Banks Deal with Documents and Not with Goods or Services to Which the Documents May Relate - Coursework Example

Introduction Under a sales contract, a letter of credit (LC) is a payment that is initiated at the buyer’s request and instructs the bank to issue credit for the seller.1 Through this process, the bank is committed to offer payment towards the seller2 according to the terms and conditions of the credit. However, because of the long time between issuing the letter of credit and receiving the payment, there may be issues that affect three relationships: between the seller and buyer, the buyer and the bank and the beneficiary and the bank.3 This essay seeks to analyse the role of banks in issuing letters of credit when the beneficiary demands payment. The limitations of the bank’s role in dealing with documents without exceeding these limits in the light of judiciary’s view will be discussed.4 This is divided into three sections: the principle of independence in the bank’s role in complying with the documents, analysing the doctrine of strict compliance and the position of the bank in interpreting the doctrine and the bank’s duty in relation to the exceptions to the above doctrines. 2. The Principle of Independence 2.1 General overview As Goode highlights, the principle of independence, or the principle of autonomy, is the most essential principle of a document of credit (DC).5 It is not an exaggeration to say that the true benefits of the LC go hand-in-hand with this principle. It is the “cornerstone of the law relating to a letter of credit”.6 This means that an LC is separate and independent from underlying contracts between the credit’s parties7. In Nareerux Import Co. vs. Canadian Imperial Bank of Commerce8, the Court of Appeal stated: “A letter of credit thus exists in the context of three separate and distinct agreements: (i) the underlying contract between the buyer and seller; (ii) the contract between the buyer and the bank and (iii) the contract between the bank and the beneficiary…these contracts are separate and independent from each other”.9 In fact, the main purpose of the credit document is to create an ‘abstract payment’ commitment.10 Therefore, the rights and obligations resulting from the DC do not depend on the relationship between the seller and the buyer, with the former fulfilling his contractual obligations towards the latter.11 Generally, not carrying out some or all of these obligations does not give the buyer the right to ask the bank to withhold payment to the seller as long as the documents presented by the beneficiary are compatible ‘on their face’ with the LC12. This is true unless it does not fall into any of the exceptions13 that will be discussed in Section 3 of this essay. Therefore, the commitments of both the confirming bank and the issuing bank are considered in regards to the documents and not the goods. This has been confirmed in the Sztejn vs. Henry Schroeder Banking Corporation 14 case, where the court stated that: “It is well-established that a letter of credit is independent of the primary contract of sale between the buyer and the seller. The issuing bank agrees to pay upon presentation of documents, and not the goods. This rule is necessary to preserve the efficiency of the letter of credit as an instrument for the financing of trade.”15 Moreover, Act 4(a) the UCP 600 states that a credit is a separate transaction from any other underlying contract, and banks are not bound to such contracts. Therefore, the role of the bank is to honour, negotiate or fulfil obligations under the credit.16 However, the bank, as a plaintiff or defendant, in the case regarding the LC, does not have the right to plead its relationship with the other bank or with the buyer. This is true even in the case when the buyer does not pay for the LC.17 2.2 Case Laws under the Principle of Independence The sanctity of the LC and its separation from any contractual relations between the credit parties has been emphasized in many case laws18. This makes independency of the bank’s role related to the DC very clear. Thee role of a bank is related to the documents only and not to any goods, services or performances related to these documents.19 In the Power Curber International Ltd. vs. National Bank of Kuwait S.A.K20 case, the sanctity of the credit documents and necessity for the parties to comply, even in the case of a court order that may affect independence, was discussed. In this case, the buyers, who were Kuwaiti distributors, bought machinery from the claimant. The National Bank of Kuwait issued an irrevocable LC in favor of the seller. After contractual disputes between the seller and buyer, a Kuwaiti court made an order of ‘provisional attachment’ of the sums due to the plaintiffs that was