LETTERS OF CREDIT

SOME FUNDAMENTALS

WHY USE LETTERS OF CREDIT?

A great compromise and mechanism to conquer lack of trust resulting from the time & distance of international trade [Middle Earth picture]

WHY USE LETTERS OF CREDIT IN INTERNATIONAL TRADE

You pay

You ship

WHY USE LETTERS OF CREDIT?

Distance (and time)—Simultaneous exchange of goods for cash not possible

Seller wants payment before shipping goods

Buyer wants to inspects good before giving payment

Bank as paymaster

Seller: Can be induced to ship

knowing that he can receive

payment commitment

Buyer: Can be committed to pay

knowing that goods have been

shipped

But now the seller does not

trust the bank

LET’S PLAY FOOTBALL

Advising bank

L/C payment

Issuing bank

Credit facility

Confirming bank (up front)

Negotiating bank

UCP 600 - Article 2 Definitions For the purpose of these rules: Advising bank means the bank that advises the credit at the request of the issuing bank. Applicant means the party on whose request the credit is issued. Banking day means a day on which a bank is regularly open at the place at which an act subject to these rules is to be performed. Beneficiary means the party in whose favour a credit is issued. Complying presentation means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice. Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation. Confirming bank means the bank that adds its confirmation to a credit upon the issuing bank's authorization or request. Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.

Honour means: a. to pay at sight if the credit is available by sight payment. b. to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment. c. to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance. Issuing bank means the bank that issues a credit at the request of an applicant or on its own behalf. Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. Nominated Bank means the bank with which the credit is available or any bank in the case of a credit available with any bank. Presentation means either the delivery of documents under a credit to the issuing bank or nominated bank or the documents so delivered. Presenter means a beneficiary, bank or other party that makes a presentation.

Article 2 con’t

At end of the day, it is about

getting paid

Hence, UCP favours Seller

Buyers somewhat prejudiced

Makes it easy to create fraud

Fraud almost always comes from

the Seller’s side (that’s the

party trying to get the money)

References to similar

instruments in ancient Rome,

Egypt, China

Much law governing L/Cs

grounded in custom &

mercantile practice

‘Legal ways follow folk ways’

UCP 600 2007 Revision

No international law or convention on L/Cs

Does not have force of law

Global convergence through ICC & UCP

UCP = Uniform Customs & Practices

‘most successful harmonising measure in the history of international commerce’

Has to be specifically Incorporated into contract (sales & L/C)

1st issued in 1929; not well Accepted until revisions in 1950’s & 60’s

L/Cs Classified by:

Payment type Features

Sight payment

Acceptance: Sight or time draft

Deferred: No draft

Negotiation

Irrevocable (Revocable extinct?)

Back-to-back

Transferable

Usance L/C

Also

If Buyer goes bankrupt, seller

can re-sell goods

But in a strange land far, far

away

Ties up capital during transit

Who is better protected under an L/C,

the Beneficiary or the Applicant?

3 most fundamental L/C

principles

Autonomy

Art 4

Separate legal contract

Deals in documents, not

goods—Art 5

Strict compliance

AUTONOMY—Article 4

Credits v. Contracts a. A credit by its nature is a separate transaction from the sale or other

contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary.

A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank. b. 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.

UCP 600 - Article 5 Documents v. Goods, Services or Performance Banks deal with documents and not with goods, services or performance to which the documents may relate.

Documents, documents, documents, nothing but documents

STRICT COMPLIANCE

Moralice (London) v ED&F Man

L/C stipulated a B/L for 5,000 bags

B/L: 4,997 bags

Bank rejected the documents

Beneficiary sued

UCP Relief:

Only commercial invoice has to have exact description

Other descriptions on other documents approximate but not contradicting

Allowance to tolerances

Decision: ‘The words in that bill of lading clearly are not the same as those required by the letter of credit. … the bank were entitled to refuse…on the grounds that the documents tendered…did not comply precisely with the terms of the letter of credit’

STRICT COMPLIANCE RELIEF: UCP 600

ART 30 a:

The words ‘about’ or

‘approximately’ used in

connection with the amount of

the credit or the quanity or the

unit price stated in the credit are

to be construed as allowing a

tolerance not to exceed 10%

more or 10% less…

Art 30 b:

A tolerance not to exceed 5% or

5% less than the quantity is

allowed, provided the credit does

not state the quantity in terms of

a stipulated number of packing

units or individual items…

5,000 bags: Hence…still no

relief for Moralice v. ED&F Man

BANK LIQUIDITY/CREDIT CRISIS: OPENING AN L/C

Buyer has to arrange opening with

Issuing Bank

Instructions on documents to be

tendered

Buyer and Seller agree to payment

via L/C

L/C opening a condition precedent

to shipment

Essential term of sales contract

[Trans Trust SPRL v. Danubian

Trading Co. Ltd][1952]

What is the Issuing Bank’s

obligation to open the L/C?

None—Bank not a party to the sales

contract

When should an L/C be opened?

Seller & Buyer agreed to a 2 month

shipping period 1st Feb - 30th April

CIF contract

CIL/C specified as payment method

Silent on date of L/C opening

Buyer opened L/C on 22nd April

Seller sued buyer for damages for

breach of contract due to delay in

L/C opening

What damages?

