AN OVERVIEW OF THE CONCEPT OF LETTERS OF CREDIT AND DOCTRINE OF STRICT COMPLIANCE IN FINANCING INTERNATIONAL TRADE
Olajide Akinleye-Martins
Solicitor; Researcher in International Investment Arbitration Law (Environmental policy); Academic
Introduction
The Letters of credit also referred to as ‘documentary credits’ or ‘bankers’ commercial credits’ is an important tool in the finance of international trade. Parties involved in international trade are usually from different countries and arranging for payment to be made under the letters of credit is an effective means that eases the procedure of payment for the buyer and ensures certainty of payment to the seller.
The law relating to the letters of credit is however founded on two major principles, one of which is the doctrine of strict compliance, which demands that the documents presented by the seller under the credit must conform strictly to the terms of the credit.
The problem posed by the issue of compliance, especially as interpreted by the courts can be a daunting one. In the words of Professor Ellinger,[1] ‘From the point of view of the average businessman, nothing is simpler and clearer than a documentary transaction. He takes a letter of credit at its face value. (…) However, the legal basis for this expectation is by no means easy to discover’. This goes to reflect the challenges that can be encountered in the letters of credit arrangement, much of which deals with the issue of documentary compliance.
It has been estimated that discrepancies in documents presented under the letters of credit have led to about 60% to 70% of such documents being rejected on first presentation.[2] The courts in a number of cases appear to adopt a standard of strict compliance in interpreting the UCP rules over the years, while in some other instances; the standard had been interpreted as one that allows for a degree of latitude.
The International Chamber of Commerce have however, over the years drafted rules to combat the problems that have accompanied the examination of documents under the letters of credit transaction. These applicable rules are briefly discussed hereunder.
THE APPLICABLE RULES
The law and practice of letters of credit transactions is standardized by the Uniform Customs and Practice for Documentary Credits (hereinafter referred to as ‘the UCP’). These are a set of rules formulated by the International Chamber of Commerce (hereinafter referred to as ‘the ICC’), which aims at harmonizing worldwide trade practices and safeguarding the interests of international trade and the banking community.[3] These rules have been in existence since 1933[4] and have been revised over the years. The current version is the 2007 Revision, ICC Publication No. 600 (herein after referred to as ‘UCP 600’).[5]
The UCP is applicable in many countries including the United Kingdom and Nigeria and its adoption is not reinforced by any local law but it flows from the agreement of the parties to the sale transaction.
The UCP rules are not a legal regime automatically applicable to all letters of credit, but are a voluntary self-regulatory regime devised by the ICC for express incorporation into letters of credit. Thus, to make it applicable in a case, the parties have to incorporate its terms into their contract.[6] Article 1 of the UCP 600 expressly states that the rules will only apply “when the text of the credit expressly indicates that it is subject to these rules”. According to a commentator,[7] the major advantage of incorporating the UCP into the credit for a seller is that it enables him to know in advance the criteria against which the banks will examine the shipping documents in deciding whether to make payment under the credit. For the buyer, the incorporation of the rules makes him know in advance the criteria against which the price for the goods will be paid against tender of documents.
The International Standard Banking Practice for the Examination of Documents under Documentary Credits 2007, ICC Publication No. 681[8] (hereinafter referred to as ‘the ISBP’) focuses on clarifying the bank’s duty in the examination of the documents presented for payment under a letter of credit. It was drafted in a bid to facilitate the reduction of the number of documents rejected by banks.[9]
THE CONCEPT OF THE LETTERS OF CREDIT
A. Definition
The Letters of credit are mainly used to finance international trade or contracts for provision of services.[10] They are ‘undertakings to honour documents representing the current delivery of goods or services’[11].
It has been described by the courts as the “lifeblood of international commerce”[12] and defined as, a promise by a bank of immediate or future payment to the seller, against specified documents on terms that the bank will be reimbursed by the buyer.[13]
In Nigeria, the External Trade Letters of Credit (Control) Act[14], which is the national legislation that regulates letters of credit in Nigeria, defined the ‘letters of credit’ as ‘any undertaking or authority in writing (whether or not against production of any document or documents) given to finance payment in respect of overseas goods or services on account of any person resident in Nigeria.’[15] The Courts in Nigeria have also attempted a definition of the letters of credit in a few cases. The Court in Union Bank of Nigeria v. Sparkling Breweries Ltd[16] defined it ‘as a modern device whereby the buyer requests his banker to open credit in favour of the seller and in pursuance of that, the banker or his foreign agent, issues a confirmed credit in favour of the seller’. In Union Bank of Nigeria v. Okwara,[17] Katsina-Alu JCA., defined it as ‘an irrevocable promise by a banker to pay money to the seller in return for the shipping documents’.