payable by the defendant’s bank under the letter of credit. This banned the defendant’s bank from receiving payment under the LC, whether inside or outside of Kuwait. Although the bank protested and appealed against the order, the lower court rejected it and the Court of Appeal upheld this rejection. The Kuwait National Bank, which had a branch in London, was sued by the beneficiary. The English court gave judgment against the bank and the Court of Appeal upheld the decision. Lord Denning stated that: “It is vital that every bank that issues a letter of credit should honour its obligations. The bank is in no way concerned with any dispute that the buyer may have with the seller….A letter of credit is like a bill of exchange given for the price of goods. It ranks as cash and must be honoured.”21 This case stresses the bank’s specified obligation towards the LC is to fulfil the payment, although the final judgment prevented payment from occurring. This means that despite any standing cases between the parties, the bank should respect its independent duty. Lord Denning supported this opinion by stating that the LC should have been treated as cash because an LC resembles a bill of exchange. But there seems to be a misunderstanding with this point due to the differences between the LC and bill of exchange22. First, the independence of the LC is clearer and is a standalone letter by itself. This means that the bank’s role is restricted only in confirming compliance of the documents presented by the beneficiary with the terms and conditions of the LC. This leads to payment unless any exceptional cases exist.23 However, in regard to the principle of autonomy, both the issuing bank and the confirming bank, pay attention only to the documents presented by the beneficiary and their compliance; this is followed by either payment or rejection. In Hamzeh Malas & Sons vs. British Imex Industries Ltd.,24 the claimant was contracted to buy steel from a British company in two instalments. The payment was arranged to be made with a LC, which the buyer issued in favour of the seller. After the buyer had received the first instalment, he found out that the goods were defective and were not compatible with the sale contract. This resulted in asking for an injunction to withhold payment under the LC. However, the court rejected to grant the injunction. In this case, Lord Jaklins stated that: “...it seems to be plain enough that the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon 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.”25 Despite the fact that there was a breach in the sale contract, according to Lord Jaklins, supporting business confidence leads to the need of independence of the LC in order to have absolute payment for the beneficiary, regardless of any dispute between the parties.26 Consequently, the duty of the bank is specified in the complying documents, with the LC independent from the underlying contract and all surrounding circumstances. This holds true unless there is an exception, either illegitimacy or fraud; however, this will be discussed in detail later. The recent decision in the Nareerux Import Co. vs. Canadian Imperial Bank of Commerce27 case clearly emphasizes that the bank's role of not confirming the documents if influenced by extraneous elements.28 Moreover, as the trial judge observed, the limits of the bank’s duties towards the beneficiary under the LC lie in complying with the provided document’s terms and conditions. This is followed by either payment or rejection, without extending these limits to be affected by any dispute that may occur between the buyer and the beneficiary, or the buyer and the bank. The Court of Appeal stated: “This obligation to pay is a duty that the bank owes the seller. The obligation of the issuing bank (or the confirming bank) is to pay if the terms and conditions of the letter of credit have been carried out by the seller. This obligation must be carried out irrespective of any dispute between the buyer and seller or between the bank and customer. This has been referred to as the autonomy of the credit transaction.”29 In the above cases, the stability of judiciary’s approach is apparent towards the bank’s role regarding the documents of credit provided by the beneficiary. This is to approve their conformity with the terms and conditions of the LC irrespective of the surrounding circumstances of the contractual relations between the parties. This role is restricted to documents without relating to any goods. Moreover, the necessity to support international trade by allowing the seller to have confidence of obtaining his rights in exchange for the sold items by having the LC is emphasized. It is believed that despite the importance of giving such confidence to the