Legal Problems Of The Letter Of Credit Mechanism

In international business transactions, in order to avoid the distrust between the seller and the buyer and the unbalanced capital burden, a form of credit settlement has come into being, which gives attention to the benefits of both seller and buyer, features in bank credit and is independent of underlying transactions. Such credit settlement form is famed as "the life blood of international business".A documentary credit is an undertaking issued by a bank for the account of the buyer or for its own account, to pay the beneficiary the value of the draft and/or documents provided that the terms and conditions of the documentary credit are complied with. In simple words, it's a conditional bank undertaking of payment. This documentary credits arrangement provides confidence and security for all parties engaged in international transactions. It also satisfies the seller's desire for cash and the importer's desire for credit. UCP500, which is widely acceptable around the world, is a standard practice and a code of practice in documentary credit operations.Credit transaction brings a chain of contracts. Parties to a documentary credit are the issuing bank and the beneficiary. Other participants in credit transactions are parties to contracts related to the Credit. The legal nature of Credit remains a controversial topic for the scholars studying letter of credit. So far, many theories about legal nature of credit have been proposed, in which the Offer and Acceptance Theory matches nature of credit much better than any other theories. Nevertheless, it is common sense that credit is a legal paper with contractual character, which was developed in the business world and came from commercial customer.Principle of Independence, Principle of Documents Compliance and Principle of Fraud Exception are three fundamental rules to credit mechanism, which reflect unique characteristic of credit. Principle of Independence and Principle of Documents Compliance mean that, Credits, by their nature, are separate transactions from the underlying transactions. In credit operations all parties concerned deal with only documents. The issuing bank must perform its payment liability under the credit provided that the terms and conditions of the credit are complied with. Such deviceprovides the seller with prompt payment after presenting required documents and secures the buyer to obtain documents representing contracted goods after his payment is effected. Principle of Independence and Principle of Documents Compliance are the basis and ground of credit transactions. Deviating from these principles, credit mechanism cannot exist and develop. Generally, the payment obligations under the Credit cannot be intervened by the court. When material fraud is found in underlying transactions and in documents, an injunction will be issued by the court to stop payment under the credit. Only in the case of fraud exception, the payment liability of the issuing bank can be excluded. It must be noted that Principle of Fraud Exception shouldn't apply to bona fide holder. It is inevitable that there exists conflict between Principle of Independence and Principle of Fraud Exception. Judges must seek balance between the different interests of either of them.All credits must clearly indicate whether they are available by sight payment, by deferred payment, by acceptance or by negotiation. The availability of each credit defines the rights and the obligations of the parties involved in a documentary credit. There are complicated legal consequences caused by different type of availability. Different type of availability concerns different time limit and place for payment as well as different rights, obligations and risks of all parties. Banks must take different financing strategy and risk management according to different type of credit availability.One of the most important foundations of credit mechanism is that the bank obtains the documents representing the goods after making payment for those documents. It is widely accepted that the bank has the express or implied right to the goods represented by the documents. However, it is still being discussed that what is the nature of the bank's right to the documents. In the opinion of the author, it is suitable that the aforementioned right of the bank is considered as the pledge in export negotiation. However, under other circumstances, it is reasonable to regard the right of the bank as the ownership.