letters of credit, stand by letters and bank demand
TRANSCRIPT
Presenting a live 90‐minute webinar with interactive Q&A
Letters of Credit Stand by Letters Letters of Credit, Stand‐by Letters and Bank Demand GuaranteesCrafting Credit Instruments for Domestic and International Financing Transactions
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, DECEMBER 20, 2011
Today s faculty features:
Kevin J. Connolly, Shareholder, Anderson Kill & Olick, New York
Isaac E. Druker, Shareholder, Anderson Kill & Olick, New York
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Strafford Publications WebinarDecember 20 2011December 20, 20111:00 pm-2:30 pm
LETTERS OF CREDIT AND OTHER FIRST DEMAND
PAYMENT INSTRUMENTSPAYMENT INSTRUMENTS
Your SpeakersYour Speakers
Kevin J Connolly EsqKevin J. Connolly, Esq.(212) 278-1471
k ll @ d [email protected]
Isaac E. Druker, Esq.(212) 278-1475( )
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DisclaimerDisclaimerThe views expressed by the participantsThe views expressed by the participants in this program are not those of the participants’ employers, their clients, orparticipants employers, their clients, or any other organization. The opinions expressed do not constitute legal advice, or risk management advice. The views discussed are for educational
l d id d l fpurposes only, and provided only for use during this session.
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OriginsOrigins• Lombard Bankers of
15th Century Italy laid the foundations of the first international b ki tbanking system.
• A merchant could deposit bullion in Rome, travel to Adrianopolis intravel to Adrianopolis, in the shadow of Istanbul, and draw his money from a correspondent infrom a correspondent in order to fund the caravan
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Circular Letter of CreditCircular Letter of Credit• Very closely related toVery closely related to
the Lombard Credit• Enables an agent to
have access to fundshave access to funds while far away from home base
• Protects against theft• Protects against theft• Facilitates accounting• Rarely seen today but
was common 25 years ago
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Payment Letter of CreditPayment Letter of Credit• Workhorse ofWorkhorse of
international trade• Quintessential
d t ldocumentary sale– Deals with documents,
not goods– Payment is made by
buyer’s bank upon tender of conforming documents
– Itemized on the Letter of Credit
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Documentary CollectionDocumentary Collection• Notice that nothingNotice that nothing
in the cycle addresses where th dthe goods are
• Documentary sales are differentsales are different from other sales but still covered in the UCC, CISG and other regimes
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The DocumentsThe Documents• The letter of creditThe letter of credit
specifies what documents must be
t d i dpresented in order to get paid– InvoiceInvoice– Bill of Lading– Draft– Letter of Credit– Others
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The DocumentsThe Documents• Unless the credit specifies p
otherwise, the bill of lading must be “clean”
• A bill of lading or other “transport document” thattransport document that takes exception for damaged containers or like evidence that the contents have been tainted is not cleantainted is not clean
• Banks do not accept a document package with transport documents so noted unless the creditnoted unless the credit expressly stipulates the notations that are permitted.
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Others?Others?• In a documentary sale, the y
parties deal in documents not goods
• Documentary sale needs to provide reasonableprovide reasonable assurances that the goods will actually arrive
• Cargo Inspection Certificates are frequently required toare frequently required to prevent receiving a containerful of sawdust
• Crime insurance may be needed for a completeneeded for a complete solution to the shipment risk
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Conforming DocumentsConforming Documents• Proof of insurance is
t i d lnot required unless specified in the letter of creditI ti f• Incorporation of contract term by reference does not affect draws under theaffect draws under the L/C
• L/C transaction is based on the DOCUMENTSon the DOCUMENTS and critically the four corners of the L/C
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Commercial Letter of CreditCommercial Letter of Credit• Serves to identify an L/C y
that is expected to serve as the payment facility for the contract
• Identifies the bearer as a• Identifies the bearer as a financially-responsible party recognized as such by correspondent banks y pat the remote location
• The Seller in such a transaction can discount the bill of exchange forthe bill of exchange for cash more readily
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Commercial Letter of CreditCommercial Letter of Credit• Commercial paper• Commercial paper
backed by a letter of credit can be discounted more readily
• Letters of Credit are fundamental to the f f iti k tforfaiting market
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Standby?Standby?• The Great Depression led
to the enactment in theto the enactment in the United States of the Glass-Steagall Act.
