Internation Trade Law: Letter of Credit

SUBMITTED TO
Dr. Parvez Ahmed
Assistant Professor

SUBMITTED BY
Sadiya Sultana Silvee
Program: LL.B Honors
ID: 110311004
Batch: 1103
Topic of the Assignment :

Internation Trade Law: Letter of Credit

 CONTENTS

Page No.

Introduction 3

Acknowledgement 4

Acronyms 5

Table of Cases 6

Table of Figures 7

 Chapter I - Introduction 8

1. Rationale of the Assignment

2. Methodology
3. Limitation of the Assignment

 Chapter II – Fact Analysis  9

1. Summary of the Case I – R D Harbottle (Mercantile) Ltd Vs. National Westminster

Bank Ltd. [1978] 1 QB 146
2. Summary of the Case II- R Sztejn v J. Henry Schroder Banking Corporation. [1941]
177 Misc. 719, 31 NYS 2d 631
3. Summary of Few Related Case

1
 Chapter III – Utilization of Letter of Credit 15

1. Introduction of Letter of Credit

2. Objective of Letter of Credit
3. Principals of Letter of Credit
4. Analysis on Utilization of Letter of Credit

 Chapter IV – Analysis of the Statement 24

1. Analysis of the Statement – “The lifeblood of International Commerce”

2. Current Scenario
3. Supporting Statement
4. Area of Development

 Conclusion 27

 Recommendation 28

2
 INTRODUCTION

The Letter of Credit has been an important and most popular method of payment in International

Trade. It is widely used for the International trading transaction. Justice Kerr of the English

Court has defined letter of credit as, “the life-blood of international commerce.” It is most

effective method to secure payment in an International trade transaction. Letter of credit looks

for the interest of the parties, the seller and the buyer. In the global information age the nature

of international commerce has changed, so do the transaction method. This study will relate the

traditional law and practice of letter of credit with the global information age.

3
 ACKNOWLEDGEMENT

This is an analytical study on Letter of Credit focus on the principals of letter of credit and its
current utilization.

I, consider it a great privilege to thank my course Lecturer Mr. Parvez Ahmed for his invaluable
guidance, supervision and encouragement without which this study would never have come to
fruition.

I would like to express my sincere gratitude to all my course lectures for helping me in
completing my study. And I would also like to show my gratitude to my course mate and friends
for their support and active participation in my study.

Finally, a big thank to all the co-operation in providing the relevant data for the study.

Thank you

Sadiya Sultana Silvee

Program: LL.B Honors
ID: 110311004
Batch: 1103

4
 ACRONYMS

CBOE Chicago Board Options Exchange

EIU Economist Intelligence Unit

Uniform Customs and Practice for Documentary Credits for Electronic

eUCP
Presentation

ICC International Chamber of Commerce

LC Letter of Credit

UNCITRAL United Nations Commission On International Trade Law

UNIDROIT Institut International Pour L'Unification du Droit Prive

UCP Uniform Customs and Practice for Documentary Credits

U.S. United States

VIX Volatility Index

5
 TABLE OF CASES

No. Name of Cases Page No.

R D Harbottle (Mercantile) Ltd Vs. National Westminster Bank

1 9
Ltd. [1978] 1 QB 146
R Sztejn v J. Henry Schroder Banking Corporation. [1941] 177
2 11
Misc. 719, 31 NYS 2d 631
Discount Records v Barclays Bank and another [1975] 1 WLR
3 12
315

4 Edward Owen Engineering v Barclays Bank [1978] 13

5 United City Merchants v Royal Bank of Canada [1982] 13

6 Deutsche Ruckversicherung v. Walbrook Insurance [1996] 14

Standard Chartered Bank v. Pakistan National Shipping

7 14
Corporation [2000

6
 TABLE OF FIGURES

No. Subject of Figures Page No.

1 Stages of Letter of Credit 17

2 Growth Trade Finace, Percentage of goods exports 20

3 Growth Trade Finace, Percentage of goods exports 21

4 Letter of Credit Use as a Function of Destination Country Risk 22

Profitability of Exporting as a Function of Destination Country

5 23
Risk

7
 CHAPTER I - INTRODCUTION

1. Rationale of the Assignment

The purpose of the study is to review the utilization of Letter of Credit in this global information
age when electronic transaction is known as one of the popular method of transaction. In this
study we will relate the past and the present scenario through different case study and popular
statements. This study will completely focus on the Letter of credit, its utilities and current
scenario. With this study we will also put light on the stages of letter of credit.

2. Methodology

Our study methodology required gathering relevant data from the specified documents and compiling
databases in order to know tax at a glance.

The assignment is not exploratory in nature, because the aim of the assignment is to just focus on few
essentials of Letter of Credit.

Sources of Data Collection: The study required secondary data only. Secondary data has been collected
from various books authored by foreign writers, National and International journals, previous studies,
articles, Internet and various government documents.

3. Limitation of the Assignment

My study had several limitations. The study was limited to its small size data collection. The assignment
has been made as comprehensive as possible by making use of available information from different
initiatives from various sources. There was also limitation in access. If access to different organizational
reports and document was available the study would have been broader. If any server could have been
performed, that report would have given a broader scenario. However, several information is web-based,
social groups, newspapers, books etc. Nevertheless, a broader picture of other initiatives would have
definitely enriched this assignment. So, this could be the major limitation of the study.

