Documentary Credit in International Sale of Goods - Research Proposal Example

Documentary Credit Documentary Credit in international sale of goods Introduction Documentary credit differs from other payment methods in international sale of goods by eliminating the risk of non-payment by the buyers and fraud by the sellers since the principle of autonomy separates the credit from any defects in the underlying contract while the principle of strict compliances eliminates possible fraud by the seller by requiring the documents to be represented in stipulated form.1 The method differs from other payment settlement methods since it is not linked to the sales transactions. The payment method obliges the issuing bank to pay to a beneficiary a specified sum of money upon the presentation of documents specified in the credit.2 Documentary credit is different from other methods of payments since it ensures prompt payments and eliminates fraud due to its principle of autonomy and strict compliance in the legal framework. Legal framework of documentary credit In international sale of goods contract, the seller faces the risk of prompt payment by the buyer while the buyer faces the risk that the goods may not conform to the specified quality and quantity.3 The bank’s payment undertaking is not subject to the sale contract or the quality or quantity of goods, but is on the compliance of the seller’s documents.4 By the use of documentary credit, the seller is assured of prompt payment by presentation of the compliance documents before the bank and the buyer avoids prepayment of the entire amount of purchase prior to shipment without any assurance of satisfactory performance of the sales contract.5 The legal framework of documentary credit had developed mainly through custom and many of the rules have emerged from the customs of bankers, exporters and importers, shipping and insurance industries involved in international trade.6 The customs are embodied in Uniform Customs and Practice for Documentary Credits (UCP) rules developed by the International Chamber of Commerce (ICC), the Uniform Rules for Contract Guarantees (URCG), and Uniform Rules for Demand Guarantees (URDG) and the International Standby Practices (ISP98). The current UCP 600 rules outlines that rules are binding on all parties unless expressly excluded by the credit and the credit is independent of the underlying transactions while the banker deals with documents and not the goods. UCP 600 came in to force in 1st July, 2007 in order to solve problems encountered in previous versions, but still remains silent on the issues of fraud.7 The legal framework of documentary credit in effecting payments breaks in to four separate contracts. The first is the underlying contract that is separate from the contracts involved in the letter of credit.8 The second is the obligation under contract of sale where applicant instructs its bank (issuing bank) to open credit in favour of seller. The is the issue of credit in favour of the seller by the issuing bank and this is an irrevocable contract under UCP 600 unless varied as long as the seller tenders the required documents. The fourth is the issuing bank contract with corresponding bank in the seller’s country where the second bank is reimbursed for risk it undertakes by the issuing bank. The documentary payment mechanism is anchored in UCP 500 Article 4 that states that banks deals with documents and not the goods or performance which the documents relate. Article 4 of UCP 600 provides that credit is separate from sales transactions and issuing bank should discourage applicants from making copies of underlying contract or pro-forma invoices an integral part of the credit.9 The third element is the strict compliance with terms of documentary credit and documents since issuing and confirming banks are barred from acting outside their authority. UCP 600 contemplates that payments can be effected at sight, incurring deferred payment undertaking and paying at maturity or acceptance of a bill of exchange drawn by beneficiary and paying at acceptance.10 Principle of independence (autonomy) The principle of independence is a cornerstone of the legal framework of documentary credit and the obligation of the issuer to honour is entirely separate and distinct from other related transactions such as the sales contract between the applicant and beneficiary.11 This autonomy principle was explained by Lord Denning M.R in the case of Power Curber International Ltd v. National Bank of Kuwait (CA) 1981, where the Lord outlined that the bank is not concerned with any dispute that the buyer may have with the seller and thus the bank must honour its obligations even when the quality and quantity of goods are not up to the contract or when there is a cross-claim in large amount. The reluctance of the courts to intervene is further