• This prohibited pcommercial banks from selling insurance or underwriting securities, prohibited investmentprohibited investment banks from accepting demand deposits or selling insurance, and k t i ikept insurance companies out of banking
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Standby?Standby?• The anti-underwritingThe anti underwriting
clauses also prohibited commercial banks from guaranteeing the obligations of unrelated partiesp
• The surety industry could not fill the gap because surety bonds because su ety bo dsare not “pay now—fight later” documents
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Letter of Credit Bond (Surety Bond)• Accessory• Primary
• Independent• Payable promptly
• Accessory• Co-extensiveness• Payable upon decree of tribunal
(not prompt)• Payable promptly• “First Demand”
Instrument
• Suretyship is implied if instrument provides for payment upon obligor’s default
– Effektivklausen
– Also known as “suicide standby”
– Payment made upon
• Documentary guaranty requires submission of third-party certifications such as court decree or arbitral award, but Payment made upon
simple demand• No proof of default or
amount owed
there is great inconsistency of nomenclature
• US standby L/C is termed “documentary” because it entails
• Not even a declaration of default is needed
ythe presentation of at least a draft, but the L/C is a independent undertaking to pay, accept or negotiate
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Standby?Standby?• Within a few years after y
the enactment of Glass-Steagall, commercial banks had found a way
d th t i t faround the strictures of the statute
• They issued letters of credit that provided thatcredit that provided that no draws could be made absent a default by the account partyby the account party under some other obligation
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Governing CodeGoverning Code• Standby letters ofStandby letters of
credit began with a problem: they are square pegs in round q p gholes
• The Uniform Customs and Practices forand Practices for Documentary Credits were for years employed as the e p oyed as t egoverning regime for standbys.
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UCP 600UCP 600• The Uniform Customs and PracticesThe Uniform Customs and Practices
perform admirably in their intended bailiwick: international payments for documentary salesdocumentary sales
• The UCP lacks provisions for the distinctive features of a standbydistinctive features of a standby
• The UCP-credit still represents the “basal” form of L/C
• Much of the L/C jargon finds its roots in the documentary credit
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UCP 600UCP 600• “Credit” means an irrevocable definite• Credit means an irrevocable, definite
undertaking of the issuer to “honor” a presentationp
• “Honor” means– For a sight credit, by making payment– For a deferred credit, to incur the bank’s own
obligation and to pay the same at maturityFor an acceptance credit to accept a bill of– For an acceptance credit, to accept a bill of exchange or draft drawn by the beneficiary and to pay the acceptance at maturity
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UCP 600: JargonUCP 600: Jargon• Advising • Nominationg
– Advising bank issues formal notice of the issuance of the credit by another bank
– Serves to make L/Cs drawn d bl b d
– Banks at which the credit may be presented
– Not all nominated banks are advising or confirming banks b t d i i / fi i b kand payable abroad more
manageable but the advising bank is not liable to make payment
– Advising bank often acts as
but advising/confirming banks are nominated
• Negotiation– Nominated banks make the
dit il bl b h iAdvising bank often acts as intermediary
• Confirming– In addition to “advising” of the
credit, the confirming bank
credit available by purchasing the draft(s) and making the proceeds available to the beneficiary
– Negotiation is limited tocredit, the confirming bank adds its own obligation to the credit
Negotiation is limited to nominated banks unless the credit is issued payable through “any bank”
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UCP 600 JargonUCP 600 Jargon• Presentation • ComplyingPresentation
– Delivery of documents under a creditMade at issuing or
Complying Presentation is a presentation that
I i d ith– Made at issuing or nominated bank (including advising or confirming banks)
– Is in accordance with the terms of the credit
– Is in accordance with th l f thconfirming banks)
– Bank has a limited time in which to examine the presented
the rules of the governing regime (e.g., UCP 600)Complies ithexamine the presented
documents for compliance
– Complies with standard international banking practice
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UCP 600: JargonUCP 600: Jargon• Independence – The obligation to pay Independence
– The right of the beneficiary to payment does not depend on th t t d
g p ydoes not depend on the right or practical ability of the issuing bank to reimbursementthe contract under
which the L/C was issued
– Neither the beneficiary
bank to reimbursement– However, the issuer’s
right to reimbursement depends on the – Neither the beneficiary
nor the bank may look to the underlying contract
pcompliance of the documents to the requirements of the credit UCP andcredit, UCP and standard practices
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UCP 600: JargonUCP 600: Jargon• Documentary – Issuing banks are Documentary
