1. DEFINITION
What is an LC as a concept? Is it a type of contract similar to a sale contract (with two parties) or a bill of exchange (a three party contract with no rule of independence)? Or, is the credit contract as a special type of arrangement with its own specific peculiarities, namely, a three party agreement, independent from its underlying contract(s)? A general view of the character of points related to credit arrangements is given below.
1.1. UCP 500
Regarding the meaning of a credit, UCP 500 provides that "Credit(s), mean any arrangement, however named or described, whereby a bank (the "Issuing Bank") acting at the request and on the instructions of a customer (the "Applicant") or on its own behalf, (i) is to make a payment to or to the order of a third party (the "Beneficiary"), or is to accept and pay bills of exchange (Draft(s) drawn by the Beneficiary, or (ii) authorises another bank to effect such a payment, or to accept and pay such bills of exchange (Draft(s)), or (ïîi) authorises another bank to negotiate, against stipulated document(s), provided that the same terms and conditions of the Credit are complied with."^ According to this definition a letter of credit is a type of agreement belonging to the form of contract usually concluded between three parties; however, as pointed out above. Article 2 of UCP 500, by including the terms "on its own behalf, prepared the way for two parties LCs.^ ’ Article 2 o f UCP 500; for a similar definition see Section 5-103 o f the UCC.
^ El linger, E.P., ’T h e U niform Customs and Practice for Documentary Credits- the 1993 Revision", LMCLQ, part 3, August 1994, p. 377 [hereinafter referred to as Ellinger's article 1994], at p. 383 says: "[...] while the 1983 definition encompassed a letter o f credit only where the bank issued it on behalf o f its customer (the "applicant"), the new Article 2 covers credit opened by the issuing bank on its own behalf. Such credits are, for instance, used where a bank issues a standby credit in order to back a trasnaction in which it participates as principal."; Dolan, John P., "W eakening the letters o f credit product: The new U niform Customs and Practice fo r Documentary C redits". International Business Law Journal, No. 2, 1994, pp. 149-177 [hereineafter referred to as Dolan], at p. 168 regarding "two party credit" said: "Bankers are properly concerned with the development o f new products. That concern is evident in Article 2 o f UCP 500 where the Uniform Customs for the first time sanction the two party credit, that is, they permit a credit to issue when there is no bank customer. This provision enables banks to issue their obligations as letters o f
Moreover, it is a type of conditional payment, in contrast to a bill of exchange or a promissory note, namely, against document(s) which are also included as a document of title.
1.2. English law
in English law there is no comprehensive definition of the credit; nevertheless, its character has been described through court cases. For example,
Scrutton, L.J., in Guaranty Trust Co. v. Hannay & Co.^ explained the operation of
the documentary credit."^ Rowlatt, J., in Urquhart Lindsay & Co. Ltd. v. The Eastern Bank Ltd.,® tried to give a general definition for the LC. He said; "A credit is in general a contract for payment of money against documents of title to goods."® credit or to enhence their obligations with their own credits. The two party credit is, however something o f a chimera. It looks like a letter o f credit but does not operate like one; and the effect o f it is to dilute the independence feature o f credits that is so essential to the commercial utility o f the letter o f credit device." ^ [1918J2KB 623 (CA).
