Queen’s Bench Division (Commercial Court)

The court considered the issue of Article VIII, Section 2(b) to be “the most difficult and novel part of this case.”⁶ The court referred to the proposition accepted by the English Court of Appeal in Wilson, Smithett & Cope Ltd. v. Terruzzi⁷ that an “exchange contract” under the provision means a contract for the purchase and sale of one currency against another and that contracts involving securities or merchandise are not exchange contracts except when they are monetary transactions in disguise. This proposition, declared the court in the Glass Fibres case, was not greatly helpful in defining monetary transactions in disguise.

The court analyzed the agreement as one that, if carried out, would lead to the receipt by Vitro, through an intermediary, of U.S. dollars and the obligation of Vitro, through Banco Continental, to make repayment over a period of five years by selling Peruvian soles for U.S. dollars. On this analysis, the contract of sale between Glass Fibres and Vitro could be described “as constituting an exchange contract by being a monetary transaction in disguise”⁸ contrary to Peru’s exchange control regulations and therefore unenforceable under the 1946 Order in Council.

The court disposed of an objection by the plaintiff that the exchange control regulations were not maintained or imposed consistently with the Articles. The report does not include the plaintiff’s argument in support of this objection, but the court’s reference to “very sweeping allegations which could perhaps be said of most member countries”⁹ suggests that the argument was the incompatibility in principle of exchange controls or exchange restrictions with the broad objectives of the Articles. The treaty, however, does not invalidate exchange controls or all exchange restrictions. The Fund concluded, in a communication to one of the parties, that the Peruvian exchange controls were not inconsistent with the Articles. The reasons were stated in the earlier article that has been referred to above.¹⁰

The court rejected the objection of inconsistency with the Articles by referring to the dictum in the Terruzzi case that courts should not assume without evidence that the authorities of a member country administer their exchange control regulations in a manner contrary to the Articles. This dictum amounts to a presumption in favor of the consistency of exchange control regulations with the Articles, which places the burden of proving inconsistency on the plaintiff. But a defendant who relies on Article VIII, Section 2(b) necessarily asserts that exchange controls are maintained or imposed consistently with the Articles, and he should have the burden of proving this fact.

This allocation of the burden of proof is not intended to suggest that a court is debarred from raising the question of the application of Article VIII, Section 2(b) when the parties have failed to refer to the provision.¹¹ The only safe way to settle the question of consistency or inconsistency is to request a certificate from the Fund. The request can be made by a party or by the court itself if its procedures authorize this step. The reason why the Fund should be approached is that the answer may depend on the exercise of the Fund’s discretionary powers to approve exchange restrictions if approval is required by the Articles. In the Glass Fibres case, it is not clear whether the court thought it necessary to rest on the dictum in favor of consistency, even though the Secretary of the Fund, acting with the authority of the Executive Board, had provided one of the defendants with a statement affirming the consistency with the Articles of the exchange control regulations cited in the case.¹²

Another objection rejected by the court was that the restriction in this case was on the import of capital goods and was contained in the law relating to industry and not exchange control. The court held that this contention was not in accord with the evidence.

The court then turned to the “perplexing and difficult”¹³ question of the effect of its findings on the claim against Royal Bank as the confirming bank. In the first part of this litigation, the court had concluded that, except in the case of fraud, a bank that confirms a letter of credit must pay against documents appearing to comply with the terms of the credit, and that the bank is not concerned with the question whether the goods complied with the terms of the contract of sale.¹⁴ The problem was whether this principle was affected in any way by the Bretton Woods Order in Council. By stating the problem in this way, the court was asking whether fraud in the underlying contract between the beneficiary and the bank’s customer at whose instance the letter of credit is arranged, which is a recognized exception to the principle of the independence of the letter of credit, is the only justification for the confirming bank’s refusal to honor the instrument, or whether the Order in Council is a second and independent justification. The issue arose because the court held that in the circumstances of the case the established exception of fraud was not available to Royal Bank as a justification for refusing payment.

In examining the question whether the Order in Council was an independent justification for refusing to honor a letter of credit, the court discussed the decisions of the Court of Appeal in Sharif v. Azad¹⁵ and Batra v. Ebrahim.¹⁶ In the former case, the Court of Appeal permitted the plaintiff to recover on a check in England, notwithstanding the fact that the check was delivered as part of a plan to evade the exchange control regulations of Pakistan. The court in the Glass Fibres case noted the emphasis that the Court of Appeal had placed on the language of the regulations in Sharif v. Azad. They applied to “any person in or resident in Pakistan,” but the parties to the action in England were resident in England. The court noted also the absence of any argument that the check was affected with fraud as between the parties.