– Banks deal with documents and not with goods, services or
gcautioned to resist attempts by applicants to incorporate a contract or otherg
performance to which the documents relate
– The letter of credit should state within its
contract or other document into the L/C
• IrrevocableA dit ishould state within its
four corners all of the elements of a complying presentation
– A credit is irrevocable and need not say so expresslyexpressly
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UCP 600: Required TermsUCP 600: Required Terms• Credit must state the • Credit must state an• Credit must state the
bank(s) with which it is available or that it is
• Credit must state an expiry date for presentation
available at any bank• Credit must state
h th it i il bl
p• If the bank is closed
on the date when whether it is available by sight payment, deferred payment,
the credit expires, presentation on the
t b ki d ide e ed pay e t,acceptance or negotiation
next banking day is timely
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ExcuseExcuse• Expiration of the L/C is • If the bank is closed p
a complete defense to payment and if paid notwithstanding the
i th b k l k
due to force majeure, neither the issuing nor any confirming bank is bli t d texpiry, the bank lacks a
right to reimbursement under the UCPIt may have contracted
obligated to pay• If the L/C expired while
the bank was closed due to Acts of God• It may have contracted
for a right to charge the applicant for erroneous payments and such
due to Acts of God, riots, civil commotion, insurrection, war, terrorism strikes orpayments and such
clauses call for close scrutiny
terrorism, strikes or lockouts, the bank must not honor, accept or negotiate the L/C
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g
TransferTransfer• Issuing bank has no • Transferred creditIssuing bank has no
obligation to recognize a transfer of the credit to a new
Transferred credit must accurately reflect the credit (including
or additional beneficiary unless it has consented to the
( gconfirmation, if any) except:– Amount, including any
transfer• Any fees must be paid
by or for the first
, g yunit price
– The expiry date– Latest shipment date by o o t e st
beneficiary before transfer
or agreed period for shipment
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TransferTransfer• Beneficiary’s right to • If the deal between the y g
assign proceeds of the L/C is not impaired by restrictions on transfer of the credit itself
beneficiaries calls for the first beneficiary to present the draft and remit the second beneficiary’sthe credit itself
• Transfer may be partial• The transfer would recite
the reduction or
second beneficiary s account, but first beneficiary does not do so or makes a non-
f i t tithe reduction or curtailment of the amounts available
• Issuer remains liable for th b l f th dit
conforming presentation that is not corrected “upon first demand,” second beneficiary can present its
the balance of the credit which remains available to the first beneficiary
y pown draft and issuer is exonerated as to the first beneficiary
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ISP 98ISP 98• The InternationalThe International
Standby Practices-1998 Edition was
i i d bcommissioned by the ICC to fix the problems caused byproblems caused by US banks’ continued insistence on using th UCP tthe UCP to govern standby credits
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ISP 98ISP 98• ISP 98 does not • Like a commercialISP 98 does not
– Govern power or authority to issue standbys
Like a commercial credit, a standby is a definite undertaking that is irrevocable,
– Formal requirements (statute of frauds)
– Defenses based on fraud abuse or similar
,documentary and binding when issued
• Like a commercialfraud, abuse or similar matters
Like a commercial credit, a standby can be advised or confirmed by banks in co ed by ba sthe beneficiary’s locale
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ISP 98ISP 98• Like a commercial credit, a
t db i “i d d t” d• It is an “absolute” commitment
t fstandby is “independent” and the rights and defenses of the parties do not depend on
– issuer’s right to receive reimbursement
to perform– Acceptance– Sight Payment– Deferred Payment
Th i i t treimbursement– the beneficiary’s right to receive
payment pursuant to the contract– reference to any other document
in the standbyth i ’ t l
• The issuer is not a guarantor and is not liable for
– the performance or breach of the underlying agreement
– Accuracy genuineness or effect– or even the issuer’s actual knowledge that there has been a breach (or performance) of the underlying contract or reimbursement agreement
Accuracy, genuineness or effect of any document presented under the standby
– the acts or omissions of others, even if those others are selected and instructed by the issuerand instructed by the issuer
• Issuer is not required to conform to any law other than the law of the place of presentment
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ISP 98ISP 98• Standby letters of credit • The standby should specify y
generally require that the beneficiary draw a bill of exchange and present it with a certificate by the
y p ythe medium of presentment– If no medium is specified,
then paper documents must be presented
fbeneficiary– Certificates might declare that
an event of default had occurred under the “value transaction” and other
