Экзамен зачет учебный год 2023 / The independence principle of letters of credit and demand guarantees

1

INTRODUCTION

I. T H E LIFEBLOOD OF INTERNATIONAL

COM M ERCE

2 e.g. Power CurberInternationalLtd v. NationalBank ofKuwait52t/T[198l] 1 WLR 1233 at 1241; [1981J 3 AUER 607 at 612.

1

Introduction

exporter’s obligation to deliver the contract goods. In this respect, letters of credit and demand guarantees are like two sides of the same coin that performs a vital function in the financing of international trade. And it is because both instruments play such an important role in the financing of international trade that they have famously been described as the ‘life-blood of international commerce’.3

II.BALANCING TW O CO N FLICTIN G INTERESTS

1.03There are two conflicting interests in relation to letters of credit and demand guarantees that the law is always attempting to balance. The first is the general interest in promoting international trade by maintaining the flow of the lifeblood of international commerce. This interest is advanced by the principle of independence of letters of credit and demand guarantees. The principle is to the effect that the obligation of the issuer to make payment is independent of any disputes between the exporter and the importer arising from the under­ lying contract of sale. If the beneficiary of the relevant instrument presents documents that appear on their face to comply with the requirements of the instrument the issuer must pay. In the case of a letter of credit, for example, the bank is not entitled to refuse to pay because the importer says that the goods shipped are not of satisfactory quality or are less than the contract quantity. The bank must pay and the importer can sue the exporter for breach of contract if there is a basis for such a claim. Tire position is the same with a demand guarantee. If the importer makes a demand for payment which complies with the terms o f the guaran­ tee, the bank must pay even though the exporter claims that he has fully performed the contract of sale or that the importer has failed to perform his part of the contract of sale. The bank must honour its undertaking to pay and the parties can argue the rights and wrongs later. By providing an assurance of payment to beneficiaries ofletters of credit and demand guarantees, the principle of independence serves the wider public interest of promoting international trade, financed by means of these instruments.

1.04On the other hand, the assurance of payment provided to the beneficiary exposes the bank and ultimately the account party, who is liable to reimburse the bank, to the risk of abusive demands for payment. For example, in the case of a letter of credit, the exporter may present to the bank a document, such as a bill of lading, which appears to comply with the require­ ments of the credit because it states that the contract goods have been shipped whereas in fact the document is false to the knowledge of the exporter and no goods have been shipped. If the principle of independence is adhered to strictly the bank would have to pay the exporter even though no goods have been shipped. But such a strict application of the principle of independence would leave the importer without protection against fraud or abuse by the exporter and would conflict with the wider public interest in discouraging commercial fraud. Yet to allow the bank to refuse to pay because of the beneficiary’s fraud, the evidence of which would normally lie outside the document presented and would involve looking into the underlying contract will be a breach of the principle of independence. There is there­ fore a conflict between the need to preserve the independence ofletters of credit and demand3

3 R.D. Harbottle v. National WestminsterBank Ltd[ 1978] QB 146 at 155.

2

III. The Structure a n d Scope o f the Book

guarantees and the need to protect the account party from fraud or abuse and the wider public interest in favour of discouraging reprehensible conduct such as fraud and illegality.

In order to provide a better balance between, on the one hand, the need to maintain the 1.05 international commercial value ofletters of credit and demand guarantees which is based on

the independence principle and, on the other hand, to protect the interests of the account party and the wider public interest in discouraging wrongdoing, the courts have recognized a number of exceptions to the principle of independence. The fraud exception has long been recognized. There are indications that the English courts may now be prepared to accept further exceptions including, an illegality exception, an unconscionable conduct or bad faith exception, an exception where a demand is made in breach of a promise in the underlying contract and perhaps even a recklessness exception. The English courts have rejected a nullity exception which has been recognized in Singapore. Whether the courts have achieved the right balance between the principle of independence and the exceptions to it will always be difficult to determine.

III. TH E STRUCTURE AND SCOPE OF TH E BOOK

This book is concerned with two instruments used in the financing of international trade: 1.06 letters of credit and demand guarantees. It is concerned with the fundamentally important feature of the instruments which give them their international commercial value, namely,

their independence from the underlying transaction in respect of which they are issued. It considers the extent to which the need to protect the account party and to advance the public interest has resulted in exceptions to the independence principle. In the following account four main areas are covered.

transaction, including the functions and types of demand guarantee. It also considers the main contractual relationships arising in a demand guarantee transaction. In order to high­ light the legal nature of a demand guarantee, this chapter identifies the main differences between a demand guarantee and a true (suretyship) guarantee. These differences flow from the chief distinction between the two, namely, that in the case of a demand guarantee the issuer’s obligation to pay is independent of the account party’s obligation under the underly­ ing contract whereas in the case of a suretyship guarantee the surety’s liability is dependent on the liability of the principal obligor. In spite of the differences, problems of characteriza­ tion have surfaced in recent years as courts endeavour to answer the question whether a particular instrument takes effect as a suretyship guarantee or as a demand guarantee.4

