This is a chapter from the Bloomsbury Professional book Jack: Documentary Credits, 4th Edition, which is a detailed and authoritative account of the law and practice of documentary credits, including standby credits and demand guarantees. It also explains the rights and liabilities of each of the parties in the chain of complex relationships involved. Written from the perspective of banking practices as well as the law, it considers the Uniform Customs and Practice for Documentary Credits 600, as well as a full review of the body of case law on the UCPDC 500.
This chapter, the table of contents and the index are FREE to view, as a sample of the book's contents.
Table of Contents
2.1 The rights and obligations created by a credit are to be found in its terms; whether they are or are not typical of a particular type of credit must be treated with caution as a guide to their understanding. For a label may be helpful or it may be misleading if the credit is typical in some respects but not in others. Where, however, a categorisation is established by the UCP, it is important because the rules applying to the category provided by the UCP will apply. This is of particular importance with regard to the distinction between confirmed and unconfirmed credits. The discussion which follows provides a means of further introducing the differing obligations that may be undertaken in connection with credits.
2.2 A revocable credit is one which may be cancelled or amended by the bank undertaking to pay, without the beneficiary's consent. An irrevocable credit can be cancelled or amended only with the consent of the applicant, the issuing bank and the beneficiary. UCP 500 distinguished in Article 6 between revocable and irrevocable credits, and provided that in the absence of any clear indication the credit 'shall be deemed to be irrevocable'. By way of contrast, however, revocable credits are entirely excluded from the scheme of the new UCP 600. Irrevocability is now an essential part of the definition of a documentary credit, Article 2 providing that 'Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation'. A credit shall be treated as irrevocable even if there is no indication to that effect in its terms: Article 3.
2.3 Given the unsatisfactory nature of a revocable credit,[1] it is right that a credit should be irrevocable in the absence of any contrary indication. The approach of the UCP, that irrevocability is a defining characteristic of a documentary credit, is consistent with the view that an English court would likely take, that an irrevocable credit must be provided where the underlying contract simply provides for payment by letter of credit. This is on the ground that a revocable credit provides no security.[2] In International Banking Corpn v Barclays Bank Ltd, Atkin LJ stated in respect of the (admittedly unusual) credit he was there considering: 'And the other matter which I think quite plainly emerges is that a credit so announced is irrevocable unless it appears on the face of it that it is revocable.'[3]
2.4 There is no place for revocable credits within the scheme of the UCP 600. Should parties nonetheless wish to create a revocable credit, one way of doing so would be to incorporate the relevant provisions of UCP 500. UCP 500 Article 8 related to revocable credits and provided as follows:
'Article 8: Revocation of a Credit
a. A revocable Credit may be amended or cancelled by the Issuing Bank at any moment and without prior notice to the Beneficiary.
b. However, the Issuing Bank must:
i. reimburse another bank with which a revocable Credit has been made available for sight payment, acceptance or negotiation – for any payment, acceptance or negotiation made by such bank – prior to receipt by it of notice of amendment or cancellation, against documents which appear on their face to be in compliance with the terms and conditions of the Credit;
ii. reimburse another bank with which a revocable Credit has been made available for deferred payment, if such a bank has, prior to receipt by it of notice of amendment or cancellation, taken up documents which appear on their face to be in compliance with the terms and conditions of the Credit.'
2.5 Although UCP 500 Article 8 may at first sight suggest that a bank can never come under an obligation to a beneficiary in respect of a revocable credit, it is clear that where the credit provides for payment by means of a time draft or for deferred payment (in the sense explained in paragraph 2.16 below) and the beneficiary has presented documents which are accepted by the bank, an obligation will come into being. For Article 8.b assumes that the bank for whose reimbursement it is providing has become obliged to the beneficiary. In any event it would be wholly unacceptable for a bank to be able to reject its payment obligation to the beneficiary after it had accepted the documents and the beneficiary had lost control of them.
2.6 Apart from this very limited protection, a revocable credit provides no undertaking by the issuing bank to the beneficiary at all. For even if the correct documents are presented and the bank has not until then decided to revoke the credit, it may still do so and reject the documents.[4] It might, for instance do that if it thought that the financial circumstances of its customer, the applicant, had deteriorated since the credit was opened. For this reason a confirmed revocable credit would ordinarily be a contradiction in terms, there being no effective undertaking to confirm. A confirmation would mean something, however, where the credit provided for payment to be deferred: then the confirming bank would add its undertaking to that of the issuing bank – which becomes irrevocable after documents have been accepted – that payment will be made in due course.