seller in good faith, it should not lead to complete inconsideration of the buyer, whose part is significant in the nourishment of international trade, particularly with the increasing approaches of the courts towards the sanctity of the principle of independence that the judiciary, as Goode has said, has become so beguiled with it.30 3. The Doctrine of Strict Compliance 3.1 General Overview “There is no room for documents that are almost the same, or which will do just as well... if the bank does as it is told, it is safe; if it declines to do anything else, it is safe; if it departs from the conditions laid down, it acts at its own risk.”31 This is the meaning of strict compliance that was developed by Lord Sumner in 1927.32 In other words, the bank is obliged to comply precisely with the offered documents by the beneficiary in order to get the amount of money in the LC, with the terms and conditions stated in the credit. This principle is regarded as another essential principle of credit documents that partakes with the principle of independence in determining the bank’s role in dealing with the documents only, and not goods, services or performance. The aim of the LC is to guarantee immediate payment to the beneficiary without considering conditions surrounding other contractual relations between the two parties. While the principle of independence, as seen above, tends to be in favour of the seller rather than the buyer, the strict compliance principle offers the buyer a guarantee by confirming compliance between the documents that the beneficiary presented and the terms and conditions stated in the LC.33 The question here is that to what extent the bank respects its role in dealing with these documents in the light of judiciary system. This issue will be looked at in the following cases. 3.2 Case Law under the Doctrine In Equitable Trust Company of New York vs. Dawson Partners34, which involved the buyer (defendant) and the bank (plaintiff), the purchaser bought vanilla from the seller in Indonesia and established an LC in favour of the vendor. The credit required presentation of a certificate of quality issued by the Dutch Government and signed by the Chamber of Commerce in Batavia. However, the certificate, which was provided by the beneficiary, was issued by an expert and certified by the Commercial Association of Batavia without being signed by the Chamber of Commerce. After the seller received payment, the buyer discovered that fraud had been committed and that the bank gave payment despite the non-compliance of the quality certificate, which was stated in the LC. For this case, Lord Sumner stated that: “It is both common ground and common sense that the accepting bank can only claim indemnity if the conditions on which it is authorized to accept are in the matter of the accompanying documents and is strictly observed. There is no room for documents that are almost the same, or which will do just as well.”35 The J.H.Rayner & Co. Ltd. vs. Hambros’s Bank Ltd.36 case involved a Danish buyer, who issued an LC in favour of an English seller, and included goods of “Coromandel groundnuts.” The beneficiary presented a bill of lading, which stated “machine–shelled groundnut kernels”. The bank rejected to pay on the grounds of non-compliance and, as a result, the beneficiary sued the bank claiming that it is widely known in trade that the two terms are synonyms. In this case, Atkinson accepted the beneficiary’s evidence and judged in his favour. The bank appealed and indicated that it had no knowledge regarding trade between the buyer and vendor. Also, there was an obvious difference between the bill of lading and the invoice. The Court of Appeal dismissed the decision of the lower court and held the view that “a bank is under no duty to know the trade customs and trade terms of its customers.”37 In the view of Mackinnon L.J: “The words in that bill of lading clearly are not the same as those required by the letter of credit. I think that the bank was entitled to refuse to accept this sight draft on the grounds that the tendered documents did not comply precisely with the terms of the letter of credit which they had issued”. 