8
 CHAPTER II – FACT ANALYSIS

1. Summary of the Case I – R D Harbottle (Mercantile) Ltd Vs. National Westminster

Bank Ltd. [1978] 1 QB 1461

The plaintiffs had entered into contracts of sale with Egyptian buyers. Each contract provided that the
plaintiffs would establish a guarantee confirmed by a bank in favour of the buyers. The guarantees were
widely expressed, and secured payment on the buyers’ demand. They were established with Egyptian
banks and confirmed by the defendant English bank. The buyers demanded payment under the
guarantees. The plaintiffs maintained that there was no justification for the demand for payment, and
sought declarations to that effect and injunctions against the defendants from making payment under the
guarantees. Interlocutory injunctions were granted ex parte but then discharged on the application of the
defendant bank. Kerr J said: “If [the threatened payment] is in accordance with the contract, then the
plaintiffs have no cause of action against the bank and, as it seems to me, no possible basis for an
injunction against it. Alternatively, if the threatened payment is in breach of contract . . then the plaintiffs
would have good claims for damages against the bank. In that event the injunctions would be
inappropriate, because they interfere with the bank’s obligations to the Egyptian banks, because they
might cause greater damage to the bank than the plaintiffs could pay on their undertaking as to damages,
and because the plaintiffs would then have an adequate remedy in damages. The balance of convenience
would in that event be hopelessly weighted against the plaintiffs.” He added: “banker’s irrevocable
obligations are the ‘…life blood of international commerce…’ 2and, that a buyer must establish a…’except possibly
in clear cases of fraud of which the banks have notice, the courts will leave the merchants to settle their
disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts.
The courts are not concerned with their difficulties to enforce such claims; those are risks which the
merchants take . .”3 The machinery and commitments of banks are on a different level. They must be
allowed to be honoured, free from interference by courts. Otherwise, trust in international commerce
could be irreparably damaged.

1
http://swarb.co.uk/r-d-harbottle-mercantile-limited-v-national-westminster-bank-limited-1978/ [Last visited -05-Apr-2015]
2
RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] 1 QB 146, at 870
3 Ibid

9
  Judgment of the case

Justice Kerr of the English Court said: “It is only in exceptional cases that the Court will interfere with the
machinery of irrevocable obligations assumed by banks. They are the life-blood of international
commerce. Such obligations are regarded as collateral to the underlying rights and obligations between
the merchants at either end of the banking chain. Except possibly in clear cases of fraud of which the
banks have notice, the courts will leave the merchants to settle their disputes under the contract by
litigation or arbitration……. The courts are not concerned with their difficulties to enforce such claims:
these are risks which the merchants take. In this case, the Plaintiffs took the risk of the unconditional
wording of the guarantees. The machinery and commitment of banks are on a different level. They must
be allowed to be honoured, free from interference by the Court. Otherwise, trust and international
commerce would be irreparably damaged.”4

 Findings of the Case

RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd 5 involves three different facts, which
are the principals of Letter of Credit. Firstly, the Autonomy of the Credit, according to this principle, the
letter of credit is separate from and independent of the underlying contract in respect of which it is issued.
That means the claims or defenses arising under the underlying contract do not affect the bank’s
undertaking to pay. Under this principal the Bank is in obligation to pay the beneficiary. Secondly is the
exception to this principal known as “Fraud Exception” led by the famous case of Sztejn.6 The exception
entitles buyers either to restrain sellers from drawing the credit or to restrain banks from making
payments to sellers. If buyers can present sufficient evidence of material or established fraud, banks may
withhold the payment to sellers. If buyers cannot, banks have discretionary power whether to pay. Lastly,
Doctrine of Strict Compliance, The doctrine of strict compliance protects the interests of the buyer and of
the paying bank. When submitting the required documents, the law expects the seller to comply strictly
with the requirements stated in the letter of credit.7 This assures the buyer that the bank will not pay the
seller, unless the seller presents documents that satisfy the requirements of the buyer. The issues that are
presented in this case do not only cover the issue of fraudulent documents, but an overall fraudulent
transaction. The importer discovered in good timing and prevented payment under the letter of credit
through null and void. If the documents are forged or fraudulent, including the transaction, the bank can
make a payment if it is acting in good faith. However, the company who is exporting is still at fault if they
committed fraud through the shipment or transaction of products or document.

4
RD Harbottle (Mercantile) Limited v. National Westminster Bank Limited [1978] QB146 at pages 155/156
5 [1978] 1 QB 146
6 Sztejn v J. Henry Schroder Banking Corporation, 177 Misc. 719, 31 NYS 2d 631 (1941)
7 See Delfs v Kuehne & Nagel 1990 (1) SA 822 (A). See also the judgement of Zulman J in Nedcor Bank Ltd v Hartzer 4CLD 278

(W). See also the judgement of Sir John Donaldson M.R. in Banque Indochine v. J.H.Rayner [1983] 1 QB 711 (CA) at 731 to 733,
and Banker's Trust v SBI. [1991] 1 Lloyd's Rep 587 (QB) for the clear understanding of the principal.

