United States Court of Appeals,
First Circuit.
ITEK CORPORATION, Plaintiff, Appellee,
v.
The FIRST NATIONAL BANK OF BOSTON, Defendant, Appellee.
Bank Melli Iran, Defendant, Appellant.
730 F.2d 19, 39 UCC Rep.Serv. 625
Decided March 22, 1984.

BREYER, Circuit Judge.
The First National Bank of Boston (“FNBB”), at the request of Itek Corp., issued several letters of credit running in favor of Bank Melli Iran (“Melli”). Melli demanded payment from FNBB of the money that the letters promised. Itek obtained a federal district court injunction prohibiting FNBB from paying Melli. Melli, the true party in interest, appeals. The basic question that Melli's appeal presents is whether its effort to obtain the money by calling the letters is “fraudulent.” 
a. The basic contract. The letters of credit arise out of promises made in a 1977 contract between Itek and Iran's Imperial Ministry of War. The contract provided that Itek would make and sell high-technology optical equipment to the War Ministry at a price of $22.5 million. Iran was to make a twenty percent down payment ($4.5 million). It would pay Itek sixty percent of the total price ($13.5 million) as work progressed; it would pay the remaining forty percent upon satisfactory completion. The down payment amount would be deducted gradually from the payments due under Itek's “work-in-progress” invoices.
b. The contract's bank guarantees. The contract required Itek to provide two types of bank guarantees. The first, the “down payment” guarantee, was for $4.5 million, the amount of the down payment. Its object apparently was to give the Ministry the right to obtain return of the down payment (or portions of the down payment) until Itek produced work of sufficient value to have “earned” the down payment. The second, the “good performance” guarantee was for $2.25 million, ten percent of the contract price. Its object was to protect the Ministry against a breach of contract as might occur, for example, if the goods produced were defective. These guarantees were to be issued in favor of the Ministry by an approved Iranian bank. The Ministry could call for payment under the guarantees simply by submitting a written request for payment to the bank.
Bank Melli, an instrumentality of the Iranian government, issued the guarantees. Melli, as a condition for issuing them, required Itek to provide it with similar “standby” letters of credit, issued by an American bank in Melli's favor, and payable on Melli's certification that the Ministry had required it to pay under its letters to the Ministry. The “standby” letters are the FNBB letters at issue here.
The contract provided if the contract “is cancelled due to Force Majeure, all Bank Guarantees of good performance of work will be immediately released.” The contract defines “Force Majeure” to include cancellation by the United States of necessary export licenses. If force majeure occurs—if, for example, there is a war or a natural disaster, or if the United States cancels the export license—either party can cancel the contract. A party can cancel the contract on this basis, however, only if it has notified the other party of the occurrence of force majeure.  The contract also stipulates that, if force majeure leads to cancellation of the contract, Itek will be paid for equipment shipped, for equipment then being manufactured, and for all services rendered to date.
d. The circumstances of cancellation. Itek's work proceeded uneventfully until Iran's government collapsed in early 1979. At that time Itek's performance was ahead of schedule, but it had not yet delivered any equipment to Iran. In April 1979 the United States suspended Itek's export license. In May Itek notified Iran's new Ministry of National Defense about this “force majeure” problem, and, in accordance with the contract's terms, sought to cancel the contract. Melli demanded payment of the standby letters of credit then outstanding. 
After Itek cancelled the contract, it asked the court to enjoin FNBB from honoring any call on the letters. The court granted a temporary restraining order. Itek then joined Melli as a defendant. In April 1981, after hearings and fact finding, the court entered a preliminary injunction forbidding FNBB to pay Melli. now appeals that decision.

requisite to the award of an injunction. Second, it claims that Itek has not shown the “fraud” here necessary to stop a beneficiary from calling a letter of credit. The record before us supports the district court's rejection of these arguments.

Fraud
UCC § 5–114 (2)(b), authorizes a court to enjoin payment on a letter of credit when it finds “fraud in the transaction.” 

(2) Unless otherwise agreed when documents appear on their face to comply with the terms of a credit but a required document is forged or fraudulent or there is fraud in the transaction
a) the issuer must honor the draft ... if honor is demanded by ... a holder in due course ...; and
(b) in all other cases as against its customer, an issuer acting in good faith may honor the draft or demand for payment despite notification from the customer of fraud, forgery or other defect not apparent on the face of the documents but a court of appropriate jurisdiction may enjoin such honor.
The basic legal question in this case is whether the circumstances surrounding Melli's calls on FNBB's letters of credit establish “fraud in the transaction” within the meaning of this U.C.C. provision.  We answer this question fully aware of the need to interpret the “fraud” provision narrowly. The very object of a letter of credit is to provide a near foolproof method of placing money in its beneficiary's hands when he complies with the terms contained in the letter itself—when he presents, for example, a shipping document that the letter calls for or (as here) a simple written demand for payment. 
Despite this reason for hesitating to enjoin payment of a letter of credit, the need for an exception is apparent. Suppose the document for which a letter calls has been forged. Or suppose that the beneficiary has knowingly failed to comply with an important term contained in the underlying contract—a term that the parties intended as a precondition for the beneficiary's exercise of his right to call the letter. Courts have not hesitated to examine the documents that the letter calls for to see if they show fraud. And courts have also enjoined payment where there was relevant fraud in the underlying transaction. Thus, in a leading case, a seller, contractually committed to ship bristles to a buyer, shipped rubbish instead. The court refused to allow the seller to call the letter, put the money in his pocket, and let the buyer sue him, for in the court's view, the seller did not even have a colorable claim that he had done what the contract called for as a precondition to obtaining the money, namely, ship the bristles. Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup.Ct.1941).
Yet, the law also recognizes the need for courts to tread with care lest they deprive the letter's beneficiary of the very benefit for which he bargained. Thus, courts have stated that the “fraud in the transaction” exception is available only where the beneficiary's conduct has “so vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served.” 
We take as a given that the parties intended the contract's express terms concerning the guarantees to govern the Ministry's right to call the letters from Melli to the Ministry. And we take as given that these same contract terms limit the rights of Melli to call the FNBB letters; Melli could only legitimately call the FNBB letters if the Ministry had legitimately called the Melli guarantees. We conclude that the issue before us is whether, given the terms of the contract, the Ministry and in turn Melli have a colorable right to call the “guarantees,” or whether Itek has successfully shown that, in light of the contractual terms governing the guarantees, the beneficiaries' demands for payment have “absolutely no basis in fact.” If Melli has no plausible or colorable basis under the contract to call for payment of the letters, its effort to obtain the money is fraudulent and payment can be enjoined.

Affirmed.