In Batra v. Ebrahim, the two parties were resident in England, but the plaintiff failed. The court in the Glass Fibres case pointed out that the exchange control regulations of India, which were in issue in Batra v. Ebrahim, “were not expressly tied to residency.”¹⁷ This attempt to reconcile the two cases is an unhappy one. The words “involve the currency of any member” in Article VIII, Section 2(b) mean, according to one interpretation, that an exchange contract contrary to the exchange control regulations of a member is unenforceable only if performance of the contract would affect the member’s balance of payments. According to another interpretation, performance must affect a member’s exchange resources. On the basis of these interpretations, the residence of a contracting party within a member’s territory, or the transfer of assets across its borders, is relevant under Article VIII, Section 2(b) whether or not the exchange control regulations in issue are formulated in terms of residence within the territory or the transfer of assets out of the territory.

The court explained that Sharif v. Azad had been decided on the basis of Section 30 of the Bills of Exchange Act, 1882, for which reason that case could be distinguished from one in which the question was the effect of the Order in Council on a confirmed letter of credit. This explanation of Sharif v. Azad adds nothing to the understanding of Article VIII, Section 2(b) and its possible application to letters of credit. The explanation amounts to no more than the proposition that the provision did not apply in Sharif v. Azad because the Bretton Woods Agreements Act and the Order in Council had not made it applicable in the circumstances of the case. The decision did not hold that the Bills of Exchange Act would have prevented a more extensive application of the provision. Earlier statute law would have been no more an obstruction than the traditional principles of private international law that the Court of Appeal in Sharif v. Azad recognized as inapplicable as a result of Article VIII, Section 2(b) and the Order in Council.

It is obvious that the Queen’s Bench Division in the Glass Fibres case did not find guidance in the two earlier cases, although it may have thought that Batra v. Ebrahim gave it some support in denying recovery by the plaintiff. “After considerable hesitation,”¹⁸ the court decided that the Order in Council should not be rendered ineffective by enforcing the letter of credit. Once any payment was made by the Royal Bank under the letter of credit, effect would be given to some extent to a monetary transaction in disguise, and therefore to an exchange contract that was contrary to the exchange control regulations of Peru.

The court rejected with some warmth the suggestion that the plaintiff should be allowed to recover half its claims under the letter of credit. That instrument could not be severed in this way. It was either enforceable in full or not at all. Judgment was given for the Royal Bank of Canada.

Some Comments on the Case in the Queen’s Bench Division

1. The court of first instance noted the absence of authority on the effect that Article VIII, Section 2(b) had on letters of credit, but it seems that the decision of the New York Court of Appeals in J. Zeevi and Sons, Ltd., et al v. Grindlays Bank (Uganda) Limited¹⁹ was not cited, although decisions of courts in the United States on other aspects of the litigation were discussed, particularly on the issue of fraud in the underlying transaction. In the Zeevi case, the court held that a letter of credit issued as the result of an agreement between a Ugandan Bank and an Israeli corporation was enforceable by the beneficiary of the letter of credit, notwithstanding the prohibition of Uganda’s exchange control regulations. The court’s primary motivation seems to have been the undesirability of a policy of refusing to enforce a letter of credit under which funds were to be made available in New York. The argument based on Article VIII, Section 2(b) was swept aside with the brief comment that a letter of credit was not an “exchange contract.” This conclusion made it unnecessary for the court to examine other problems, such as the question whether the Ugandan exchange control regulations were consistent with the Articles.

Another case that the court might have wanted to consider, had it been cited, was the decision delivered by the Supreme Court of the Federal Republic of Germany on April 27, 1970, in which it was held that bills of exchange were within the reach of Article VIII, Section 2(b).²⁰

2. The Glass Fibres case was an action between two nonresidents of Peru, and discharge of the defendant’s obligation to the plaintiff, taken in isolation, would not require any transfer of assets from Peru. On these facts alone, and on the basis of an economic interpretation of the currency “involved,” there would have been no reason to hold that the letter of credit was unenforceable under Article VIII, Section 2(b) even if the underlying transaction was deemed to be a monetary one in disguise. But the court pointed out that enforcing the letter of credit would have made Banco Continental, a resident of Peru, liable to sell Peruvian soles to obtain U.S. dollars with which to repay Royal Bank, a nonresident of Peru, contrary to Peru’s exchange control regulations.

It was possible that Royal Bank would not have had recourse against Banco Continental except by suit in Peru. It may be assumed that in these circumstances Peruvian courts would deny recovery as being in contravention of Peru’s exchange control regulations. It is doubtful, however, that a plaintiff should be allowed to rely on such a response to the contention that Peru’s balance of payments or exchange resources were affected and its currency involved within the meaning of Article VIII, Section 2(b).

