## Facts

- Chester Charles Sztejn and a coadventurer contracted to buy bristles from Transea Traders, Ltd., an Indian seller.
- To pay, they procured an irrevocable letter of credit issued by J. Henry Schroder Banking Corp., requiring presentation of an invoice and bill of lading for the described merchandise.
- Transea shipped fifty cases and procured documents that were facially regular and complied with the credit’s documentary requirements.
- Transea drew a draft under the credit to the order of The Chartered Bank of India, Australia and China, which held the draft and documents for collection.
- Sztejn alleged Transea intentionally shipped worthless material (cowhair and rubbish) instead of bristles as part of a fraudulent scheme, and alleged the collecting bank was not a bona fide holder for value.
- Sztejn alleged the issuing bank received notice of the fraud before the drafts and documents were presented for payment.
- Sztejn sought to restrain payment under the letter of credit and to obtain declaratory relief invalidating the credit and drafts as applied to the fraudulent transaction.
- The collecting bank moved to dismiss the supplemental complaint for failure to state a cause of action.

## Issues

1. Whether a complaint states a cause of action to enjoin payment under an irrevocable letter of credit when the presented documents facially comply with the credit but the underlying shipment is alleged to be intentional fraud and the issuer is notified before honoring the draft.
2. Whether the independence of the letter-of-credit obligation bars injunctive relief against payment where the collecting bank is alleged to be only an agent for the seller rather than a holder in due course.

## Decision

- The court denied the collecting bank’s motion to dismiss.
- The court held that, on the pleaded facts, the independence principle does not require honor when the issuer is notified before payment that the seller is committing active fraud by shipping worthless goods while presenting conforming documents.
- The court treated the allegations as more than breach of warranty and sufficient to support equitable relief preventing the letter of credit from being used to effectuate fraud.
- The allegations that the collecting bank acted as a collection agent, not a holder for value, supported allowing the claim to proceed against it.

## Legal Principles

- A letter of credit is generally independent of the underlying sales contract; an issuing bank ordinarily pays against conforming documents without investigating the goods.
- The independence principle has a fraud exception: where the seller’s intentional fraud is brought to the issuer’s attention before honor, a court may restrain payment despite facially conforming documents.
- The fraud exception targets situations tantamount to no performance (e.g., shipment of worthless rubbish instead of the contracted goods), not ordinary disputes over quality or warranty.
- Equitable relief is more available where the party seeking payment is not a holder in due course and is alleged to be acting only as the seller’s collecting agent.

## Conclusion

The court allowed the action to proceed and permitted pursuit of an injunction against honor of an irrevocable letter of credit where the complaint alleged egregious seller fraud and timely notice to the issuing bank, limiting the independence principle so the credit mechanism would not be used to effectuate fraud.


Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719 (N.Y. Sup. Ct. 1941)