10
 2. Summary of the Case II – R Sztejn v J. Henry Schroder Banking Corporation. [1941]
177 Misc. 719, 31 NYS 2d 6318

Chester Charles Sztejn, the plaintiff, brings forward the case of credit fraud, which originally occurred on
January 7, 1941. Sztejn, who bought a shipment of bristles from (defendant) Transea Traders, Ltd (based
out of Lucknow, India) originally opened an irrevocable letter of credit with Henry Schroder Banking
Corporation (defendant). Sztejn presented the necessary documents (letter of credit and draft) to the
Chartered Bank, who then presented the documents to Schroder Banking. The documents provided that
Schroder would pay a specified portion of the purchase price of the bristles, upon shipment with the
invoice and bill of lading being shown. The letter of credit was shipped by Schroder’s correspondent bank
in India, where it was then delivered to Transea. Transea Traders, however, ended up shipping crates
filled with “cowhair and other worthless material”, and not what Sztejn had originally ordered. Transea
procured a bill of lading from the steamship company that shipped these materials, as well as obtaining
the customary invoice (for the bristles). Naturally, Sztejn filed a case that declared the letter of credit
under null and void, so that the defendant could not pay the draft. The original draft and the other
fraudulent documents were delivered to the Chartered Bank, who then presented to Schroder for payment.
The court ended up favoring Sztejn, whom they believed that the allegations he presented were correct.
This stated that Transea had in fact committed fraud, and that the Chartered Bank was not completely at
fault for the fraudulent transaction.

 Judgment of the case9

In the New York Court of Appeal, Judge Shientag stated that a Letter of Credit is “independent of the
primary contract of sale between a buyer and a seller. The issuing bank agrees to pay upon presentation of
documents not goods. This rule is necessary to preserve the efficiency of the Letter of Credit as an
instrument for the financing of trade.” The Judge further said “on the present motion, it must be assumed
that the seller has intentionally failed to ship any goods ordered by the buyer. In such a situation, where
the seller's fraud has been called to the bank's attention before the drafts and documents have been
presented for payment, the principal of the independence of the bank's obligation under a Letter of Credit
should not be extended to protect the unscrupulous seller.”

8http://shannoneileencampbell.blogspot.com/2015/01/sztejn-vs-j-henry-schroder-banking.html [Last visited – 12- Apr-2015]

9http://www.lawteacher.net/free-law-essays/criminal-law/courts-and-fraud-exception.php#ixzz3X4pjB0Mu [Last visited – 12-
Apr-2015]

11
  Findings of the Case

R Sztejn v J. Henry Schroder Banking Corporation10 involves three different facts, which are the
principals of Letter of Credit. Firstly, the Autonomy of the Credit, according to this principle, the letter of
credit is separate from and independent of the underlying contract in respect of which it is issued. That
means the claims or defenses arising under the underlying contract do not affect the bank’s undertaking to
pay. Under this principal the Bank is in obligation to pay the beneficiary. Secondly is the exception to this
principal known as “Fraud Exception” led by this case. The exception entitles buyers either to restrain
sellers from drawing the credit or to restrain banks from making payments to sellers. If buyers can present
sufficient evidence of material or established fraud, banks may withhold the payment to sellers. If buyers
cannot, banks have discretionary power whether to pay. Lastly, Doctrine of Strict Compliance, The
doctrine of strict compliance protects the interests of the buyer and of the paying bank. When submitting
the required documents, the law expects the seller to comply strictly with the requirements stated in the
letter of credit.11 This assures the buyer that the bank will not pay the seller, unless the seller presents
documents that satisfy the requirements of the buyer. The issues that are presented in this case do not only
cover the issue of fraudulent documents, but an overall fraudulent transaction. The importer discovered in
good timing and prevented payment under the letter of credit through null and void. If the documents are
forged or fraudulent, including the transaction, the bank can make a payment if it is acting in good faith.
However, the company who is exporting is still at fault if they committed fraud through the shipment or
transaction of products or document.

3. Summary of Few Related Case:

 Discount Records v Barclays Bank and another [1975] 1 WLR 31512

Discount Records, the plaintiff, brings forward the case of credit fraud. Discount Records, who bought a
shipment of goods from a French company. Discount Records opened an irrevocable letter of credit When
the first shipments arrived, many of the boxes were filled with rubbish. There was evidence that the
shipping marks had been tampered with. Discount Records sought an injunction against the bank to stop
the payment to the sellers, under letters of credit. It was held that the fraud had been alleged but was not
yet proved, so an injunction would not be granted, as in such circumstances, the grant of an injunction
would prevent the bank from performing its obligations.

