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Kurkela, Martin S., Letters of Credit and Bank Guarantees Under International Trade Law, 2nd ed. 2008

Kurkela, Martin S., Letters of Credit and Bank Guarantees Under International Trade Law, 2nd ed. 2008
Table of Contents

Chapter I




I.7 Letters of credit

Letters of credit are often defined as contracts sui generis. The credits are unilateral undertakings of the issuer to render certain specific services to the beneficiary for and on behalf of the account party and at his request.44 Dolan gives the following functional definition in The Law of Letters of Credit on p. 2-3:


“It is more accurate to say that credits are sui generis and that the law of contracts supplements the law of credits only to the extent that contract principles do not interfere with the unique nature of credits.”

The beneficiary has no explicit and enforceable duties under them. Letters of credit cannot be amended without the consent of the beneficiary. They are irrevocable unless otherwise expressly indicated.45



“Issuance, Amendment, Cancellation, and Duration. (a) A Letter of credit is issued and becomes enforceable according to its terms against the issuer when the issuer sends or otherwise transmits it to the person requested to advise or to the beneficiary. A letter of credit is revocable only if it so provides. (b) After a letter of credit is issued, rights and obligations of a beneficiary, applicant, confirmer, and issuer are not affected by an amendment or cancellation to which that person has not consented except to the extent the letter of credit provides that it is revocable or that the issuer may amend or cancel the letter of credit without that consent. (c) If there is no stated expiration date or other provision that determines its duration, a letter of credit expires one year after its stated date of issuance or, if none is stated, after the date on which it is issued. (d) A letter of credit that states that it is perpetual expires five years after its stated date of issuance, or if none is stated, after the date on which it is issued.”

They are usually materially independent from the transaction and based on documents only — in general nothing else has any relevance.46 They do not replace any other obligations of the parties.




III.4 Strict compliance doctrine

The strict compliance doctrine refers in general to the examination of documents under both stand-by and commercial letters of credit. The documentary conditions precedent must be strictly met in order for the duty of honor to arise. The strict compliance requirement, as applied these instruments means formal or literal compliance, and the reality existing or even known beyond the documents is not relevant at all. The formal test is merciless: discrepancy leads to dishonor regardless of its substance or significance.

URDG Art 2 (b)


“Guarantees by their nature are separate transactions from the contract(s) or tender conditions on which they may be based, and Guarantors are in no way concerned with or bound by such contract(s), or tender conditions,



despite the inclusion of a reference to them in the Guarantee. The duty of a Guarantor under a Guarantee is to pay the sum or sums therein stated on the presentation of a written demand for payment and other documents specified in the Guarantee which appear on their face to be in accordance with the terms of the Guarantee.”

When the instrument is substantively independent, what de facto has taken place or may take place under the transaction is irrelevant and the reality has no relevance de jure to the rights of the beneficiary or the duties of the issuer under the instrument: only the conditions precedent, specified as to the documents to be presented therein, are to be met strictly by the beneficiary in order for him to be entitled to performance under the instrument.17

ISP 4.01


“a. Demands for honour of a standby must comply with the terms and conditions of the standby. b. Whether a presentation appears to comply is determined by examining the presentation on its face against the terms and | conditions stated in the standby as interpreted and supplemented by these Rules which are to be read in the context of standard standby practice.”

CAI v. GB et al.

This well-established rule was expressed as follows:


“I was not addressed at any length as to the proper approach to the question of discrepancy. Indeed, the principles are well established and were



recently re-emphasized by the Court of Appeal in both Seaconsar Far East Ltd. v. Bank Markazi Jomhouri Islami Iran, [1993] 1 Lloyd’s Rep. 236 and in Glencore International A.G. v. Bank of China, [1996] 1 Lloyd’s Rep. 135. For present purposes it is sufficient to state as follows:


The banker is under no duty to consider the legal effect of the documents or their purpose; Midland Bank Ltd. v. Seymour, [1955] 2 Lloyd’s Rep. 147 and Commercial Banking Co. of Sydney v. Jalsard Pty. Ltd., [1973] A.C. 279.