– However, if the standby is payable on simple demand and the beneficiary is a bank of S.W.I.F.T. participant, the presentment may be made bytransaction and other
conditions (notice, lapse of time) entitling beneficiary to draw
– More modern practice is for
presentment may be made by S.W.I.F.T., tested telex, or other “similar authenticated means”
– Issuer may always permit l t i t t i itMore modern practice is for
beneficiary simply to certify that it is entitled to present the draft under the standby
electronic presentment in its discretion
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ISP 98ISP 98• Standby letters of credit • The standby should specify y
generally require that the beneficiary draw a bill of exchange and present it with a certificate by the
y p ythe medium of presentment– If no medium is specified,
then paper documents must be presented
fbeneficiary– Certificates might declare that
an event of default had occurred under the “value transaction” and other
– However, if the standby is payable on simple demand and the beneficiary is a bank of S.W.I.F.T. participant, the presentment may be made bytransaction and other
conditions (notice, lapse of time) entitling beneficiary to draw
– More modern practice is for
presentment may be made by S.W.I.F.T., tested telex, or other “similar authenticated means”
– Issuer may always permit l t i t t i itMore modern practice is for
beneficiary simply to certify that it is entitled to present the draft under the standby
electronic presentment in its discretion
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ISP 98ISP 98• Examination • Extraneous documents
– Following a presentation, the issuer (or confirming bank) must examine the documents for conformity
are those not required by the standby– These don’t have to be
i ddocuments for conformity to the standby
– Examination is limited to ascertaining whether the presentation satisfies the
examined– They shall be
disregarded for purposes of determining whether presentation satisfies the
requirements set out in the standby
– Non-documentary diti i th t db
gthe presentation conforms to the standby
• Consistency is not part of the examinationcondition in the standby
are disregardedof the examination unless the standby provides otherwise
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ISP 98
• No formalities required • Unless the standby q(notarization, officialization, witnesses) unless stipulated in the standby
yrequires the presentation of an electronic record, issuer owes applicant no duty to ascertain thestandby
• If formalities are required, issuer is not required to vet the authenticity of the
duty to ascertain the identity of the person making the presentation– But note that if the standby
i th t tiy
indicia of notarization etc.– Apparent compliance is
sufficient to authorize payment
requires the presentation of a bill of exchange, the issuer is bound by the law of negotiable instruments to make payment only to apayment to make payment only to a holder
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ISP 98: Legal DocumentsISP 98: Legal Documents• Unlike the situation with • Issuer’s examination isUnlike the situation with
commercial credits, a standby is not transmuted into an
Issuer s examination is limited to the apparent good order of the documentstransmuted into an
accessory surety bond by requirements for court decrees arbitral
documents• Issuers should examine
their Financial Institution Bonds to seecourt decrees, arbitral
awards, government-issued documents and the like
Institution Bonds to see what insurance they have for defending against claims that thethe like against claims that the nonconformity of the presentation was patent
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ISP 98: Examination Standard
• “A document presented • The UCP requires strict punder a standby is to be examined in the context of standby practice under these Rules even if the
qcompliance with the terms of the credit– Issuer of a commercial
credit makes payment asthese Rules even if the document is of a type (such as a commercial invoice, transport d t i
credit makes payment as the applicant’s agent
– Agent who does not strictly comply with his principal’s instructions isdocuments, insurance
documents or the like) for which the Uniform Customs and Practices for
principal s instructions is not entitled to reimbursement for expenditures made
Documentary Credits contains detailed rules”
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Demand GuarantiesDemand Guaranties• The Uniform Rules for • Undertaking is given
Demand Guaranties, ICC Document 458, defines these as an undertaking to pay money upon a
g geither– at request of the Principal
and under its liability orAt the request of a bank orto pay money upon a
presentation of a written demand for payment in accordance with the terms f th d t ki
– At the request of a bank or insurance company (the “Instructing Party”) acting on behalf of the Instructing Party’s own client which isof the undertaking
• Other documents (architect’s certificate, judgment or arbitral
Party s own client, which is also a Principal
• The Guaranty is “independent” on the same terms as discussedjudgment or arbitral
award) specified in the Guaranty
same terms as discussed for letters of credit
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Demand GuarantiesLike an L/C or standby, a guarantee should specify:
• The Principal • Expiry Date or• The Principal• The Beneficiary• The Guarantor
• Expiry Date or Expiry Event
