What is a letter of credit?
The steps of a letter of credit...
Step 1: First contract between B and S which will include the price, terms and conditions and that letter of credit will be the payment method
Step 2: Buyer instruct the IB (in their own country) to open credit
Step 3: AB will act on instructions of IB and the relationship between the two is one of agency. NB: a confirming bank confirm the credit and the relationship changes in that there is a direct relationship between the confirming bank and the seller, although the relationship between the IB and CB is still one of agency as it is with IB and AB.
Step 4: seller will ship goods and present documents to confirming bank
Step 5: CB has paid the seller
Step 6: CB will pass documents back to IB in exchange for reimbursement
Step 7: Documents go from IB to buyer for payment and buyer can go to the port and get the goods.
Definition of a letter of credit...
Basic definition: A letter of credit is a letter issuing from a bank that promises payment in the event that the recipient (beneficiary) presents to the bank stipulated documents. These will be shipping documents consisting of a bill of lading (or equiv) and other documents. These will then be passed on by the bank to the buyer. The buyer (applicant) is the person who took the steps leading to the issuance of a letter of credit.
The UCP 600: Article 1 states that the UCC are rules that apply to any letter of credit when the text expressly indicates it is subject to such rules, which are binding on such parties unless expressly excluded or modified. (NB: Prof. Goode says even in absence of express incorporation the UCP would still be used as good business practice and rare to find a letter of credit without).
FIRST: underlying contract of sale (B + S)
SECOND: contract between IB + B (bank/customer)
- IB strictly adhere B's instructions. Midland Bank v Seymour (Devlin) 'when an agent acts on ambigious instructions, he is not in default if he can show tht he adopted a reasonable meaning'.
- Commercial Banking Sydney v Jaslard (Diplock) 'where banks instructions from customer are ambigious or unclear, he commits no breach of his contract if construed in reasonable sense'.
- European Asian Bank v Punjab Bank: 'where terms so ambigious, bank should simply clarify'
- The Q must be: has IB acted in accordance w/mandate to get reimbursement.
Contractual relationships: part 2
- UCP 600 Art 14(a): (IB must examine docs to determine compliance) banks must examine a presentation to determine on docs alone whether appear on their face to comply. Gian Singh v Banque de I'Indochnine (Diplock) 'visual inspection of docs is all that is called for. Bank under no duty to take further steps to investigate genuineness of signature'. (Singh to sue seller not bank, req'd to tender certificate of quality of goods and signed by X person, but was forged and bank accepted docs and paid seller. Docs not compliant but were on face per Art 14(a)).
- UCP 600 Article 14(b): (time to comply): 5 banking days following day of presentation to determine compliance (amended from reasonable time in UCP 500): Bankers Trust v State Bank of India (if days exceeded, will be estopped and buyer can sue for breach of mandate).
THIRD: Contract between IB and CB/AB in sellers country (not compulsory step). This is governed by law of agency if AB and agent or CB and dual capacity agent.
Contractual relationships: part 3
FOURTH: Contract between S and IB & S and CB. (Diplock in UCM case said only 4 contracts, ommitting 4thcontract+Mance in Bank of Baroda v Vysa Bank 'the last 4th (CB + S and S and IB) relationship co-exists, beneficiary2banks to hold resp'.) If CB bust=S has IB=certainty to transac.
-UCP 600 Art 7(a) & Art 8(a) - undertaking of the IB and CB that £ will be made if docs presented
-UCP 600 Art 14(b) - 5 banking days
-UCP 600 Art 15(a) & (b) - IB and CB must honour when compliant
- *UCP 600 Art 16(a): when docs do not comply as determined, it may refuse to honour credit
- UCP 600 Art 16(b): IB may approach the B for a waiver of discprencies. (not-reinspection)
- Article 16: Bankers Trust Co v State Bank of India COA (Farqhuharson) - 'if submit docs to B for opinion on discrepencies, not for B to find more, the bank makes the decision to reject'.
Contractual relationships: part 4
FOURTH (cont'd): notice of rejection to S:
Art 16(C): must give single notice to that effect to include:
1. bank refusing to honour or negotiate
2. each discrepency in respect of which bank refusing to honour
3a. bank is holding the docs pending further instructions, b. IB is holding docs until receives waiver or receives further instructions prior to agreeing to accept waiver, c. bank returning docs, d. bank acting in accordance with instructions recieved previously.