The basic principle is that documents must comply strictly with the terms and conditions of the letter of credit: Equitable Trust Co. New York v. Dawson Partners Ltd., (1927) 27 LLL.Rep. 49.


It is not enough to check each document individually against the wording of the credit. Each document must be compared with the other documents to ensure that they are consistent. See Glencore v. Bank of China (sup.).


The documents have to be taken up or rejected promptly and without any opportunity for prolonged enquiry so that a tender of documents which, properly read and understood, invites litigation or calls for further enquiry is a bad tender: Golodetz & Co. Inc. v. Czarnikow-Rionda Co. Inc., [1980] 1 Lloyd’s Rep. 453; [1980] 1 W.L.R. 495.18."18

The strict compliance rule demonstrates the special character of these instruments: they do not operate as ordinary contracts. Under contract law a breach must in general be material in order to justify cancellation or termination for cause, whereas under these instruments any insignificant deviation or discrepancy entitles the bank to refuse payment.19 However, once accepted, the bank is entitled to be reimbursed if the documents “appeared prima facie” to be strictly conforming i.e., they do not have to be de facto strictly conforming. If the tender is, on the other hand, refused, the discrepancies must be identified and specified to the beneficiary, and the documents returned to him, and the bank is precluded from raising new objections as to the documents tendered. The beneficiary may


thus tender again, until expiry of the instrument. The bank may raise new objectives as to documents not tendered earlier, but not to the ones already tendered and not objected to.




Chapter IV


IV.1 Fraud ("abuse") or "fraus omnia corrumpit", generally

The fraud exception is globally well-established, but what constitutes fraud for the purposes of these instruments? There is both a criminal and a civil dimension in what we call fraud.

Fraud is hard to define under many laws as are abuse, unreasonableness, unfairness and unconscionability.1 There is no international standard, nor


are there internationally agreed criteria, either. We are told by commentators that:


“The fraud rule is “the most controversial and confused area” in the law governing letters of credit, mainly because the standard of fraud is hard to define. The divergent views expressed by courts and commentators with respect to the essence of the standard of fraud reflect the tension between two different policy considerations: “the importance to international commerce of maintaining the principle of the autonomy of documentary credits... and the importance of discouraging or suppressing fraud in the letter of credit transaction.""2



Clear proof, which allows a bank to refuse to pay, is generally memorialized in a court decision or a temporary injunction or other protective order, which, however, need not be final.19 This is not a problem at all, but the “guessing” that the bank needs to do in the absence of such a court order may be very painful and expose the bank to liability. Sometimes a pending criminal investigation, a court decision or other evidence may establish fraud beyond any doubt. The banks may not necessarily have to be judges in this respect and should rather avoid it, since court systems often provide interim measures to parties to accomplish an attachment or other court intervention by obtaining injunctive temporary relief or by resorting to other such measures or remedies.20 If the parties fail to do this,


it should reduce or eliminate the banks exposure to liability for wrongful payment.

UNC Art 20 provides some shelter:


“(1) Where, on an application by the principal/applicant or the instructing party, it is shown that there is a high probability that, with regard to a demand made, or expected to be made, by the beneficiary, one of the circumstances referred to in subparagraphs (a), (b) and (c) of paragraph (1) of article 19 is present, the court, on the basis of immediately available strong evidence, may: (a) Issue a provisional order to the effect that the beneficiary does not receive payment, including an order that the guarantor/ issuer hold the amount of the undertaking, or (b) Issue a provisional order to the effect that the proceeds of the undertaking paid to the beneficiary are blocked, taking into account whether in the absence of such an  order the principal/applicant would be likely to suffer serious harm.


(2) The court, when issuing a provisional order referred to in paragraph (1) of this article, may require the person applying therefor to furnish such form of security as the court deems appropriate. (3) The court may not issue a provisional order of the kind referred to in paragraph (1) of this article based on any objection to payment other than those referred to in subparagraphs (a), (b) and (c) of paragraph (1) of article 19, or use of the undertaking for a criminal purpose."