4 e.g. Vossbh Aktiengeselbchaft v. Alpha Trains (UK) Ltd [2010] EWHC 2443 (Ch); Carey ValueAdded SL (Formerly Losan Hotels WorldValueAddedISL) v. Grupo UrvascoSA [2010] EWHC 1905 (Comm); IIG Capital

3

Introduction

Chapter 3 also considers this issue and attempts to identify some factors that may serve as

indicators.

1.09The nature, rationale and scope of the independence principle is considered in Chapter 4. The chapter also contains a discussion of the doctrine of strict compliance, seen as a measure of protection for the account party which does not require a departure from the principle of independence.

1.10Following the discussion of the principle of independence, the five main exceptions to the principle are considered. The fraud exception is examined in Chapter 5. This includes a dis­ cussion of the meaning of fraud in the context of the fraud exception, the standard of proof and the limits of the fraud exception in relation to innocent third parties. Prevention of fraud by stipulating for specific documents to be presented with a demand for payment is also considered in this chapter. As the fraud exception does not extend to a case where the pre­ senter of a document is not aware that the document is false or contains a false statement, the question has arisen whether there should be a separate exception where a document pre­ sented is a nullity because, for example, it is forged. This very controversial issue is discussed in Chapter 6. A nullity exception has been recognized in Singapore although it has been rejected in England. But in rejecting a nullity exception the English Court of Appeal left open the possibility of a recklessness exception, which may apply where a document is a nul­ lity and the conduct of the beneficiary in the preparation or presentation of the document, although not amounting to fraud, was reckless.567The unconscionable conduct or bad faith exception is considered in Chapter 7. This exception, which has been recognized in Singapore

and Australia, received a warm welcome in England in T T I Team Telecommunications International Ltd v. Hutchison 3 G UKLtd.bChapter 8 deals with the exception based on the illegality of the underlying contract. Recognition of this exception in England received a major boost in Mahonia Ltd v. JPMorgan Chase Bank7 In Chapter 9 the exception based on a demand made in breach of the underlying contract is discussed. This exception, which has been recognized by courts in Australia, appears to be gaining ground in England.8

1.11In some cases, where a recognized exception applies, the bank would rely on the exception as a ground to refuse payment. However, in certain cases, the bank may be willing to make payment even though the account party is claiming that payment should not be made on the ground of a recognized exception. In such a case, the account party may be left with no option but to seek an interim injunction either to prevent the beneficiary from demanding or receiving payment under the instrument or, if it is too late, to prevent the bank from making payment to the beneficiary, pending resolution of the claim that the beneficiary is not entitled to payment because of a recognized exception. In certain cases, it may be more appropriate for the account party not to attempt to prevent payment under the instrument but rather to seek a freezing injunction preventing the beneficiary from removing the

LLC v. Van Der Merwe [2008] EWCA Civ 542; Marubeni Нощ Kong v. Government o fMongolia [2005] 2 All ER (Comm) 289.

5MontrodLtdv. Grundkotter Fleischvertriebs GmbH [200T\ 1 WLR 1975.

6[2003] 1 All ER (Comm) 914.

7[2004] EWHC 1938 (Comm); [2003] 2 Lloyds Rep. 911.

8Sirius International Insurance Corp v. FAI General Insurance Co Ltd [2003] 1 All ER (Comm) 865; TTI Team Telecommunications InternationalLtd v. Hutchison 3G UKLtd [2003] 1 All ER (Comm) 914.

4

a comprehensive account of the law of foreign jurisdictions on the topic, it has been possible to discuss authorities from other Commonwealth countries, such as Australia, Canada, Scotland and Singapore. Some authorities from the United States have also been considered and reference has been made to the Uniform Commercial Code of the United States. There is also some reference to the UN Convention on Independent Guarantees and Standby Letters of Credit and to international practice as reflected in publications by the International Chamber of Commerce, notably, the Uniform Customs and Practicefor Documentary Credits (UCP 600), the International Standard Banking Practice (ISBP) and the Uniform Rulesfor Demand Guarantees (URDG 758), which entered into effect on 1 July 2010.