Ibid., at p. 659 it is said:"The enormous volume o f sales o f produce by a vendor in one country to a purchaser in another has led to the creation o f an equally great financial system intervening between vendor and purchaser and designed to enable commercial transactions to be carried out with the greatest money convenience to both parties. The vendor, to help the finance o f his business, desires to get his purchase price as soon as possible after he has despatched the goods to his purchaser; with this object he draws a b ill o f exchange for the price, attaches to the draft the documents o f carriage and insurance o f the goods sold, and discounts the bill that is, sells the b ill with documents attached to an exchange house. The vendor thus gets his money before the purchaser would, in the ordinary course, pay; the exchange house duly presents the bill for acceptance and has, until the b ill is accepted, the security o f a pledge o f the documents attached and the goods they represents. The buyer, on the other hand, may not desire to pay the price till he has resold the goods. I f the draft is drawn on him, the vendor or the exchange house may be w illing to paid with the documents o f title till the acceptance given by the purchaser is met at maturity. But i f the purchaser can arrange that a bank o f high standing shall accept the draft, the exchange house may be w illing to part with the documents on receiving the acceptance o f the bank. The exchange house w ill then have the promise o f the bank to pay, which, if in the form o f the b ill o f exchange, is negotiable and can be discounted at once. The bank w ill have the documents o f title as security for its liability on acceptance, and tlie purchaser can make arrangements to sell and deliver the goods. Before acceptance, the documents o f title are the security, and an unaccepted bill without documents attached is not readily negotiable. After acceptance, the credit o f the bank is the security."; Gutteridge, H.C., and Megrah, M., "The Law o f Banker's Commercial C re d it", London, 1984, 7th ed., pp. 2-3 [hereinafter referred to as Gutteridge]; G.A. Penn, A.M . Shea, and A. Arora, "The Law and Practice o f International Banking" . Banking Law, Vol. 2, London, Sweet & Maxwell, 1987, pp. 291-92 [hereinafter referred to as International Banking Law (Int.B.L.)].
^ (1921)27 Com. Cas. 124.
^ Ibid., p. 128; Megrah, M., "The Uniform Customs and Practice for Documentary Credits, the 1962
Revision and a fte r". Gilbert Lectures on Banking 1969, (Printed for King’s College by Walter Bargeiy Ltd., London, S.E. 1), p. 4 [hereinafter referred to as Megrah]; see also International Banking Law, supra (f.n. 4),
As a distinction between letters of credit and bills of exchange, it has been said: "A bill of exchange must be an unconditional order, and any agreement between the parties to it that the order shall be conditional causes the document to cease to be a bill of exchange. But a commercial letter of credit may be, and often is, a conditional promise. The importation of a condition does not render the instrument any less a letter of credit. What is all important is that there shall be a promise of reimbursement by the giver of the letter. The terms attached to that promise are a matter for agreement between the parties."^
2. FUNCTION
The most important function of the documentary credit system is to facilitate payment against a document of title serving as a "constructive delivery" in international trade. Lord Wright in T.D. Bailey, Son and Co. v. Ross T. Smyth & Co. Ltd.,® described the function of a banker's commercial credits as: "The general course of international commerce involves the practice of raising money on the documents so as to bridge the period between shipment and the time of obtaining payment against documents." Devlin, J., in Midland Bank Ltd. v. Seymour,^ said the effect of the letter of credit is that the seller/beneficiary has obtained a guarantee from a person who is solvent that, if he carries out his part of contract, he will p. 290, para. 13.01, in which documentaiy credit was described in terms as follows: "A commercial letter o f credit may be said to be an undertaking by a bank to pay a sum o f money to the person in whose favour the credit is issued, or to accept or purchase a bill o f exchange drawn or held by that person. The bank's undertaking is usually conditional on the presentation o f certain specified documents to the bank showing that the goods described in the credit have been despatched to the beneficiaiy."; Harfield, H., "B an k Credits and Acceptances". 5th ed., 1974 [hereinafter referred to as Harfield], at pp. 3-4 said: "Credit is made up of three elements: the acceptance o f a duty by an obligor; the presumed ability o f the obligor to perform that duty; and the availability o f social sanctions, in the form o f law, to compel performance or a compensatory substitute for performance. The combination o f these elements is credit and it is essential building block upon which they be classified by duration, such as short, medium or large term credit; or by function, such as commercial, customer, construction, or working capital credit; or by form, such as secured or unsecured credit; or by character o f the creditor, such as trade or bank credit."
^ Davis, A.G., "The law relating to commercial letters o f c re d it". London, 3rd ed., 1963 [hereinafter referred to as Davis], pp. 13-14.