3. In the United States, a surge of litigation and debate is taking place on the circumstances in which courts may grant injunctions restraining a bank from making payment on a letter of credit. Cases decided in the United States have influenced this sector of English law. Some of the questions raised in recent litigation in the United States are whether fraud in the underlying contract between the beneficiary of the letter of credit and the customer of the issuing bank is a basis for refusing relief, and whether fraud for this purpose connotes deceit, some other form of subjective behavior, or some form of objective behavior. The courts have found it difficult to reconcile the principle that commerce must be unimpeded, which leads them to hold that banks confirming letters of credit deal in documents and not goods, with the need to insist on basic honesty in commercial transactions.²¹

So far, in the United States only the Zeevi case has raised the question of the effect of Article VIII, Section 2(b) on a letter of credit, but fraud in the underlying transaction was not alleged. The decision in that case protected the beneficiary of the letter of credit and the beneficiary’s assignee. The decision of the Queen’s Bench Division in the Glass Fibres case was in favor of the bank confirming the letter of credit and indirectly in favor of the issuing bank. In some cases, the courts are called on to protect the issuing bank’s customer. In cases involving Article VIII, Section 2(b), the interests of yet another entity can be prejudiced: the member of the Fund whose balance of payments or exchange resources would be affected by enforcement of the letter of credit. The protection of the member should not be made to depend on a demonstration of fraud in any form on the part of contracting parties. Such a demonstration is not required by Article VIII, Section 2(b). Even a contract that is entered into innocently may be caught by the provision. In the Glass Fibres case, the court emphasized the element of “a monetary transaction in disguise,” but this approach was followed because of the narrow definition of exchange contracts adopted in the Terruzzi case and because the parties to the underlying contract were buying and selling goods.

4. The court’s rejection of the argument that the restrictions in the case were on the importation of goods and were not exchange control regulations deserves a comment. The exchange control regulations of Peru’s Decree Law No. 18275 applied directly to transactions in foreign exchange, and Decree Law No. 18891 made it a criminal offense to overvalue imports and obligations in foreign exchange, as well as to undervalue exports, in violation of the regime of foreign exchange certificates. The regulations were intended to control payments and transfers for international capital transfers and were obviously exchange control regulations within any reasonable meaning of the expression.

Suppose, however, that regulations are contained in a law relating to industry and the importation of capital goods as contended by the defendant. Regulations would not cease to be exchange control regulations by reason of that fact alone. Legislation frequently imposes restrictions on trade and augments them with regulations that deal with the financial aspects of restricted trade transactions. An importer might be required by law to obtain authority to make an import, and the same law might provide that an exchange license would be granted automatically if the import was authorized. In these circumstances there would be no restriction on the making of payments, but there would be a control of exchange. Whether there is a restriction on the making of payments depends on whether a discretion is exercised to permit, prohibit, or unduly delay payment. Under some laws, discretion is exercised with respect to both the trade and the financial aspects of transactions. These laws establish restrictions of a joint character on trade and payments.

Article VIII, Section 2(b) refers to exchange control regulations and not to the narrower concept of restrictions on the making of payments and transfers. A reasonable test to determine whether a measure is an exchange control regulation is whether its subject matter is the availability or use of exchange as such, but the regulation need not impose “a direct governmental limitation on the availability or use of exchange as such.”²²

Court of Appeal

The Court of Appeal, consisting of Lords Justices Stephenson, Ackner, and Griffiths, each of whom delivered an opinion, dealt with the two defenses of Article VIII, Section 2(b) and fraud in the underlying transaction. The Court of Appeal affirmed the decision of the Queen’s Bench Division in favor of the defendant, but did so on the basis of the second defense while the lower court had rested its decision on the first defense.

On the subject of the first defense, the court held that the letter of credit contract between Glass Fibres and the defendant, considered in isolation, was not an exchange contract because it was a contract to pay U.S. dollars against documents and was not a contract to exchange one currency against another. The court followed the decision in the Terruzzi case in holding that “exchange contracts” in Article VIII, Section 2(b) meant contracts for the exchange of currencies, so that contracts involving securities or merchandise were not exchange contracts unless they were “monetary transactions in disguise.”

The facts were analyzed by Lord Justice Stephenson as involving four contractual relationships, as follows:

• (1) between Glass Fibres and Vitro for the sale and purchase of goods;

• (2) between Vitro and Banco Continental for the opening of an irrevocable and transferable letter of credit in favor of Glass Fibres for the account of Vitro;

• (3) between Banco Continental and Royal Bank by which Royal Bank confirmed the letter of credit opened by Banco Continental; and

• (4) between Royal Bank and Glass Fibres as beneficiary of the letter of credit, which was the contract sued on in this case.