38 In light of this case, it is clear that the bank’s obligation does not exceed caring for documents in their compliance. As Carr explained, in the view of the fact that the bank is not responsible for recognizing trade customs and terms, the provided documents must accurately comply with the requirements mentioned in the LC.39 The question raised here is what the extent of the bank’s commitment to this principle is in the case of when the bank’s knowledge of these terms exists. In other words, the issue is whether the bank should consider or neglect this knowledge when complying with documents. According to Goddard L. J., the bank’s knowledge of such terms and customs does not affect the judgement of the case when taking into consideration that the buyer, by requesting the issuance of the LC, has his own reasons for choosing a specific term rather than any other terms.40 Thus, the bank should respect the buyer’s request41 and honour its duty by complying with documents and not acting according to its own knowledge when, except in exceptional cases, this exceeds the extent of this duty. In a more recent case, Credit Agricole Indosuez vs. Chailease Finance Corp42, the bank (defendant) issued a LC in favour of the claimant. The agreement of sale was made on the 31st of July, 1998. The bank rejected to pay because “...the date of delivery of the vessel was stated in the bill of sale and the signed acceptance of sale to be 21st of August 1998, when the letter of credit stated that the vessel ‘was for delivery on August 17–20th 1998’”.43 In this case, the court pointed out that the date of delivery was not part of the description of the goods; therefore, the presented documents complied with the terms and conditions of the credit.44 It stated that: “...it is plain to see that in this case each of the individual documents presented was, on its face, compliant with the requirements of the credit. The letter of credit does not state that the documents, and in particular the acceptance of sale and bill of sale, have to show that the vessel has been delivered within any range of dates, … if it had been intended that the bank was obliged to pay only against documents showing that delivery of the vessel had been effected by a particular date, that could readily have been provided for.” 45 This case, which is contrary to the above cases, is not because it was not on the side of the bank, but because the bank went further than the DC stated. The checking of the documents was accompanied with a kind of analysis without consideration to the limits of its role that required only complying with the documents. Therefore, the Court of Appeal upheld the decision of the lower court and stated that, “each of the individual documents presented at face value was compliant with the requirements of the credit. It can be said that the approach of judiciary has been clear and accurate with regards to the bank, when dealing with a DC, by limiting its role to only dealing with the documents and strictly complying them without exceeding this role. This is true even in the case of when there is no convincing reason for rejection, such as on the basis of differences of terms, which may be familiar for almost everyone. For example, in the case of Bank of Italy v. Merchants National Bank46, in which there was a difference in the terms “raisin” and “dried grape”, the court accepted the bank’s refusal to pay due to incompliance. 4. Exceptions to the Rule As discussed above, the bank’s role remains in confirming the rendered documents at their face value followed by payment in the case of compliance. However, there are two exceptions to this principle: fraud and illegality. 4.1 Fraud Exceptions Fraud issues in banking transactions are not regarded as something new, but, as Jones stated, “… as old as banking itself”.47 Despite its long prevalence and significance in LC, the UCP 600 has not clearly considered this matter.48 As for the practical execution of this exception from the judiciary side,49 it is apparent that it had been narrowed down in its scope by the judiciary by making it applicable only in exceptional cases50 that require the existence of clear evidence that the beneficiary of the LC knows about.51 This will be discussed in the following cases. 4.1.1 Evidence of Fraud is clear In Discount Records Ltd. v Barclays Bank Ltd.,52 the plaintiff ordered a particular amount of cassettes and records from a French firm. A letter of credit for the benefit of the seller was requested to be issued. After receiving the goods, the buyer found out that there was fraud; some crates of goods were rubbish, while some were empty. In general, the buyer had only received 25 percent of the underlying contract. Therefore, the buyer sought to have an injunction issued to prevent the bank from paying the LC. However, the court rejected this and pointed out that the plaintiff had to show “sufficiently grave cause” to be granted the injunction.53 According to the view of the case, there was no room for an allegation of fraud to prevent the mechanism of payment under the LC. In other words, fraud has to be proved. In this case, no fraud was established; there was only an allegation of fraud.54 It is well known that the buyer, in such a situation, may find it difficult to provide evidence. In turn, this secures the beneficiary’s position to obtain the amount of payment in the LC, even with the existence of fraud. In this case, although the issuing bank was present during the inspection of goods, it seems that the court did not consider this sufficient evidence for the existence of fraud.55 Accordingly, this puts the buyer at risk and indicates that it may influence the degree of trust in international trade credibility. From a contrary view, this case analyses the degree of evidence of fraud as an accepted requirement to protect the role of credit documents in international trade. It seems that more balance is needed between the interests of the two parties. 