BANKERS’ LIABILITY IN A DOCUMENTARY CREDIT

When commercial parties who carry on business in their own country want to buy goods from sellers in another country it is the usual practice that the price is paid by means of Bankers’ Documentary Credit which is the common method of payment in international trade.

Documentary Credit has been described by the English Judges as ” the life blood of International Commerce.”

The Bankers’ Commercial Credit has been invented to meet the commercial exigencies in order to enable the exporter to obtain prompt payment while permitting the importer to delay payment until such time he markets the goods he imported. The whole commercial transaction through the documentary credit system entails payment against sight draft or exact documents called for in the credit.

Briefly stated, Documentary Credit is a conditional undertaking in writing to pay by a bank provided the seller complies with the credit terms and conditions. A Documentary Credit should clearly indicate as to whether the credit is revocable or irrevocable. However, under the UCP 500 a credit is deemed to be irrevocable unless it is clearly indicated otherwise.

In a Documentary Credit transaction there are at least four contractual relationships.

a) The underlying contract of sale between the importer and exporter.

b) The contract between the Issuing Bank and the buyer; under this contract the issuing bank agrees to issue the credit and, through the correspondent bank to notify the credit to the seller and make payment to the seller against presentation of shipping documents and the buyer agrees to reimburse the confirming bank for payments made under the credit.

c) the contract between the Confirming Bank and the Issuing Bank, which agrees to reimburse the Confirming Bank for payments, made under the credit on transport documents presented by the seller.

d) the contract between the Confirming Bank and the seller. Under this legal relationship the Confirming Bank undertakes to pay the exporter against

* L.L.M (Aberdeen), Deputy Solicitor General

presentation of transport documents having informed the exporter that it will accept, negotiate or pay as per the credit terms.

It is a well-settled principle that the relationship between the Issuing Bank and the Confirming Bank is a principal to agent one.

In the case of Guaranty Trust Co. Newyork v. Hatmay[1] Scrutton L.J. gave a detailed definition of the operation of a Commercial Credit, which is quoted below:-

“The enormous volume of sales of produce by a vendor in one country to a purchaser in another country has led to the creation of an equally great financial system intervening between the vendor and purchaser, and designed to enable commercial transactions to be carried out with the greatest money convenience to both parties. The vendor, to help the finance of his business desires to get his purchase price as soon as possible after he has dispatched the goods to the purchaser

Thus it can be seen that in international trade an impasse has been created between the parties when the buyer is unwilling to pay without the goods being received and the seller does not part with the goods before the buyer pays for it. The Documentary Credit device comes into play in this situation as a means of resolving the problem. When the seller presents the documentary evidence of shipment of goods the banker’s role is to pay him against such documents.

It is one of the fundamental principles of the Documentary Credits that under the Strict Compliance doctrine, that the bank is entitled to reject the documents, which do not conform strictly to the credit, terms. Under the Uniform Customs and Practice a bank is dealing in finance and not in goods. It is obvious that a bank has no expert knowledge of the practices and usages in trade.

1 [1918] 2 KB 623

According to Articles 3 and 4 of the Uniform Customs and Practice for Documentary Credit- (1993 Revision) UCP 500, credits, by their nature, are separate transactions from the underlying Contract of Sale

Even if any reference is made to such contract in the credit the banks are in no way concerned with or bound by such contract/s. In credit operations, all parties deal with documents and not with goods

It is to be noted that a bank which operates a documentary letter of credit deals with one issue that is whether the documents submitted for payment to the Advising Bank correspond to the instructions contained in the credit.

The Documentary Credit transaction is a paper transaction.[2]

It is immaterial for the bank whether the underlying contract is for purchase of motor vehicles, timber, gas, machinery or textiles unless there is exfacie, evidence of fraud on the part of the exporter.

The autonomy of the Documentary Credit was explained by Lord Denning M.R. in the case of Power Curber International Ltd. v. National Bank of Kuwait[3]

” It is vital that every bank which issues a Letter of Credit should honour its obligations. The bank is in no way concerned with any dispute that the buyer may have with the seller. The buyer may say that the goods are not up to the contract. Nevertheless the bank must honour its obligations. The buyer may say that he has a cross-claim in a large amount. Still the bank must honour its obligations. A letter of Credit is like a Bill of Exchange given for the price of the goods. It ranks as cash and must be honoured…”

The Court of Appeal in that case held that order of Court in Kuwait did not affect the obligations of the bank to honour the credit. It is to be noted as was decided in that case that the Documentary Letter of Credit is completely independent of the underlying contract of sale.