2.7 The serious disadvantage of revocable credits is shown by Cape Asbestos Co Ltd v Lloyd's Bank Ltd.[5] There the plaintiffs agreed to sell 30 tons of asbestos to buyers in Warsaw, who opened a revocable credit through Lloyd's Bank in London. Lloyd's informed the plaintiffs: 'This is merely an advice of the opening of the above-mentioned credit, and is not a confirmation of the same.' The first shipment of 17 tons was duly paid for through the credit. The plaintiffs then shipped the remaining 13 tons. Meanwhile, unknown to them, Lloyd's had been informed of the cancellation of the credit. The documents were presented to Lloyd's in London and refused. The action was brought against them on the basis that it was their duty to give reasonable notice of the withdrawal of the credit. The evidence established that it was usual for the defendants to give notice of the withdrawal of credits, but here they had omitted to do so. The court held that there was no legal obligation on the bank to give notice. Thus the credit turned out to be an illusory security, and since the plaintiffs were unable to recover from their buyers they went unpaid. The position where an un-notified amendment took place, for example one involving the addition of a document to those to be presented in order to obtain payment, would be no less galling.
2.8 Almost all credits issued today are irrevocable, and it is only those that will provide the security that the seller has no doubt sought in specifying that payment shall be by letter of credit. As mentioned above, UCP 600 only applies to irrevocable credits. Where a contract specifies payment by letter of credit, an irrevocable credit is required.[6] When a bank issues an irrevocable credit, the bank gives its undertaking that the beneficiary will receive payment as the credit may provide. Article 2 of the UCP uses the term 'honour' to encompass the different methods by which a bank may be required to perform its financial obligations under the credit:
'Article 2
…
Honour means:
a. to pay at sight if the credit is available by sight payment.
b. to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment.
c. to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance.
…'
Article 7.a of the UCP then spells out the obligations of an issuing bank to honour the credit. In summary, the issuing bank undertakes to pay where the credit provides for sight payment or deferred payment (by itself or by a nominated bank); it undertakes to accept drafts drawn on it, or to be responsible for their acceptance and payment at maturity if they are to be drawn on another bank;[7] where the credit provides for negotiation with another bank, it undertakes to pay if negotiation is not effected by that bank. Article 8.a sets out the equivalent undertakings which are given by a confirming bank to honour or negotiate the credit. These undertakings are further considered in Chapter 5.[8] They are at the heart of a documentary credit, and they make the instrument the secure means of payment that it is intended to be. Article 10.a provides that the undertakings cannot be amended or cancelled without the agreement of the issuing bank, the confirming bank (if any), and the beneficiary. Obviously the agreement of the applicant (who has ultimately to fund the operation) is also needed. The amendment of a credit is considered in detail in Chapter 3.[9] If the issuing bank purports to revoke the credit unilaterally, then this amounts to a renunciation of the contract with the beneficiary. The beneficiary can elect to accept this renunciation as terminating the contract forthwith and claim damages, but, as with any contract, he must communicate his acceptance clearly and unequivocally to the bank, silence or inactivity generally being insufficient.[10] If the beneficiary does not accept the renunciation, then the contract remains in full effect for the benefit of both parties; in particular if the beneficiary then proceeds to make a non-complying presentation of documents, then the bank has no liability to pay under the credit.
2.9 It may be questioned at what point the relevant undertaking becomes binding on the issuing and confirming banks. Clearly the credit must be communicated to the beneficiary, and it is suggested that it becomes binding at that moment. Any previous uncertainties as to the legal position have now been put to rest, at least where UCP 600 applies. This expressly provides in Article 7.b that the issuing bank is irrevocably bound to honour its obligations 'as of the time it issues the credit'. Article 8.b deals with the position of any confirming bank, providing that it is irrevocably bound to honour or negotiate 'as of the time it adds its confirmation to the credit'. This analysis is also confirmed by Article 10.b which provides that an issuing bank is irrevocably bound by an amendment from the moment the amendment is issued (and a confirming bank as of the time when it advises the amendment). There is thus no distinction in this respect between the issue of a credit and the issue of an amendment.
