When it comes to letter of credit, it is being invariably quoted as “the lifeblood of international commerce” in the literature on international trade borrowing from the oft- quoted judgment of Kerr LJ in RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd.  It is also known as “crankshaft of modern commerce”  The importance of the letter of credit in the international commerce is that it acts as a bridge between the buyer and seller of goods or services located in different countries. Being irrevocable, it guarantees payment to the seller and performance of contract by seller to buyer through the documentary evidence of shipment of goods. Hence, it is rightly called as documentary credit.  Letter of Credit is an instrument issued by a bank on behalf of its constituent in favour of another party named by its constituent. The named party called beneficiary in the credit negotiates it though its bank who in turn forwards the credit along with the documents furnished by the beneficiary as stipulated in the letter of credit by the issuing banker.  Thus, letter of credit is a banking instrument used by the purchaser and seller during the course of the trading transactions between them. The source of law for letter of credit is the Uniform Customs Practices (UCP) issued by the International Chamber of Commerce in different versions from time to time.  The latest version is known as UCP 600 which came into force from 2007. The UCP version which started in 1933 is essentially a codification of customary practices during the course of international commerce relating to payments for goods and services rendered. The UCP shall be the law governing the letter of credit if the instrument so mentions. Thus, the UCP will be the binding law on the part of parties to the letter of credit. 
The letter of credit transaction involves seven stages. Stage 1: Seller and buyer agree to payment through letter of credit. 2. The buyer (applicant) submits his application to his bank (issuing bank) to open a letter of credit favouring the seller (beneficiary) with a stipulation of documents to be produced by the seller such as bill of lading, charter party or airway bill , invoice, insurance policy, certificate of quality and certificate of origin at the appointed day and place.  Most important of all these is the transport document i.e bill of lading which is the evidence for the shipment of goods ordered by the buyer. In this connection Articles 20, 21 and 22 apply.  Article 21 states that the bill of lading also known as the sea waybill should be non-negotiable. It should contain the name of the carrier and be signed by the carrier or his authorised agent or by the master or his authorised agent. It should be mentioned who has signed, whether the carrier, master or agent. The agent who has signed must indicate whether he has signed on behalf of the carrier or master.  The sea way bill should also show that goods have been shipped on board a named vessel at the port as mentioned in the letter of credit. The wordings can be either pre-printed or by a notation as to the date of goods shipped on board. The date of the non-negotiable sea way bill is deemed to the date of shipment unless otherwise mentioned by a notation.  Similarly, if there is no pre-printed name of the vessel or there is an indication of the “intended vessel”, the notation must indicate the name of the actual vessel in which good have been shipped. So also, if there is no port of loading in the sea waybill or it is mentioned as the intended port, the notation must state the port of loading. This provision is mandatory even where there are pre-printed particulars of loading on board or shipment on a named vessel in the non-negotiable sea waybill. The sea waybill should be in original and should have additional copies as mentioned on the sea waybill.  There should be no indication that it is subject to a charter party. There are similar conditions relating to other transport documents such as the charter party and the airway bill dealt with by article 22 and 23 of the UCP. Another important condition for all the transport documents is that they should indicate whether goods are subject to subject to transhipment or not. 
Stage 3 involves processing of the credit by the issuing bank as mentioned by the applicant and forwarding it to the beneficiary’s bank. In stage 4, the beneficiary’s bank which acts as the advising or confirming bank. It informs the beneficiary about the opening of the letter of credit in his favour.  The credit will usually be a confirmed one and would contain an undertaking by the issuing bank that it would pay the beneficiary the face amount of bill of exchange or drafts drawn within the terms of the credit and containing the number and date of the credit and accompanied by the original letter of credit and all amendments thereto.  Stage 5 involves shipment of goods by the seller on his finding that the letter of credit conforms to the terms of the sale contract between him and the buyer. He may also relax his conditions in case the letter of credit has not fully complied with his terms and conditions. This will amount to his waiver or variation. In stage 6, the seller obtains transport documents such as bill of lading or as the case may be and other documents the buyer has stipulated such as certificate of quality and origin and presents them along with Invoice describing the goods as exactly as mentioned in the letter of credit.  The transport document should be clean without any notation or clause as to any defects in the goods shipped as per Article 27 of UCP 600. It is not necessary to mention the wording “clean” in satisfaction of the condition “clean on board”. Stage 7 involves payment by the bank on presentation of documents that should be in full compliance of the conditions mentioned in the credit. The payment may be immediate or deferred depending on the terms of the credit. 
