Payment: documentary credits
Deferred payment
An agreement for deferred payment means the bank agrees to pay at some determinable time in the future (eg, a certain number of days after shipment of goods) without presentation of the documents.
Seller's advantages of documentary credit
Subject to the solvency of the bank, the seller is certain of payment under the credit provided he can present conforming documents to the bank and comply with any other terms of the credit. Where the credit is transferable, the seller can use it to finance his own acquisition of the goods.
Article 4 of the UCP 600
Article 4 of the UCP 600 (article 4) states, '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'
Royal Bank of Scotland plc v Cassa di Risparmio Delle Provincie Lombard
If there is conflict between the express terms of the credit and the UCP, the express term will prevail over the latter.
Bankers Trust Co v State Bank of India
One of the documents gave the seller's telex number as 931310 instead of 981310. Held: this is trivial because there is no doubt that this was a mere typographical error NB: Today, under the UCP 600, art 14(j) contact details (fax, telephone, e-mail and the like) stated as part of the beneficiary's and the applicant's address are now to be disregarded for the most part)
Sight Payment
The bank undertakes to pay the seller (the beneficiary) on presentation of the specified documents. It usually calls on the seller to draw a sight draft (a draft is a bill of exchange) on the issuing bank, advising bank or another bank, and for him to present it with the documents for immediate payment.
Beyene v Irving Trust Co Ltd
Where it is not clear whether the departure from the detail set out in the credit is a draftsman's error or not, the discrepancy justifies the rejection of the documents (a US case where held that where party was described as "Mohammed Soran" instead of "Mohammed Sofan" could be rejected as there was no evidence before the court that "Soran" would be recognized as an obvious misspelling of "Sofan" in the Middle East)
The Autonomy of the credit rule
A documentary credit is separate from and independent of the underlying contract between the seller and the buyer, and the relationship between the issuing bank and the buyer. In general, therefore, the seller's breach of the underlying contract is no defence to the issuing bank (nor to the confirming bank). By the same token, the issuing bank cannot refuse to honour its undertaking just because of the buyer's failure to put it in funds. The principle of autonomy of the credit is enshrined in Article 4 of UCP 600 which provides that '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.'
Irrevocable credit
An irrevocable credit embodies a promise by the issuing bank to honour (pay) the credit upon the presentation of the documents specified in the credit (UCP 600, articles 2 and 7(a)). The UCP 600, article 2 defines a credit as 'any arrangement that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation'. In other words, it is an undertaking by the issuing bank that payment will be made provided the stipulated documents are presented and the terms of the credit met.
'Functional standard of verification' approach
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Mirror Image approach unworkable
A 'mirror image' interpretation of the strict compliance rule is probably unworkable in practice. Rejection of tendered documents becomes the norm. The latest rules (UCP 600) also contain a number of new provisions designed to ensure that documents are not rejected for overly technical reasons. For example, UCP 14(d) provides that data need not be identical in each document provided it does not conflict ie. Not a mirror image but not inconsistent. As to the description of goods, Art 18*c) provides that the description of goods in the Commercial Invoice must correspond with the description in the credit but that in all other documents the goods may be described in general (but not inconsistent) terms. Bankers have recognized the need for a more commercial approach for some time and this has lead the ICC to promote a more flexible approach to documentary compliance where the strict compliance rule is modified by "a functional standard of document verification" now enshrined in UCP 600 art 14 which provides that compliance of the stipulated documents on their face with the terms and conditions of the credit, shall be determined by international banking practice as reflected in the other Articles. This allows the credit to function as a payment instrument, something it cannot do when so many documents are rejected on first tender. The real difficulty is to identify the practices that reflect agreed international standards. The ICC resolved to address the issue. It May 2000 it established a task force to document international standard banking practice for the examination of documents presented under documentary credits issued subject to the UCP. The ICC has now produced a document attempting to identify some of these practices (ISPB International Standard Banking Practice for the Examination of Documents under Documentary Letters of Credit Jan 2003, and updated with the UCP rules in 2007).