Under the Strict Compliance Rule if the exact documents called for in the Credit are tendered by the exporter. The Paying Bank will pay against presentation of documents. If the Advising/Confirming Bank does not comply with the terms of the credit the importer may not reimburse that money to the bank. Moreover, if the Issuing Bank or the Correspondent Bank pays against the wrong documents and the buyer’s account debited suing bank, the buyer may resort to litigation against such bank under the Rule.

2 Schmitthoff s. Export Trade 9th edition at page 404 3 ibid at page 1241

In the case of Equitable Trust Company of Newyork v. Dawson Partners [4] which was the leading common law authority on the Strict Compliance Rule, the Defendants bought vanilla beans from a seller in Batavia (Presently Jakarta). The purchaser required the bank to pay only against a Dutch Government certificate certifying that the goods were sound, sweet and prime quality. However, the agreement was subsequently varied substituting for the certificate, certificates of quality to be issued by experts who were sworn brokers and signed by the Chamber Commerce. Apparently, terms “experts and brokers” were incorrectly decoded during the transmission by cable. The advising bank in Batavia informed the seller that the credit was available on the tender of a certificate ” by expert”. The sellers whose sole purpose was to conceal the fraud fraudulently shipped a quantity of sticks, stones and old iron covered by a thin layer of vanilla beans.

The House of Lords held that the Plaintiff Bank was not entitled to be reimbursed by the buyers as the bank acted contrary to the instructions by making available finance on a certificate of one expert only instead of two experts.

It is necessary to understand the credit instructions. By issuing a Documentary Letter of Credit a Bank undertakes an obligation on behalf of the importer.

It is to be remembered that Article 13 of the UCP 1993 Revision (UCP 500) provides that banks must examine all Documents stipulated in the Credit with reasonable care to ascertain whether or not they appear on their face, to be in compliance with the terms and conditions of the credit.

The Uniform Customs and Practice for Documentary Credits 1993 Revision (UCP 500) applies to all Documentary Credits and they are all binding on all parties thereto unless otherwise expressly stipulated in the credit.

It can be seen that the common law seems to have insisted that description in all the documents should be exactly the same as that of the credit instructions.

However, Article 13 (a) of the UCP 1993 Revision has added an important rule to the effect that ” compliance with the stipulated documents on their face, with the terms and conditions of the Credit shall be determined by the International Standard banking practice as reflected in the Articles”. Documents not stipulated in the credit are not examined by the banks. If they receive such documents banks will return them to the presenters or pass them on without responsibility.

Some commentators like John Dolan published in International Banking Law Journal 1994 has been critical of the UCP Article 13 (a) on the basis that such standards

4 [1927] 27 Lloyds Rep. 49

effectively introduces greater uncertainty into the documents examination process and it will frustrate the reasonable expectations of commercial parties.

Article 14 of UCP (1993 Revision) also provides that when the Issuing Bank that is authorised by another bank to pay/incur a deferred payment undertaking, accepts drafts or negotiates against documents which appear on their face to be in compliance with the terms and conditions of the credit, the Issuing Bank and the Confirming Bank, if any, are bound to:-

i. reimburse the nominated bank which has paid/incurred a deferred payment undertaking, accepted Drafts or negotiated the same

ii. take up the documents.

It is also provided that if the Issuing Bank determines that the documents appear on their face not to be in compliance with credit terms and conditions the Bank may in its sole judgement approach the applicant (importer) for a waiver of the discrepancy.

In case the Confirming Bank without proper consent of the Issuing Bank, makes payment against discrepant documents, the Confirming Bank is not entitled to recover* the money from the Issuing Bank on the basis it has acted exceeding the mandate given.

If the Issuing Bank pays against the discrepant documents, the applicant is not liable to be reimbursed.

It is also important to note that there is an obligation on the part of the bank to scrutinise and examine the Bill of Lading, Commercial Invoice, Insurance Cover, and any particular certificate called for and to comply with any other condition by the beneficiary in accordance with credit terms before any payment is made.

In the case of Indian Overseas Bank Ltd. v. S.K. Ramalingam Chettiar and another[5] the Letter of Credit called for inter alia, complete set of clean on board railway receipt to order of the Indian Overseas Bank and also required that insurance should cover risks of war, marine theft, pilferage, non delivery civil commotion, strikes, riots, warehouse to warehouse clause and transhipment. The shipment was made and the documents were accepted by the bank and also the seller was paid. When the shipment arrived at Madras six of the 48 drums were found to be damaged and there was a shortage of goods attributed to pilferage. The insurance policy accepted by the bank had not covered the risks of theft and pilferage. The Plaintiff claimed damages from the bank pleading negligence on its part in accepting a foul bill of lading and not scrutinising the insurance policy.