4.1.2 The Bank’s clear Knowledge of the Fraud While complying rendered documents to give payment, the existence of fraud may become apparent. In this case, the bank is entitled to reject payment as long as it has clear knowledge.56 As Browne L.J. explained in Edward Owen Ltd. v. Barclays Bank Ltd., 57 the “...exception is that where the documents under credit are presented by the beneficiary himself, and the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled to refuse payment”.58 Furthermore, Geoffrey Lane L.J. stated that “the only circumstances which would justify the bank not complying with a demand made under that agreement would be those… if it had been clear and obvious to the bank that the buyers had been guilty of fraud”.59 4.1.3 The Beneficiary himself is Fraudulent or is aware of Fraud The bank’s knowledge and clarity of fraud evidence are not sufficient enough for the bank to prevent payment, unless the beneficiary himself is fraudulent or is aware of fraud. Other than this case, the beneficiary is entitled to the payment of the LC despite evidence of fraud.60 In the case of United City Merchant Ltd. v. Royal Bank of Canada,61 despite the presence of fraud in the bill of lading, according to the House of Lords, the beneficiary was entitled to receive payment and the bank did not have the right to stop payment. This was because the fraud was committed by a third party, the loading brokers, without the knowledge of the beneficiary.62 4.2 Illegality The other exception to the principle of autonomy is illegality. The bank’s obligation, whether it is the issuing or confirming bank, is to honour its duty to comply with the rendered documents under the terms and conditions of the credit. This obligation is limited, which means that banks are not permitted to go beyond this duty. However, under illegality, this obligation is restricted.63 In Group Josi Re v. Walbrook Insurance Co. Ltd.,64 the case dealt with reinsurance contracts as the underlying contracts; these contracts were unlawful under English law. In this case, Staughton L.J. stated that: “… if the reinsurance contracts are illegal, and if the letters of credit are being used as a means of paying sums due under those contracts, and if all that is clearly established…Court would do so [restrain a bank from making a payment]. That would not be because the letter of credit contracts were themselves illegal, but because they were being used to carry out an illegal transaction”.65 However, the inquiry here is which law should be applied, particularly in a relationship of more than one state. In fact, the UCP 600 has not dealt with this matter.66 In this position, an example will be mentioned of an English judiciary and another of an American judiciary. The case of Power Curber International Ltd. v National Bank of Kuwait67 was considered by the English judiciary and enforced the LC, which was payable in North Carolina. In J. Zeevi and Sons Ltd. v. Grindlays Bank (Uganda) Ltd.,68 the government of Uganda issued an order for the issuing bank to prevent it from making payment on the LC due to the nationality of the beneficiary (Israeli). The Court of Appeal in New York did not consider this matter because the applicable law and the place of execution were both located in New York.69 In cases where the banks have branches under two jurisdictions, there is no clarity regarding which law should be applied when the beneficiary seeks to make payment on the LC. As seen in the above cases, the subject matter of illegality differs between jurisdictions. In other words, what is illegal in one jurisdiction may not be illegal in another. 