyconstructed,noscopeforthecourtsto

consider the severity of the fraud or the culpability of the beneficiary. To illustrate the

problem, it will be remembered that the fraud exception can be equally satisfied by a

phantom shipment as by the falsification of documents to conceal late shipment of the

contractualgoods.Thereisnodoubtthatthebeneficiaryresponsibleforaphantomshipment

ismore culpable and deserving of punishment than his counterpart in this example. The

singularnatureofthefraudexceptionwouldresultinsimilarcounterintuitiveeffectsashave

beendemonstratedintheinsurancecontext.Similarly,therefore,aframeworkofnuanced

remedies to combat fraudwouldbemore appropriate. Thismirrors the recommendation

madeaboveinrespectofinsuranceclaimsfraudandMacDonaldEggers’conclusionsonthe

tortofdeceit.97Thereisnodoubt,however,thatwearea longwayfromsucharguments

takingrootinthedocumentarycreditcontext.

IV. ConcludingReflectionsThisthesishasfocussedonthejudicialconceptionoffraudininsuranceandintransactions

financedbydocumentarycredit.Thediscussionnowreflects,moregenerally,onwhatthese

findingstellusaboutcommerciallaw.

TheEnglishcommercialcourts fallbackonsimplephrasestoexplain intervention in fraud

cases.Itseemsunlikelythatathree-wordphrasecouldeveraccuratelyexplainjudicialaction

andyetthisistheintentionwhen‘fraudunravelsall’isinvokedbythecourts.Simplephrases

96MacDonaldEggers(n2)[1.4].97Ibid[9.7].

315

suchasthisdonothavethecapacitytorecognisecontextualmatterswhichdistinguishareas

oflawandjustifydifferenttreatment.Theimportanceofcontextisparticularlyapparentin

thecomparisonbetweenthefraudrulesinmarineinsuranceanddocumentarycredits.These

bodiesof law,andtherulesrelatingto fraud,servefundamentallydifferentpurposesand

trigger different policy concerns. It is likely, therefore, that a consideration of other

commercialfraudruleswouldbringtolightadditionalpolicyconcernstobebalancedagainst

deterrence, and further demonstrate the importance of understanding contextual issues

affectingtheoperationofarule.

Policyargumentshavebeencritical in the judicial response to insuranceclaims fraudand

fraudincredittransactions.Thereisnoreasontosupposethatasimilarrelianceonpolicy

wouldnotbefoundinothercommercialfraudrules.Whathasbeenparticularlyinteresting

isthatthecourtshavecharacterisedtheirpolicychoicesasinevitable;aclassicexampleof

judges‘finding’thelaw.But,ifwerecognisepolicyassimplya“value-judgment,”98typically

employedincaseswhere“therulesofthelegalsystemdonotprovideaclearresolution”,99

this notionof inevitabilitydiminishes.As Toddhas argued in the contextof documentary

credits,

There is nothing inevitable about these policies, and the autonomy principle in

particular is less strongly developed in the United States…They represent the

uncompromisingchoicethathasbeenmadebytheEnglishcourts.100

Thesameconclusioncanbedrawnaboutfactualassumptions101madebythecourtsaswell

astheassumedbehaviouralconsequencesflowingfromajudicialdecision.102Thisshouldlead

academicstobewaryofsimpleanswersindicatedbypolicyandtoapproachsuchquestions

98JBell,PolicyArgumentsinJudicialDecisions(ClarendonPress,1983),36.99Ibid22-23.100Todd,MaritimeFraud&Piracy(n59),[4-014].101 A Kronman, ‘Mistake, disclosure, information, and the law of contracts’ [1978] 7 J Leg. Stud. 1, 2: “Everycontractual agreement is predicated upon a number of factual assumptions about the world. Some of theseassumptionsaresharedbythepartiestothecontractandsomearenot.Itisalwayspossiblethataparticularfactualassumptionismistaken.”102PCserne, ‘Policyargumentsbeforecourts: Identifyingandevaluatingconsequence-basedjudicialreasoning’[2009]HumanitasJofEur.Studies9,15-16:“amoreorlesseducatedguessabouthypotheticalscenariosastohowcertaingroupsoflegalsubjectswouldchangetheirbehaviourinresponsetothisorthatdecision.”;Bell(n33)67.