Buyer argued L/C opened prior to

tendering of documents and that this

was sufficient duty

Is the Seller entitled to damages?

Date of COS

Beg. of

Shipment period

1 FEB 30 APR

End of

Shipment period

22 APR

L/C opened

THE COURT’S DECISION

Object of credit is to assure the seller prior to shipment that he will be paid’

‘’Seller is entitled before he ships the goods to be assured that…he will be paid’

If the Buyer is to fulfil his obligations, he must make the credit available at the very first date when the goods may be…shipped in accordance with the contract’

BUYER IS IN BREACH

Case: Pavia & Co. v Thurmann-Nielsen [1952]

Seller can sue for damages

Damages include:

Difference between contract price and market price

Seller’s profit had contract been successfully fulfilled

CASE: FAILURE TO OPEN AN L/C

CASE:

Steel sales contract

L/C not opened in time

Seller claimed loss of profits

Buyers argued damages only

nominal as Seller could sell into

a rising market

SALES CONTRACTS, DOCUMENTS & L/Cs:

LIFE IN A DISCREPANT WORLD

UCP 600: ICC Survey indicates that 70% of presentations under L/Cs have discrepancies, i.e., documents are rejected

Only 30% clean first-time presentations

What does this mean for security under an L/C?

Where does the responsibility lie?

Ship us 1,000 footballs ± 5% Received 995 footballs

995 footballs

995 footballs

IL/C Bailout Bank We hereby issue our IL/C Goods: 1,000 footballs ±5%

The words are consistent: Docs compliant: Bank has to pay

Meanwhile, back at the Sales Contract

Dennis R Effect: 70% clean presentations

DISCREPANCIES: THE CHINESE COMPANY CHOP CASE

Unique in Chinese

culture

Practical functions

Also are works of art

themselves and an

indispensable part of

Chinese painting and

calligraphy.

From Lehman Brown Accountants website

A "Chop“: necessary for approving decisions relating to the

operations and management of a company in China and for legally

authorising documentation.

A Company Chop mandatory for every company incorporated in

China, A Company may hold a wide range of chops, each used for

different purposes and applying to different documentation.

Number of chops which have a very specific scope and power. Not

mandatory and may include: Financial chop, Human Resources chop,

Contract chop. Such 'specific' chops provide company departments

with the ability to, for example, enter into contracts on behalf of the

company without having to gain the seal of the Company Chop.

CASE: THE CHINESE CHOP I

X-Trader sold metal to Chinese company

CIL/C; Renationalised Bank is Confirming Bank in London

Company had tight cash flow

Carrier was COSCO (China Overseas Shipping Co.)

B/L signed using chop with Chinese characters (corporate or personal?) + signature

UCP 600 Art. 20a:

A bill of lading…must appear to:

(i)Indicate the name of the carrier and be signed by: The carrier or a named agent …on behalf of the carrier, or

The master or a named agent…on behalf of the master

What did the Confirming Bank do?

Confirming bank rejects

documents

Cannot identify who signed the

B/L

X-Trader talks to banks in Hong

Kong and learns that this is

standard practice and would not

cause a discrepancy

Big fight

CASE: THE CHINESE CHOP 2—THE SEQUEL

3 months later

X-Trader buys 5,000 mt of copper

concentrates (20% copper content)

from Chinese mine, Y-Mine

Contract value $3,000,000

Sells to Korean smelter

2-day voyage

Bailout Bank London has issued the

L/C on behalf of X-Trader

Your trader has found out that the

assay was fraudulent

Concentrates have only 1/3 of

copper content claimed

Value of shipment is $1,000,000

Bailout Bank receives and is

reviewing the documents; X-Trader

review copies

What do you do? What can be

done?

UCP 600: PRINCIPLE OF AUTONOMY & FRAUD

Art. 4 Credits v. Contracts

The credit…is a separate

transaction from the sale…

A The undertaking of a bank…is

not subject to claims or defences

by the applicant resulting from

its relationships with the issuing

bank or the beneficiary.

Art 5. Documents v. Goods

Banks deal with documents and

not with goods…

UCP DOES NOT DEAL WITH FRAUD

Bank’s obligation to pay on documents that appear to conform on their face

BUT ENGLISH LAW DOES: THE FRAUD EXCEPTION

Discount Records Ltd v

Barclays Bank [1975]

Buyers alleged fraud; sought

injunction to stop the bank from

paying beneficiary

Decision:

Mere allegation of fraud

insufficient cause to issue

injunction

Another legal case:

Enough information that would

lead the bank to infer fraud

Insufficient

[The Society of Lloyds v

Canadian Imperial Bank]

FRAUD HAS TO BE PROVEN

SAVINGS GRACE

X-Trader scrutinises documents—and finds…

X-Trader convinces Bailout

Bank to reject documents as

they cannot identify who signed

the B/L

X-Trader able to withhold

payment, negotiates paying

only the worth of the

concentrates; L/C amended

TRUST IN THE DOCUMENTS ESSENTIAL FOR TRADE TO

FLOURISH

$$$

X

X

Is L/C a conditional payment by bank?

Or absolute payment by bank?

Who takes the bank risk?