• Terms forThe Guarantor• The underlying “value
transaction” that calls
Terms for demanding payment
• Any provisions forfor the Guaranty
• Maximum amount
Any provisions for reduction of the guarantee amount
payable and currency in which payable
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Demand GuarantiesDemand Guaranties• Examination • CounterguarantiesExamination
standard: Guarantor shall exercise due care to ascertain
Counterguaranties– When an Instructing
Bank requests a confirming bank to i it t fwhether the
documents presented appear to conform to
issue its guaranty for the account of the principal, it generally issues a credit to thepp
the term of the guaranty
• Essentially the same
issues a credit to the confirming bank stipulating the amounts the Instructing Bank will reimburse to thesse t a y t e sa e
standard as applies under ISP98
will reimburse to the confirming bank, and on what terms and conditions
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CounterguarantiesCounterguaranties• The counterguaranty is • In other markets, g y
implied when the instructing bank requests the confirming bank to establish a guaranty “for
,counterguaranties are used to allocate risks of non-completion and paymentestablish a guaranty for
our account”• If a formal credit is issued,
the Instructing Bank does
payment– Instead of retaining 10% of
progress payments, developers in the Middle East will release the entireg
so for the principal’s account in order to establish its right to reimbursement from the
East will release the entire contract sum in exchange for a counterguaranty from the contractor for 10% of the price of the workreimbursement from the
Principalthe price of the work
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CounterguarantiesCounterguaranties• The contractor’s guaranty is
l t l• The objective then becomes
fi i t h f h d thalmost always a counterguaranty because the developer generally furnishes a bank guaranty covering payments to the contractors
figuring out how far ahead the contractor really is and providing for a bank guaranty to cover that difference
• Bank guaranties are often usedpayments to the contractors• Other layers of
(counter)guaranties come into play when mobilization payments mean that the owner
• Bank guaranties are often used as a functional substitute for performance bonds
– Fundamental difference: performance bonds are written for payments mean that the owner
has laid out more money than the work is actually worth
pthe full amount of the contract
– Bank guaranties or L/Cs for that amount would be prohibitively expensive
– Owner/Developer must be moreOwner/Developer must be more proactive because it can’t sit back and make the surety pay for the mess
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Types of Bank GuarantiesypVery similar to surety bond products
• Tender Guaranties correspond t Bid B d i US l
• Maintenance and Warranty G tito Bid Bonds in US parlance
– Generally payable on First Demand
• Performance Guaranties pays an owner if a contractor has not
Guaranties– Functionally similar to the
Performance Guaranty but covers post-completion defects only
– Generally written for much lessan owner if a contractor has not, not timely, not completely or not properly per-formed its contract
– Typically written for 5% to 10% of the contract sum
Generally written for much less than a corresponding performance guaranty
• Repayment/Advance Payment Guaranties
I t d f b i d ith• Retention Guaranties– Instead of retaining 10% of each
progress payment, Owner pays 100% of the value of the work each payment and the contractor
– Instead of being concerned with a credit to cover the difference between the cost of the work and its reasonable value, a contractor could deliver a guaranty for the performance of Work for whicheach payment and the contractor
furnishes a guaranty to substitute for retention
performance of Work for which the Owner has made advance mobilization payments
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Types of Bank GuarantiesTypes of Bank Guaranties• Anything that can be • Bank guaranties are y g
done with a standby can be accomplished with a properly-drafted b k t
goften required as security for food exporters in Europe
bank guaranty, including provision of security for a lease, purchase & sale
– Exporters are charged an amount intended to recoup the government subsidies on the purchase & sale
agreement• Bank Guaranties are
accepted as security for
production of their foods– When exporting foods,
the exporters typically provide the customsaccepted as security for
the payment of import duties throughout the EC
provide the customs collectors with bank guaranties for the amounts being recouped
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FraudTh h l id b hi d N th l th l• The whole idea behind these instruments is their absolute nature
• Nonetheless, the rule has grown up that fraud may be sufficient to
• If a seller of goods falsely certifies that he has shipped the goods
inspire a court to enjoin an issuer from making payment or to enjoinhas shipped the goods
covered by the buyer’s letter of credit, he most lik l
payment or to enjoin the beneficiary from presenting a draftTh i t d l tlikely can secure
payment under the L/C long before Buyer
• There is a great deal to be said about fraud….so much that
realizes that he has been had
we’re not going there today. Fraud needs its own program
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own program