Article 2 of UCP 600 defines a credit as any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.
The importance of the letters of credit lies in its ‘documentary character’.[18] In TD Bailey, Son & Co v. Ross T Smyth & Co Ltd[19], Lord Wright described the function of the Letter of credit thus ‘The general course of international commerce involves the practice of raising money on documents so as to bridge the period between the shipment and the time of obtaining payment against documents.’
The significance of Letters of credit arrangement cannot be overemphasized in a developing country like Nigeria that is essentially a consumer country with most of its developmental needs and efforts met through imports.[20] The Nigerian Supreme Court in Akinsanya v. United Bank for Africa Limited[21] described the commercial purpose of Letters of credit as that which ‘gives the seller an assured right to be paid before he parts with the control of the goods; that does not permit of any dispute as to the performance of the contract of sale being used as a ground for non-payment or reduction or deferment in payment’.
The Letters of credit transaction poses two main advantages as a means of financing international trade. First, it enables the seller as an exporter to obtain payment immediately for the price of the goods upon shipment. For as long as the bank is solvent, the seller is assured of payment provided he is able to meet the terms of the credit.[22] Secondly, it enables the buyer as the importer to get credit upon security of title documents with the bank.[23]
B. Parties to the Letters of Credit Transaction
According to Article 2 of UCP 600 the parties involved in a letter of credit transaction are:
Other applicable terms defined therein are:
In line with the agreement between the seller and the buyer, the buyer arranges for payment to be made by a Bank usually at the seller’s place of business or country on presentation of specified documents, and on the performance of other terms of the credit (if any) and ‘advised by the bank to the seller’.[25]
Letters of credit transactions normally operates in four stages[26]:
(a)?The seller (the exporter) and the overseas buyer (the importer) both agree in the contract of sale that payment will be made under a letter of credit.
(b)?The overseas buyer (hereinafter referred to as the ‘applicant for the credit’) instructs a bank (hereinafter referred to as the ‘issuing bank’) at his place of business or country to open a letter of credit in favour of the seller/exporter (hereinafter referred to as the ‘beneficiary’) on terms specified by the buyer in his instructions to the issuing bank on the opening of the credit.
(c)?The issuing bank in turn makes arrangement with a bank in the seller/exporter’s place of business or country (known as the ‘advising bank’ or ‘correspondent bank’) to negotiate, accept, or pay the seller’s draft upon his presenting specified documents in accordance with the terms of the credit.
(d)?The advising bank then informs the seller/exporter that it will negotiate, accept or pay his draft upon delivery of the specified documents. The advising bank in addition to giving this notification of credit could also undertake to confirm the credit, in which case, it also acts as a confirming bank.
Where the correspondent bank acts as a confirming bank, it adds its??confirmation to the credit at the request of the issuing bank and thus undertakes to pay the beneficiary upon presentation of the specified documents.
It should however be noted that the buyer’s liability to the seller is a primary liability[27] as a letter of credit is not to be regarded as absolute payment[28]. Consequently, where the seller does not receive payment from the bank for instance, because he fails to meet the terms of the credit within the validity period of the credit, or due to the banks default, he would have recourse to the buyer for payment.[29]??
C. The Fundamental Principles of the Letters of Credit
There are two fundamental principles on which the law of letters of credit is founded. These are: (a) The principle of Independence of the credit; (b) The doctrine of strict compliance. These principles are explained briefly below:
(i)???????????The principle of Independence of the credit
This principle is also referred to as the ‘autonomy of the credit’. In the context of letters of credit, this principle is to the effect that the letters of credit transaction is to be treated as an independent and separate transaction. Particularly, it is independent of the terms of the underlying contract of sale or the transaction that gave rise to the letters of credit arrangement, and its performance is independent of the performance of the underlying contract.[30] Article 4(a) of UCP 600 provides for the principle of autonomy of the credit by stating inter alia 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.’
A Bank operating a credit is only concerned with whether the documents the seller tenders correspond to those specified in the credit instruction.[31]
The only instance under which the paying bank would refuse payment under a letter of credit arrangement is a situation where it is proved to its satisfaction that the documents even though apparently conforming on their face, are fraudulent and that the beneficiary has knowledge of the fraud.[32] This is commonly referred to as the ‘fraud exception’.[33]
(ii)?????????The doctrine of Strict Compliance
Letters of credit transactions being documentary in nature are judged by the principle of strict compliance and the first rule of this doctrine is that all the specified documents need to be tendered.[34] This principle posits that the documents tendered by the beneficiary to the bank shall strictly conform on their face with the documents specified under the terms stipulated under the credit.