The criteria applied to establish fraud before a bank must be even stricter than those applied by courts. Banks do not need to be, and should not be, active in
establishing fraud.


“Tt is simply not for a bank to make enquiries about the allegations that are being made one side against the other. If one side wishes to establish that a demand is fraudulent, it must put the irrefutable evidence in front of the bank. It must not simply make allegations and expect the bank to check whether those allegations are founded or not . . .[I]t is not the role of a bank to examine the merits of allegations of breach of contract. To hold otherwise would place banks in a position where they would in effect have to act as Courts in deciding whether to make payment or not. Of course, if a beneficiary were to admit to the bank that it had no right to make the demand, then a totally different situation would arise.

44UCC 5-102 official comments:
“A letter of credit is an idiosyncratic form of undertaking that supports performance of an obligation incurred in a separate financial, mercantile, or other transaction or arrangement. The objectives of the original and revised Article 5 are best achieved (1) by defining the peculiar characteristics of a letter of credit that distinguish it and the legal consequences of its use from other forms of assurance such as secondary guarantees, performance bonds and insurance policies, and from ordinary contracts, fiduciary engagements, and escrow arrangements; and (2) by Preserving flexibility through variation by agreement in order to respond to and accommodate developments in custom and usage that are not inconsistent with the essential definitions and substantive mandates of the statute. No statute can, however, prescribe the manner in which such substantive rights and duties are to be enforced ot imposed without risking stultification of wholesome developments in the letter of credit mechanism. Letter of credit law should remain responsive to commercial reality and in particular to the customs and expectations of the international banking and mercantile community. Courts should read the terms of this article in a manner consistent with these customs and expectations.”

Greece (DCL) Art. 25:
“1. A Documentary credit is an agreement between a banking corporation (creditor) party (debtor) and another to issue a credit for the benefit of a third party (beneficiary). By this agreement the bank undertakes to pay to such third party the credit amount upon presentation of the bill of lading. Such amount shall be reimbursed by the debtor upon forwarding the bill of lading. 2. By payment of the amount the bank acquires a pledge over the goods referred to in the bill of lading. 3. The agreement on the credit shall be in writing. 4. The agreement on the credit is a commercial transaction for both parties”

45UCC Section 5-106:
“Added by Laws 2000, Ch. 471, eff. Nov. 1, 2000. Official comment: 1. This section adopts the position taken by several courts, namely that letters of credit that are silent as to revocability are irrevocable See, e.g, Weyerhaeuser Co. v. First Nat. Bank, 27 UCC Rep. Serv, 777 (SD. lowa 1979); West Va. Hous. Dev. Fund v. Sroka, 415 F. Supp. 1107 (W.D. Pa. 1976). This is the position of the current UCP (500), Given the usual commercial understanding and purpose of letters of credit, revocable letters of credit offer unhappy possibilities for misleading the parties who deal with them.”

46UCC 5-103 provides:
“Of course, no term in a letter of credit, whether incorporated by reference to practice rules or stated specifically, can free an issuer from a conflicting contractual obligation to its applicant. If, for example, an issuer promised its applicant that it would pay only against an inspection certificate of a particular company but failed to require such a certificate in its letter of credit or made the requirement only a nondocumentary condition that had to be disregarded, the issuer might be obliged to pay the beneficiary even though its payment might violate its contract with its applicant.”

17ISP 4.02:
“Documents presented which are not required by the standby need not be examined and, in any event, shall be disregarded for purposes of determining compliance of the presentation. They may without responsibility be returned to the presenter or passed on with the other documents presented” 4.03: “An issuer or nominated person is required to examine documents for inconsistency with each other only to the extent provided in the standby.’; 4.09 (c): “Specifted wording by the use of quotation marks, blocked wording, or an attached exhibit or form, and also provides that the specified wording be “exact” or “identical”, then the wording in the documents presented, including typographical errors in spelling, punctuation, spacing and the like, as well as blank lines and spaces for data, must be exactly reproduced”. Russia (DCL) Art. 870: “In order to execute a letter of credit the beneficiary shall present to the executing bank documents evidencing due performance of all conditions of the letter of credit. If any — even if only one — condition of the letter of credit is not met, the letter of credit shall not be executed”.