illustrated by the statements of Jenkins LJ of the court of appeal in the case of Hamzeh Malas & Sons v. British Imex Industries Ltd (1958) 2 QB 127, that clarified that the bank assumes absolute obligation to honour the documentary credit without having to investigate the nature of default in the underlying contract.12 Lord Justice Jenkins outlined that the obligation of the bank is to examine whether the documents submitted corresponds with the requirements for documents contained in the documentary credit. Similarly, Jacob LJ in the case of Sirius International Insurance v. Fai General Insurance Ltd (2003) stated that the autonomy principle was important and was not undermined in special case where a party expressly agreed not to draw down unless certain conditions are met.13 According to Justice Stephen in the case of Wood Hall Ltd v. Pipeline Authority (1979) 141 CLR 443, the autonomy principle was necessary since it ensures that documentary credit remains as good as cash.14 A similar opinion was expressed by Canadian Court where Justice Le Dain ruling in the case of Angelica-Whitewear Ltd v. Bank of Nova Scotia (1987) 1 SCR 59 outlined that the fundamental principle autonomy governing documentary credit grants the method of effecting payments n international commercial efficacy and utility.15 Justice Le Dain pointed out that the issuing bank is obliged to honour the credit when specified documents are provided with terms and conditions of the credit irrespective of the underlying contract performance. Sir Johnson MR held that an application for injunction to restrain a bank from making payments in the case of Bolivinter Oil SA v. Manhattan Bank MA and Others (1984) 1 All E.R 351was inadmissible since the disputes were arising from the underlying contracts and banks should honour their obligations if not prima facie challenges to the documentary credit.16 However, the principle reduces the risk of non-payment for the beneficiary, but creates a risk that the issuer may honour the draft even when the beneficiary has failed to perform his obligations and has fraudulently demanded the payment.17 Fraud exception The fraud exception deals with the dilemma of forged documents or fraudulent demand by the beneficiary since strict application of the independence principle could unjustly enrich unscrupulous beneficiaries. The leading case law is the United City Merchants (Investments) Ltd v. Royal Bank of Canada (American Accord), where Lord Diplock outlined that there is an exception when the seller fraudulently presents to the confirming bank either expressly or by implication material representations of fact that to the best of his knowledge are untrue. Justice Selvam clarified that all parties are deemed innocent to the credit unless there is fraud that undermines the trust and confidence of documentary credit in international trade. The court revoked a documentary credit on the basis of fraud in the case of Agritrade International Pte Ltd v. Industrial Commercial Bank of China (1998) 3 SLR 211 where Justice Selvam ruled that courts must do their utmost to preserve integrity.18 However, UC P 500 does not recognize fraud as an exception to the autonomy while there are no express provisions dealing with fraud in UCP 600. Principle of strict compliance The principle outlines that every party to the documentary credit has to tender complying documents and all documents tenders in the chain of compliance must adhere to the terms and conditions. The strict compliance doctrine was endorsed in the case of Equitable Trust Co of New York v. Dawson Partners (1927), whereby Lord Summer outlined that there is not room for documents that are almost the same or which do just well.19 The courts consider irrelevant irregularities in the documents as evidenced by the case of Bank Melli Iran v. Barclays Bank D.C.O Ltd (1951) 2 Lloyd’s Rep 367 where the court held that defendant bank should have rejected the documents tendered ‘as good as new trucks’ since they were not the same as new trucks.20 There may be irrelevant variations in the document such as shipping and insurance documents, but the irregularity can be avoided since the tendered documents should not insist on rigid fulfillment of the precise wording if documents can be ‘properly read and understood’.21 UCP 600 requires that issuing bank should give a single notice of the refusal to pay if there is discrepancy in the documents. According to Article 13 of UCP 500, the documents tendered by the beneficiary must strictly comply with the terms of credit and are determined by international standard banking practice.22 Article 14 of UCP requires the banks to follow international standard banking practice as strict compliance has remained cornerstone of English common law. Lord Sumner outlined that there is ‘no room for documents that are almost the same, or