10 177 Misc. 719, 31 NYS 2d 631 (1941)

11 See Delfs v Kuehne & Nagel 1990 (1) SA 822 (A). See also the judgement of Zulman J in Nedcor Bank Ltd v Hartzer 4 CLD 278
(W). See also the judgement of Sir John Donaldson M.R. in Banque Indochine v. J.H.Rayner [1983] 1 QB 711 (CA) at 731 to 733,
and Banker's Trust v SBI. [1991] 1 Lloyd's Rep 587 (QB) for the clear understanding of the principal.
12 http://www.lawteacher.net/free-law-essays/criminal-law/courts-and-fraud-exception.php#ixzz3X4pjB0Mu [Last visited – 12-

Apr-2015]

12
  Edward Owen Engineering v Barclays Bank [1978]13

In this case, Court of Appeal approved the decision of Sir Michael Kerr in the Harbottle case. Lord
Denning described the fraud exception the following words:

“that case (the Sztejn case) shows that there is this exception to the strict rule: the bank ought not to pay
under the credit if it knows that the documents are forged, or that the request for payment is made
fraudulently in circumstances where there is no right to payment” (page 982).

In the same case, Lord Justice Brown, said about the fraud exception:

“that exception is that where the documents under the credit are presented by the beneficiary himself and
the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled
to refuse payment”(page 984).

Lord Justice Geoffrey Lane also said at page 986:

“the only circumstances which would justify the bank not complying with the demand ……..is this, if it
had been clear and obvious to the bank that the buyer had been guilty of fraud”.

 United City Merchants v Royal Bank of Canada [1982]14

In this case, documents presented to the confirming bank, contained a misstatement, i.e. the bill of lading
showed the shipment date as 15th December 1976 which was the last date for payment, while in fact
shipment was on 16th December. So the Defendant bank refused to pay. In the House of Lords, Lord
Diplock described the autonomous nature of the letters of credit, that the goods are irrelevant to the
seller's right to payment from the bank. However, he said:

“to this general statement of principle as to the contractual obligations of the confirming bank and the
seller, there is one established exception: that is, where the seller for the purpose of drawing on the
credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication,
material representations of fact that to his knowledge are untrue.”

Lord Diplock further referred to the Sztejn case and said:

“the exception for fraud on the part of the beneficiary seeking to avail himself of the credit is a clear
application of the maxim ex turpi causa non oritur actio or, if plain English is to be preferred, ‘fraud
unravels all'. The Courts will not allow their process to be used by a dishonest person to carry out a
fraud.”

13 Edward Owen Engineering Limited v. Barclays Bank International Limited [1978] 1All ER 976
14 United City Merchants (Investments) Limited v. Royal Bank of Canada [1982] 2 All ER 720

13
  Deutsche Ruckversicherung v. Walbrook Insurance [1996]15

In this case, Lord Justice Staughton emphasised on the distinction between preventing a seller from
getting payment from the issuer or preventing a bank from making a payment under a letter of credit
transaction. He said:

“the effect on the lifeblood of commerce would be precisely the same whether the bank is restrained from
paying or the beneficiary is restrained from asking for payment.”

 Standard Chartered Bank v. Pakistan National Shipping Corporation [2000]16

This is an important case in relation to the liability of a bank in case of contributory negligence, where
false documents are delivered by the beneficiary in support of an application to get payment under a letter
of credit. In the proceedings before the English Court, Standard Chartered Bank had established a good
cause of action against the defendant, Pakistan National Shipping Corporation. Pakistan Shipping
Corporation issued a Bill of lading which to its knowledge contained a false shipment date. The Bill of
Lading was presented to Standard Chartered Bank under a letter of credit which was issued by Incobank
of Vietnam and was confirmed by the Standard Chartered Bank. In fact the shipping documents were
presented to Standard Chartered Bank late. However Standard Chartered Bank made the payment without
the authority of Incobank, and hence claimed reimbursement on the basis of a false statement that the
documents had been presented on time. Incobank refused to make payment because of discrepancies.
Pakistan Shipping Corporation argued that the damages caused due to Standard Chartered Bank's
negligence in failing to find out the discrepancies in the documents presented before the bank, and the
Court should reduce the amount payable under the provisions of Section 1 of the Law Reform
(Contributory Negligence) Act 1945.

The Court of Appeal held that under section 4 of the 1945 Act, for a defence of contributory negligence,
negligence should be actionable. In this case Pakistan Shipping Corporation's claim for reduction of the
damages payable depends upon its establishing that the act of Standard Chartered Bank has given rise to
an action for contributory negligence. However, it was unbelievable that the deceitful conduct of Standard
Chartered Bank would have afforded Pakistan Shipping a defence, as in any event, a Defendant, liable in
a deceit could not establish a defence based upon the contributory fault of a Claimant. Therefore, there
were no grounds for reducing the damages recoverable on the basis of contributory negligence. The Court
of Appeal criticised the role played by Standard Chartered Bank in this case. Lord Justice Ward referred
to Standard Chartered Bank, “scandalous attempts to deceive the issuing bank on the basis of a false
statement that the documents were presented to them in time.”17 Later he referred to his “…..distaste for
the bank's conduct. They have brought dishonour upon themselves and upon the City. It is quite another
question whether the dishonest ship owners can benefit from the attempted fraud”

15 Deutsche Ruckversicherung AG v. Walbrook Insurance Company Ltd [1996] 1 All ER 791

16 http://www.lawteacher.net/free-law-essays/criminal-law/courts-and-fraud-exception.php#ixzz3X6PHS141 [Last visited – 12-
Apr-2015]
17 Standard Chartered Bank v. Pakistan National Shipping Corporation [2000] 1 Lloyd's Rep 218 page 948