5

2

THE NATURE OF LETTERS OF CREDIT

I.IN TRO D UCTIO N

1.Main Features of a Letter of Credit Transaction

A.The bank’s undertaking

7

The N ature o f Letters o f Credit

the exporter under the underlying contract of sale. The bank must pay against complying documents even though the importer alleges that the exporter has committed a breach of the contract of sale. Linked to the principle of independence is the principle that the bank deals in documents not with the goods to which the documents refer. Thus if the documents comply with the requirements of the credit the bank is bound to pay even though the buyer complains that the goods are not up to the contract quality. In this sense, the letter ot credit, as Lord Denning remarked in Power Cuber International Ltd v. National Bank o f Kuwait SA K 1 ‘ranks as cash and must be honoured’. It is the independent nature of the bank’s obligation to pay that gives the exporter the assurance of payment. The independence of the letter of credit from the underlying contract is discussed further in Chapter 4.

B. The parties and the process

2.03The importer or buyer who applies for the credit is known as the ‘applicant’ or the ‘account party’. The buyer’s bank that issues the credit is known as the ‘issuing’ bank. The party in whose favour the credit is issued is known as the ‘beneficiary’ (the seller). In international transactions where the seller is in a different country, a bank in the seller’s country normally notifies him of the opening of the credit. This bank is the ‘advising’ bank.2* There may be a different bank in the seller’s country, known as the ‘nominated bank’,3 to which documents are to be presented and payment received. If the nominated bank gives its own promise to pay the beneficiary, in addition to the promise of the issuing bank, it is known as a ‘confirm­ ing bank’.4 The seller does not have a contract with the advising bank but it has a contract with the issuing bank in the buyer’s country and a separate contract with the confirming bank in his country. So the seller may sue the confirming bank in his country for breach of contract if the bank fails to pay according to its undertaking.

2.04There are a number of stages in a letter of credit transaction. The first stage is where the buyer and seller negotiate the terms of the credit. The agreed terms are normally stated in the contract of sale. The second stage is for the buyer to approach his bank to request the bank to issue a letter of credit in favour of the seller in accordance with the terms agreed in the contract of sale. The buyer will normally complete the bank’s standard application form. The third stage is for the buyer’s bank to issue the credit to the seller. If the bank agrees to issue the credit, it will normally send it to the seller’s bank or another bank in the seller’s country,5 rather than direct to the seller. The bank in the seller’s country will check the credit and then send it to the seller. The seller will receive the credit, be assured of payment and so will acquire and ship the contract goods.

2.05Following shipment, the seller will prepare the shipping and other documents required by the credit and the process is reversed. The seller will present the documents to the nominated bank. The nominated bank will check the documents for compliance. If they comply with the requirements of the credit, the bank sends the documents to the issuing bank. In certain cases the nominated bank may pay the seller before receiving reimbursement from

' [1981] 1 WLR 1233; [1981] 3A11 F.R607at612.

2See discussion in para 2.58 below.

3See discussion in para 2.59 below.

4See discussion in para 2.60 below.

5This isnormallydone through SWIFT, theSocietyforWorldwidelnter-bankFinancialTelecommunication. SWIFT provides proprietary communications platform, products, and services that allow banks and other financial institutions to exchange financial information securely and reliably. See <http://www.swift.com>.

8

/. Introduction

the issuing bank.6 The issuing bank checks the documents again. If it agrees that they comply with the credit, it sends them to the buyer. The buyer’s account with the issuing bank will be debited and the issuing bank will reimburse the bank in the seller’s country if that bank had already paid the seller. If the seller had not been paid by the bank in his country, payment will be sent to the seller once received from the issuing bank.

2. Functions of a Letter of Credit

6This will be the case where the nominated bank negotiates (that is to say, buys) the credit or if where the nominated bank is a confirming bank.

7'[here are other risks associated with payment by the buyer, including country risks and fluctuations in

exchange rates. See, e.g. the remarks of Lord Sumner in Kronprinsessan Margareta [1921] 1 AC 486, 510.

8This transfer of risk, from the seller’s point of view, makes the letter of credit a better payment instrument than a bill of exchange drawn on the buyer, since such a bill only contains the buyers promise to pay.

9Confirmed credits are described in para 231 below.

9

The N ature o f Letters o f Credit

buyer will have a claim for damages for breach ofcontract against a seller in a foreign country. The letter of credit provides assurance to the buyer that the goods will be delivered because, under the credit, the bank will only make payment to the seller if the prescribed documents are presented to the bank. These are documents relating to the goods including shipping documents (such as a bill of lading) and other certificates confirming that the seller has deliv­ ered the contract goods to a carrier for transportation to the buyer. Moreover, since, as explained below, the letter of credit can also help the seller to raise finance before payment by the buyer, it reduces the risk of non-delivery by the seller for lack of funds.