It was held that on the face of it the bank was liable for authorising payment on presentation of an unclean bill of lading and an insurance policy, which was not in accordance with the instructions of the buyer.

5 1970 MLJ vol.2 at page 288

It is to be noted that in a situation where a credit is advised to the beneficiary through another bank (Advising Bank) and if the Advising Bank decides to advise the credit it has to take reasonable care to ascertain the authenticity of the credit and if the Advising Bank elects not to advise it must without delay inform the Issuing Bank. Article 7 of UCP 500.

Empirical Study

Needless to say, that complexity in documents and discrepancies therein tendered by the beneficiary cause delay resulting in payments being put off or refused and sometimes it may end up in a loss of future trade. It is important that overseas buyers avoid calling for unnecessary documents and should include only the required documents for credit purposes.

It has been said that both the buyer and the seller realise that simpler the credit terms, the easier it is for the trade to take place. It also appears from a reading of a Guidance Book on Documentary Credits issued by the Barclays Bank in England that the common faults and problems bankers find when they handle documentary transactions on presentation of documents by the beneficiaries are as follows.

(i) The Documentary Credit does not strictly comply with credit terms and or by the time of presentation of documents the credit has expired.

(ii) As regards the commercial invoice the description of goods differs from that of the credit. Shipping marks differ from the bill of lading.

(iii) The importer’s name differs from that of the credit or the invoice is not issued by the exporter and or invoice is not signed when the Letter of Credit calls for signed invoices.

(iv) In regard to the bill of lading the full set of bills of lading as requested is not presented by the exporter.

(v) The bill of lading is not clean or it is not endorsed by the exporter when drawn to ‘order’ – alterations are not authenticated by an official of the shipping company or its agents.

(vi) In regard to insurance policy does not cover the risks called for in the credit. Insurance policy or certificate bears a date later than the date of shipment/ dispatch.

(vii) Another discrepancy is that the carrying vessel’s name is not mentioned or correctly stated in the insurance papers.

On an investigation conducted by the author in some of the leading banks in United Kingdom in the recent past on Documentary Credit issues encountered by the bankers when handling the payments it was found that 100% of the discrepancy cases are referred to the Issuing Bank or if it is the Issuing Bank they refer the discrepant documents to the customer with a view to bringing about a waiver of discrepancies. So that bargain contract of sale would proceed.

It was also revealed that in cases where the Advising Bank make the payment to the beneficiary in terms of the credit but nevertheless, the Issuing Banks pick up some minute discrepancies and delay payments for a number of months.

On an investigation conducted in one of the leading banks in Sri Lanka it was found that when the beneficiary presents the documents for payment to the Advising Banks the Letters of Credits had expired and the sellers are not concerned about the late shipment or expiry of the credit and furthermore the Advising Banks / Negotiating Banks in some countries like India claim 100% reimbursement which is a problem for the local Issuing Banks. It was also found that the Issuing Banks make every effort to negotiate with such banks and retain 5% of the money claimed until and unless the importer/applicant approves. In respect of other international documentary credit transactions the local bank reimburses only 95% of the claim until the applicant gives clearance.

On a careful study of the above situation it can be seen that local banks endeavour to see that bargain contract of sale proceeds and a waiver of discrepancies is permitted by the applicant.

In the case of Bankers Trust Co. Ltd. v. State Bank of India[6] The Plaintiff summoned an expert witness Bernard Whemble who was the chairman of the International Chamber of Commerce Banking Commission and Mr. Whemble thought it was appropriate for the bank to consult the applicant when it had found the discrepancies in documents.

It is to be noted a banker should not approach the problem of discrepancies and refuse the documents for the sake of refusing merely because of an error of peripheral nature unless the irregularity is a material one.

Conclusion

It appears from a reading of the judgements in the United Kingdom and other jurisdictions in the area of Documentary Credits that the strict compliance doctrine has caused difficulties and delays in handling documentary transactions by the bankers due to discrepancy problems in documents presented by the beneficiaries. In interpreting the

6 [1991] Vol. 2 Lloyds Rep.

credit terms the Courts seem to have adopted a stringent approach towards this problem. The study however, shows that beneficiaries’ documents are rejected despite the fact that discrepancies are of a peripheral nature. It further shows that the bankers make arrangements and negotiate with the applicants in Documentary Credits to waive the discrepancies in order to ensure that commercial expectations of the parties succeed. It seems that if a rigid approach is adopted the accuracy, clarity and certainty of the Documentary Credit system, will be lost.

The question that should be addressed is whether a literal interpretation of the credit terms should be adopted or a less rigid approach should be adopted by Banks when handling the Documentary Credit transactions. A Bank has also the duty to examine the documents in good faith and with due diligence and ensure business efficacy.