Documentary credit (banker's commercial credit or commercial letter of credit)
A letter of credit is a document issued by a bank assuring payment to a seller of goods provided certain documents have been presented to the bank. A documentary credit is an arrangement whereby the issuing bank, at the request of the applicant (buyer), and on presentation of documents stipulated in the credit: • will make a payment to (or to the order of) the beneficiary (the seller), or • will accept and pay bills of exchange (drafts) drawn by the beneficiary, or • authorizes another bank to do these things. The documentary credit provides a means of avoiding some of the difficulties posed by the documentary bill. It represents a bank's assurance of payment against presentation of specified documents. The seller stipulates in the contract of sale that payment is to be made by documentary credit. The buyer then gets his bank to issue the credit in favour of the seller, so that the seller has the bank's independent payment undertaking. • The seller and the overseas buyer agree in the contract of sale that payment shall be made under a documentary credit. • The buyer (acting as the 'applicant' for the credit) requests a bank in his own country (the 'issuing' bank) to open a documentary credit in favour of the seller (the 'beneficiary') on the terms specified by the buyer in his instructions. • The issuing bank opens the credit and undertakes to pay, if documents specified in the credit, which relate to the goods, are presented (e.g. the bill of lading, insurance policy, invoice). The credit may be sent to the seller, but, more usually, the issuing bank instructs a bank (the advising or correspondent bank) in the beneficiary's country to inform the beneficiary that a credit has been opened. The issuing bank will be bound to the seller as soon as the advising bank advises the seller that the credit has been opened. • The issuing bank may also ask the advising bank to add its 'confirmation' to the credit. If the bank agrees to add its confirmation, and it may be under no obligation to do so, the advising bank (now called the 'confirming' bank) gives the seller a separate payment undertaking in terms similar to that given by the issuing bank and this gives the seller another - and local - course of action against the confirming bank, in addition to the action against the issuing bank. • The seller, who ships the goods, tenders the documents to the nominated bank either directly or, more often, through their own bank. The nominated bank is authorised to honour the credit (and may also be the advising bank). This does not put the nominated bank under an obligation to the beneficiary of the credit to pay, unless it is the confirming bank, or it has agreed to pay and this has been communicated to the beneficiary (UCP 600, article 12(a)). • If the documents conform to those stipulated in the credit, the nominated bank or confirming bank will pay. • Before releasing the documents to the buyer, the issuing bank will in turn seek payment from him. If he is not in a position to pay w/o first reselling the goods, the issuing bank may release the documents to him under a 'trust receipt', thereby giving the buyer access to the goods on arrival without destroying the bank's security interest in the goods and in the proceeds of sale.
Seaconsar Far East Ltd v Bank Markazi Jomhouri Islami Iran
Example of the strict compliance principle: Even apparently insignificant discrepancies will mean the bank must not pay. But the courts are willing to overlook a trivial defect in the tendered documents where there is a patent typographical error, or other obvious slip or omission: (eg. Bankers Trust Co v State Bank of India: one of the documents gave the seller's telex number as 931310 instead of 981310. Held: this is trivial because there is no doubt that this was a mere typographical error) cf: Beyene v Irving Trust Co Ltd (the credit clearly stated that each document had to contain certain particulars (the letter of credit number and the buyers name). The advising bank refused to pay relying on the fact that one of the documents, the list of the goods shipped, did not carry the letter of credit number nor the buyer's name. Held: while the discrepancies in the documents do not appear to be of any great significance, that is neither here nor there. It is hornbook law for bankers that the documents must appear on their face to be precisely in accordance with the terms and conditions of the credit'. A failure to do so on one of the documents could not be regarded as trivial and could not be cured by reference to other documents.
Forestal Mimosa Ltd v Oriental Credit Ltd
In cases where there is no such express exclusion of the UCP, the courts will endeavour to construe the express terms of the credit so as to avoid conflict with the rules of the UCP. (the credit was expressed to be subject to the UCP 'except so far as otherwise expressly stated'; but it was held that the UCP would only be overridden where there was an irreconcilable inconsistency between the express terms and the UCP.)
