China Esquire

The International Lawyer published article a few months back from Professor Xiang Gao at China University of Political Science & Law in the Winter 2007 Edition (Vol. 41, No. 4) entitled “The Fraud Rule in Law of Letters of Credit in the P.R.C.” While the article may make for interesting reading about letters of credit and the history of the fraud rule, I am more concerned about what the fraud rule means today for practicing attorneys. On the whole, I am rather impressed with the sophistication and policy decisions that were made in the 2005 draft of the fraud rule after reading this article, and thought that parts of it would be worth sharing.

I will not expound on letters of credit for those who are not familiar with the topic. For a basic understanding, Wikipedia does a decent enough job. I just want to highlight certain sections:

Standard of Fraud

The fraud rule is developed to prevent fraudsters from using letters of credit to unjustly enrich themselves. It is applied when fraud is found in the transaction . . . .

In the P.R.C., fraud is defined under Article 68 of the Interim Opinions of the Supreme People’s Court Concerning the Implementation of the General Principes of the Civil Law of the P.R.C. (IOGPCL) as “one party intentionally telling the other party a lie or concealing the truth of a fact in order to induce the other party to come to a decision it would otherwise not come to.”

Of course, this standard can be tough to apply. It is not quite like U.S. fraud rules because it seems the causation bar in the IOGPCL seems higher: to cause a party to do something it would otherwise not do. Of course, it is vague, so the article lays out some examples:

(i) The beneficiary has forged documents or presented documents containing fraudulent information;

(ii) The beneficiary has intentionally failed to deliver goods or delivered goods with no value;

(iii) The beneficiary has conspired with the applicant or a third party and presented fraudulent documents whereas there is no actual underlying transaction; or

(iv) Other circumstances that constitute letter of credit fraud.

The article goes on to expound on each of these categories. The most sophisticated part seems to address the third option, where companies can use the fraud rule in order to conspire to cheat banks for funds or avoid the law of foreign exchange control. That to me shows an alignment with reality and appreciation for modern economic concerns.

Parties Immune from the Fraud Rule

A people’s court shall make a ruling to suspend the payment or a judgement to permanently stop the payment under a letter of credit when fraud is established, unless one of the following has happened:

(i) The nominated person or the person authorised by the issuing bank has paid in good faith in accordance with the instructions of the issuing bank;

(ii) The issuing bank or its nominated or authorized person had accepted the draft under the letter of credit in good faith;

(iii) The confirming bank has paid in good faith; or

(iv) The negotiation bank has negotiated in good faith.

While “immunity” from the fraud rule seems like it ends up protecting wrongdoers to some degree (and it does), it also impresses me that there is enough sophistication in this law to create such a category of immune parties because the letters of credit law deals with business transactions that ideally are outside the realm of the law. As well, letters of credit involve 3 separate commercial transactions due to banks acting as escrow services, and thus, end up being highly complicated. One instance of fraud can grind the entire process of transactions to a halt.

Jurisdiction

[O]nly the following courts can hear foreign-related commercial cases or are competent courts that can hear letter of credit cases:

a). People’s courts of the Economic and Technological Development Zones approved by the State Council;

b). Intermediate people’s courts of the capital cities of provinces, autonomous regions and municipalities directly under the control of the Central Government;

c). Intermediate people’s courts of the Special Economic Zones and Municipalities financially directly report to the Central Government;

d). Other intermediate people’s courts specially designated by the SPC for the jurisdiction of foreign-related commercial cases; and

e). High People’s Court.

Currently, all letter of credit cases in the SPC are under the jurisdiction of the No. 4 Civil Division.

Again, this is good information for any practicing Chinese lawyer to know. You don’t want to file suit in the wrong court or the wrong division of the right court.

There is a lot more to Professor Gao’s article, but I think these are the most relevant to any China practitioner. If you want to read me, pick up the article.

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