The fourth contract, however, came into existence to ensure payment of the U.S. dollars payable under the first contract. The first contract, by doubling the purchase price and providing for transfer of the excess to the United States, was a monetary transaction in disguise because it would result in an ultimate exchange of U.S. dollars for Peruvian soles in contravention of Peru’s exchange control regulations. It was admitted that the regulations were maintained or imposed consistently with the Articles. The fourth contract was a necessary step toward the ultimate exchange of soles for dollars. Both the first and the fourth contracts, therefore, were exchange contracts, although this character was clearer in the latter contract than in the former. The main submission for Glass Fibres, however, was that the fourth contract was legally independent of the first contract. Glass Fibres contended that the independence of the contract for an irrevocable letter of credit was well established and commercially important. The court recognized the principle that the irrevocable obligations of banks, such as obligations under irrevocable confirmed letters of credit, guarantees, and performance bonds, were the lifeblood of international commerce because they were separate legally from the underlying rights and obligations between merchants. A bank’s obligation is to pay promptly and without question if the documents presented by the beneficiary are in accordance with the terms of the letter of credit, whether or not the documents conform to the terms of the underlying contract between the beneficiary and the issuing bank’s customer. The bank must not pay if the documents are not in conformity with the terms of the letter of credit, however minor the nonconformity may be.

Lord Justice Stephenson considered the principle that the independence of the letter of credit would be undermined if the court looked beyond the letter of credit to its object and ultimate outcome or to other contracts connected with it, including exchange contracts. The contention had been made that a court must consider only the specific contract before it, so that the existence of an exchange contract could not be inferred by taking a variety of different contracts as a whole, none or only some of which, if taken separately, would constitute an exchange contract. The approach that refused to consider a scheme or arrangement as a totality did not recommend itself to Lord Justice Stephenson, who commented that

almost every contract constituting a step towards an exchange contract would be enforceable and the currencies would in fact be illegally exchanged unless the last contract necessary to carry out the unlawful exchange required the help of a court of law to enforce it. That consequence might be thought to undermine to a surprising extent this important provision of the Bretton Woods Agreement.²³

Lord Justice Stephenson discussed two decided cases that were relied on by the plaintiff to refute the proposition that the court could examine a scheme as a whole. The first was Southwestern Shipping Corporation v. National City Bank of New York,²⁴ which was decided by the New York Court of Appeals and which has been discussed earlier in this series of articles.²⁵ Lord Justice Stephenson agreed that the majority of the New York Court of Appeals had isolated the contract sued on from the connected contracts.²⁶ He understood the decision to be based on the common law exception, which was not affected by Article VIII, Section 2(b), that if a party to an exchange contract that would be unenforceable under Article VIII, Section 2(b), if unperformed, turns over money or property to a third person for the use by the other party to the contract, the third party cannot rely on Article VIII, Section 2(b) to resist the claim of the other party to the money or property. Lord Justice Stephenson found the Southwestern case unhelpful in deciding whether the contract sued on in the case before him should be isolated.

His understanding of the Southwestern case can be stated in other words: transfer of the money or property to a third person for use of the other party to the contract amounted to performance of the contract. Article VIII, Section 2(b) applies to executory (unperformed) contracts and not to executed (performed) contracts.

Sharif v. Azad was the second of the two cases that Lord Justice Stephenson discussed. He remarked that, although there were striking similarities between it and the Glass Fibres case, there were also important dissimilarities. The facts must be repeated briefly in order to explain how he distinguished between the two cases. The plaintiff, a Pakistani citizen resident in England, sued the defendant, also a Pakistani citizen resident in England, on a sterling check drawn on a bank in England. Behind the check was a transaction between the plaintiff* and Latif, a Pakistani citizen resident in Pakistan, by which the plaintiff had given Latif the sterling equivalent of the check in cash and had received in return a check in Pakistani rupees drawn by Latif on his bank in Pakistan, but with the payee’s name left blank. The plaintiff* took the rupee check to the defendant, who filled in the name of his brother as payee and sent the check to the brother in order to collect the rupees from Latif’s bank. The object of the transaction was to evade Pakistan’s exchange control regulations. The defendant pleaded that he had delivered the sterling check, on which the plaintiff was suing, in return for the rupee check provided by the plaintiff. The rupees were paid into the account of the defendant’s brother but, as the result of action by the Pakistani authorities, the brother could not draw on them without official permission. The Court of Appeal in Sharif v. Azad held that the contract between the plaintiff and Latif would have been unenforceable as a result of Article VIII, Section 2(b) and the Order in Council, but the contract between the plaintiff and the defendant represented by the sterling check was separable, and the plaintiff could succeed on it.

One of the dissimilarities noted by Lord Justice Stephenson was the fact that the defendant’s brother did receive rupees, even if they were blocked. Another dissimilarity was the fact that the plaintiff was suing not on a contract but on the sterling check issued in performance of it. Checks as negotiable instruments, which letters of credit are not, are regarded as equivalent to cash. Moreover, all members of the Court of Appeal in Sharif v. Azad appeared to have held that each of the two contracts, resulting in the sterling and rupee checks, was an exchange contract in itself.²⁷ The first two of these dissimilarities imply that the contracts in Sharif v. Azad had been executed by the delivery of checks, so that Article VIII, Section 2(b) was not applicable. More particularly, the sterling check was performance of the contract between the plaintiff and the defendant. The explanation of the case understood in this way would be the same as the explanation suggested by Lord Justice Stephenson’s discussion of the Southwestern case.