18Credit Agricole Indosuez v. Generale Bank and Seco Steel Trading Inc. and Considar Inc., 1999 WL 1319093 (QBD (Comm Ct)), [2000] C.L.C. 205, [2000] 1 Lloyd’s Rep. 123, {1999] 2 All E.R. (Comm) 1016.
19Pifer presents various theories of strict compliance doctrine on p. 4: Flexible strict compliance, substantial compliance and reasonable compliance in addition to classic strict compliance rule (Tom Pifer, “The ICC Publication of International Standard Banking Practice (ISBP) and the Probable Effect on United States Letter of Credit Law”, Texas Wesleyan Law Review, (Spring 2006).)
1Quentin Loh and Tang Hang Wu in “Injunctions restraining calls on performance bonds - is fraud the only ground in Singapore?”:
“As can be seen from the discussion above, the ambit of the notion of “unconscionability” is far from settled and some confusion has been thrown on the standard of proof required. In particular, the Min Thai case suggests a relaxation of the court’s attitude in granting injunctive relief to restrain the call on the performance bond?
Charles Proctor, “Enron, Letters of Credit and the Autonomy Principle’, Butterworths Journal of International Banking & Financial Law (2004 19(6), 204-209): “What conclusions can be drawn from the above analysis of the Mahonia decision? First of all, it may be concluded that the *fraud exception’ is not limited to cases in which the applicant for the credit or the issuing bank is the victim of the fraud. The exception may apply if the request for the credit is made as part of a scheme to deceive the public by preparing misleading accounts or in some similar way. To this extent, the ambit of the fraud exception may perhaps be broader than previously thought. The courts must however, be astute to keep the exception within its proper limits, to ensure that the utility of documentary credits in international transactions is not undermined?
Anthony Pugh-Thomas, “Performance Guarantees and Unconscionable Conduct - An Australian Perspective’, Case Comment, J..B.L. (1997, 12(10), 414-417):
“Referring to earlier cases, the judge felt that the word” “unconscientious” caught better the flavour of the evil to which the TPA was directed than” “unconscionable” and he referred in particular to Logue v. Shoalhaven Shire Council where” “it is said that what is involved is a situation or conduct unconscionable so as to invoke the intervention of the court that from the beginning regarded itself as a court of conscience.”
Dong-heon Chae, “Letters of Credit and the Uniform Customs and Practice for Documentary Credits: The Negotiating Bank and the Fraud Rule in Korea Supreme Court CASE 96 DA 43713”, 12 Fla. J. Int IL. 23, (Spring, 1998):
“The concept of “fraud (Sagi)” in Korea in legal activities is expressed in Article 110 of the Korean Civil Code, which provides that "a declaration of intention induced by fraud or duress may be voidable.” Fraud is established when a deceitful act by one party causes a mistake to be made by the other and induces the mistaken party to make a declaration of intention. ....In this case, the Supreme Court used the good faith principle, which in Article 2 of the Civil Code provides that “the exercise of rights and performance of duties shall be in good faith and in accordance with the principles of trust.""