B.Financing instrument

2.09The second function of the letter of credit is as a method of financing of international trade. Normally the buyer would not want to pay the seller in advance or immediately the goods are shipped because he would not want to be out of pocket in the period between advance payment or despatch of the goods and their arrival and re-sale. Instead the buyer would like to pay the seller only after arrival and re-sale of the goods. But the seller would want to have cash in advance or immediately the goods are despatched and may not be prepared to remain without cash in the period between shipment and arrival or re-sale by the buyer. There is thus a funding gap dividing the two parties. The letter of credit bridges that gap by providing a mechanism that enables the buyer to postpone payment until re-sale of the goods in his home market whilst making it possible for the seller to obtain immediate cash. The letter of credit can achieve this because it is a flexible instrument and can provide for payment at some future date, after despatch of the goods and presentation ol documents.10 In such a case, the buyer will receive the goods but will not have to reimburse the bank until some time in the future, after the bank has made payment on the specified date. In other words, if the specified date was fixed with the expected date of arrival and re-sale in mind, the buyer will not pay for the goods until after re-sale. This will help the buyer with his cash flow.

2.10At the same time, the letter of credit also helps the seller with his cash flow since the seller does not have to wait for payment on the specified future date. He can use the credit to raise finance before or after shipment. Even before he despatches the goods, a seller who needs cash, to pay his own suppliers, can use the letter of credit as security to obtain finance from his bank.11 Alternatively, the seller may require finance after he has acquired the goods, shipped them and presented the documents to the bank but before the date of payment. In such a case, the seller can still use the credit to get immediate cash before the date ofpayment. The precise manner in which he can do so depends on the type of credit. Where the credit is available by negotiation with any bank,12 the seller can negotiate, (that is to say, sell) the documents to any bank. The negotiating (or purchasing) bank will pay the seller imme­ diately13 and collect payment later from the issuing bank on the specified future date. Alternatively, if it is an acceptance credit where a bill of exchange is used,14 after the bill has been accepted by the bank, the seller can negotiate it in the forfait market and obtain

10As where it is a deferred payment or acceptance credit.

11The finance could be in the form of a cash advance or in the form of a letter of credit issued by the seller’s bank in favour of the seller’s own suppliers.

12See discussion on negotiation credits at para 2.37.

13Ihe amount paid will normally be less than the full amount of the credit to take account of interest and charges of the paying bank.

14On the use of the bill of exchange in letter of credit transactions, see the discussion at paras 2.24 to 2.27 below.

10

I. Introduction

immediate cash.15 Even in the case of a deferred payment credit where a bill of exchange is not used, the seller may also receive pre-payment from any bank with which the credit is available (the nominated bank).16 A letter of credit can therefore help with the cash flow of the buyer and the seller.

Cl. Security for other obligations

documents to the bank.19 If he presents documents that fail to comply with the credit and the bank rejects them and refuses to pay, the seller is not entitled to claim against the buyer even though the goods conform to the contract of sale.20 However, if the seller presents docu­ ments that comply with the requirements of the credit but the bank fails to pay because it has become insolvent before the time of payment, the seller is entitled to payment from the buyer even though the buyer had already paid the bank.21 In such a case, the seller has two possible paymasters, first the bank and, if that fails, the buyer. In this respect the letter of credit performs a very important function of providing the seller not just with an alternative paymaster but with an additional paymaster, namely, the bank.

15See discussion at para 2.34.

16See discussion at para 2.35.

17See, e.g. the letter of credit issued in respect of the retrocession arrangement in Sirius International v. FA.I

GeneralInsurance Co Ltd [2003] 1 All ER (Comm) 865.

18 e.g. Rosen v. Pullen (1981) 126 DLR (3d) 62, where a letter ofcredit was issued in respect ofa cohabitation agreement between parties who were contemplating marriage.

19Soproma SpA v. Marine andAnimal By-Products Corporation [1966] 1 Lloyds Rep. 367.

20ShamsherJute Mills Ltdv. Sethia (London) Ltd [1987] 1 Lloyd’s Rep. 388. The case of Newman Industries

Ltd v. Indo-British Industries Ltd [1956] 2 Lloyd’s Rep. 219, where a seller whose claim had been rejected by the bank was allowed to sue the buyer, may be distinguished on the ground that in the Newman Industries case it was not established that the seller’s presentation of documents was non-complying. However, where the seller presents documents that do not comply with the credit and the bank refuses to pay, if the buyer accepts delivery of them under the contract he may be considered as having waived the discrepancy in the documents and may be liable to pay the price under the contract of sale: UzinterimpexJSC, v. Standard Bank pic [2008] EWCA Civ 819 at [29]. See also Saffron v. Societe Miniere Cafrika (1958) 100 CLR231.

21 Maran RoadSaw Mills v.Austin Taylor& Co Ltd[l975] 1 Lloyd’sRep. 156; ED and F Man Ltdv. Nigerian Sweets and Confectionary Co Ltd [1977] 2 Lloyd’s Rep. 50.

11