The UCP 600 governing the letter of credit operations are the guidelines for banks to follow strictly failing which the defaulting bank will be at the risk of making good the loss to either party. There are 39 Articles of the UCP 600 which the banks shall comply with. This version of the UCP which came into force from 1 July 2007 is the revised version of UCP 500. The UCP which was first issued in 1933 has undergone six revisions so far. 
Doctrine of strict compliance
The above position gives rise to the doctrine of strict compliance. Banks have no discretion to relax the conditions violative of the UCP Articles except at their peril. The discrepancies in the documents are sometimes are trivial in which case the bank will not be called into question. Thus, Hanson v Hamel & Horley Ltd  , Equitable Trust Company of New York v Dawson Partners Ltd  , JH Rayner & Co v Hambros Bank Ltd  , and Bank Meli Iran v Barclays Bank DCO  are some of many leading cases that have led to the development of common law of doctrine of strict compliance.
In Hanson v Hamel & Horley Ltd above certainty of port of loading is insisted upon. Lord Summer’s observation is that the buyer is entitled to documents that substantially confer him protective rights throughout. Thus, if the bill of lading shows a different place of receipt of goods, the notation must show that port of loading is the same as mentioned in the letter of credit even if the vessel is the same as mentioned in the bill of lading.  In regard to Equitable Trust Company of New York v Dawson Partners Ltd which was a House of Lords decision, seller Roggie & Co had shipped scrap such as old iron, wood and rubbish instead of Vanilla beans but managed to obtain a certificate of quality for vanilla beans. It was learnt that seller managed to replace the goods after obtaining certificate of quality. Moreover, buyer’s condition that there must be more than one certificate quality was not complied with. The documents presented at the bank contained only one certificate of quality. The respondents Dawson Partners objected to pay for want of more than one certificate of quality. But ignoring this, the bankers paid the bill of exchange and claimed it from Dawson Partners. It was held that as there was no compliance in respect of the number of quality certificates, the buyers were right in refusing to pay. Hence, the bankers who ignored the doctrine of strict compliance must bear the loss. The bankers’ contention that the plural wording “brokers” in general trade parlance meant only singular was rejected 
Principle of Autonomy
The letter of credit is made up of more than one contract. Besides, the contract between the buyer and the issuing bank and seller and his bank, there is an underlying contract between the buyer and seller which does not bind the issuing bank. Thus, any dispute between the buyer and seller does not affect the rights of the bank. This independence from the underlying contract is known as autonomy principle.  UCP 500 Article 3 (A) dealt with the principle of autonomy as “Credits, by their nature, are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts”  Corresponding article in UCP 600 is Article 3 to which has been added a sub clause (b) as “An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like.”  The separation of letter of credit contract from that of the underlying contract is sacrosanct as could be understood by these articles. This principle of autonomy is often put to test because of applicants’ (buyers) tendency to seek injunctions from the courts against banks’ payment to the beneficiaries for one reason or other. In Discount Records Ltd v Barclays Bank Ltd  , the buyer found that cargo received were empty boxes without records and boxes with cassettes instead of records and wanted bank not to make payment by seeking an injunction in the court. Court refused to grant injunction for the reason that the underlying contract was separate from obligation of the bank to pay under the credit. Court could interfere only if more serious cause was shown. If courts, in such cases of goods not conforming to the requirements of the underlying contract, were to interfere, it would affect the international trade. The beneficiary had relied on the irrevocable condition of the credit and shipped the goods on documentary credit basis. This however does not prevent the buyer from proceeding against the seller separately for breach of the underlying contract. In yet another Power Curber International Ltd v National Bank of Kuwait  This case involved payment allowed by English courts in spite of an order of a Kuwaiti court not to make payment. Power Curber, an American company shipped machinery to a Kuwaiti firm on the strength an irrevocable letter of credit of the National Bank of Kuwait. The bank instructed Bank of America to advise the sellers. As soon as the machinery was delivered, the buyers made a counter-claim and obtained an order from the Kuwaiti court restraining the bank from making payment to the seller. The seller sued the bank which had a registered office in London. Both the English courts of first instance and appeal held that the Kuwaiti court’s order did not affect the right of the issuer of credit since contract in the credit was separate from the underlying contract.  