Glencore International AG v Bank of China
The effect of the judgment is that potentially all documents required to be original and submitted under letters of credit, unless handwritten or manually typed, must be marked as "original", failing which the paying bank is entitled to reject them and refuse payment. Since most documents are generated with a word processor, any such documents now in circulation and so produced carry the risk that, unless duly marked as "original", they will be rejected. (1. Bank of China rejected the documents presented by Glencore (through its bankers) on the basis that a beneficiary's certificate required under the terms of the credit was not "marked as original". The document in question was generated by the sellers' word processor, and was then copied many times. One copy only was then signed by the sellers for the purpose of submission under letters of credit. It did not bear the word "original", but bore an original signature in blue ink. The CoA upheld the rejection by Bank of China on the basis of the UCP 500 which states that documents produced or appearing to have been produced by "reprographic, automated or computerised systems" will only be accepted as original documents if marked as "original". A signature is irrelevant in this respect. 2. The issuing bank argued that the description o f the goods (aluminium ingots) contained in the commercial invoice ('Origin: Any Western brand -- Indonesia (Inalum Brand)') was inconsistent with that in the credit ('Origin: Any Western brand'). The CoA rejected that argument on the basis that the description in the commercial invoice fell within the broad generic nature of the description in the credit.)
Obligation of the Issuing bank
The key obligation of the issuing bank is to pay the seller against conforming documents, even if there is a breach of the sale contract. If the issuing bank wrongfully refuses to pay, the seller can bring an action for the value of the credit or the loss suffered as a result of the refusal.
Strict compliance
English common law adopts the principle of strict compliance. The doctrine of strict compliance means that any documents required by the credit must conform strictly to the requirements of the contract. This is important because: (a) banks can only be expected to be familiar with banking practices and not the underlying commercial practices or terminology; (b) the banks act as agents of the applicant and must remain within the terms of their mandate to ensure repayment; (c) allows banks to take quick decisions The requirement of strict compliance applies to all contracts arising out of the documentary credit transaction. In the words of Viscount Sumner in Equitable Trust Co of NY v Dawson Partners 'there is no room for documents which are almost the same, or which will do just as well.' Sellers need to be reassured that banks across the world will use the same standards when determining if the documents comply with the terms of the credit. The UCP 500 and its predecessors did not require strict compliance between the documents and the credit, and the UCP only lays down broad principles. The courts therefore look at standard international banking practice and at the International Standard Banking Practice for the Examination of Documents under Documentary Credits, which was produced by a taskforce appointed by the Banking Commission of the ICC. The principle of strict compliance applies to all contracts arising out of a documentary credit transaction: the underlying contract; the contract between the applicant and the issuing bank; the contract between the issuing (and confirming) bank and the beneficiary; and the contract between the issuing and correspondent bank. In summary, for the protection of the issuing (or confirming) bank and the applicant, the bank is only obliged to pay against strictly conforming documents, and is only entitled to reimbursement if the terms of the credit have been strictly complied with.
Test the courts apply in determining whether a discrepancy is trivial
The test would seem to be that a discrepancy is trivial where there is no ambiguity as to meaning, so that a reasonable banker would recognize the error and the true meaning. If the reasonable banker (assuming no knowledge of the underlying contract or the particular trade involved) would be uncertain as to the true meaning of the document, the discrepancy is material. Kredietbank Antwerp v Midland Bank: "the requirement of strict compliance is not equivalent to a test of exact literal compliance in all circumstances and regards all documents. To some extent, therefore the banker must exercise his own judgment whether the requirement is satisfied by the documents presented to him".
