Fraudulent payee – where’s the Risk ?

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Here, Stephen Mann, Associate Director and a solicitor within MECO’s London office, reviews a recent London High Court decision (on appeal from arbitration). The parties remained anonymous through the process and were referred to by their initials so the case is simply known as K v A; it relates to a sale of sunflower meal on FOB terms with shipment from Romania.

Before going into more detail about K v A itself, it may be helpful (particularly in a short article of this kind) to sum up the kind of issues it addresses. Primarily, it is about contract payment terms and the importance of making them clear and of complying with them (particularly where an intermediary broker is involved). Otherwise, there are lots of potential problems. A failure to comply with the contractual terms (as to time, amount, deductions, destination bank account, currency or whatever) may allow the payee party to terminate certain contracts. There may (whether there is a termination or not) be a liability in damages for late or incorrect payment. The payer may incur losses by way of interest, currency exchange losses and extra bank charges. One or other party may be exposed to the risks of fraud, which is an ever-growing problem. The case also teaches something about the parameters of London arbitration and what happens if a Tribunal doesn’t conduct an arbitration in the way required by law, and how the English Court can assist a party aggrieved in such circumstances.

If True North were then to assist a client in relation to the drafting of a similar type of contract (or carriage contract) in the future, it would be these types of issues that we would have in mind, with a view to eradicating scope for dispute or fraud, and to keep our clients away from future expensive and time-consuming legal disputes.

We appreciate your time is better spent on trading.

Anyway, turning to the case itself, the FOB contract terms relevant to this discussion were:

  • A payment term providing:

“100% Net cash within 2 banking days to Sellers’ bank upon presentation of scan/fax copies of the following original documents to [Buyers].

Commercial Invoice …”; and

  • Clause 18 of GAFTA Form 119 (incorporated) reading:

“Notices.

All notices required to be served on the parties pursuant to this contract shall be communicated rapidly in legible form … A notice to the Brokers or Agent shall be deemed a notice under this contract.”

The point of these terms was to establish when and where the payer was to pay. He was to pay to the account identified by the commercial invoice (or other notification of payee bank account details) and he was to pay within 2 banking days of being notified of this. The GAFTA terms allowed the notification to be sent to the broker for the deal.

What went wrong here was that after the payee sent the broker the commercial invoice with bank details, the broker’s correspondence with the payer was infected by the actions of a fraudster, who managed to interpose his own bank account details into the instruction to the payer, these being with the same bank as the legitimate payee. Fortunately, the fraud was noticed and the bank withheld the money from the fraudster. However there was a considerable delay in consequence, before the payment was credited to the account of the legitimate payee and (as often seems to happen in this kind of case!) currency movements in the interim period meant that the sum so credited had a considerable shortfall of around USD161,000 (the money received into the fraudulent account having been converted into sterling on receipt there and a dollar conversion was needed to pay the legitimate payee once the problem was identified, with the dollar having considerably strengthened against the pound in the intervening period).

This raised a question of material financial value: was the payer to “pay again” to make up the shortfall, or was that loss to be left to lie with the payee, whose bank had received the payment when it had such value (in currency exchange terms) that there was no shortfall at all? Put another way – who was to be “on risk” for this problem, under the governing FOB contract?

When the question of whether the payer had to “pay again” in respect of the shortfall reached GAFTA arbitration the Tribunal took the view that GAFTA Form 119/clause 18 meant the intermediary broker was an appointed recipient of notices from the payee to the payer in such manner as if notice to him was in fact notice to the payer. So – since the payee had provided him with the correct bank details, the payer was deemed to have received these correct details, even though in fact what the payer had received was an incorrect notification of the fraudster’s bank account details. This appointment of the intermediary broker as “notice-receiver” for the payer meant any problem or error in what was passed on to the latter, was at the payer’s risk.

The payer was unhappy with this decision and appealed to Court. It is important to note that appeal to the English High Court in respect of an Award in London arbitration is very restricted, since after all the parties have agreed to resolve their disputes by arbitration.  The case illustrates two grounds where an appeal can be made: a serious procedural irregularity that has caused or will cause substantial injustice and an error on a point of law.

In this case, the Tribunal’s decision that – effectively – the intermediary broker was the payer’s agent for receiving notices was said to be reached by a serious irregularity of process, because the payee had not in fact made any submission to that effect, and the Tribunal’s conclusion had been made at the Tribunal’s own instance. This meant – as a matter of procedure – that the payer had never had a chance to address the point in its own submissions. In consequence, the procedure adopted was irregular in a serious way and had potential to cause substantial injustice.  We say “potential” because it need only be shown that it might do so to prove the point on appeal, and this cannot be defeated by establishing on the facts at the time that the Tribunal’s decision was probably right on the point. The relief granted by the Court was to send this point back to the arbitration Tribunal to decide it in accordance with a regular and fair procedure.

The second ground on which the payer sought to overturn the Tribunal’s decision on appeal was that by which the Court (in certain limited circumstances) can correct a point of law wrongly decided by the Tribunal. The point of law in question was whether a payee is “paid” under a contract when the payer’s transfer “hits” the payee’s bank, or whether “payment” is at a later point, after crediting to the payee etc.

The Court addressed the question of the nature of a contractual obligation to pay “net cash” as above and explained that the payer must make a transfer of something “equivalent to cash”, which means proceed in a manner that gives the payee a free and unrestricted right to the immediate use of the funds being transferred. This means the payer’s “payment” is not made until the payee is put in such a position where he can withdraw the payment in cash from his own bank account. Clearly, this requires sending the receiving bank the correct account name and number and other details needed for that bank to credit the funds to the payee, in such manner as they are at his immediate use and can be withdrawn. A mere transfer of the funds to the bank itself, without these details (either because no details or the wrong details are given), cannot achieve the above effect, so is not to be considered payment in law.

Accordingly, the Court ruled that merely “passing” funds “over the fence” into the control of a bank that is the payee’s bank is not in itself contractual “payment”. This cannot be so without the necessary information to allow the payee’s account to be credited such that he can withdraw the payment in cash. The payer who doesn’t provide this information, accordingly does not “pay” the sum due at the time of mere remittance to that bank, and hence remains a non-payer until all steps are taken to achieve crediting to the payee. This may mean, for instance, he is in breach of payment obligations in a manner that the seller can terminate the contract, sue for damages, and is “on risk” for all the other matters mentioned in above. The case shows that this kind of innocent mistake, on top of drafting issues, can lead to a loss of significant monies, even where a contract is performed and not terminated.

Given that this effectively determines that the payee was not in fact paid when the payer made his remittance to the payee’s bank, it looks like the payer is in a difficult position in relation to the question of the shortfall – whatever decision is made by the Tribunal on the point being re-heard by it – since the loss arose from banking time needed to sort out the consequences of the fraudster’s unfortunate involvement and may end up lying where it fell: with the payer.

True North can help with this kind of problem in a number of ways: at the drafting stage we can assist in advance with a review of standard or bespoke sale or carriage contract terms and advise on anti-technicality clauses, and or building-in checking processes to payment systems, and advising on currency hedging, and after disputes have arisen can advise on ways to mitigate loss and/or resolve them, with our access to means of securing unpaid but disputed sums, and network of supporting counsel and experts on associated matters (including banking practice) that can assist in achieving the optimum quick and cost-effective solution.