2.10 The contrary analysis (no longer arguable if UCP 600 applies) is that the credit only becomes binding when the seller has acted on it by doing something towards the performance of his contract. This might be the making of an arrangement to ship the goods, or commencing to manufacture or continuing to manufacture them. This was the suggestion of Rowlatt J in Urquhart, Lindsay & Co Ltd v Eastern Bank Ltd.[11] But in Dexters Ltd v Schenker & Co,[12] Greer J pointed out[13] that on receipt of the credit the seller becomes bound to proceed with the contract (for the provision of the credit is normally a condition precedent to the seller's obligation to ship), and he appeared to consider a bank bound from that moment. These cases are considered further in connection with the consideration for the bank's undertaking.[14]
2.11 Where a contract of sale calls for an irrevocable credit to be opened in London, a credit which is advised through a London bank which does not confirm it does not satisfy the contract, since the London bank gives no undertaking: Enrico Furst & Co v WE Fischer Ltd.[15] However, the objection must be taken in time by the seller; in Enrico a request by the seller for an extension of the credit was held to be a waiver. See paras 3.4 to 3.7 below.
2.12 The use of these terms assumes the existence of an advising bank (also called the correspondent bank), and the distinction depends upon the position taken by that bank. In short, with a confirmed credit the advising bank adds its own undertaking to that of the issuing bank that the credit will be honoured. If the credit is unconfirmed, it does not: the sole undertaking is that of the issuing bank.
2.13 Where the credit is unconfirmed, the advising bank acts solely as the agent of the issuing bank. It will be instructed by the issuing bank to notify the credit to the seller. The credit is likely to provide for the documents to be presented to the advising or correspondent bank, and it will receive them as agent for the issuing bank. If it is to pay, it will pay simply as the agent of the issuing bank and not because of any obligation existing between it and the seller. The position of the advising bank as agent is considered in greater detail subsequently.[16] The important feature where the credit is unconfirmed is that, if the documents are wrongfully refused by the bank to whom they are presented, the seller has normally a remedy only against the issuing bank, which is usually abroad, and so proceedings may be more difficult than if he had an undertaking from a bank in his own country.
2.14 Where a credit is confirmed, the advising or correspondent bank adds its own undertaking to that of the issuing bank to honour or negotiate the credit as the case may be. This then gives the beneficiary the advantage of having a paymaster in his own country. The credit will also be an irrevocable credit (see above),[17] and so the beneficiary will have the full benefits that the developed form of documentary credits provides. Article 8 of the UCP sets out the undertaking of a confirming bank (in similar terms as Article 7 sets out the undertaking of the issuing bank) to honour or negotiate the credit, with appropriate changes. Thus, for example, the confirming bank undertakes as appropriate to pay at sight or on a deferred date, to accept bills drawn on itself, and to be responsible for the acceptance of bills drawn on other drawees, and to negotiate without recourse bills drawn by the beneficiary on any drawee apart from itself. Where an advising bank purports to confirm a credit but reserves for itself a right of recourse against the seller, the two are inconsistent and the advising bank is not giving an absolute undertaking. The credit in these circumstances is not to be treated as a confirmed credit: see Wahbe Tamari & Sons Ltd v Colprogeca.[18] The position of the confirming banker is further discussed in Chapters 5 and 6.[19] Silent confirmations and confirmations on request are considered in paras 6.25 and 6.26 below.
'Article 6:
a. A credit must state the bank with which it is available or whether it is available with any bank. A credit available with a nominated bank is also available with the issuing bank.
b. A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation.'
This provides an important and convenient means of categorising credits in accordance with the type of payment obligation undertaken by the obligated banks. The bank with which the credit is made available, that is, at which the documents may be presented, is known as the 'nominated bank'; see Article 2, which also provides that any bank is a nominated bank if the credit is said to be available at any bank.
2.16 A credit may provide for payment on presentation of documents – after allowing time, of course, for them to be examined for compliance with the credit. Then it can be called a sight payment or sight credit.
2.17 Alternatively, the credit may provide for payment to be made at the conclusion of a period measured from the presentation of documents or, for example, from the date of the transport document. Then the credit is called a deferred payment credit. Such a credit has the advantage, for the buyer/applicant, that he need not reimburse the issuing bank until payment has been made and to that extent has the benefit of time to pay. In the UCP, the requirement that a bank should 'honour' the credit includes the obligation 'to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment' (Article 2). Where payment is deferred, the beneficiary must wait for his money but has the security of the bank's undertaking; however, if the applicant is in the meantime to receive and to be able to deal with the goods, the bank will have to release the documents to him. The loss of security for the bank which would otherwise occur can be avoided by the use of a trust receipt as described in Chapter 11.[20] The risks for a bank which discounts its own deferred payment obligation by early payment, now considerably ameliorated by the UCP 600, are discussed at para 9.43 to 9.47 below.