Art 16(d): form of notice: telecommunication or other experditious means no later than 5th day
Art 16(f): IB or CB fails to act with article 16, be precluded from claiming docs do not comply.
Why have a doctrine of strict compliance?
- Strict compliance is in place because it provides protection to the banks because banks cannot be expected to have knowledge of all industries. It is also for the benefit of certainty too as it would be too difficult to require an all-embracing definition and easier to have in or out. LOC are equivalent to cash and strict compliance needs this method to be conforming for the certainty of commercial expediency.
- Mackinnon L.J. in JH Rayner v Hambro's Bank affirmed that it is quite impossible that a banker is to be affected with knowledge of the customers of every one of thousands of trades for whose dealings he may issue a documentary credit.
Doctrine of Strict Compliance
Equitable Trusts Co of New York v Dawson HoL's (Viscount Sumner): 'no room for docs almost the same, or which will do. Bank cannot decide what will do+what wont. If it does as it is told=safe. If departs=at own risk.' (cert of excellence by experts but was by 1 expert+bank £ S. Docs back to B, refused to reimumburse due to non-compliance. HoL's ruled in favour of B).
- Quantity compliance: Moralice Ltd v F Man (S tendered docs to bank showing shipment of X tonnes of sugar, credit called for 500 tonnes, court held bank entitlted to refuse as de minimis rule did not apply). (But now have...UCP 600 Art 30: 5% allows more/less, Moralice bad law now).
- Terminology compliance: JH Rayner v Hambro Bank (Mackinnon LJ) coromandel groundnuts v machine-shelled groundnut, same thing but 'banker not affected with knowledge of customs of every 1 of the thousands of trades for whose dealings he may issue a letter of credit'. Confirmed in Bank Melli Iran v Barclays- trivial will justify rejection, new vs. new/good = inconsistent.
- Trivial/typo errors: Seaconsar (Sir Staughton): 'discprepencies not of great signif, but that is neither here nor there. Hornbrook law for banks that docs appear on their face to comply. Lord Lloyd: 'cannot define trivial discrepency but Bankers Trust v State of India where telex number 1 digit wrong. (LOC said docs should bare name of B+LOC no.Docs presented w/out to AB +refused to £ as no name. CoA held bad tender+not trivial. Hing Yip Hing Fat v Daiwa Bank (industrial vs industry)&Beyene v Irwing (Soran vs. Sofan) = trivial!
Erosion of the doctrine of strict compliance?
Article 14(d): 'data in doc need not be identical to but must not conflict'
Article 14(f): Except transport+insurance docs and invoice, docs w/out whom doc is to be issued will be accepted by banks if content appears to fulfil function of req'd doc+complies with 14d.
Article 18(c): strict approach to invoices (discprencies + descriptions of goods)
Article 14(e): in all other docs, goods can be described generally but not conflict LOC.
- Glencore International v Midland Bank: (IB argued description of goods = original western bound Indonesia vs. original any western bound was inconsistent but CoA rejected argument as descrip was OK and acceptable. Court held that the bank was not entitled to reject the documents on the basis of the terminology presented in the commercial invoice as the description fell within the ‘broad generic nature of the description in the credit’. Art 18c applied.
- Kredietbank Antwerp v Midland Bank COA (Evans LJ): (draft survey report issued at port, signed on behalf of Griffith as a member of worldwide inspectorate group. 'Requirement of strict compliance is not equiv. to test of exact literal compliance. Banker must exercise own judgment if satisfied'. Was a trivial and evidence of moving away from strict compliance.
Doctrine of strict compliance 2
Originals & Photocopies:
- UCP 500, Art 20(b): unless otherwise stated, banks will accept docs as original a doc appearing or produced: 1. by reprographic, auto or computerised, 2. As carbon copies - if marked original and signed (hand or facsimile or perforated, stamp, symbol or other methods of authentication).
- Glencore (photocopies on non-headed paper but signed and original, WP not an original. or Credit Industriel et Commercial v China Bank (CoA more lenient, WP ok if clearly original and not copy of another doc so should be treated as original).
