An Appeal Court ruling clarifies exposure to risk when dealing with letters of credit transactions, writes Roger Masefield. Roger Masefield is a tenant of Brick Court Chambers.

The decision of the Court of Appeal in Banco Santander v Banque Paribas is important for those involved in letter of credit transactions.

The case concerned the shipment of oil from Kazakhstan CIF Porvoo, Finland. The sale was to be by an English firm, Bayfern, to Napa Petroleum – at an agreed price of about $20m (£1.28m).

Payment was to be by way of a deferred payment letter of credit for payment 180 days after the bill of lading date. The letter called for the presentation of various documents, including certificates of quality and quantity.

Banque Paribas issued the letter of credit, and Banco Santander added its confirmation. Bayfern then presented Banco Santander with the documents, including quality and quantity certificates. The documents appeared to be in order, so Banco Santander sent them to Banque Paribas.

Bayfern then asked Banco Santander to make a discounted (an earlier, but reduced) payment. Banco Santander agreed and took an assignment of the proceeds of the credit only to be informed by Banque Paribas that the latter was rejecting the documents on various grounds, including forgery.

The question for the court was whether Banco Santander, in making a discounted payment and taking an assignment from Bayfern, took the risk that the transaction was a fraud. The court held that it did and that it was not entitled to reimbursement from Banque Paribas.

The court drew an important distinction between deferred payment letters of credit and acceptance credits. Under the former, a discounting bank merely obtains an entitlement to the proceeds of the letter of credit by way of an assignment from the beneficiary – and accordingly its entitlement is subject to equities, including the risk of there being a fraud.

However, in the case of an acceptance credit, a discounting bank becomes a holder for value in due course of the bill of exchange and accordingly will not be exposed to that risk.