14
 CHAPTER III – UTILIZATION OF LETTER OF CREDIT

1. Introduction of Letter of Credit

Letter of Credit is a written commitment to pay, by a buyer's or importer's bank (called the issuing bank)
to the seller's or exporter's bank (called the accepting bank, negotiating bank, or paying bank). A letter of
credit guarantees payment of a specified sum in a specified currency, provided the seller meets precisely-
defined conditions and submits the prescribed documents within a fixed timeframe. These documents
almost always include a clean bill of lading or air waybill, commercial invoice, and certificate of origin.18

2. Objective of Letter of Credit

A letter of credit typically includes three contracts: a contract between an issuing bank and a seller, one
between the buyer and the issuing bank and one between the buyer and seller. Ultimately, the purpose of a
letter of credit is to ensure successful business transactions between sellers and buyers. The main
objectives are mentioned below:

Payment Assurance

Letters of credit are especially useful if you're not well-established, you don't have the best credit, you're
dealing with an overseas company and you want to give assurance that you'll pay for your products. To do
this, you make an agreement with the issuing bank, promising to pay for the products. You'll of course
pay a fee for this service. The bank then makes an agreement to pay the seller as long as they agree to the
terms outlined in the document. Since the seller knows the bank's credit is good, he doesn't need worry
about your ability to pay. If it's an international transaction, an advising bank may come into play as the
seller might want a local bank to verify that the issuing bank is legit.19

Set Payment Terms

You can set certain terms, such as delivery address and time, in the letter of credit. If the seller accepts the
letter of credit, she must abide by the terms of the document to receive payment. The seller will need to
provide proof that she complied with the terms of the document. Proof can be a bill of lading, which is the
receipt the shipper gives the seller, or it can be your notice to the bank advising that you received your
stuff.20

18 http://www.businessdictionary.com/definition/letter-of-credit-L-C.html#ixzz3WSGlWLDZ [Last visited – 05- Apr-2015]

19 http://budgeting.thenest.com/purpose-letter-credit-28303.html [Last visited – 05- Apr-2015]
20 Ibid

15
Buyer and Seller Protection

Sometimes, letters of credit involve large sums of money as you might want to pay for a large purchase
without the risk of losing your money. The letter of credit can give you some security because the bank
acts as the intermediary. As such, the bank can help reduce the risk of nonperformance because it won't
issue payments unless everything is in order. A letter of credit also serves as protection for the seller
because it acts as a legal agreement, allowing the bank to release payments once the seller fulfills his end
of the deal. All this means is that the seller can't run off with the money without delivering the goods and
the buyer can't run off with the goods without paying the seller.21

Types

Letters of credit come in several forms, including revocable, irrevocable, confirmed, transferable and
back-to-back documents. The issuing bank can cancel a revocable letter of credit at any time and it
doesn't need to tell you a thing; however, irrevocable letters of credit can't be cancelled or changed unless
everyone involved agrees. With a transferable letter of credit, you can have the bank split the payment
between you and another supplier or pay someone else entirely. An irrevocable letter of credit serves as
collateral for another letter of credit if you have a back-to-back letter of credit.22

Risks

There are risks attached to letters of credit. For example, because the letter of credit guarantees payment,
sellers can receive their money even if they willfully give you crappy products. The bank only verifies
that the seller provided the documents specified in the letter of credit. Regulatory risks also can be a
problem when regulators change policies. You also can run into issues if you don't get the goods because
they were damaged while in transit or other issues, such as strikes or even civil unrest, occurred in the
seller's country.23

21 Ibid
22 Ibid
23 Ibid

16
 3. Stages of Letter of Credit

The mechanism of Letter of Credit can be divided into the stages below:

Step 1

LC APPLICANT (BUYER) LC BENEFICIARY (SELLER)

Step 5

Step 4 Step 6
Step 2 Step 8

Step 3

ISSUING BANK ADVISING BANK

Step 7

Fig-1: Stages of Letter of Credit

• Stage 1: Formation of Contract

The starting point of the letter of credit process is the agreement upon the sales terms between the
exporter and the importer. Then they sign a sales contract. It is important to stress here that letters of
credit are not a sales contract. Actually, letters of credit are independent structures from the sale or other
contract on which they may be based. Therefore, it should be kept in mind that a good sales contract
protects the party, which behaves in goodwill against various kinds of risks.

• Stage 2: Opening of Letter of Credit ( Application for LC )

LC Applicant is normally the buyer under the sales contract and the party that initiates the request to the
Issuing Bank to issue an LC on its behalf. The LC Applicant normally maintains banking facilities with
the Issuing Bank.

17
 • Stage 3: Mailing of LC to Beneficiaries bank

If the LC Applicant and its bank reach an agreement together on the working conditions the Applicant’s
bank (issuing bank) issues its letter of credit. In case the issuing bank and the Beneficiary are located at
different countries, the issuing bank may use another bank's services (advising bank) to advise the credit
to the beneficiary. The advising bank advises the letter of credit to the beneficiary without any
undertaking to honor or negotiate. The advising bank has two responsibilities against to the beneficiary.
Advising bank's first responsibility is satisfy itself as to the apparent authenticity of the credit and its
second responsibility is to make sure that the advice accurately reflects the terms and conditions of the
credit received.