2.18 As a further alternative, the credit may provide that it will be honoured not by payment of money by the bank with which it is available but by the acceptance of a bill of exchange drawn by the beneficiary. This is known as an acceptance credit. If the bill is what may be called a time draft or a usuance draft and provides for payment after a period from acceptance of the bill, then, unless the credit otherwise provides, payment will only be forthcoming when that time comes. Again, the UCP definition of 'honour' includes the obligation 'to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance'. The bill must be presented to the party on whom it is drawn for payment to be triggered. This will normally be the bank to which documents are to be presented under the credit and which is to make payment. But if the bill is drawn on the issuing bank or another bank, then, unless the credit otherwise provides, the strict position is that payment is only due on presentation of the bill to the party on whom it is drawn. The issuing bank and any confirming bank are of course obliged to ensure payment, whether or not payment is forthcoming from the party on whom the bill is drawn. The use of a time or usuance draft provides another means of deferring payment under the credit, but with the advantage for the beneficiary that he obtains a negotiable instrument and can obtain payment before maturity by discounting the bill with another bank or finance house. Sometimes credits provide for the acceptance of a sight bill, that is, one payable at sight; those credits are equivalent to sight credits and the bill in that case has no real purpose.
2.19 Finally, the credit may be available by negotiation with a bank nominated in the credit (or with any bank if the credit so provides). UCP Article 2 defines negotiation as follows:
'Article 2:
Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.'
The purpose of making a credit available by negotiation is that it enables the beneficiary to get money immediately by negotiating—in effect selling—the documents to the nominated bank. The nominated bank, having negotiated, is then entitled to be reimbursed by the issuing bank in due course. The sum payable to the beneficiary on negotiation will be discounted to reflect the interest accruing between the date of receipt of payment by him and the date on which payment is due from the issuing bank. It is apparent that there will only be need for negotiation where the credit does not provide for immediate payment: if it does, the beneficiary may just as well present the documents to the issuing bank himself either directly or using his own bank as his agent for collection.[21] The term 'negotiation' is sometimes used to refer the acceptance and payment against documents of the full amount of the credit. This is a misuse. Negotiation is better used only when the paying bank pays less than the full amount by reason of a time element, as Article 2 indicates.
Although the UCP envisages that negotiation will take place through the nomination mechanism just described, the cases show that the term is sometimes used in a somewhat different sense to refer to a situation where the undertaking in a credit is extended to third parties as well as the beneficiary, so that any third party covered by the undertaking may purchase the documents and present them to the issuing bank in his own name and his own right. In this book, credits of that type are referred to as 'negotiation credits' (as opposed to credits 'available by negotiation' with a nominated bank) and are discussed in the next section. However, the practice of using negotiation credits in that sense is now very limited and, particularly with the advent of UCP 600, offers little advantage. If, under a credit subject to the UCP, it is intended that the beneficiary should be able to obtain payment by selling the documents to any bank, then the credit should be made freely available by negotiation.
2.20 A straight credit is one under which the undertaking of the issuing bank, or, if it is a confirmed credit, the undertakings of the issuing and confirming banks, are directed to the named beneficiary alone, and only he may rely on them. With a negotiation credit, by contrast, the undertakings are directed to any bank, or to any bank of a description stated in the credit, which becomes a bona fide holder of any bill of exchange and the other documents which are stipulated by the credit.