Kredietbank Antwerp v Midland Bank (Mirror image compliance)
There is evidence that the English courts have moved away from "mirror image approach" to strict compliance which had been the favoured approach for many years. The requirement of strict compliance is not equivalent to a test of exact literal compliance in all circumstances and regards all documents. To some extent, therefore the banker must exercise his own judgment whether the requirement is satisfied by the documents presented to him". (credit specified for "Draft survey report issued by Griffth Inspectorate at port of loading". The claimant accepted a draft survey report signed on behalf of Daniel C Griffith (Holland) BV, "member of the worldwide inspectorate group". Held: the document was conforming. Having referred to cases of "trivial" non-compliance referred to above he said "For these reasons, the requirement of strict compliance is not equivalent to a test of exact literal compliance in all circumstances and regards all documents. To some extent, therefore the banker must exercise his own judgment whether the requirement is satisfied by the documents presented to him". The courts have allowed some tolerance by not requiring mirror image compliance (that is, the use of exactly the same words), but only that the words used in one document should not be inconsistent with those used in another: Example: 'Coromandel groundnuts' is consistent with a document describing the goods as 'Coromandel groundnuts per order 3702' but not with one describing them as 'machine-shelled groundnut kernels'.
United City Merchants (Investments) Ltd v Royal Bank of Canada
Where the beneficiary or his agent is not aware of the untruth and has acted in good faith, the bank is obliged to pay as long as the documents 'appear on their face to be in accordance with the terms and conditions of the credit', notwithstanding that the bank may know of a dispute between buyer and seller as to the underlying contract of sale. The bank is not required to pay where there is compelling evidence of fraudulent presentation by the beneficiary or their agent. Lord Diplock: "The whole commercial purpose for which the system of confirmed irrevocable documentary credits has been developed in international trade is to give the seller an assured right to be paid before he parts with control of the goods and that does not permit of any dispute with the buyer as to the performance of the contract of sale being used as a ground for non-payment or reduction or deferment of payment." (The goods were shipped on 16 December. However, the credit specified that the last day for shipment was 15 December and so the carriers' agent fraudulently issued a bill of lading showing shipment to have been made on 15 December. The sellers knew nothing of this fraud. On presentation of the documents the confirming bank refused to pay on the ground that it had information suggesting that shipment had no t taken place on the day stated in the bill of lading. The sellers sued the confirming bank under the credit. But the documents conformed on their face and the Bank had to pay. Held: The instant case does not fall within the fraud exception, as the sellers had been unaware of the inaccuracy of the notation of the date at which the goods were actually shipped.)
Contractual relationships in a documentary credit
the underlying sale contract between the buyer and seller the contract between the buyer and the issuing bank under which the bank issues the credit, notifies and pays (either itself or through another bank) the seller, and the buyer undertakes to reimburse the issuing bank the contract between the issuing bank and the advising bank, under which the latter makes payments and remits the stipulated documents to the issuing bank, and the issuing bank reimburses the advising bank the contract between the issuing bank and the seller under which the issuing bank promises to make the payment the contract between the confirming bank and the seller in which the bank undertakes that that the seller will be paid against presentation of the stipulated documents.
Group Jose Re v Walbrook Insurance Co
A documentary credit may itself be illegal where its issue is prohibited or because of some supervening prohibition. A court would not give judgment for the beneficiary against a bank that refused to pay because the letter of credit was being used to carry out an illegal transaction, such as an illegal sale of weapons. It would not be sufficient for the bank to refuse payment merely because the legality was doubtful.
Documentary bill (bill of exchange)
A written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately (a sight bill) or on a fixed date (a term bill), for payment of goods and/or services received. The drawee accepts the bill by signing it, thus converting it into a post-dated check and a binding contract. The seller draws (i.e. writes) the bill, naming the seller as the person to whom payment is to be made (the payee). The bill is transmitted to the buyer along with a document of title to the goods, such as a bill of lading.
Article 17 of the UCP 600
Because the credit requires the presentation of certain documents the UCP recognises the likelihood that these may not be strictly speaking the original documents but may be photocopies or may be produced by computers. Thus Article 17 sets out that "A bank shall treat as original any document bearing an apparently original signature, mark, stamp, or label of the issuer of the document, unless the document itself indicates that it is not original." The Article also states that a bank will also accept as original a document that: "appears to be written, typed, perforated or stamped by the document issuer's hand; or appears to be on the document issuer's original stationary; or states that it is original, unless the statement appears not apply to the document presented." Note, an unmarked but clearly original document must be accepted, as the UCP is only concerned with the circumstances in which documents that appear to be copies and when they could be presented as originals. Crédit Industriel et Commercial v China Merchants: "documents which are obviously original, or which would have been accepted as original prior to the UCP must be accepted, even if they are produced by automated or computerised systems and not marked "original".