• Stage 4: Mailing of LC to Beneficiary

The beneficiary should check the conditions of the credit as soon as it is received from the advising bank.
If some disparities have been detected beneficiary should inform the applicant about these points and
demand an amendment. If letter of credit conditions seem reasonable to the beneficiary then beneficiary
starts producing the goods in order to make the shipment on or before the latest shipment date stated in
the L/C. The beneficiary ships the order according to the terms and conditions stated in the credit.

• Stage 5: Shipment

When the goods are loaded. The beneficiary ships the order according to the terms and conditions stated
in the credit. The beneficiary collects the documents, which are requested by the credit and forwards them
to the advising bank.

• Stage 7: Presentation of Documents

The advising bank posts the documents to the issuing bank on behalf of the beneficiary. The issuing bank
checks the documents according to the terms and conditions of the credit. In addition, the governing rules,
which are mostly latest version of the UCP are taken into account. If the documents are found complying
after the examination the issuing bank honors the payment claim. The Advising Bank adds its own
undertaking to pay the LC beneficiary if all terms and conditions of the credit are complied with. Such
undertaking is in addition to that given by the Issuing Bank at the request of the Issuing Bank. The
Advising Bank will only confirm an LC upon satisfactory evaluation on the conditions of the Issuing
Bank and its domicile country.

• Stage 8 : Settlement of Payment

The documents transmit to the applicant. The applicant uses these documents to clear the goods from the
customs.

18
 4. Principals of Letter of Credit

One of the fundamental principles governing the LC operation is the principle of strict compliance. The
principle requires the seller to present the necessary documents in accordance with LC requirements; in
order to claim payment for the goods sold. The principle of strict compliance is defined as the legal
principle that entitles the bank to reject documents which did not strictly comply with the terms of LC.24
The issue of strict compliance comes into the picture during the process of checking documents in LC
transactions. The principle of strict compliance aims to protect the buyer who has neither the opportunity
to examine the physical goods nor to supervise the process of loading the goods in the seller’s country
due to geographical distance. Therefore, the documents are the only security for the buyer. The
documents prove that the goods have been properly delivered in accordance with the description in the
sale contract.25

The principle of autonomy stands fundamental among the laws pertaining to the Letters of Credit . This
principle is also known as the ‘independence principle’. This determines the separation and independence
of the letters of credit from the underlying contract for the credit in respect of which the letter of credit is
issued. This means that those claims made or defense taken under the contract cannot specifically affect
the payment undertaking of the banks. The doctrine of autonomy is considered lying at the heart of the
documentary credits.26

The Autonomy Principle has an exception known as the ‘Fraud Exception’. The exception entitles buyers
either to restrain sellers from drawing the credit or to restrain banks from making payments to sellers.
After a while, other common law countries approved the reasoning of the court in that case and the
application of the Fraud Exception became a widespread phenomenon.27

24
Alan Davidson, “Commercial Laws in Conflict - An Application of the Autonomy Principle in Letters of Credit,” 6 Int'l. Trade &
Bus. L. Ann. 65 (2001).
25
PRINCIPLE OF STRICT COMPLIANCE IN LETTER OF CREDIT (LC): TOWARDS A PROPER STANDARD OF COMPLIANCE by DR
Rosmawani Che Hashim
26 http://www.lawteacher.net/free-law-essays/commercial-law/essential-principles-of-letter-of-credit-commercial-law-

essay.php [Last visited – 06- Apr-2015]

27
THE FRAUD EXCEPTION IN DOCUMENTARY CREDITS: A Global Analysis by Nevin Meral

19
 5. Analysis on Utilization of Letter of Credit

Fig: 2- Growth Trade Finace, Percentage of goods exports28

From the above data, we can calculate the trade finance intensity as the ratio of U.S. banks’ trade finance
claims divided by U.S. exports. The chart above plots this variable and the three-month Libor from 1997
to 2012. There’s a strong negative relationship, since LCs become cheaper relative to the two alternative
arrangements when interest rates fall.

28 http://libertystreeteconomics.newyorkfed.org/2014/05/why-us-exporters-use-letters-of-credit.html#.VTIE8PApy1s [Last
visited -18-Apr-2015]

20
Fig: 3- Growth Trade Finace, Percentage of goods exports29

From the above chart, trade finance intensity and the four-quarter moving average of the CBOE Volatility
Index (VIX), this is a measure of global financial market uncertainty. When uncertainty rises, both trading
partners are more concerned that the counterparty might default. LCs then becomes more attractive since
they reduce the risk for both sides of the transaction.

29 Ibid

21
Fig: 4- Letter of Credit Use as a Function of Destination Country Risk 30

The data above suggests that the use of LCs depends on country risk, which we measure by a composite
index of sovereign, banking, and currency risk from the EIU. The chart illustrates the relationship
between LC use and country risk that results from regression analysis. The EIU country risk is on the x-
axis and a measure of the use of LCs compared to a hypothetical risk-free country is on the y-axis.