2.21 Negotiation by a bank under a negotiation credit may be distinguished from negotiation by a bank which does so as nominated bank under a credit providing for payment to be available from it by negotiation.[22]
2.22 What is necessary to make a credit a negotiation credit, so that its promise may be accepted by any bank of appropriate description that negotiates documents complying with the credit? This is a matter of construing the words of the credit, and if the credit is carefully worded there will be no problem. If it does not appear that the undertaking embodied in the credit is to be construed more widely, the credit must be given effect to as a straight credit. The answer may be provided as a matter of necessary implication, as it was in the old case of Re Agra and Masterman's Bank, ex p Asiatic Banking Corpn.[23] There was there an undertaking to honour drafts drawn on the bank, together with this statement 'This credit will remain in force for twelve months and parties negotiating bills under it are requested to indorse particulars on the back hereof.' It was held that this anticipated the negotiation of bills by other parties, and hence that there was an undertaking to them. The credit was not a documentary credit, but was simply a facility to obtain funds by drawing bills. But the logic of the construction was in no way dependent on that and would apply equally to a documentary credit. In M A Sassoon & Sons Ltd v International Banking Corpn,[24] a similar argument was presented based on wording that was less clear. The Privy Council merely noted the argument, observing that 'it is a very summary way of converting the terms of a discount offer by one bank into an undertaking applicable to actual discounts by any other bank'. The ground of decision in the case, however, was that the seller had discounted the draft to the plaintiff not on terms that it was a negotiation pursuant to the credit, but on terms that the plaintiff should present the bill and documents to the buyer and so obtain payment. The buyer accepted the bill but later dishonoured it by non-payment, and the plaintiff was held to be entitled to recover from the seller as the drawer of a dishonoured bill.
2.23 Suppose that a credit simply states 'negotiation is permitted', and an undertaking is given in these terms: 'We undertake to honour all drafts drawn under and in conformity with the terms of this credit'. Would such wording make the credit generally negotiable? There is no authority on such a wording in English law. A meaning has to be found for the words 'negotiation is permitted'. Their placing and context within the credit will be relevant. It may simply mean negotiation by a bank named in the credit. But if that does not appear possible, then probably the credit should be construed as permitting negotiation by any party.[25], [26] What is the position where the credit does not nominate any bank authorised to accept, pay or negotiate, nor allow negotiation by any bank? It is suggested in the ICC's More Case Studies on Documentary Credits[27] that it is a normal practice in this event to deem the credit freely negotiable. It is then stated 'However this is not without risk.' It would indeed be a risky assumption to make. For such a credit contains nothing in its wording to suggest that it is freely negotiable and the sounder assumption must be that it is available only with the issuing bank. UCP Article 6.a begins 'A credit must state the bank with which it is available or whether it is available with any bank…'. It does not follow from this drafting that if the credit does not contain any such statement it is presumed to be freely negotiable with any bank.
2.24 European Asian Bank AG v Punjab and Sind Bank (No 2)[28] demonstrates the difficulties which may arise as well as the principles to be applied in resolving them, and is worth detailed consideration. The Singaporean sellers, Bentrex, sold cloves to the Indian buyers, Jain, c. & f. Bombay. At Jain's request, the Punjab Bank in New Delhi opened a letter of credit through their correspondents in Singapore, the Allgemene Bank, which was advised to Bentrex through the European Asian Bank. The credit was available by Bentrex's drafts at 180 days after bill of lading date. Clause 6 provided 'Letter of credit should be advised through European Asia Bank… and should be divisionable and unrestricted for negotiation'. Clause 9 provided 'We hereby engage with drawers, endorsers and bona fide holders of drafts drawn under and in compliance with the terms of this credit that such drafts will be honoured on presentation and delivery of documents as specified above. Negotiations under this credit are restricted [to Allgemene Bank, Singapore]'. Reimbursement was to be effected from the Irving Trust, New York. Bentrex presented to the European Asian Bank documents and a draft drawn on Jain made payable to the order of the European Asian Bank. The bank sent the documents directly to the Punjab Bank in India, where the draft was accepted by Jain. Jain were then informed that the vessel and cargo had been lost, and claimed on their insurers who repudiated liability: there had been a fraud, and no goods had been shipped at all. Meanwhile Bentrex had been paid by the European Asian Bank who were therefore out of pocket. The Irving Trust were not put in funds. Both the Punjab Bank and the Allgemene Bank (who had confirmed the credit) refused to pay the European Asian Bank. The main points decided by the Court of Appeal were these. It was held first that the European Asian Bank had negotiated the documents[29] and draft and were seeking payment on their own behalf: they were not acting as agents of Bentrex and so were unaffected by the fraud of Bentrex. Secondly, the apparent contradiction between clause 6 and clause 9 was to be resolved as follows. In clause 6 'divisionable' was an error for 'divisible' and the clause meant that the credit was transferable in whole or in part (clause 7 permitted part shipments). 'Unrestricted for negotiation' meant that documents could be presented under the credit by any transferee of the credit. Clause 9 meant that whoever presented the documents (Bentrex or their transferee) could only do so through the Allgemene Bank who would then negotiate the documents as the only authorised negotiator. It was therefore not a negotiation credit, and under the terms of the credit the European Asian Bank had no rights against the Punjab Bank. By reason, however, of the communications between the two banks at the time of the delivery of the documents to the Punjab Bank and Jain's acceptance of the bill, the Punjab Bank was estopped from denying that they were responsible for ensuring payment to the European Asian Bank at maturity. Therefore they were obliged to pay.[30]
2.25 As the Sassoon and European Bank cases[31] demonstrate, in order to claim under a negotiation credit, the holder of the documents must have acquired them by a negotiation pursuant to the credit and not by other means. The wording of the credit is in any event likely so to provide.