which will do just as well’ in the case of Equitable Trust Company of New York v. Dawson Partners. However, some legal commentators outline that Article 13 (a) of the UCP 500 introduces greater uncertainty in the document examination process thus frustrating the reasonable commercial expectations of the parties. In this case, Article 14 of UCP 600 has established a responsibility for banks to comply with the standards for document examination under letters of credit which include ‘on face value’ time provided for examination, and consistency between the documents. UCP 500 required the banks to examine the documents with reasonable care while Article 13 (b) required the banks not to exceed seven banking days in examination of the documents following the receipt of the documents.23 Article 14 (b) has dealt with the issue of ‘reasonable time’ by providing a fixed maximum number of days which is a maximum of five working days following the day of presentation. Article 14 (j) of UCP 600 deals with inconsistency by outlining that addresses of the applicant and beneficiary should be similar to those noted in the documentary credit provided they are in the same country.24 Deferred payments The legal framework has dealt with the role of the bank in ‘deferred payment’ since earlier versions did not address the cases where the nominating bank would pay less than the face value of the credit.25 UCP 600 responds to legal questions raised by UCP 500 or international standard banking practice supporting discounting. For instance, Article 7 (c) requires the issuing bank to reimburse the nominated bank on maturity, but deferred payment was not provided under UCP 500. An example is the case Banco Santander v. Banque Paribus Ltd (2000), where the documentary credit was made under UCP (1993 Revision), but Paribas issued a deferred payment letter of credit payable at 180 days from the bills of lading date in favor of Bayfern.26 Paribas refused to reimburse Santander since the presented and accepted documents included forged documents. The appeals court held that Article 10 (d) of UCP 500 did not entitle Santander to reimbursement since Santander had no the mandate to discount and should have obtained Paribas’s authority and confirmation.27 The decision discouraged banks from making deferred payments, but Article 7 (c) and 8 (c) of UCP 600 resolves the controversy by making a provision for prepayments since it makes sound commercial practice in international trade.28 Conclusion Documentary credit differs from other methods of effecting payments in international sale of goods due to the autonomy nature and independence from the underlying sale contracts and the strict compliance required in honouring the letters of credit. The common laws have endorsed certain provisions of Universal Customs and Practices of Documentary Credits that outline the honouring procedures and the measures that banks should undertake in examination of the documents. The banks deal with documents and not the goods thus any discrepancies on the underlying contract does not affect the documentary credit. The courts have provides for exceptions in cases of fraud in obtainment of the records or when there are substantial discrepancies in the documents. Bibliography Books Brand, Ronald, Fundamentals of International Business Transactions, (Kluwer Law International, 2000) Burnett, Robin and Bath, Vivienne, Law of International Business in Australia, (Federation Perss, 2009) Campbell, Dennis, Remedies for International Sellers of Goods, (Lulu publishers, 2009) Farnsworth, Edward, Cases and Materials on Commercial law, (Foundation Press, 1993) Gao,Xiang, The Fraud Rule in the Law of Letters of Credit: a Comparative Study ( Kluwer Law International, 2002). Gillies, Peter and Moens, Gabriel, International Trade and Business Law and Policy, (Routldge, 1998) Mugasha, Agasha, The Law of Letters of Credit and Bank Guarantees. (Federation Press, 2003) Worthington, Sarah, Commercial Law and Commercial Practice, (Hart Publishing, 2003) Case laws Agritrade International Pte Ltd v. Industrial Commercial Bank of China (1998) 3 SLR 211 Angelica-Whitewear Ltd v. Bank of Nova Scotia (1987) 1 SCR 59 Banco Santander v. Banque Paribus Ltd (2000) 1 All ER 776 Bank Melli Iran v. Barclays Bank D.C.O Ltd (1951) 2 Lloyd’s Rep 367 Bolivinter Oil SA v. Manhattan Bank MA and Others (1984) 1 All E.R 351 Equitable Trust Co of New York v. Dawson Partners,(1927) 27 Hamzeh Malas & Sons v. British Imex Industries Ltd (1958) 2 QB 127 Power Curber International Ltd v. National Bank of Kuwait CA (1981) Sirius International Insurance v. Fai General Insurance Ltd (2003) EWCA Civ 470 Wood Hall Ltd v. Pipeline Authority (1979) 141. CLR 443 Commercial codes Uniform Customs and Practice for Documentary Credits (UCP) 500 Uniform Customs and Practice for Documentary Credits (UCP) 600 Read More