30
Ibid

22
Fig: 5- Profitability of Exporting as a Function of Destination Country Risk31

The chart above has a hypothetical U.S. exporter’s profits under the three different payment forms as a
function of the default risk of the importer. Start on the left hand side, where the country risk is low. In
this case, the exporter makes the highest profits with an open account, as the low risk of an importer
means money can be saved by not relying on a letter of credit.

As risk rises, LC becomes more attractive relative to an open account. At some point, the gain from using
LC is greater than the bank fee. At an even higher level of risk, the bank fee increases, and due to the
additional risk, the two sides of the trade shifts to a cash-in-advance arrangement, this eliminates the risk
of the importer.

31 Ibid

23
 CHAPTER IV- ANALYSIS OF THE STATEMENT

1. Analysis of the Statement – “The lifeblood of International Commerce”

In RD Harbottle (Mercantil) Ltd v National Westminster Bank Ltd 32, Justice Kerr of the English Court
addressed Letter of Credit as “the Lifeblood of International Commerce”. Afterwards many Courts have
consistently endorsed letter of credit as the life-blood of commerce. Because, if the flow of the credit
transactions stop or is interrupted, the international commerce will come to a grinding halt and will be
interrupted. The slightest delay can lead to huge loss due to exchange fluctuations during the period delay.
There are instances of huge losses in the international trade by way of exchange fluctuations alone.

The importance of the letter of credit in the international commerce is the reason why it is known as the
Lifeblood of International Commerce .Letter of credit 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 33.
Hence, it is rightly called as documentary credit. Letter of Credit is an instrument issued by a bank on
behalf of its constituent in favor 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. And as the courts have not minced words in terming letter of credit as
equivalent to cash which goes to show the life-blood nature of the instrument for keeping the international
commerce live as ever.

32[1978] 1 QB 146
33http://www.lawteacher.net/free-law-essays/commercial-law/letter-of-credit-transaction-commercial-law-essay.php#ftn18
[Last visited -18-Apr-2015]

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 2. Current Scenario

The use of letters of credit as a form of payment in international trade transactions carried is out in
accordance with the ICC publication number UCP 600, revised 2007.34 In response to the growing need
for the banks industries to utilize electronic commerce, the International Chamber of Commerce
authorized the Task Force to formulate standards for electronic presentation of documents. The new
supplement for the UCP was adopted by the ICC Banking Commission meeting in Frankfurt in 1st April
2002; the Uniform Customs and Practice for Documentary Credits for Electronic Presentation or the
“eUCP” V1.0. Corresponding to the development of the UCP600, the updated version of the V1.1 eUCP
came into force on 1st July 2007. There are no substantive changes to the eUCP.35

It can be seen from the title of the eUCP; the Supplement to the Uniform Customs and Practice for
Documentary Credits for Electronic Presentation, that it is simply a supplement to the UCP not
independent from it. Thus, the eUCP, when used in conjunction with the UCP, will provide the essential
rules needed for presentation of the electronic documents, under letter of credits. The eUCP allows for
complete electronic presentation of documents or for a part-electronic (mixture of paper documents and
electronic presentation). The eUCP has taken a step towards the electronic age where the documents will
be electronically presented.36

3. Supporting Statement

Letters of credit is a document issued on behalf of a buyer by a bank that essentially acts as a guarantee of
payment to a beneficiary. This simply means if a buyer do not perform its obligations, the bank pays. The
letter of credit which is usually referred to as L/C can also be the source of repayment of a transaction
meaning the supplier will get paid with the redemption of the letter of credit.
Letters of credit can be issued in different forms by a bank depending on the type of transaction being
undertaken by both parties usually involved in international trade. As the payment instrument, letter of
credit has become widely used in international trade. Letter of credit is even described as ‘...the life blood
of international commerce...’

Letters of credit became necessary when trade between countries made it impossible to do business with
the basic trust needed. Letters of credit were initially introduced by the merchant banking system in
Europe. Letters of credit are governed by rules and trade terms set forth in the standards established by
the INTERNATIONAL CHAMBER OF COMMERCE (ICC).The rules and language spelled out in the
documentation of letters of credit are very strict and specific as edited in the ICCs uniform customs and
practice for documentary credits-ICC publication 500 or UCP500.
On the other hand, international trading between individuals acting on behalf of companies has also
emerged in the advent of letters of credit. Letters of credit is still being applied for any transaction like

34 ICC Uniform Customs and Practice for Documentary Credits 2007 revision, Article 1
35 http://www.lawteacher.net/free-law-essays/international-law/the-uniform-customs-and-practice-for-documentary-credits-
international-law-essay.php#ftn26#ixzz3XegwmTbQ[Last visited -18-Apr-2015]
36 Ibid

25
then wherein one or more parties to the transaction requires payment by a reputable bank to erase any
doubts about business. Nowadays, one may request for a letter of credit for a business transaction
involving goods or services where the parties involved are in foreign or domestic.

