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"Where the seller's fraud has been called to the bank's attention before the drafts and documents have been presented for payment the principle of the independence of the bank's obligation under the Letter of Credit should not be extended to protect the unscrupulous seller. It is true that even though the documents are forged or fraudulent, if the issuing bank has already paid the draft before receiving notice of the seller's fraud, it will be protected if it exercised reasonable diligence before making such payment."

The facts, as stated above, were that the sellers had drawn the draft under the letter of Credit to the order of the Chartered Bank of India, Australia and China and delivered the draft and the fraudulent documents to the said Chartered Bank's branch at Kanpur for 'collection' on account of the sellers. The Chartered Bank could not compel the issuing Bank, Schroder Banking Corporation, to pay by seeking a dismissal of the buyer's application by way of a demurrer. The plaintiff was entitled to injunction for it had brought the allegation to the knowledge of the Issuing Bank, before the payment was made. Shientag, J. further observed:

"As one Court has stated: obviously, when the issuer of a letter of Credit knows that a document, although correct in form, is, in point of fact, false or illegal, he cannot be called upon to recognise such a document as complying with the terms of a letter of credit" No hardship will be caused by permitting the bank to refuse payment where frauds is Claimed, where the merchandise is not merely inferior in quality but consists of worthless rubbish, where the draft and the accompany document are in the hands of one who stands in the same position as the fraudulent seller, where the bank has been given notice of fraud before being presented with the drafts and documents for payment, and where the bank itself does not wish to pay pending an adjudication of the rights and obligations of the other parties."

Legal relation of a Negotiating Bank vis--vis the Issuing Bank:

The contract between the issuing banker and the paying or negotiating (intermediary) banker may partake of a dual nature. The relationship is mainly that of principal and agent, mandator and mandatory. In order that he may claim reimbursement for any payment he makes under the credit or the indemnify of an agent, the intermediary banker must obey strictly, the instructions he receives, for by acting on them, he accepts then and thus enters into contractual relations with the issuing Bank. The instructions may take the form of an authority either to pay against documents or drafts accompanied by document; or to negotiate drafts drawn either on the issuing banker or on the buyer. The authority may be accompanied by instructions to the intermediary banker to confirm the credit, that is, to place himself in binding contractual relationship with the beneficiary. There is ordinarily no privity between the intermediary banker and the buyer. But the intermediary banker, though initially the agent of the Issuing Bank, may also act as principal in relation to him. (Pagets' Law of Banking, 9th Ed., (1982) p. 543, 544).