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?
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
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
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?
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
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
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