Letters of credit displays its unique characteristics to be effective anytime it’s being used for the intended
business transaction. Usually, letters of credit are negotiable. The beneficiary may decide to nominate any
bank besides itself to be paid by the issuing bank not making it obligatory for the issuing bank to make
payment to beneficiary only in the transaction. Negotiable measures are passed on freely from one party
to the other almost the same way as transaction on cash money. The letter of credit must contain in a
clause an unconditional promise to acknowledge payment in full on demand or at a definite time in order
to make it negotiable. In this case the beneficiary’s nominated bank becomes a holder in due course. The
letter of credit now has to be taken for value in good faith, without notice to any claims against it by
holder in due course. Under the uniform customs and practice documentary credits (UCP)37, the holder is
treated favorably. Whereas; a transaction is considered a straight negotiation when the beneficiary of the
credit is marked or stated as the only one to be paid by issuing bank. It is normally referenced on the face
of letters of credit “we engage with you “or available with ourselves” for you to know it is a straight
negotiation. The beneficiary under these conditions become the only one obligated to be paid by issuing
bank.

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. The law provides the doctrine of strict compliance just
as the principle of strict liability. Courts have not minced words in terming letter of credit as equivalent to
cash which goes to show the life-blood nature of the instrument for keeping the international commerce
live as ever.38

37
http://www.lawteacher.net/free-law-essays/commercial-law/letter-of-credit-transaction-commercial-law-
essay.php#ixzz3Xevb30EV [Last visited -18-Apr-2015]
38
http://www.lawteacher.net/free-law-essays/commercial-law/letters-of-credit-life-blood-of-commerce-
commercial-law-essay.php#ixzz3XeucA8Tg [Last visited -18-Apr-2015]

26
 CONCLUSION

In this paper, we tried to summarize the whole assignment, mainly concentrating on Letter
of Credit and its utilization.

In Chapters II, we have analyzed few cases to understand the principal and utilization of
letter of credit.

In Chapter III, we have introduced Letter of credit, its stages and principal. We have also
tried to put light on its utilization.

In Chapter IV, we have analyzed the famous statement from a leading case and have
discussed about the current scenario of letter of credit. We have also tried to put out
opinion about the statement relating to the utilization of letter of credit.

The whole assignment is design to give knowledge about letter of credit, its stages,
utilization and principles.

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 RECOMMENDATIONS

There are different views with regards to what can be added to the UCP, these are:39

The ICC should only think about issues that fall under the UCC and UCP. If this happened, many of the
problems would be resolved, however, there would be many differences between the set of standards with
regards to the LC that would not be settled.

The ICC could only contemplate issues that are not significantly related to the legalities of letters of credit
transactions, like fraud, insolvency, indemnity and other issues that aren’t related to one certain legal
system, such as consideration. If this approach was taken on then harmony could be reached between
UCP 600 and the UCC. However, if there were two sets of standards there would still be confusion
between parties with regards to LCs transactions and the laws regarding LCs would not be uniform
internationally.

So that a uniform global set of standards, regarding LCs can be achieved, the ICC should think about all
the differences that there are between UCP 600 and the UCC. This includes, legal standards and customs
and practices in relation to LCs. It is believed that this could be the approach that is most appropriate in
achieving international uniform laws for the LCs. For this approach to work the ICC would need to have
strong motivation, a good source of money and make sure that there is a reasonable balance between the
differing interests of the parties. It has been outlined:

"The essence of uniform law revision is to obtain a sufficient consensus and balance among the interests
of the various participants so that universal and uniform enactment by the various states may be
achieved."

The questions that still remain are that will the ICC be able to take on such a challenge and if they can’t
what alternative option is there? Although steps have been taken to create a uniform set of standards,
there is still a big gap between them and a solution needs to be created. It is believed that this
harmonization will take a while; there needs to be a change in attitude from both parties; the ICC and the
USA.

39
http://www.lawteacher.net/free-law-essays/international-law/the-uniform-customs-and-practice-for-
documentary-credits-international-law-essay.php#ftn26#ixzz3XewAklYm [Last visited -18-Apr-2015]

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With regards to an alternative solution for harmonising the UCP 600 and the UCC laws on LCs, it is felt
that unified laws should be decided upon globally. The preparation of Article 5 showed that there is a
need for strong willingness and dedication to making the laws uniform, coupled with financial support. If
this is the case, there will be more of a chance of harmonisation. This has already happened in many
states in the USA, that have different jursidictions. Furthermore, it is an ideal time to carry out a
compartive study between different legal systems, with regards to LCs under different auspices of United
Nations Organisations (such as UNCITRAL or UNIDROIT).

With regards to coding the law of LCs from a global perspective, it would be impossible for the ICC to
take on the task of creating a set of global standards concerning LCs, which cover both the issues of the
practicalities of the existing system and legalities relevant to the documentary credit system in
international trading. Moreover, leaving the development of a uniform code up to national law of each
individual state has no justification. Banks and international organisations also need to play a role in the
promotion of a uniform law as having uniform provisions, with regards to practical issues of the
documentary credit system is important. Past experience of creating the UCP and Article 5 of the UCC
can provide valuable insights and a cornerstone for the development of the documentary credit system in
the future.

The need for the harmonization of the law of LCs at an international level, will be considered in the
conclusion chapter; this chapter confirms that the UCP as the main existing source of the letter of credit
law at an international level; but, still needs more efforts to cover all the vagueness aspects in LCs.

29