The basic tenor of the law and practice of letters of credit is that the parties deal in documents and not in goods.[35] Article 5 of UCP 600 states that ‘Banks deal with documents and not with goods, services or performance to which the documents may relate’.?
Only if the bank strictly adheres to the requirements of the applicant under the credit and ‘only if it makes payment when compliant documents are presented is the security of the documentary credit safeguarded’.[36] The bank is however entitled to reject documents even on the smallest discrepancy that do not correspond strictly with the instructions of the applicant.[37]
The rationale behind this doctrine is that the bank acts as agents of the buyer, who is the applicant for the credit. If it exceeds the authority given in the credit instruction, the buyer is not bound to ratify such act and is not liable to reimburse the bank for any payment made on non-conforming documents regardless of whether or not the goods have been shipped to the buyer.[38] Moreover, as Banks deal in documents and finance, not in goods,[39] they normally do not have expert knowledge of trade usages and practices.[40]
D. Evolution of the Doctrine of Strict Compliance
The 1927 decision handed down by the English court established the doctrine of strict compliance as a principle under the letters of credit.?In Equitable Trust Co. of New York v. Dawson Partners Ltd [41] the credit called for a “certificate of quality issued by experts who are sworn brokers”. The bank paid against a certificate signed by only one expert and claimed reimbursement from the applicant who in turn refused to reimburse. The House of Lords applying the ‘perfect tender’ rule developed under the sale of goods law to letters of credit transactions[42] held that the documents tendered were not exactly what the credit called for. Lord Sumner expressed it inter alia thus:
?‘there is no room for documents which are almost the same, or which will do just as well (…) the bank which knows nothing officially of the details of the transactions financed cannot take upon itself to decide what will do well enough, and what will not. If it 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.’[43]
The tender of similar documents are not acceptable under the doctrine.[44] The paying bank’s refusal to make payment to the beneficiary when the presented documents are not compliant with the terms of the credit in the majority of cases has been upheld by the courts.[45]
E. Effect of the Doctrine of Strict Compliance on the Finance of International Trade
The doctrine of strict compliance is significant to the buyer, the seller as well as the banks in the finance of international trade. Since letters of credit are transactions in documents, if the documents conform to the terms of the credit, the bank must honour its payment obligations under the credit.[46] This gives the seller certainty of payment, which gives the letters of credit transaction, its uniqueness. On the other hand, it ensures that the seller produce the required documents, which also assures the buyer as the applicant for the credit that the stipulated documents will be made available to him by the bank.
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With respect to the bank, the doctrine spares the bank from value judgments about discrepancies in tendered documents and prevents the bank from scrutinizing the underlying transaction, which is not within the scope of its normal business.[47]
REFERENCES
[1] E. P. Ellinger, Documentary Letters of Credit: A Comparative Study (University of Singapore Press, Singapore 1970) p. 39.
[2] Jason C. Chuah, Law of International Trade: Cross-Border Commercial Transactions (4th edn Sweet &Maxwell, London 2009) 549.
[3] Rolf A. Schutze and Gabriele Fontane, Documentary Credit Law throughout the world: Annotated Legislation from more than 35 countries (Banking Series, International Chamber of Commerce, Paris 2001) 15.
[4] This was preceded by the 1929 Revision, which was accepted only by France and Belgium. See further: E.P. Ellinger, ‘The Beneficiary’s Bank in Documentary Credit Transactions’, (2008) 124 Law Quarterly Review 299.
[5] The UCP 600 is the seventh version of the rules. The first version of the rules was published in 1933 (ICC Brochure No.82), the second in 1951 (ICC Brochure No. 151), the third in 1962 (ICC Brochure No. 222), the fourth in 1974 (ICC Brochure No. 290), the fifth in 1983 (ICC Brochure No. 400) and the sixth version was published in 1993 (ICC Brochure No. 500); See also: <http: www.iccwbo.org>.
[6] Per Oguntade JSC., in Eagle Super Pack (Nig.) Ltd v. A.C.B. Plc. (2006) 19 NWLR (Part 1013) 20 at 40 para. G.
[7] Charles Debattista, ‘Changes To The Tender of the Seller’s Shipping Documents Under Letters of Credit’ in James E. Byrne and Christopher S. Byrnes (eds), 2008 Annual Survey of Letter of Credit Law & Practice ( Institute of International Banking Law & Practice, Inc., United States 2008) 127-128.
[8] Drafted by a task force of the International Chamber of Commerce (ICC) in 2002 and revised in 2007. The ISBP does not amend the UCP 600, but it serves as a practical complement to it by explaining in explicit detail how the UCP rules are to be applied.
[9] Janet Ulph, ‘The UCP 600: documentary credits in the 21st Century’ (2007) JBL 355.
