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THE INDEPENDENCE

PRINCIPLE OF

LETTERS OF CREDIT

AND DEMAND

NELSON ENONCHONG

THE INDEPENDENCE

PRINCIPLE OF

LETTERS OF CREDIT

AND DEMAND

GUARANTEES

N E L S O N E N O N C H O N G , L L . M ., P H . D . ( C A N T A B )

O fthe Inner Temple, Barrister

Barber Professor o f Law,

University o f Birmingham

OXFORD

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FOREWORD

Letters of credit have been familiar to those who engage in commerce for centuries. Demand guarantees, on the other hand, are a relatively recent creation, but their use in international transactions has expanded rapidly. It is no exaggeration to say that it would not be possible in any meaningful way nowadays to trade across international boundaries without these instruments. The exporter needs to be sure that he will be paid before he ships goods to the importer. He needs more than the importer’s undertaking if he is to be sure that he will receive payment of the price without question when the goods are despatched. The importer, for his part, needs to be sure that he is protected against the risk of the exporter’s default in performance under the contract.

It is a cardinal feature of these arrangements that the obligation of the bank is independent of the obligations of either party under the underlying contract. The importer cannot be allowed to prevent the bank from paying the exporter by alleging that the goods are defective. Otherwise the exporter would be no better off than he would have been if he had to rely solely on the importer’s obligation to pay. The demand guarantor’s obligation to pay on default must be independent of the account party’s obligation to the party with whom he trades. So on each side there is a bargain with the bank only. The bargain is enforceable irrespective of any dispute which may arise between the parties to the underlying contract. The independence principle lies at the heart of these arrangements. It is this principle that gives the bank’s undertakings their undoubted commercial value in a world that would otherwise be beset by uncertainties.

The law surrounding these simple propositions has developed over the years and its boundar­ ies have been tested by an increasing volume of case law. While the concepts themselves are simple, the same can no longer be said of the law that surrounds them. The nature and scope of the independence principle deserves further study, as do its consequences. Among these are issues of categorization, as to the nature and effect of the particular instrument that has been used, and questions as to whether, and if so to what extent, exceptions have been or should be recognized to protect the account holder. Questions as to remedies may arise too, should a non-wrongful demand in the case of a demand guarantee result in payment by the bank of a sum that exceeds the amount of the loss incurred by the beneficiary. The interna­ tional context in which these instruments are so often used may attract conflict of laws rules if they give rise to dispute. This book seeks to address these and many other questions by subjecting the whole subject to careful and comprehensive analysis and scrutiny. As is to be expected of a work whose subject matter crosses international boundaries, it takes account of authorities from other jurisdictions as well as those of the United Kingdom. There is, of course, much detail here. But it is presented in a manner which is both logical and approachable.

A specialist monograph of this kind makes unusual demands on its author. It requires a depth of knowledge and understanding of the subject which only those who have studied it over a long period can ever seek to achieve. It also requires a degree of skill and commitment which is quite out of the ordinary. As against that are the many benefits that the book will

vii

Foreword

bring to those who will wish to use it as a work of reference or as background for further study and research. We must all be grateful to Professor Enonchong for the time and effort which he has given to this commendable initiative.

Lord Hope of Craighead KT

UK Supreme Court

January 2011

vui

PREFACE

This book considers the nature, effect, and scope of the principle of independence of letters of credit and demand guarantees. It examines the extent to which exceptions to the principle have been or should be recognized by the courts. It also considers the extent to which the account party may rely on a recognized exception in order to obtain an injunction to stop payment under a letter of credit or demand guarantee. As letters of credit and demand guar­ antees are often used in international transactions, issues of conflict of laws often present themselves in disputes between the parties. The extent to which the independence principle affects the application of conflict of laws rules to the contractual relationships arising in a letter of credit or demand guarantee transaction is considered both under the English tradi­ tional rules as well as the Brussels I Regulation, the Rome Convention, and the Rome I Regulation. Whilst the book deals mainly with the position of English law, it considers some authorities from other jurisdictions.

The book has developed from seminars which I teach at the University of Birmingham on the law relating to international trade finance. I have benefited from many illuminating discussions with generations of students about trade finance in general and letters of credit and demand guarantees in particular. I also owe gratitude to others, too many to name them all. I am particularly grateful to Dr Djakhongir Saidov of the University of Birmingham, Charles Proctor of Bird & Bird LLP, Richard Gwynne o f Stephenson Harwood LLP, and

Richard Jones QC of No5 Chambers who kindly provided helpful comments.

I am grateful to Dr Evaristus Mainsah of IBM Corporation for his support, and to Kate Brookson-Morris, Paul Mora, and Luke Price for their research assistance. I should also like to express my thanks to the staff of the TIarding Law Library for their help. Finally, I would like to thank the team at Oxford University Press for their support and efficiency in produc­ ing the book.

Nelson Enonchong

Birmingham

October 2010

IX

CONTENTS

Table o fCases

Table o fLegislation

1. Introduction

I. The Lifeblood of International Commerce II. Balancing Two Conflicting Interests

III. The Structure and Scope of the Book

2. The Nature of Letters of Credit

I. Introduction

II. Uniform Customs and Practice

III.Use of Bills of Exchange IV. Types of Letter of Credit

V.The Contractual Relationships

3.The Nature of Demand Guarantees

I.Introduction

II.The Contractual Relationships

III. Different from Suretyship Guarantees

IV. Problems of Categorization: Demand Guarantee or Suretyship Guarantee?

4.The Independence Principle

I. Introduction

II. The Scope of the Independence Principle III. The Role of Documents

IV. Exceptions

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xiii