- UCP 600, Art 17: a. at least 1 original of each doc presented. b. bank to treat original doc bearing apparently original sig, mark, stamp or label, unless says not original. c. unless doc says not original, bank accept if: appears written, types, perforated, stamped by doc issuers hand or states original, unless appears to not comply or appears to be on doc issuers original stationary. d. if doc requires presentation of copies of original docs, presentation of original or copies is permitted. e. if credit requires presentation of multiple docs by using 'in duplicate','in two-fold' or 'in two copies', this will be satisfied by presentation of at least 1 original and remaining in copies.
- Debattista 'The new UCP 600; changes under LOC' 2007 JBL 329.
Articles for Strict Compliance
1. Debattista ‘The New UCP 600- Changes to the Tender of the Seller’s Shipping Documents under Letters of Credit’  JBL. Linkage issue=inconsistencies between docs tendered to constitute a discrepency preventing £. UCP 500=light touch on linkage, art 13(c) UCP 500=on face inconsistent=discrepency, replaced by 14(d) UCP 600=need not be identical but must not conflict=attracted great support from ICC, wording only explains but doesnt extend old art 13. Effect of susbtantial word change=banks entitled+obliged to be far more rigorous in scrutinising data in each doc tend. Perhaps old art 13 terms inserted to excl art 14. BUT, limits to what can be expected of any UCP revision, tall order! Best to interpret actual contract rather than UCP. UCP necessary but not sufficient instrument for smooth operation of an international trade transaction.
2. Strict compliance: In some USA courts=applied strict compliance to contract between bank+beneficiary BUT only substantial compliance to contract between applicant+IB=bifurcated approach=not welcomed+G McLaughlin in 1990 in 'The standard of Strict documentary Compliance in letter of credit law :an american perspective':'in the overwhelming no of cases, appropriate standard is strict compliance'. R Buckley 2002 in 'Documentary Compliance in Documentary Credits:lessons from the UCC and UCP' critiqued bifurcated approach: 'nothing less than strict compliance appears workable as standard for document checkers within banks'.
Autonomy of Credit
- UCP 600: Art 4: 'A credit by its nature is a separate transaction from the sale or other contract. Banks are in no way concerned with or bound by such contract, even if referred to in contract.
- Hamzeh Malas and Sons v British Imex Industries (Jenkins): 'the LOC constitutes a bargain between the banker and vendor, which imposes an absolute obligation on the banker to pay, irrespective of any dispute between the parties as to whether the goods are up to the contract or not. Commercial system built on this and wrong for the court to interfere with established practice'. (Cl was Jordanian and agreed to buy steel rods from British seller to be delivered in 2 installments. £ to be paid on 2 separate LOC's. LOC opened with British Midland Bank and S sent first shipment and were paid under 1st LOC. Buyers complained 1st installment of goods were defective and sought injunction to refrain from drawing on 2nd installment. Court refused.
Fraud exception to autonomy
Fraud unravells all?: Fraud Exception is only one that is recognised in English law. It can relate to the underlying contract between B + S or LOC itself.
- Lord Diplock in UCM v Royal Bank of Canada: 'there is one established exception: that is where the seller for the purpose of drawing on the credit, fraudulently presents to the CB docs that contain express or impliedly, material representations of fact that to his knowledge are untrue.' (English sellers selling manufacturing equip to Perugian buyers. LOC stated last date of shipment 15th Dec. Goods not shipped til 16th. Fraudulently issued bill of lading showing 15th date. Sellers no knowledge of this. Docs presented to banks and refused as bank knew shipment on 16th. Sellers sued bank. Seller unaware of fraud so exception should apply. 1st inst: as sellers unaware, bank wrong to refuse £. CoA: bank entitled to refuse and rely on fraud. HoL's: 2 separate issues (fraud/illegality), fraud = Lord Diplock set out what the fraud exception is and dealt with quickly saying didn't fall within as sellers unaware of fraud and only applies when seller aware of fraud. Then discussed banks obligations for accepting which evolved around the banks' defence argument. Argued: Knowledge of fraud = irrelevant: Diplock: as bank not under obligation to make payment if docs conform on face but contain some fact that is incorrect. Bank also argued again from COA in HoLs: if docs contain misrep+made w/knowledge+intention to decieve, bank should be entitled to reject (reduced from S's knowledge to doc makers knowledge: this was rejected.