[10] E.P. Ellinger, (n 4).
[11] James E. Byrne, ‘Overview of Letter of Credit Law and Practice in 2007’ in James E. Byrne and Christopher S. Byrnes (eds), 2008 Annual Survey of Letter of Credit Law & Practice (Institute of International Banking Law & Practice, Inc., United States 2008) 7.
[12] Per Donaldson L.J. in Intraco Ltd v. Notis Shopping Corporation of Liberia, The Bhoja Trader (1981) 2 Lloyd’s Rep. 256 at 257; Per Kerr L.J. in R.D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd (1978) Q.B 146 at 155. Also affirmed by the Nigerian Court of Appeal in African Continental Bank v. Eagle Super Pack (Nig.) Ltd (1995) 2 NWLR (Part 379) 590 at 614-615.
[13]Ali Malek and David Quest, Jack: Documentary Credits: The Law and Practice of documentary credits including standby credits and demand guarantees (4th edn Tottel Publishing, West Sussex 2009) 2.?
[14] Cap. 124, The Laws of the Federation of Nigeria 1990.
[15] Section 2 (4).
[16] (1997) 5 NWLR (Part 505) 344.
[17] (1998) 1 NWLR (Part 532) 118.
[18] Murray et al, Schmitthoff’s Export Trade (11th edn Sweet & Maxwell London 200) 185
[19] (1940) 56 TLR 825 at 828.
[20] K. I. Igweike, Law of Banking and Negotiable Instruments (Africana-Fep, Onitsha Nigeria 1991) 83. ?
[21] (1986) 4 NWLR (Part 35) 273 at 278.
[22] Ali Malek and David Quest, (n 13) 2.
[23] I.O. Smith, Nigerian Law of Secured Credit ( Ecowatch Publications, Nigeria 2001) 392.
[24] Reference to a ‘paying bank’ in this dissertation is to the bank that would be paying the beneficiary upon presentation of specified documents. This could be the issuing bank, confirming bank or a nominated bank.
[25] Murray et al, Schmitthoff’s Export Trade (n 18) 185.
[26] Ibid. at 188.
[27] Per Ackner J., in E.D & F Man Ltd v. Nigerian Sweets & Confectionery Co. Ltd (1977) 2 Lloyd’s Rep. 50.
[28] Per Lord Denning MR, in W.J Allan & Co. Ltd v. El Nasr Export and Import Co. (1972) 2 QB 189.
[29] In African Continental Bank Plc v. Uzor & Brothers (Nig.) Limited (1997) 6 NWLR (Part 510) 692 at 702 para.F, Ayoola JCA., of the Nigerian Court of Appeal observed inter alia that ‘the buyer’s obligation to pay the price of the goods is not absolutely discharged by the opening of the credit, since the seller can claim payment from the buyer upon the banker’s default’.
[30] Ali Malek and David Quest, (n 13) 17.
[31] Murray et al, Schmitthoff’s Export Trade (n 18) 189.
[32] United City Merchants (Investments) Ltd v. Royal Bank of Canada (1983) 1 AC 168.
[33] To date this is the only recognised exception to the principle of independence of letters of credit under the English law and this same trend is adopted by Nigerian courts. See Akinsanya v. United Bank for Africa Limited (1986) 4 NWLR (Part 35) 273 at 279.
[34] E. P. Ellinger, (n 1) 293.
[35]I.J.Goldface-Irokalibe, Law of Banking in Nigeria, (Malthouse Law books, Malthouse Press Ltd, Lagos 2007) 313.
[36] Rolf A. Schutze and Gabriele Fontane, (n 3) 30. ?
[37] Murray et al, Schmitthoff’s Export Trade (n 18) 192.
[38] I.O. Smith, (n 23) 388; Nasaralai Enterprises v. Arab Bank Nigeria Ltd (1986) 4 NWLR (Part 36) 409 at 428 paras. A-C.
[39] UCP 600 Article 5.
[40] Murray et al, Schmitthoff’s Export Trade (n 18)192.
[41] (1927) 27 Lloyds’ LR 49.
[42] Agasha Mugasha, The Law of Letters of Credit and Bank Guarantees (The Federation Press, Sydney?????2003)127.
[43] Equitable Trust Co. of New York v. Dawson Partners Ltd (n 42) at 52.
[44] Indira Carr, International Trade Law (3rd edn Cavendish, London 2005) 482.?
[45] Murray et al, Schmitthoff’s Export Trade (n 18) 192.
[46] Ali Malek and David Quest, (n 13) 17.
[47] Xiang Gao, The Fraud Rule in the Law of Letters of Credit: A Comparative Study (Global Trade and Finance Series, Kluwer Law International, The Hague 2002) 27.
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