Notwithstanding his rationalization of Sharif v. Azad, Lord Justice Stephenson found the case difficult to understand. He concluded that it depended on its special facts and that the law applicable to checks should not be applied to every action to enforce a letter of credit. Sharif v. Azad did not decide that every contract made in England by parties resident there was beyond the reach of Article VIII, Section 2(b), as Batra v. Ebrahim had demonstrated.

The court must examine the particular contract sued on and its connection with the alleged breach of foreign currency regulations. If it “involves” those regulations and their breach²⁸—and “involves” is a wide word (see Reggazoni v. K. C. Sethia (1944) Ltd. [1958] A.C. 301, 330, per Lord Somervell of Harrow)—it may offend against the article and be unenforceable, whether or not it is an exchange contract when looked at in isolation.

For these reasons I feel free to distinguish Sharif’s case and to consider whether the court is required by the nature of a letter of credit to look at it in all cases and circumstances, including the circumstances of this case, in isolation from those circumstances and so lend its aid to the enforcement of a contract declared unenforceable by Article VIII, section 2(b). I do not think that the court is required or entitled to do so. International trade requires the enforcement of letters of credit but international comity requires the enforcement of the Bretton Woods Agreement.

I do not see why a court should shut its eyes to the object of the contract and with its eyes shut fall over backwards to avoid complying with the demands of international comity. On the contrary, the courts of this country should incline the other way and do their best to prevent breaches of the Bretton Woods Agreement to which this country is a party. In my judgment the courts of a country which is a party to the Agreement should do its best to promote both international comity and international trade. I have come to the conclusion that this court could best carry out this double duty in this case by enforcing the part of the sale agreement which does not offend against the law of Peru, and refusing to enforce the part of it which is a disguised monetary transaction by which currencies are to be exchanged in breach of that law. If this were the only defense to the plaintiffs’ claim I would therefore proceed to allow the plaintiffs part of their claim.²⁹

The defendant had argued that the letter of credit was illegal, void, or unenforceable under English common law principles. For example, according to these principles, English courts will not enforce claims under contracts made in England and on their face lawful under English law if they require the performance of acts in another country that are unlawful there. The reason for these principles is international comity. Lord Justice Stephenson held that, even if the common law principle mentioned above was applicable to the Glass Fibres case on the facts, it was not applicable under the law:

… the Bretton Woods Agreement lays down the standard—or requirements—of comity in the area of exchange control which it covers: whether it extends to states who are not members of the International Monetary Fund or parties to the Agreement we do not have to consider. Article VIII, section 2(b) displaces the common law principle, as was clearly the opinion of Diplock L. J. in Sharif v. Azad, … with which I respectfully agree.³⁰

The substitution in the field of exchange control of Article VIII, Section 2(b) when applicable for common law principles made it possible for Lord Justice Stephenson to dismiss any objection against severing contracts that might be based on common law principles. He held that the illegality under Peruvian law did not infect the whole range of contracts with illegality, which would be the consequence of the common law principles and which would deprive the plaintiff of all contractual rights to payment. He conceded that there were long-standing objections to severing entire contracts as there were to enforcing any part of a contract tainted with illegality. The case law, however, was not easy to reconcile, and no single principle or even clear guidelines could be derived from it on “when a court can award a plaintiff half a loaf and when it is bound to refuse him any bread.”³¹

For Lord Justice Stephenson, it was relevant to the question of severability that Article VIII, Section 2(b) rendered exchange contracts unenforceable and not illegal. He would have been willing, but for his reaction to the other defense, to give effect “to so much of the plaintiffs’ contract … as would not involve breaches of Peruvian law.”³²

In Lord Justice Ackner’s opinion, if Glass Fibres had sued Vitro on the merchandise contract, Glass Fibres could have succeeded because the contract was not illegal and was not tainted as a whole by the overvaluation that was contrary to Peru’s exchange control regulations. But Glass Fibres would not have been able to recover to the extent of the overvaluation because to that extent the merchandise contract was a monetary transaction in disguise. He agreed that in exchange control matters the situation is regulated not by the general rules of English conflict of laws but by the Bretton Woods Agreements Act and the Order made under it.

The situation as described in this way was not changed because the action was on the confirmed letter of credit and not on the merchandise contract. Once a payment was made under the letter of credit, effect would be given, to some extent, to an exchange contract contrary to Peru’s exchange control regulations. This result would follow because the contract required half of any payment to be transferred to the United States, to be held there for the benefit of Vitro. The principle of the immunity of the letter of credit from disputes between the buyer and the seller of goods, which they must settle between themselves without involving the bank, does not apply to a situation in which, as is established by Batra v. Ebrahim, the court is obliged by an international agreement not to enforce certain contracts. In that case, it will be recalled, the Court of Appeal held that the court must give effect to Article VIII, Section 2(b) even when the parties have not cited the provision.

