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Letter Of Credit

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Autor:   •  October 8, 2010  •  5,076 Words (21 Pages)  •  1,556 Views

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1 Introduction - Letters of Credit in International Trade.

In international trade, payment by means of a letter of credit has become so widely used that Justice Kerr of the English Court has called the instrument, "the life-blood of international commerce." [1] It is the most effective method to secure payment in an international trade transaction, in a way that takes care of the interests of both the seller and the buyer. This is due to the sanctity of the document.

1.1 Difficulties in International Sales Transactions.

Payment for goods sold in international sales transactions is often problematic, due to the international character of the transaction. The parties usually have their places of business in different states, and are therefore subject to different national legal systems. Furthermore, the seller will often transport goods across large distances and across national borders. Under such circumstances, the seller has a great interest in ensuring that it will receive payment for goods sold once the goods leave its possession and control, and the buyer has a corresponding interest to ensure that the seller has dispatched conforming goods before making payment in terms of the sale agreement.[2]

When goods travel across national borders, they are moved outside the jurisdiction in which the seller resides. Once outside the seller's jurisdiction, any attempts to regain control or possession of the goods will be significantly more difficult for the seller. Similarly, if the seller does not receive payment once the goods are delivered, it is all the more difficult to pursue the buyer for payment, because the buyer and all of his assets will probably be outside the seller's jurisdiction. The seller will deliver goods to a foreign jurisdiction where he has little influence, and possibly very little knowledge of the applicable law. Foreign law may govern many aspects of the transaction including procedures to obtain payment, and the seller may be required to obtain any court order necessary to enforce such payment, through a foreign forum, where it does not have easy access to the wheels of justice. This may prove to be inconvenient and expensive.[3]

Similarly, if the buyer makes payment for the goods prior to receiving delivery, and if the seller fails to make delivery or delivers nonconforming goods, then the buyer is left facing a similar prospect of pursuing the seller in a foreign jurisdiction.

1.2 Letters of Credit.

The system of documentary credits that is in use in current international trade has largely alleviated these problems relating to payment. The parties establish a letter of credit,[4] which enables the seller to obtain payment from a bank within his jurisdiction. The buyer establishes the letter of credit in such a manner, that payment is promised on presentation of certain documents, the contents of which confirm that the goods being delivered to the buyer are goods that conform to the terms and conditions of the underlying sales agreement.[5] The seller need only comply with the documentary conditions as specified in the credit, and is thereafter assured of payment.[6]

1.3 The Mechanics of Letters of Credit.

The commercial practice of documentary credits entails that the buyer makes an application to a bank to issue an undertaking to make payment to the seller, once the bank receives certain documentation on behalf of the buyer from the seller, indicating that the seller has dispatched conforming goods. This undertaking, if issued, is known as a letter of credit or a documentary credit.[7]

The buyer, as applicant, will inform the bank of the documentary requirements that he wishes to have inserted into the letter of credit.[8] These requirements are essentially designed to ensure that the seller submits documentation that records his compliance with its obligations in terms of the underlying sales agreement. [9]

The buyer will normally request the seller to submit clean shipping documents proving that the goods have been delivered to a carrier for carriage, and the seller's commercial invoice listing the goods, the quantities, and the price of the goods. The buyer may also request the seller to submit insurance documentation, certificates to prove quantity or quality, packing lists, and any other documentation required to show that the seller has complied with the terms of the underlying sales agreement.[10]

The seller will then submit all the stipulated documents to the issuing bank or to the bank nominated to receive documents and to make payment. If the submitted documents comply strictly with the terms of the credit, then the paying bank is obliged to make payment in terms of the credit, to the seller.[11]

2 The Principle of Strict Compliance, and the Independence Principle.

It is trite that every letter of credit involves at least three separate and independent transactions, between three different parties.[12]

Two distinct doctrines uphold the sanctity of the letter of credit, secure the payment transaction, and thus promote the efficiency of international trade. The doctrine of strict compliance is not the focus of this dissertation, but it is a vital component of the structure of credits. It gives rise to the doctrine of independence and therefore to the fraud exception, which in essence allows a piercing of the doctrine of independence. It therefore merits brief discussion for the purposes of a wider discussion of the fraud exception.

2.1 Strict Compliance.

The doctrine of strict compliance protects the interests of the buyer and of the paying bank. When submitting the required documents, the law expects the seller to comply strictly with the requirements stated in the letter of credit.[13] This assures the buyer that the bank will not pay the seller, unless the seller presents documents that satisfy the requirements of the buyer. The bank is protected in that it is not required to make any judgement calls as to the relevance of the requirements contained in the letter of credit. The bank is not called upon to make any decisions as to substantial compliance by the seller.[14]

Lord Sumner quite aptly encapsulates the doctrine with the following statement:

"There is no room for documents which are almost the same, or which will do just as well."[15]

Similarly, Lord Diplock states:

"The banker is not concerned whether the documents for which the buyer has stipulated serve any useful commercial purpose or as to why the customer called


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