Strict compliance rule encouraging bad faith
Because the strict compliance rule allows documents to be rejected for insubstantial discrepancies this may facilitate or encourage what has been described as 'bad faith rejection of documents. Although the bank may approach the buyer for waiver of the discrepancy, it may not be in the buyer's wider commercial interests to agree to this, for example, where the market has fallen and he can now obtain the same goods at a lower price.
Hamzeh Malas v British Imex Industries
Court applying the principle of autonomy of the credit: A documentary credit is separate from and independent of the underlying contract between the buyer and the seller and the relationship between the issuing bank and the buyer. "A confirmed letter of credit constitutes a bargain between the banker and the vendor of goods, which imposes on the banker an absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to contract or not". A vendor of goods selling against a confirmed letter of credit is selling under the assurance that nothing will prevent him from receiving the price. (Jordanian buyers agreed to purchase from British sellers a quantity of steel rods, to be delivered in two instalments. B complained first installment defective and sought injunction to restrain S from drawing on second credit. Refused. Concern that the whole system would break down if a dispute under the sale contract could have the effect of freezing the sum in respect of which the letter of credit was opened.)
Bank Melli Iran v Barclays Bank DCO
Example of strict compliance principle: (Credit called for tender of documents evidencing shipment of "sixty new Chevrolet trucks". The documents tendered included an invoice which described the trucks as "in new condition", a certificate which described them as "new, good, Chevrolet trucks" and a delivery order describing them as "new (hyphen) good". Bank Melli claimed Barclays were in breach of mandate by paying against nonconforming documents. Held: the bank should not have been accepted it, the descriptions in the tendered documents were inconsistent with each other and that the tender was bad. The stipulation in a credit that the goods were 'new' was not met by the tender of documents describing them variously as 'in new condition', 'new, good' and 'new good)
Problems with documentary bills
If the buyer does not honour the bill, the document of title (the bill of lading) must be returned and property will not pass (s.19(3) SGA 1979). However, the unscrupulous buyer might retain possession of the bill of lading and wrongfully resell the goods to a third party. This is conversion by the buyer, but the third party may acquire good title under the exceptions to the nemo dat quod non habet rule. To avoid the risk of a fraudulent buyer passing title to the goods to a third party, the seller may instruct his own bank (the 'remitting bank') to deliver the bill of lading and other shipping documents to the buyer in his own country and, as a precondition to the release of those documents, collect the price from him, ie by acceptance or payment of the bill of exchange. If the remitting bank does not have an office in the buyer's country, it may instruct a local bank (the 'collecting bank') to perform this task as its agent. In this situation, according to general principles of agency law, there is privity of contract between the seller and the remitting bank, and also between the remitting bank and the collecting bank, but not between the seller and the collecting bank. The International Chamber of Commerce has issued Uniform Rules for Collections, which, if incorporated by the parties into the sale contract, govern the relationship between the seller and the remitting bank and between the remitting and collecting banks. In most cases the remitting bank will discount the bill of exchange before acceptance or payment by the buyer. A bill of exchange is discounted when the bank credits the seller's account with the full amount of the bill or when the bank agrees to advance to the seller a percentage of the face value of the bill but withholds the balance until the bill is paid by the buyer. This has the advantage of releasing funds to the seller at an earlier date than if he waited for the bill of exchange to mature. But the remitting bank will usually retain a right of recourse against the seller: if the buyer dishonours the bill of exchange by non-acceptance or non-payment, the bank can sue the seller on the bill. This highlights the real disadvantage, from the seller's point of view, of payment under a documentary bill which is collected by, or discounted to, a bank: the buyer may accept the bill of exchange so that the bill of lading will be released to him, yet the seller has no assurance that the buyer will pay when the bill matures. Documentary credits provide a solution to this problem.