Lord Justice Ackner also distinguished Sharif v. Azad from the case before the court. He explained the earlier case on the ground that both parties to it were resident in England, so that Pakistan’s exchange control regulations were not contravened by enforcement of the claim. The cases could not be distinguished on this ground, however, because both Glass Fibres and Royal Bank were nonresidents of Peru. The second explanation by Lord Justice Ackner is more convincing: in Sharif v. Azad the payment of the rupees had been made, although into a blocked account, prior to the action. This explanation would be consistent with the suggested understanding of Lord Justice Stephenson’s analysis of Sharif v. Azad. Lord Justice Ackner drew the same distinction between checks and letters of credit that had been drawn by Lord Justice Stephenson.

Lord Justice Griffiths made the problem of severability easier by treating the contract between Vitro and Glass Fibres as two agreements: an agreement for the purchase and sale of machinery and a “collateral agreement”³³ for overvaluation of the purchase price. The latter agreement was within Article VIII, Section 2(b), but not the former.

The letter of credit in isolation was not an exchange contract, he held, but it should not be looked at in isolation, because Vitro and Glass Fibres conspired together to use the letter of credit as a means of giving effect to an exchange contract in breach of Peru’s exchange control regulations. The decisions that recognize the independence of letters of credit from underlying contracts establish that a bank is not concerned with possible breaches of an underlying contract, and not that the court must ignore the reality of a situation in which the letter of credit was not designed solely for the payment of goods and in which no dispute has arisen between the buyer and the seller.

If Mr. Hirst’s argument [that a court cannot look beyond a letter of credit] is right then the Order in Council relating to the unenforceability of exchange contracts will scarcely be worth the paper it is written on. In this case it so happens that there was a genuine sale contract which disguised the exchange contract but it would not be difficult to envisage the use of a completely spurious sale contract to disguise the exchange contract.

Unless constrained by authority to do otherwise the court, in my view, ought to look at the whole arrangement and if it sees that the sale contract disguises an exchange contract it should refuse to enforce it through the medium of the letter of credit.³⁴

Lord Justice Griffiths distinguished Sharif v. Azad from the Glass Fibres case for much the same reasons as those advanced by other members of the Court of Appeal, but he added another reason. The relevant regulations in Sharif v. Azad applied only to residents of Pakistan, but the relevant regulations of Peru were not confined to residents. Lord Justice Griffiths seems to have made this point in order to arrive at the view that Glass Fibres by providing the false invoice was itself in breach of the regulations. Sharif v. Azad did not bind him to follow a course that would “do a grave disservice to the obligations that this country accepted as a party to the Bretton Woods Agreement.”³⁵

Notwithstanding his view that Glass Fibres had violated Peru’s exchange control regulations, Lord Justice Griffiths held that considerations of comity and public policy did not require that Glass Fibres as sellers should be deprived of the price of the goods they had sold. The sellers had fallen in with the scheme through weakness.

All three members of the Court of Appeal concurred in the conclusion that the defense based on Article VIII, Section 2(b), if it stood alone, would succeed in part but would not prevent recovery of the purchase price. All agreed, however, that because of the second defense no payments could be enforced under the letter of credit. The reason for this finding was a defect in the bills of lading against which Royal Bank would have been committed to make payments under the letter of credit. The bills of lading had been prepared and issued by an employee of the loading brokers for the shipping carriers of the merchandise purchased by Vitro from Glass Fibres. The employee made out the bills on December 16, 1976 but fraudulently altered the date to December 15, 1976 and fraudulently represented in them that the goods were on board on that earlier date. The letter of credit, it will be recalled, required shipment on or before December 15, 1976. The employee knew of the importance of the date, and it was possible that he was covering up his employer’s failure to arrange the shipping on time. Neither Glass Fibres (or its assignee) nor Royal Bank knew of the fraud; the brokers and their employees were not the agents of either of these parties.

The Court of Appeal agreed that Royal Bank was not required, and indeed was not entitled, to pay under the letter of credit when it learned that the documents were not in conformity with the letter of credit if they had been completed honestly. The fraud of the person who makes out the documents vitiates the documents even though there is no fraud on the part of the seller of the goods or the beneficiary of the letter of credit or the seller-beneficiary who tenders the documents to the bank that confirms the letter of credit. There had been no earlier direct decision in England or the United States on the effect of the fraud of a third party. The decision can be understood to mean that, on facts such as those in the Glass Fibres case, it is the bank’s duty to pay only on the presentation of conforming documents and that the onus is on the party presenting the documents to present conforming documents.

Some Comments on the Case in the Court of Appeal

1. The Court of Appeal decided the case in favor of the defendant on the basis of the second defense. It was unnecessary, therefore, for the court to consider the effect of Article VIII, Section 2(b). The views of the Lords Justices on that aspect of the case, though obiter, are of considerable interest as the most recent of the statements by English courts on the subject of Article VIII, Section 2(b).