2Gao Xiang and Ross P. Buckley, “A Comparative Analysis of the Standard of Fraud Required under the Fraud Rule in Letter of Credit Law’, Duke Journal of Comparative and International Law, (Spring 2003).
19UCC 5-109 (official comment):
“4, The standard for injunctive relief is high, and the burden remains on the applicant to show, by evidence and not by mere allegation, that such relief is warranted. Some courts have enjoined payments on letters of credit on insufficient showing by the applicant. For example, in Griffin Cos. v. First Nat'l Bank, 374 N.W.2d 768 (Minn. App. 1985) the court enjoined payment under a standby letter of credit, basing its decision on plaintiff’s allegation, rather than competent evidence, of fraud. There are at least two ways to prohibit injunctions against honor under this section after acceptance of a draft by the issuer. First is to define honor (see Section 5-102(a)(8)) in the particular letter of credit to occur upon acceptance and without regard to later payment of the acceptance. Second is explicitly to agree that the applicant has no right to an injunction after acceptance/whether or not the acceptance constitutes honor. 5. Although the statute deals principally with injunctions against honor it also cautions against granting “similar relief” and the same principles apply when the applicant or issuer attempts to achieve the same legal outcome by injunction against presentation (see Ground Air Transfer Inc. v. Westates Airlines, Inc., 899 E2d 1269 (1st Cir. 1990)), interpleader, declaratory judgment, or attachment. These attempts should face the same obstacles that face efforts to enjoin the issuer from paying. Expanded use of any of these devices could threaten the independence principle just as much as injunctions against honor. For that reason courts should have the same hostility to them and place the same restrictions on their use as would be applied to injunctions against honor. Courts should not allow the “sacred cow of equity to trample the tender vines of letter of credit law”

20UCC 5-109 (official comment):
“This recodification makes clear that fraud must be found either in the documents or must have been committed by the beneficiary on the issuer or applicant. See Cromwell v. Commerce & Energy Bank, 464 So. 2d 721 (La.1985). Secondly, it makes clear that fraud must be “material” Necessarily courts must decide the breadth and width of “materiality” The use of the word requires that the fraudulent aspect of a document be material to a purchaser of that document or that the fraudulent act be significant to the participants in the underlying transaction. Assume, for example, that the beneficiary has a contract to deliver 1,000 barrels of salad oil. Knowing that it has delivered only 998, the beneficiary nevertheless submits an invoice showing 1,000 barrels. If two barrels in a 1,000 barrel shipment would be an insubstantial and immaterial breach of the underlying contract, the beneficiary's act, though possibly fraudulent is not materially so and would not justify an injunction. Conversely, the knowing submission of those invoices upon delivery of only five barrels would be materially fraudulent. The courts must examine the underlying transaction when there is an allegation of material fraud, for only by examining that transaction can one determine whether a document is fraudulent or the beneficiary has committed fraud and, if so, whether the fraud was material. Material fraud by the beneficiary occurs only when the beneficiary has no colorable right to expect honor and where there is no basis in fact to support such a right to honor. The section indorses articulations such as those stated in Intraworld Indus. v. Girard Trust Bank. 336 A.2d 316 (Pa. 1975), Roman Ceramics Corp. v. People’s Nat'l Bank. 714 F.2d 1207 (3d Cir.1983), and similar decisions and embraces certain decisions under Section 5-114 that relied upon the phrase “fraud in the transaction”.
Some of these decisions have been summarized as follows in Ground Air Transfer v. Westates Airlines, 899 F.2d 1269, 1272-73 (1st Cir. 1990): We have said throughout that courts may not “normally” issue an injunction because of an important exception to the general ‘no injunction rule The exception, as we also explained in Itek. 730 F.2d at 24-25 concerns “fraud” so serious as to make it obviously pointless and unjust to permit the beneficiary to obtain the money. Where the circumstances “plainly” show that the underlying contract forbids the beneficiary the beneficiary of even a “colorable’ right to do so, id., at 25; where the contract and circumstances reveal that the beneficiary’s demand for payment has “absolutely no basis in fact” id see Dynamics Corp. of Am. 356 F. Supp. at 999; where the beneficiary conduct has “so vitiated the entire transaction that the legitimate purposes of the independence of the issuers obligation would no longer he served,” Itek, 730 2d at 25 (quoting Roman Ceramics Corp. v. Peoples Nat’I Bank, 714 F.2d 1207, 1212 n.12, 1215 (3d Cir, 1983) (quoting Intraworld Indus., 336 A.2d at 324-25)); then a court may enjoin payment.”

Referring Principles
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