5. Conclusion The bank’s obligation towards credit documents is independent in complying with the rendered documents. The buyer is not entitled to interfere without the beneficiary’s consent, or to delay or prevent payment under the LC. Furthermore, the effect of the credit parties on the bank’s relations does not extend to the independence of documents. In the opinion of the judiciary, the independence of the bank’s role is to give the seller assurance that there will be nothing to prevent payment in a confirmed LC. However, the courts believe that, in the absence of this principle, financing of trade operations may break down in the event of a dispute between the seller and buyer.70 Business confidence leads to the need of independence of the LC to have absolute payment for the beneficiary, regardless of any disputes between the parties. Consequently, the duty of the bank is specified in complying documents with the LC independently from all surrounding circumstances, unless there are any exceptions, either illegality or fraud. But, even in the case of fraud, the court tends to narrow its effect in favour of the seller. The judiciary does not permit either the bank or buyer to prevent the beneficiary from receiving payment despite forged documents.71 While this secures the seller and guarantees his rights regardless of the presentation of the worthless documents, it does put the buyer at risk. Apparently, this is an unfair equation for the buyer as it leaves him under the seller’s mercy.72 On the other hand, it will certainly reflect negatively on international trade, which considers the buyer as one of its essential participants. It seems to be that more balance regarding the independence principle is needed. In order for the lifeline of commerce to flow uninterrupted, the UCP 600 holds that banks only need to verify the documents related to the underlying contract and not the goods, services and performance related to the documents. Bibliography: Books Bose C, Business Law (PHl learning 2010). Carr I, International Trade Law (4th ed Routledge-Cavendish 2010) 468. Gao X, The Fraud Rule in the Law of Letters of Credit: A Comparative Study, (Kluwer Law International 2002). Goode R, Commercial Law (4th edn, Lexis Nexis 2010)> Horowitz D, Letters of Credit and Demand Guarantees: Defences to Payment (oxford university press Inc. New York ,2010). Mugasha A, The Law of Letters of Credit and Bank Guarantees (The Federation Press, Sydney 2003). Thesis Karl A, ‘Letters of Credit and The Doctrine of Strict Compliance ’ (DPhil thesis, University of Uppsala 2004) . Michelle K L, Selective Legal Aspects of Bank Demand Guarantees, (Doctor of Law thesis, University of South Africa 2008). Toth Z, ‘Documentary Credit in International Commercial Transactions With Special Focus on the Fraud rule’, (DPhil thesis, The Faculty of Law- and Political Sciences 2006) Journals Dixon W M, As good as cash? The diminution of the autonomy principle, (2004). Australian Business Law Review, 391. Garcia RL G, the Autonomy Principle of Letters of Credit,(2009) Mexican Law Review Vol. III, No.1,67. Hsu C H, The Independence of Demand Guarantees, Performance Bonds and Standby Letters of Credit, ( 2006), National Taiwan University Law Review, Vol. 1: 2. Ulph J, The UCP 600: documentary credits in the 21st century (2007) J.B.L. 355. Lee R J, Strict Compliance and the Fraud Exception: Balancing the Interests of Mercantile Traders in the Modern Law of Documentary Credits, (2008) MqJlBLaw 137. Ward A and Wight R, Tortious liability of an Advising Bank in the Letter of Credit Transaction', (1995) J. Int'l Banking L.,136. Legislative and Convention measures: The Uniform Customs and Practice for Documentary Credits 600 (UCP 600) comes into effect on 01 July 2007. Table of Cases Bank of Italy v. Merchants National Bank, [1923] 236 N.Y. 106 (C.A.) Credit Agricole Indosuez v Chailease Finance Corp [2000] C.L.C. 754 Discount Records Ltd. v Barclays Bank Ltd. and Another, [1975] 1 W.L.R. 315. Edward Owen Ltd. v. Barclays Bank Ltd and Another [1977] E. No. 1065. Equitable Trust Co. of New York v. Dawson Partners Ltd, [1927] 27 Lloyd’s Rep 49 Group Josi Re v Walbrook Insurance Co Ltd and Others [1996] 1 W.L.R. 1152. Hamzeh Malas & Sons v British Imex Industries Ltd,[1958] 2 Q.B. 127. J. Zeevi and Sons Ltd v. Grindlays Bank (Uganda) Ltd., [1975] 37 N.Y. 2d 220 J.H.Rayner & Co Ltd v. Hambros’s Bank Ltd, [1943] K.B. 37 Nareerux Import Co. Ltd. v. Canadian Imperial Bank of Commerce, [2009] ONCA 764. Power Curber International Ltd. v National Bank of Kuwait S.A.K [1981] 1 W.L.R. 1233 Sztejn v. J. Henry Schroeder Banking Corp [1941] 31 NYS 2d 631 United City Merchants (Investments) Ltd v Royal Bank of Canada, [1983] 1 A.C. 168. Website John F and Dolan, A Principled Exception to the Strict Compliance Rule in Trilateral Letter of Credit Transactions , Wayne State University Law School Legal Studies Research Paper Series No. 08 < http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1 088834&http://www.google.co.uk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=9&ved=0CFEQFjAI&url=http%3A%2F%2Fpapers.ssrn.com%2Fsol3%2FDelivery.cfm%2FSSRN_ID1088834_code745030.pdf%3Fabstractid%3D1088834%26mirid%3D1&ei=xIyDT8GqGoaj8gP_493mBw&usg=AFQjCNH7prKEJgOrsuujqbo1mmTWqwGb6A> last assessed on March 28, 2012 Read More