Effects of non-compliance
It is a matter for the bank - not the applicant - to determine if the documents conform, but having identified a discrepancy the bank may approach the buyer for a waiver (UCP 600, article 16(b)). The buyer may choose not to waive non-compliance and the motive for doing so is irrelevant. • The impact that strict compliance has had on the system of payment by documentary credit is an estimated 70% of documents initially presented to banks are discrepant. • However, the strict compliance rule is commercially convenient in that it enables banks to make quick decisions about the documents presented to them. In many cases discrepancies are easily remedied by the seller and the documents represented to the bank. The seller usually has time do this because the bank must specify all of the discrepancies in a notice of rejection which must be given no later than the close of the fifth banking day following receipt of the documents, ie, the beneficiary can cure defects and tender documents again as long as the credit has not expired.
UCP
The Uniform Customs and Practice for Documentary Credits (the UCP) is a set of rules governing the use of documentary credits. The most recent version was produced by the International Chamber of Commerce (ICC) in2006 (known as UCP 600) replacing the UCP 500. The ICC was established to facilitate international trade and the objective of the UCP is to pursue this objective through the codification of best practice in international payments. That is, it is intended that the UCP should establish a degree of uniformity that is not affected by the particular country or legal system within which the rules are being applied. The UCP have no legal effect unless incorporated into a contract by the parties (UCP 600, article 1), although in the unlikely event of there being no clause incorporating the UCP, it seems likely that a court would imply them or, at least, construe the contract in accordance with the UCP - assuming this did not contradict the intention of the parties. If the UCP are incorporated particular provisions can be excluded, either wholly or partially, by express terms of the contract and by legislation. But contractual exclusions are likely to be viewed with caution by the courts. The UCP does not have the force of law. The parties are free to incorporate all or any of the UCP rules into their contracts and, if incorporated, the UCP 'Will govern all aspects of documentary credit arrangements except the relationship between the applicant and the beneficiary under the underlying contract, eg between buyer and seller, here the underlying contract is one of sale, as this contract does not usually incorporate the UCP.
JH Rayner & Co Ltd v Hambro's Bank Ltd
The credit stipulated Coromandel groundnuts, but the seller presented a bill of lading for machine-shelled groundnut kernels and an invoice for Coromandel groundnuts. Even though within the trade these terms were interchangeable, the bank was entitled to refuse payment because it could not be expected to have notice of all the trade customs involved in the transactions that underlie the documentary credits with which it might deal. Moreover, banks cannot be expected to be able to distinguish between minor and material discrepancies. • Furthermore, the parties have not agreed that the bank should have any discretion over what is required for compliance. In general terms, this approach fits in with the separation between the underlying contract and the credit, which means that the banks do not have to concern themselves with the performance of the underlying contract. Finally, the banks are agents of the applicant and so must adhere to the terms of their authority: failure to do so will mean the applicant has no obligation to reimburse.
Exception to the Autonomy of the credit rule
United City Merchants (Investments) Ltd v Royal Bank of Canada: Fraud -- The bank may refuse payment where there is compelling evidence of fraudulent presentation by the beneficiary or their agent. • Lord Diplock explained the rationale for the fraud exception in terms of an application of the maxim ex turpi causa non oritur actio (fraud unravels all). The courts will not allow their process to be used by a dishonest person to carry out a fraud.
Equitable Trust Co of NY v Dawson
Viscount Sumner: "There is no room for documents which are almost the same, or which will do just as well". (The credit called for payment against certain documents including 'a certificate of quality to be issued by experts'. The seller tendered a certificate of quality issued by a single expert. The seller was paid. When the issuing bank tendered the certificate to the buyers, they refused to pay on grounds of non-compliance with the credit. In fact, the seller had been fraudulent and shipped mainly rubbish to the buyers. The HoL ruled in favour of the buyers.)