2.26 Other aspects relating to the position of a negotiating bank are considered subsequently in Chapter 7, Part B, and the questions of recourse are referred to in paras 6.32, 7.7 and 7.9 according to context.
2.27 Where a credit is designated as transferable, the beneficiary has the right to request the appropriate bank to make the credit available in whole or in part to one or more other parties, and perhaps at some other place. It is important to emphasise at the outset that the right is only a right to request, and the bank is not obliged to accede to the request should it not wish to do so. The credit must be expressly designated as transferable. The object of transfer is to enable the beneficiary nominated in the credit to use the credit to provide a means of payment to a party, or to the parties, from whom he in his turn is buying the goods. He may indeed have contracted to provide them with a credit. He can then satisfy his obligation by the transfer of so much of the credit opened in his favour as is required to pay his seller. He must, however, ensure that the terms of the contract which he has made with the party from whom he is buying will be met by the transfer of the credit for which he has contracted with his buyer. He must also ensure that the documents to which he is entitled from his seller will meet the terms of the contract with his buyer. Where the credit which the beneficiary receives is not designated as transferable, or if the bank does not accede to the request for transfer, the seller has the alternative of arranging a back-to-back credit. UCP Article 38 governs transferable credits, a topic fully discussed in Chapter 10.
2.28 A credit may be described as back-to-back when it is intended that the documents which are received through the operation of it may be presented, with substitution of invoices (and possibly other documents), to obtain payment under another credit. Thus a seller of goods, the beneficiary of a credit opened in his favour by his buyer, may approach the bank which has advised the credit to him and request it to open a second credit in favour of his own suppliers, on the security of the first credit. This is likely to be possible only if he is already a customer of that bank. Alternatively he may approach his own bank and request them to do so using the credit already opened in his favour as a 'counter'. In the latter case the second credit may be called a counter credit. In each case the credit that the buyer has secured in favour of his own suppliers is a separate credit for which he is in the position of applicant. When complying documents are presented, he will have to reimburse the bank and take up the documents, regardless of the position between him and his buyer and under the credit of which he is beneficiary. In contrast, if he is able to arrange for transfer of the credit, he will avoid such risk. Back-to-back credits also carry a risk for banks on similar grounds: the bank in the middle of the chain has an obligation to pay the beneficiary of the credit which it has opened, regardless of whether its customer is able to obtain payment under the backing credit. For this reason, banks may prefer to use a transferable credit. It is essential that the documents required under the backing credit will be provided by the second credit. This may be difficult or even impossible where the basis of sale is different, for example, where the bank's customer is buying FOB but selling on CFR or CIF terms and a long sea voyage is involved. Here the second credit is likely to need to be in place before the backing credit is available. There is also room for differences of interpretation where the backing credit and the second credit are payable by different banks; this may create further practical and legal difficulties.