2. An outstanding feature of the views of the Court of Appeal is the concern voiced by all members of the court that Article VIII, Section 2(b), as an expression of public policy and international comity, should not be undermined. The reaction of some commentators to the Terruzzi case, not without justification, was that Article VIII, Section 2(b) would play a minimal role in England. Even though the Terruzzi case, from which there was no dissent, certainly represents an indefensibly narrow interpretation of Article VIII, Section 2(b), the Glass Fibres case shows that the provision can still have a substantial impact on litigation in England.

3. The earlier reaction to Article VIII, Section 2(b) as a provision of little practical effect is perhaps illustrated by the absence of a report of Batra v. Ebrahim in any of the standard series of English law reports. The case as reported in The Times (London) had much influence on the thinking of members of the Court of Appeal in the Glass Fibres case, particularly on the duty of courts to respect the public policy and international comity implicit in Article VIII, Section 2(b) and on the concept of unenforceability as it appears in that provision.

4. In the Terruzzi case, the Court of Appeal gave overriding effect to the undesirability of impediments to international trade, and the court took this position even though the contract sued on was entered into for the purpose of speculation in futures in metals. In the Glass Fibres case, the attitude of the Court of Appeal was that it had to balance the policy of freedom for trade with the policy of respecting the interests of other members of the Fund as expressed in their exchange control regulations.

5. A striking feature of the decision is the court’s willingness to take account of all the steps that resulted from a plan to circumvent the exchange control regulations of a member and not to concentrate on the final step. Too often courts have looked only at the last step and have completed the circumvention that is the purpose of the plan. The Court of Appeal would have completed the plan³⁶ of Vitro and Glass Fibres and achieved a result contrary to Peru’s exchange control regulations had the court considered only the letter of credit confirmed by Royal Bank for the benefit of Glass Fibres.

6. A question not clearly answered by the members of the Court of Appeal is whether their willingness to take account of all the relationships to which the plan gave rise was influenced by the fact that the plaintiff stood in the shoes of Glass Fibres, which was a participant in the plan. By taking all the relationships into account, the court was able to arrive at an amount that it considered Glass Fibres was entitled to as the seller of merchandise. It is not clear whether the Court of Appeal would have been similarly disposed to base its decision on all the relationships if the action had been between Banco Continental and Royal Bank.

7. A consequence of the refusal to look solely at the contract sued on is that the contract treated as unenforceable need not be in itself a contract for the exchange of one currency for another in accordance with the interpretation of “exchange contracts” in the Terruzzi case. The letter of credit required only that Royal Bank pay U.S. dollars to the beneficiary. It can be assumed that behind the letter of credit was an obligation by Vitro to pay Banco Continental in Peruvian soles the equivalent of the payments by Royal Bank and an obligation of Banco Continental to use the soles to obtain dollars with which to reimburse Royal Bank. Alternatively, Vitro might have been bound to obtain the dollars with soles in order to pay the dollars to Banco Continental. In either event, an exchange of one currency for another would occur, and this exchange would take place as a result of payments by Royal Bank under the letter of credit. The payments themselves, however, would not take the form of, or necessarily require, an exchange of currencies.

8. The concept of a monetary transaction in disguise is not clear. The intent may be to refer to a single design consisting of various steps of which at least one requires an exchange of one currency for another. Alternatively, the concept may cover cases in which no single step involves such an exchange, but the result of all the steps is that an exchange can be deemed to have occurred. Under either view, the monetary transaction in disguise is not a true exception to the Terruzzi interpretation of “exchange contracts.” The exceptional aspect of the concept would be only the court’s consideration of all the steps in an arrangement to circumvent exchange control regulations.

The Court of Appeal and those authors who favor the narrow interpretation of “exchange contracts” as adopted in the Terruzzi case and followed in the Glass Fibres case do not appear to treat the monetary transaction in disguise as an exception to their interpretation. They describe the transaction as an exception to the exclusion of contracts involving merchandise or securities from their interpretation.

9. The Court of Appeal ran together all relationships in the case but severed the contract between Glass Fibres and Vitro into two parts. Lord Justice Griffiths was willing to regard that contract as consisting of two agreements. This approach had seemed unjustifiable to the lower court. The Court of Appeal found justification for its approach in Peru’s exchange control regulations. The court understood Articles 1 and 2 of Decree Law No. 18275 as prohibiting the maintenance or establishment of deposits in a foreign currency in Peru or abroad. Therefore, the regulations did not reach the part of a contract that did not involve the maintenance or establishment of such deposits. The court treated Article 7 of Decree Law No. 18891 as if the offense of overvaluing imports implicitly preserved the validity of a transaction involving overvaluation to the extent of the true purchase price. There appears to have been no expert advice on this aspect of Peruvian law. The text of Article 7 can be read, at least in translation, to provide that the act of overinvoicing, and not the amount of invoicing, is the offense. The invoice as a whole is illegal on this reading and not partly legal and partly illegal.