' (1940)56 TLR 825, p. 828. [1955]2L1.L.R. 147, p. 165.
receive the purchase price. Professor Kozolchyk has described the advantage of a letter of credit in worldwide usage not only as a payment Instrument, but also as a type of payment against documents of title. He said: "With the increase in international trade since the end of the First World War, it is not surprising in the light of these advantages, that commercial letter of credit gained worldwide acceptance, not only for the financing of international sales, but also as a means of payment in non-title passing transactions."^®
3. OPERATION
A letter of credit originates in a sale contract; and the duty of arrangement rests on the buyer/applicant for the credit.^^ The operation of "opening of the credit", "communication to the beneficiary", "presentation of documents", and "acceptance and payment" involve several stages.^^ Firstly, the applicant for the credit (usually the buyer) makes a formal application (which is called "letter of request")^® to his
Kozolchyk, Boris, "L e tte r o f C re d it". 9 International Encyclopedia o f Comparative Law, Chapter 5, 1979 [hereinafter referred to as Kozolchyk], p. 7 (What is the meaning o f "non-title passing transactions"?); see also p. 27, sec. 45 o f the same reference, where the same writer said: "The commercial letter o f credit owes many o f its characteristics in the C ivil and Common law systems to the development o f documentary sale [...]. Documentary sales are "title passing" transactions. Possession o f the documents o f title to the merchandise sold even though it is not the equivalent o f absolute and unimpeachable ownership o f the goods, is, in the case o f disputes over the right to their immediate possession, decisive [...] however, commercial letters o f credit are not used solely for the purpose o f providing the buyer with assurance o f the seller's compliance with the tenus o f the underlying documentaiy sale."; and also look at p. 25, col. I o f above reference, in which it is said: ""Documentaiy" sales are such as CIF, FOB, FAS, and others."
” G uaranty Trust Co. o f New Y o rk v. FTannav [1918] 2 KB 623, at p. 659; for further details see "G uide to Documentary C redit O perations". ICC Publication No. 415.
Kozolchyk, supra (f.n. 10), pp. 7-8; International Banking Law, supra (f.n. 53), p. 291; Ellinger, EP, "Docum entary credits and fraudulent documents". (Kee, Ho Peng, "Singapore Conferences on International Business Law, C urrent Problems o f International Trade F inancing". Butterworths, 1990, 2nd Edition [hereinafter referred to as Singapore Conferences 1990]), pp. 139-87, at pp. 140-45 [hereinafter referred to as Ellinger's paper].
Davis, supra (f.n. 7), at p. 16 describes the contention o f a "letter o f request" by saying that: "In this document a buyer w ill request the bankers to issue a letter o f credit in favour o f B. He w ill state what documents must be delivered to the bankers before they honour B's drafts. He may request that the opening o f the credit be advised through the banker's agents [...]. After the terms o f request, A's obligations towards the bankers are stated. These are, broadly, an undertaking to reimburse the bankers for all payments they may make under the letter o f credit subsequently to be issued, to pay freight and landing charges, to pay the bankers' commission, and to allow the bankers to hold the goods, or the documents o f title to them, as security for their advances, until such time as A shall reimburse the bankers what they have paid. There is o f course nothing to prevent the bankers from acting upon a verbal request to issue the credit; but any bankers
bank, usually in his country, to open a letter of credit for him. That letter of request contains details of the terms of the credit contract between the bank and the applicant and plays an important role if a conflict arises between the parties. When the banker accepts the buyer's application, the contract is completed between the bank and its client.
As a second step the issuing bank approves the credit directly to the beneficiary (usually the seller), or may ask another bank, as an intermediary bank, to do this, either advising the beneficiary (as an "advising bank"), or adding its confirmation (as a "confirming bank"). At the next stage, upon receipt of the credit the beneficiary/ seller is guaranteed that if he carries out his duties under the sale contract the payment will be secured and credited to him. By tendering the proper documents the seller/ beneficiary is then entitled to obtain the purchase price. However, when the payment is made by an intermediary bank, the presented documents must be forwarded to the issuing bank to claim reimbursement.
Finally, the issuing bank passes all documents to its client. Nevertheless, if the buyer cannot repay his debt, the bank is entitled to exercise its right of sale under security measures usually granted by the client.^"^