While being engaged in international business, seller looks for minimizing the payment risk subsequent to delivery of goods by receiving either cash in advance or payment on delivery or where the buyer’s interest is to pay only after being certain about receiving goods in accordance with contract of sales. Additionally, reasons including: lack of familiarity with other party’s financial standing possibility for either party to default in the course of business transaction, geographical distance of parties , difference in national currencies, need for intermediaries , multi-jurisdictional nature of the transaction are behind decision of parties to use documentary letters of credit as a method of payment in their international transaction. LC is a written undertaking by a bank which assumes primary and absolute liabilities of buyer (applicant) and promises to pay the beneficiary (seller) to pay in accordance with terms of underlying contract of sales previously negotiated between him and the applicant.
Since the buyer and seller in an international contract are generally in different countries, in the process of LC transaction, it is popular to include a fourth party from the country of beneficiary, namely a bank known as corresponding bank. According to Uniform Customs and Practices for Documentary Credits (currently UCP 600), different functions for corresponding bank are: acting as advising bank, nominated bank, negotiating bank and confirming bank. By confirming the credit, confirming bank assumes same liabilities as issuing bank towards beneficiary and relieves him from certain degree of risk which may result in not effectuating payment by issuing bank in accordance with terms and conditions of the credit. Autonomy principle and strict compliance as two main governing principles of LC provide that in effectuating the payment, issuing bank does not look into the performance of beneficiary in the framework of underlying contract and beneficiary is only supposed to produce complying presentation of documents stipulated in the LC to receive payment from either of issuing or confirming bank. Any claim regarding performance of beneficiary under the contract of sales should be followed separately as banks deal only with documents and not goods.
According to Kudrianchov, the LC is a “complex of contractual obligations”. Lord Diplock in United City Merchants (Investments) Ltd. v. Royal Bank of Canada defines the relations under the letter of credit as four autonomous but interrelated contracts:
“…it is trite law that there are four autonomous though interrelated contractual relations involve:
(1) Underlying contract for the sale of goods, to which the only parties are the buyer and the seller;
(2) The contract between buyer and the issuing bank under which the latter agrees to issue the credit and either itself or through a confining bank to notify the seller and to make payments to or to the order of the seller (or to pay, accept or negotiate bills of exchange drawn by the seller) against presentation of stipulated documents; and the buyer agrees to reimburse the issuing bank for payment made under the credit. For such reimbursement, stipulated documents, if they include a document of title such as bill of lading, constitute a security available to the issuing bank;
(3) If payment is to be made through a confirming bank, bank authorizing and requiring the later to make such payments and to remit the stipulated documents to the issuing bank when they are received, the issuing bank in turn agrees to reimburse the confirming bank for payments made under the credit;
(4) The contract between the confirming bank and the seller under which the confirming bank undertakes to pay the seller (or to accept or negotiate without recourse to drawer of bills of exchange drawn to him) up to the amount of the credit against presentation of the stipulated documents”.
Interestingly, Lord Diplock does not give any reference to the contract between issuing bank and seller. This issue has been noticed by Raymond Jack. Therefore, it is possible to mention that there are five autonomous but interconnected contracts between parties in the system of international documentary letter of credit. Among them, scholars mostly debate on legal nature of relations between issuing bank and beneficiary.
Issuing bank-beneficiary relations and its liabilities towards beneficiary as the centre of focus in current paper are important since the legal basis for their relation is not clear in different legal systems. UCP does not provide any precise definition on legal nature of relations between issuing and confirming bank with beneficiary in LC system. English law has never taken a thorough approach to relations between issuing bank and the beneficiary. In a way, Gutteridge and Megrah consider it as an unresolved issue. Such uncertainty in legal basis of obligations of issuing bank towards beneficiary creates troubles on the way to study rights and liabilities of them against each other. Current paper tries to clarify the legal nature of relations between issuing bank and beneficiary and explain obligations of issuing bank towards beneficiary based on extensive comparative research in existing literature on subject matter as well as case law available under English law. In doing so, part one of the paper will explain the procedure of functioning of the documentary letter of credit and its main principles. Part two will focus on duty of beneficiary on presentation of documents. Part three will define obligations of the issuing bank and tap on legal basis of issuing banks obligations towards beneficiary. Finally, part four will explain conditions under which issuing bank has the right for recourse against beneficiary.
According to Kudrianchov, the LC is a “complex of contractual obligations”. Lord Diplock in United City Merchants (Investments) Ltd. v. Royal Bank of Canada defines the relations under the letter of credit as four autonomous but interrelated contracts:
“…it is trite law that there are four autonomous though interrelated contractual relations involve:
(1) Underlying contract for the sale of goods, to which the only parties are the buyer and the seller;
(2) The contract between buyer and the issuing bank under which the latter agrees to issue the credit and either itself or through a confining bank to notify the seller and to make payments to or to the order of the seller (or to pay, accept or negotiate bills of exchange drawn by the seller) against presentation of stipulated documents; and the buyer agrees to reimburse the issuing bank for payment made under the credit. For such reimbursement, stipulated documents, if they include a document of title such as bill of lading, constitute a security available to the issuing bank;
(3) If payment is to be made through a confirming bank, bank authorizing and requiring the later to make such payments and to remit the stipulated documents to the issuing bank when they are received, the issuing bank in turn agrees to reimburse the confirming bank for payments made under the credit;
(4) The contract between the confirming bank and the seller under which the confirming bank undertakes to pay the seller (or to accept or negotiate without recourse to drawer of bills of exchange drawn to him) up to the amount of the credit against presentation of the stipulated documents”.
Interestingly, Lord Diplock does not give any reference to the contract between issuing bank and seller. This issue has been noticed by Raymond Jack. Therefore, it is possible to mention that there are five autonomous but interconnected contracts between parties in the system of international documentary letter of credit. Among them, scholars mostly debate on legal nature of relations between issuing bank and beneficiary.
Issuing bank-beneficiary relations and its liabilities towards beneficiary as the centre of focus in current paper are important since the legal basis for their relation is not clear in different legal systems. UCP does not provide any precise definition on legal nature of relations between issuing and confirming bank with beneficiary in LC system. English law has never taken a thorough approach to relations between issuing bank and the beneficiary. In a way, Gutteridge and Megrah consider it as an unresolved issue. Such uncertainty in legal basis of obligations of issuing bank towards beneficiary creates troubles on the way to study rights and liabilities of them against each other. Current paper tries to clarify the legal nature of relations between issuing bank and beneficiary and explain obligations of issuing bank towards beneficiary based on extensive comparative research in existing literature on subject matter as well as case law available under English law. In doing so, part one of the paper will explain the procedure of functioning of the documentary letter of credit and its main principles. Part two will focus on duty of beneficiary on presentation of documents. Part three will define obligations of the issuing bank and tap on legal basis of issuing banks obligations towards beneficiary. Finally, part four will explain conditions under which issuing bank has the right for recourse against beneficiary.