10. Two consequences of severing the merchandise contract should be noted. First, the contract in circumstances similar to those in the Glass Fibres case becomes riskless for the exporter. This consequence may have induced Lord Justice Griffiths to point out that Glass Fibres and Vitro were not in pari delicto and that Glass Fibres was less at fault.

The other consequence, which members of the Court of Appeal did not discuss, was that the recovery it would have allowed Glass Fibres to make for its merchandise would have had the effect of condoning that part of the planned deposit abroad that Vitro and Glass Fibres had succeeded in making in contravention of Peru’s exchange control regulations. The calculation concurred in by Lord Justice Stephenson is not completely clear, but in substance it appears to have been arrived at as follows. The true purchase price was doubled. An initial payment of 20 per cent of the full (i.e., double) contract price was made under the letter of credit. In accordance with the contract, half of this 20 per cent was transferred to the United States for the ultimate benefit of Vitro. The amount that the Court of Appeal would have been willing to award to Glass Fibres was half the full contract price less half the payment that had been made under the letter of credit. No deduction was made for the other half that reached Vitro. If this part had not been paid already, the court would not have enforced payment of it.

If the calculation by Lord Justice Stephenson was indeed the one described above, it could be defended perhaps on the ground that Article VIII, Section 2(b) does not provide remedies in respect of contracts that have been executed or to the extent that they have been executed. This analysis might be justified if the court thought that it was being requested to make Vitro refund what it had received. A different view could prevail if the remedy were considered payment to Glass Fibres of the purchase price less the amount already paid to it. On this view, the full 20 per cent that had been paid to Glass Fibres under the letter of credit could be credited against the purchase price payable to it, even though this procedure would not force a surrender by Vitro of what it had gained.

11. The judgment that the Court of Appeal would have been willing to make in favor of the plaintiff had Article VIII, Section 2(b) been the only defense raises a problem of logic, at least on the reasoning of Lord Justice Ackner. He agreed with the lower court that once “any payment”³⁷ was made under the letter of credit, effect would be given, to some extent, to an exchange contract that was unenforceable under the provision. It is not obvious why this consequence should justify a decision in favor of the payment of half the amount of the letter of credit, because on the reasoning of Lord Justice Ackner this amount was a payment that was subject to sharing according to the contract between Vitro and Glass Fibres.

12. The decision of the Court of Appeal adds further authority to the proposition that unenforceability under Article VIII, Section 2(b) is not equivalent to illegality. Moreover, as Batra v. Ebrahim demonstrated, the unenforceability that is imposed by the provision does not have attached to it all the traditional incidents of unenforceability in English law.³⁸ Had this proposition not been true, an English court would not be able to call Article VIII, Section 2(b) into play in the absence of reliance on the provision by a party.

13. The view that Article VIII, Section 2(b) is an expression of the standard of international comity in the field of exchange control, and that this standard has displaced common law principles of comity in this field, may lead to interesting legal questions in the future. Lord Justice Stephenson has suggested one such question already in referring to the applicability of the standard to nonmembers of the Fund. There has been some speculation about the extent to which the Articles can be taken to express general principles of law that apply even to nonmembers. There has been more speculation, and more legal authority, on the question whether new principles of public policy have been enacted by the Articles among members even though these principles are not made explicit in the Articles.

The proposition that Article VIII, Section 2(b) can be taken to be the standard of comity in the field of exchange control that applies to nonmembers as well as members is not wholly indefensible in view of the common law principles referred to earlier. They developed without the benefit of the Articles. The nonrecognition of the interests of other countries that is dictated by certain traditional legal doctrines is based on a parochialism that increasingly appears to be inconsistent with interdependence among countries in modern conditions. Nevertheless, if Article VIII, Section 2(b) is broader than common law principles in the field of exchange control, the use of the provision as a standard that applies to nonmembers will be difficult to reconcile with the obvious spirit of Article VIII, Section 2(b). That spirit is one of collaboration among members, all of which undertake the same standard of behavior not only under that provision but also under the other provisions of the Articles. It may also be difficult to reconcile the recognition of Article VIII, Section 2(b) as the general standard of comity with the right of members to impose restrictions on exchange transactions with nonmembers.³⁹

14. Whatever doubts the Glass Fibres case may suggest because of the willingness of the Court of Appeal to enforce payment of part of the amount of the letter of credit, the major importance of the case in relation to Article VIII, Section 2(b) is the affirmation that a letter of credit is not an absolute bar to the application of the provision. Moreover, the provision may be applied even though the circumstances do not involve fraud in the underlying transaction of the kind that is a recognized exception to the independence of a letter of credit.