Mahonia Ltd. v JP Morgan Chase Bank

A documentary credit is autonomous from the underlying transaction, but autonomy does not give a beneficiary an unqualified right to enforce it. The court will not permit its process to confer a benefit derived from an unlawful purpose where the credit formed an integral part of that purpose. This may apply to illegality under the law of a foreign friendly state. The seriousness of the illegality is relevant, particularly where the credit was merely collateral rather than an integral part of the unlawful scheme. The bank need not have possessed clear evidence of illegality when payment was due if clear evidence is available by the hearing of an application for summary judgment. Whether enforcement is barred by public policy ordinarily requires determination at trial.

Mahonia sought payment of US$165 million under an irrevocable standby letter of credit issued by WestLB in connection with a circular series of swaps involving Enron and Chase. WestLB refused payment after presentation of conforming documents and pleaded that the swaps and the credit formed part of an unlawful scheme to disguise a loan in Enron’s accounts and mislead United States regulators and the public.

For the purposes of the applications, the alleged facts and the absence of clear evidence in WestLB’s possession when payment was due were assumed. Mahonia applied under CPR 3.4(2)(a) to strike out the illegality defence and under CPR 24.2(a)(i) for summary judgment. The central issue was whether the autonomy principle prevented WestLB relying on illegality and public policy.

1. Applications dismissed. Mahonia’s applications to strike out WestLB’s illegality defence and for summary judgment were refused. The defence had at least a realistic prospect of success and required determination at trial.
2. The autonomy principle ordinarily requires payment against conforming documents without reference to disputes under the underlying transaction. It protects the commercial integrity of documentary credits. It does not, however, require the court to enforce a credit where doing so would allow the beneficiary to obtain a benefit from its own unlawful purpose.
3. A contract lawful on its face may be unenforceable where a party entered into it with the purpose of using its subject matter, existence or performance for an unlawful purpose. That principle applies equally where the unlawful purpose arises under the law of a foreign friendly state. The fact that the bank was unaware of the purpose when the credit was opened does not necessarily prevent the defence.
4. Tinsley v Milligan did not abolish illegality as a defence to enforcement of a contract itself. Its principle concerning collateral proprietary rights did not extend to a contractual claim under the illegal contract. Bowmakers Ltd v Barnet Instruments Ltd therefore did not require enforcement of the credit.
5. The distinction between an integral credit and a merely collateral facility was material. The reasoning in Group Josi Re v Walbrook Insurance Co Ltd was persuasive where the credit was separate from and not an integral part of the unlawful insurance business. Here, the pleaded case was that the credit was procured from the outset as essential security for the circular scheme.
6. For the fraud exception and analogous ex turpi causa defence, the strength of the case may be assessed on the evidence available at the summary judgment hearing, not solely on the evidence available when demand was made. Accordingly, the absence of clear evidence of illegality when WestLB’s payment obligation arose did not prevent reliance on the defence if clear evidence was available by the hearing.
7. The court did not finally decide whether the credit was unenforceable. That question depended in part on the gravity of the alleged illegality and required evidence at trial.

First-instance decision. No prior or subsequent appellate decision is stated in the judgment.