316

withanopenmind.Robust,empirically-informedmodelsshouldbepreferredtolawmaking

basedonsimplisticandinstinctiverulesofthumb.Thecostsassociatedwiththisapproach

wouldnodoubtbejustifiedbythenuancedandmoreefficientlegalruleswhichwouldresult.

ThepiecemealnatureoftheEnglishcommonlawsystemalsomeritsconsideration.103The

courts are limited by the facts of the instant case and, certainly at the lower levels,

constrainedbythedoctrineofprecedent.ThisaspectoftheEnglishsystemishighlightedby

thefactthatforeignjurisdictionshavereacheddifferentanswerstothesamequestionsof

policy,typicallyafterlengthyconsultationandlegislativeprocesses.104Onarelatednote,itis

difficulttodisputethesuggestionthatthefraudexceptionindocumentarycreditshasbeen

hinderedbytheabsenceofcasesreachingtheappellatecourts.Thiscontrastsstarklywith

themuchgreatervolumeofjudicialdiscussionoftheforfeiturerule.Thecommonlawcourts

arenecessarilyreliantonprivatepartieslitigatingdisputesandthislimitstheopportunities

toreflectonthedevelopmentofthelaw.Thisshouldberememberedontherareoccasions

thatcourtshavetheopportunitytoreconsiderthedirectionorshapeofthelaw.

RawlingsandLowryhavedescribedLordMance’sdissentinVerslootas“unsurprising”105and

thisiscertainlyasentimenttheauthorwouldendorsefollowingabriefconversationwithhis

Lordshipatthisyear’sSocietyofLegalScholarsconference.Theauthor’soverridingsenseof

thedecisioninVerslootisoneofdissatisfaction.Ifthepre-Verslootpositionwascriticisedfor

itsseverityandpro-underwriterstance,itisnobetterfortheSupremeCourttohavereplaced

thatmodelwithanequallysimplisticonewhichinsteadfavoursthefraudster.Theauthoris

equallydissatisfiedwiththesimplisticapproachtofraudwhichhasbeendevelopedinthe

context of documentary credits.106 To develop the law with commercial need in mind is

admirable,butthecourtsshouldnotbecontentwithafraudrulewhichis,inpractice,wholly

“illusory.”107Thisthesisis,inbroadterms,arejectionofsimplisticideasusedtoshapelegal

103RawlingsandLowry,‘Insurancefraudandtheroleofthecivillaw’(n16)525,describedas“thehappenchanceoflitigation.”104Forexample,TaskForceontheStudyofUCCArticle5 (LettersofCredit), ‘AnexaminationofUCCArticle5(Letters of Credit)’ (1989-1990) 45 Bus Law 1521, 1532, 1536; Australian Law Review Commission, InsuranceContracts(ALRCReport20,1982).105RawlingsandLowry,‘Insurancefraudandtheroleofthecivillaw’(n16)529-530.106Indeed,thiswastheauthor’sheadlineargumentinherSLSpresentation(paperonfilewithauthor).107WSChong,‘Theabusivecallingofperformancebonds’[1990]JBL414,416.

317

policy.Itisalsodesignedtohighlighttheimportanceofchallengingseeminglysettledjudicial

doctrineinfavourofnuanced,empirically-informedlegalrules.Indeed,theauthorintendsto

explore the shape of more flexible remedial regimes in future work, to mirror the

recommendationsofMacDonaldEggersinhisconvincingrestatementofthetortofdeceit.108

108MacDonaldEggers(n2)[9.5]-[9.9].

318

319

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