2.29 In Ian Stach Ltd v Baker Bosley Ltd[32] Devlin J described the manner in which transferable credits and back-to-back credits may be used to provide payment in a string of sale contracts:
'Where, as in the present case, there is a string of merchants' contracts between the manufacturer or stockist and the ultimate user, the normal mechanism for carrying out the various contracts is the familiar one which was intended to be used in this case: the ultimate user, under the terms of his contract of sale, opens a transferable, divisible credit in favour of his seller for his purchase price: his seller in turn transfers so much of the credit as corresponds to his own purchase price to his seller or, more probably, if his own contract with another merchant also calls for a transferable, divisible credit, procures his own banker to issue a back-to-back credit – that is to say, he lodges the credit in his favour with his own banker, who in his turn issues a transferable, divisible credit for the amount of his purchase price to his own seller; and so on, through the string of merchants, until the banker of the last merchant in the string issues the credit in favour of the actual manufacturer or stockist. The reason why they issue fresh credits is that in banking practice a transferable credit is regarded as transferable once only, and, also as is obvious in this sort of trade, it is desired, naturally enough, by any merchant in the string to conceal from his buyer and his seller who his own customer is. That is the way, as both parties to the present transaction knew, in which this type of business is normally carried on.'[33]
2.30 It has been suggested[34] that if a credit is not transferable it may be wrong for the advising bank to open a back-to-back credit at the seller's request upon the strength of it. Two reasons are suggested. The first is that the opening of a back-to-back credit is equivalent to transfer, and that, as the first credit is non-transferable, transfer is prohibited. It may be thought more precise to say that transfer is not permitted; it may not be permitted simply because, for reasons of his own, the seller did not contract for a transferable credit. Secondly, it is said that the buyer wants the seller's own goods and not those of a third party; so the bank should not facilitate supply from another source. But often the seller is not a producer of goods, and some goods, such as commodities, may be expected by their nature to be purchased by the seller for the purpose of the contract to which the credit relates. If the buyer requires the seller's own particular goods and no others, he should ensure that the sale contract reflects this: he may also be able to provide that the documents required under the credit also confirm this, which would give further protection. In the absence of any judicial precedent, it is submitted that the practice whereby correspondent banks open back-to-back credits is acceptable in law and in practice.
2.31 The difficulties which may befall banks who find themselves in what may be termed a quasi back-to-back situation, in particular where the object of the transaction is to trade goods between countries that forbid trade with each other, are well illustrated by the case of Mannesman Handel AG v Kaunlaren Shipping Corpn.[35] It was held that in the special circumstances of that case it would be contrary to the principle of good faith in Swiss law (the governing law of the documentary credit) for a bank that had received the assigned proceeds of a backing credit nonetheless to refuse to pay out on documents presented in order to claim payment under the credit that it had itself opened – even though there were undoubtedly discrepancies. It remains unclear whether a similar principle will be recognised by English law.
2.32 A revolving credit is one in which the credit limit (that is, the invoice value of the goods in respect of which documents can be presented) is not limited to a fixed overall amount. Rather, the maximum value is restored in a manner provided by the credit. For example, it may stipulate that the limit be restored each time a shipm ent is made: thus if the limit is £100,000 and a shipment of £95,000 is made, the limit is immediately restored to £100,000, but no single shipment may exceed £100,000. Alternatively the limit may be restored only after an appropriate period of time: there could be a limit of £100,000 per month, which would limit the goods to be shipped in any one month to that figure. Such a revolving credit may be arranged on a cumulative basis, meaning that any sum not utilised during one month is carried forward and will be available subsequently. This is to be contrasted with a non-cumulative instalment credit containing no such provision, which requires a specific shipment each month. In such a case, UCP Article 32 applies to provide that, should any instalment not be drawn in the allowed period, the credit ceases to be available for that and any subsequent instalments (unless the credit provides otherwise: Article 1). As the term 'revolving credit' may mean such different things and as the operation of such a credit can be complicated, it is particularly important that the buyer and seller should spell out in the underlying contract precisely what they intend, and that this should be fully and accurately set out in the credit itself.
2.33 Red clause credits contain a clause traditionally printed in red enabling the seller to draw on the credit in advance of the shipment of the goods. They may be used to finance a seller's own purchase or production of the goods. The buyer may obtain security if the advance is only to be made against documents such as a warehouseman's receipt (although the seller must retain his ability to deal with the goods for the purpose of the shipment, and this of course also enables him to deal with them in other, less desirable, ways). The inclusion of a red clause represents a considerable display of trust by the buyer in his seller. The issuing bank is entitled to be reimbursed by the buyer, whether or not shipment takes place, but it has no right to recover the payment from any other party in the absence of an express repayment guarantee.[36] As to the type of documents which at one time a seller might be required to deposit with the paying bank, see South African Reserve Bank v Samuel & Co.[37] The red clause was developed in the Australian, New Zealand and South African wool trades.