- Recognised in other jurisdictions i.e. Singapore (Beam Technologies) but refused to be recognised in this country.
- UCM (Diplock): date changed but still valid receipt.
- Montrod Ltd v Grundkotter (LJ Potter): 'the fraud exception has been restricted in English law. It should not be extended by the argument that a document presented, which conforms on its face, is none the less of a character which disentitles a person making the demand to payment because it is fraudulent in itself.' Sellers are entitled to payment always. Many reasons for rejecting a nullity exception: incapable of precise definition and would lead to uncertainty, undermine principle of autonomy, threaten principle of apparent conformity, prejudice innocent sellers and general nullity would undermine whole system of documentary credits. (seller of pork to russian buyer. LOC specified 1 doc to be presented was inspection cert signed by Montrod, a doc signed by seller honestly mistaken was allowed to. Became clear that Montrod not given auth and then disputed sellers entitlement to £. 1st inst and upheld by CoA: seller innocent and entitlted to £.)
- Beam Technologies : recognised nullity exception.
- Prof. Goode and Healy argues for (see essay) as null doc is worthless piece of paper.
No successful use of this exception and stagnated!!!
- UCM: (Diplock): illegality first raised in this case. 'contrary to exchange control regs'. Raised as UK compnay agreed to invoice buyers at double the money paying to exchange currency for excess, which was against Perugian currency and illegal. Court held transaction split from sale - illegal and LOC could be enforced. Illegality didn't cause an issue as transaction severed.
- Groupe Jose v Walbrook Insurance Co (Straughton obiter only): (insurance contracts + illegal nature of them, court ultimately held not illegal and exception didn't apply...BUT did discuss illegality and when could apply which is when illegality in underlying contract between B & S and bank would have a defence to refuse to pay because the 'LOC was being used to carry out an illegal transaction'.
- Mahonia Ltd v JP Morgan (J Coleman): (swap transactions entered into by 3 parties, Enron being loaned 350mill for 6 months then £ back in full and interest, like a loan in disguise, Enron in return provided security in form of LOC but filled bankruptcy. LOC presented to bank, did bank have to pay or illegal transaction, bank argued loan and against US securities law: 'strong arguable case that LOC cannot be enforced against bank'. LOC was essential and indivisable from transaction and couldnt be severed like in UCM case.
Further academic commentary: exceptions
1. Illegality exception: Proffesor Nelson Enonchong 'The autonomy principle of letters of credit: an illegality exception? 2006: law should recognize an illegality exception provided that it is confined within a narrow scope. Distinguishes between cases where the letter of credit is illegal and where the underlying contract is illegal but the letter of credit is sound.
2. Fraud exception: Yanan Zhang- 2014 'Evaluation of documentary letter of credit fraud exception rules in China'. Supreme People’s Court of PRC (SPC) (although it is not a legislature officially in China), played an important role in gradually developing L/C fraud exception rules in judicial practice and formulated several documents. Thinks we decision in UCM was commercially and practically reasonable: an antedated date but genuine bill should not render it a fraud. The SPC create a new legal instrument to standardise the approach that the courts in China deal with L/C fraud dispute the "stop-payment order" especially for dealing with L/C fraud dispute cases. It can be seen that the function of "stop-payment order" in art.9 is the same as that "preliminary injunction" in the United States, and the "interlocutory injunction" in England, under the context of L/C fraud disputes. BUT it is not clear whether a beneficiary is considered fraudulent when he/she submits fraudulent documents, which are made by a third party, but the beneficiary does not know this (3rd party fraud). Obtaining a stop-payment order does become more difficult, and the judicial intervention to the L/C system in China is now highly restricted.
Potential exam Q's
1. Problem question (Art 16 and Art 17 photocopies or doctrine of strict compliance)
2. "The doctrine of strict compliance is necessary in letter of credit transactions and any deviations therefrom would only cause undue uncertainty in international trade financing." Do you agree?
3. Do the English courts recognise an illegality exception to the rule that the credit is autonomous?