Letters of Credit – Reconciling Legal Rules with Commercial Realities

Prof Jason ChuahCity University London

A bit of history

* Origins not very clear – Ancient Babylonian (a clay promissory note dating back to 3000 BC) and Egyptian (248 BC); Ancient Greece – banks were issuing documentary letters “ “on correspondents with the view to obviating the actual transport of specie in payment of accounts”.

* 13th century Marco Polo reported that the negotiable letter was a “way... the Great Chan can have and indeed does have more treasures than all the kings in the world”

* 14th century – Medici banks in Bruges and Italy

* 19th century – virtual monopoly by British banks

What is an LC?

Method of trade finance Sale contract (usually cross border – reason: trust)

Buyer (applicant) Seller (beneficiary) Issuing Bank (payer)

In order to paid, seller must tender conforming documents evidencing its performance of the sale contract.

Two key principles

Principle of Autonomy Sztejb v Henry Schroeder Banking Corp Fraud Exception – narrowly construed (The

American Accord (1983)) Principle of Strict Compliance

A means to control fraud and forgery? A matter of construction? No non-documentary conditions can be required by

the LC

Trends and developments

Use of LC in decline in intra-EU trade High rate of rejection; fear of fraud Protection from credit crunch? More creative use of the LC

As a guarantee for conventional (high risk) lending As a no-questions asked payment instrument

Legal status of the LC

Not a negotiable instrument, not a promissory note, not a bill of exchange

Is is a contract? Requirement for consideration? Definition of consideration – act for an act, a

promise for a promise, a promise for an act, an act for a promise

What consideration has been provided by the beneficiary?

Does it matter?

To enforce a bare promise – issues How to construe the promise – presumed intention

test in this context Legal intent from form Status or position of the promisor becomes crucial?

Marubeni v Mongolia

Creative use – legal response?

Sirius v FAI [2003] EWCA Civ 470 Use non-documentary conditions admitted

Mahonia v Morgan Chase Bank [2003] EWHC 1927 Illegality as a justification for not paying

Marubeni v Mongolia [2005] EWCA Civ 395; also Meritz Fire and Marine Insurance Co Ltd v Jan De Nul Nv [2011] EWCA Civ 827 Construction of the documentary requirements –

seems to depend on the status of the issuer

Fear of fraud

Limits of the research – empirical work needed Much work concentrates on the problem of fraud and

abusive calls (in the context of demand guarantees) and makes the following criticisms Banks do not police fraud Misplaced belief that documentary conformity

means absence of fraud Forgery easy to commit Large value deals constitute an irresistible

temptation to fraudsters All or nothing approach – only fraud by the

beneficiary will suffice (bad faith will not)

Commercial Realities

Any alternatives?Trust in international trade – thrombosis will occur? (Donaldson LJ)

Why the arm's length approach by banks Should liability be attached to the act of giving

money? A payment instrument not a method of trading Blame not the LC but the system? Time is essential Commercial certainty A new unified code to limit LC law to trade in physical

goods?

Thank you very much.

Questions are very welcome:

Jason.Chuah.1@city.ac.uk