2.34 A relatively modern example of a red clause credit is given by Tukan Timber Ltd v Barclays Bank plc.[38] Tukan were importers of timber from Brazil and in order to finance the trade they opened a letter of credit in favour of their suppliers which appears to have been a form of revolving credit: it was referred to as an 'umbrella credit'. It contained a 'red clause' which enabled the suppliers to draw on the credit simply by presenting receipts countersigned by one or other of two directors of Tukan. Each advance was to state the lot to which it referred and the amount was to be deducted from the payment made when the lot was shipped and corresponding documents were presented. When a dispute developed between Tukan and their suppliers, the suppliers sought to take advantage of the red clause by presenting receipts which bore the forged signature of a director. The bank did not pay, but Tukan brought proceedings to secure their own position by way of an injunction. The claim failed on the ground that Tukan had not established that there was a sufficient risk of further fraudulent claims being made.
2.35 A refinement of the red clause is the 'green clause'. This allows pre-shipment advances but provides for storage in the name of the bank, and thus should provide the bank with security. Red clause and green clause credits are sometimes called anticipatory credits.
2.36 Documentary credits may be divided under two heads according to their function. The first head covers the traditional function of credits, as has already been described, namely to provide payment to the seller of goods (or less commonly to the seller of services) when he performs his contract by delivering documents to the bank.[40] Standby credits most commonly fulfil the function of providing security against the non-performance of a party to a contract, who may sometimes be a seller, but may sometimes have an entirely different capacity. Standby credits provide for payment to the beneficiary by a bank against delivery of documents to the bank. But it follows from their function that the documents required will be very different from those under a traditional credit: they may comprise only a statement in a specified form that the other party to the underlying contract has failed to fulfil his obligations. Article 1 of the UCP 600 provides for the application of the Uniform Customs to standby credits, but only 'to the extent to which they may be applicable'. The effect of this provision is considered in Chapter 12.
[3] (1925) 5 Legal Decisions Affecting Bankers 1 at 5.
[4] This is confirmed in the commentary on the Article in Documentary Credits: UCP 500 and 400 Compared, ICC No 511.
[5] [1921] WN 274.
[7] The UCP prohibit drafts drawn on the applicant; see para Article 6.c.
[10] Jaks (UK) Ltd v Cera Investment Bank SA [1998] 2 Lloyd's Rep 89.
[11] [1922] 1 KB 318 at 321, 322.
[12] (1923) 14 Ll L Rep 586.
[13] (1923) 14 LI L Rep 586 at 588.
[15] [1960] 2 Lloyd's Rep 340.
[18] [1969] 2 Lloyd's Rep 18.
[21] Although it is not unusual for credits providing for immediate payment also to be made available by negotiation; this practice is prevalent in relation to credits issued by Chinese banks.
[23] (1867) 2 Ch App 391.
[24] [1927] AC 711, PC.
[25] A different position is taken in Benjamin's Sale of Goods (7th edn) para 23-063. Whilst it is accepted that without words sufficient to indicate that the credit should be generally negotiable or available it must be construed as a straight credit (see eg Southern Ocean Shipbuilding Co Pte Ltd v Deutsche Bank AG [1993] 3 SLR 686), it is suggested that, contrary to the view expressed in Benjamin, if the meaning is not obvious, it is a question of construing the words in accordance with international banking practice, and that nowadays there is and should be no tendency in the courts to favour straight credits in cases of uncertainty.
[26] See also Udharam Rapchand (Sons) HK Ltd v Mercantile Bank Ltd [1985] HKLY 52.
[27] ICC No 489, Case 191.
[28] [1983] 1 WLR 642, [1983] 1 Lloyd's Rep 611.
[29] That is, the bank had bought the documents.
[30] This may be compared with the view expressed by the ICC Banking Commission, Opinions (1984–1986) ICCNo 434 Ref 95, that documents may be presented direct to an issuing bank which must accept them and pay even though it has specified another bank as the negotiating bank in the credit advised to the beneficiary.
[32] [1958] 2 QB 130.
[33] [1958] 2 QB 130 at 138.
[34] See Benjamin's Sale of Goods (7th edn) para 23-082.
[35] [1993] 1 Lloyd's Rep 89.
[36] More Queries and Responses on UCP 500, ICC No 596, Ref 302.
[37] (1931) 40 Ll L Rep 291.
[38] [1987] 1 Lloyd's Rep 171. See also, in the United States, Feinberg v Central Asia Capital Corpn Ltd F Supp 822 (1997).
[39] Standby credits are considered in Part B of Chapter 12.
[40] Sometimes called commercial credits in contrast with standby credits.