Lord Denning said that that the very purpose of issuing an irrevocable letter of credit was to protect from such counterclaims and setoffs. The purpose is to keep up the flow of international commerce.  Even though the issuing bank may get involved in the underlying contract by mentioning the contract number, it does not amount to its consent as mentioned in Art 3 (a) of the UCP that mere mention of the contract reference does not destroy the separation credit contract from sale contract. Although a wider wording may be necessary to do away with the separation as suggested in Royal Bank of Scotland v Cassa di Risparmio delle Provincie Lombard, no bank would be willing to entangle itself beyond the payment obligation. 
Exception to Autonomy principle.
If there is illegality or fraud in the underlying contract, bank is not allowed to make payment if notified in time. An illegality can be by way of violating the exchange control regulations. In United City Merchants (Investments) ltd v Royal Bank of Canada (The American Accord)  , the Peruvian buyer inflated the price twice as much requesting the sellers to transfer the excess amount to a US bank account which amounted to conversion of Peruvian currency into US dollars under the pretext of sale and the credit. This was in clear violation of Peruvian exchange regulation Article VIII, s 2 (b) of the Bretton Woods Agreement to which England was also a signatory.  Lord Diplock’s view was that this was unenforceable and not illegal as such. In Mahonia Ltd v JP Morgan Chase Bank and Another,  . illegality was established in the underlying swap transactions which were illegal under the US law. The court although agreed with autonomy principle of the letter of credit, did not think it proper to allow an unlawful act as a matter of public policy. Question arises whether it is the bank’s duty to check the genuineness of the underlying contract before a credit is issued or confirmed. Or whether it should be conversant with the terms and jargons of different trades and also technical specifications. 
Fraud exception rule
Banker’s autonomy is qualified by the fraud exception rule. If the bank is aware that documents presented to it under letter of credit are forged, it need not pay the credit. This is because forgery makes a document invalid in law. Bank can even recover money paid as one paid under mistake of fact as held in Balfour Beatty Civil Engineering Ltd v Technical & General Guarantee Co  and KBC Bank v Industrial Steels ltd (UK)  . However, bank is protected from any claim after the payment is made due to fraud, if the bank could prove that it exercised reasonable care before making payment as required under article 15 of the UCP 500. The fraud exception rule would apply only if the bank has knowledge or evidence of fraud before payment under the credit is made. The fraud exception rule would also extend to underlying transaction as held in the U.S. jurisdictions. However, the English law imposes exacting standard to justify an injunction against fraud vide Edward Owen Engineering Ltd v Barclays Bank International Ltd  and Deutsche Ruckverssicherung AG v Walbrook Insurance Co ltd  If there is a genuine controversy regarding breach of the underlying contract with the conflicting claims of the applicant and beneficiary, the latter’s act would not be considered fraud. For example, if the applicant says that beneficiary has breached the underlying contract by not completing the project on time and the beneficiary refutes it by holding that applicant’s default on various dates led to the delay on the part of beneficiary, bank is at liberty to make payment under the credit.  Fraud exception rule was first recognised in American courts in Toy Company Pty Ltd v State Bank of New Southwales.  In Sztejn v J Henry Schroder Banking Corporation (‘Sztejn’)  , the beneficiary shipped scrap and worthless goods which should be considered as a deliberate attempt on the part of the beneficiary to defraud which amounted to not shipping the goods actually ordered. If this is brought to the notice of the bank, then bank should not make payment under the credit to benefit the beneficiary. As mentioned elsewhere, English courts take stricter view of fraud exception. In United City Merchants (Investments) Ltd v Royal Bank of Canada  , the actual date of shipment was after the due date under the credit but loading brokers unconnected with the beneficiary entered in the bill of lading a wrong date so as to make it fall within the due date. It was held that there was no fraud since beneficiary was not a party to the fraud. This involved fraud in the documentation and not the underlying transaction. This stricter view enhances the bank’s autonomy principle. This was followed in the decision of Montrod Ltd v Grundkotter Fleischvertriebs GmBH. 
