It was strongly arguable that an issuing bank was entitled to refuse payment under a letter of credit if the bank had knowledge of illegality affecting the letter of credit.Applications by the claimant ('Mahonia') for summary judgment on, or the striking out of, those paragraphs of the defence and counterclaim by which the defendant bank ('West') sought to rely on illegality as a defence to Mahonia's claim for payment under a letter of credit. In 2001 Mahonia, the Part 20 defendant ('Chase') and a subsidiary of Enron Corporation ('ENAC') entered into a series of three swap transactions. West alleged that: (i) the effect of the circularity of the swaps was that ENAC/Enron received the use of US$350 million from Chase, via Mahonia, for six months upon repayment of just under US$356 million; (ii) the swaps were a "cosmetic" device to provide ENAC/Enron with a loan of US$350 million from Chase that Enron did not have to record in its accounts as a debt; and (iii) omission to record the loan in Enron's accounts was contrary to US securities laws and intended to defraud, thereby constituting an illegality. As a condition of the swaps Chase required ENAC to provide security by means of a letter of credit in favour of Mahonia. Part of that security was provided in a letter of credit from West in the sum of US$165 million. Upon presentation, West refused to pay under the letter of credit, relying upon the illegality. For the purposes of the applications it was common ground that: (a) facts establishing the illegality were assumed true; and (b) West had only acquired knowledge of those facts at some point after the letter of credit was presented to it for payment. The issue for determination was whether the alleged illegality was capable of affording West a defence to Mahonia's claim or whether the letter of credit was an autonomous contract insulated from any such illegality.HELD: (1) The swaps were illegal under US law and could not have been effected without the letter of credit being in place. The letter of credit was, therefore, part of the overall illegal purpose that was sought to be achieved. (2) In determining whether the English court should refuse to give effect to that purpose, it was irrelevant that: (i) the purpose was illegal under a foreign law rather than English law; and (ii) as between Mahonia and West, only the former had that illegal purpose. (3) The general principle of ex turpi causa was not defeated by the autonomy of a letter of credit. The court would not allow its process to be used so as to allow a party to gain the benefit of an illegal act. (4) On the assumed facts there was, therefore, a strongly arguable case that the letter of credit could not be allowed to be enforced against West.Applications dismissed.

[2003] EWHC 1927 (Comm)

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