Discrepancies in the documents
By virtue of the doctrine of strict compliance and autonomy principle, banks are merciless in rejecting the documents even at the slightest opportunity. Banks are pushed to wall to decide within a short time and hence they adopt a safer mode i.e to reject that is easy without risk. Advising banks sometimes accept without commitment to the beneficiary and sends it for collection because the applicant may or may not approve of the deficiencies  This state of affairs continue even after a few centuries of letter of credit practice as the only safe method of payment. It has been difficult to cut down the incidence of discrepancies since committing mistakes is inherent in human beings. During 1983, 49 % of documents lodged in U.K. were rejected due to discrepancies. In 1986, it was 51.4 %. The reasons adduced were discrepancies beside expiry of due date, shipment delays and presentation delays. West Germany and the U.S. Banks also had the U.K. pattern of rejections. But in Hong Kong it was 85 % and Australia 90 % as revealed in 1970 survey though in Australia, the discrepancies were rectified in second presentations  The annual turnover of international transactions aggregated to the U.S. $ 7 trillion out of which letter of credit transactions amounted to U.S $ 1 trillion.  The cost of documentation is worth the U.S. $ 420 million i.e 6 % of the value of transactions. Though the description of goods in the credit and in the invoice may not tally with each other, it may be otherwise clear that both are identical goods. The credit may describe the goods as ‘20 cm pipe-cutting machinery’ and the invoice as ‘two 20 cm pipe-cutting machinery. This insignificant discrepancy is not going to affect terms of contract and hence banks should not reject on this ground. But at the same time, if the credit envisages two pipe cutting machines and the invoice shows it as pipe cutting machinery without quantity, there is something amiss and hence, the bank can refuse to pay.  Banks are not expected to act like robots as observed by the Banking Commission of the ICC.  Banks are not at liberty to stretch their interpretation to benefit the party either.  According to Bergami  the U.K. incurs not less than. ₤ 113 million per annum in rectification of discrepant documents yet the letter of credit has been the preferred method of payment.  The UCP 600 which is the source of law for the letters of credit contains only 39 articles whereas its predecessor had 49 articles. The simplification makes the guidelines more succinct and precise. Article 14 of UCP 600 still retains the “doctrine of strict compliance” whereby differences in spelling between two documents lead to their rejection. However Article 14 of the UCP 600 (ex article 37) has softened its stance on the product description on the invoice. 
The autonomy accorded to banks in respect of payment of credits regardless of deficiencies in the underlying transactions keeps the wheels of international commerce moving. And the bank’s non-payment even at the slightest discrepancy makes the system fool-proof and infuses confidence in the buyers. On the one hand, the system is free to make payment to the beneficiary without being swayed by the unreasonable demands of the applicants (buyers) and on the other, the system safeguards the interests of the applicants by not entertaining the beneficiaries even for the slightest discrepancy. This makes the letter of credit a double edged sword to weed out the hindrances to the growth of international commerce. The UCP which is the codification of the common law decisions over several decades, has been instrumental in regulating the letter of credit practice to the advancement of the international trade. The fraud exception rule at the same time disciplines the unwary or careless banker by preventing him from taking undue advantage of the autonomy principle.
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