Small Bank Plc: Rights and Responsibilities - Essay Example

Essay Commercial letters of credit have been used for the centuries as a most common method of payment, in international trade. Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits (UCP). A commercial letter of credit is a contractual agreement between a bank (Small bank plc), on behalf of one of its customers (Khalil), authorizing another bank (Big bank plc), to make payment to the beneficiary (Saida). The Small bank plc, on the application of its customer (Khalil), opens the letter of credit, and makes a commitment with the Khalil to honour the credit on the presentation of the documents, conforming to the terms and conditions of the credit, by the beneficiary. Thus, the Small bank plc replaces the banks customer as the payee. Beneficiary is normally the provider of the goods or services and is entitled to payment as long as he can provide the conforming documents required by the letter of credit. The letter of credit is a distinct and separate transaction from the underlying contract (contract between Saida and Khalil). All parties deal in documents and not in goods. The Small bank plc is not liable for performance of the underlying contract between the Khalil and Saida. The Small bank plcs obligation to the Khalil-applicant is to examine all documents to insure that they are in compliance with the terms and conditions of the credit. To get the payment it is for the beneficiary to provide all the required documents. If the Saida-beneficiary conforms to the letter of credit, the Saida must be paid by the bank. Small bank plc : Rights and Responsibilities The Small bank plcs duty to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is entitled to have a reasonable time after receipt of the documents to honour the draft. The Small bank plcs duty is to provide a guarantee to the Saida that if complying documents are presented by the Saida, then the bank will make the payment to the Saida, and will only pay if these documents comply with the terms and conditions set out in the letter of credit. Typically the documents requested include a commercial invoice, bill of lading or airway bill and an insurance document; but there are many others. Letters of credit only concerns with the documents, not with the goods. An advising bank is usually a foreign correspondent bank of the Small bank plc which advises the Saida-beneficiary. Generally, the beneficiary wants to use a local bank to insure that the letter of credit is valid. In addition, the advising bank is responsible for sending the documents to the Small bank plc. The advising bank has no other obligation under the letter of credit. Therefore, if the Small bank plc does not pay the beneficiary, the advising bank is not obligated to pay. Big Bank plc At the request of the Small bank plc, the correspondent bank may confirm the letter of credit for the Saida-beneficiary and obligates itself to insure payment under the letter of credit. The confirming bank is usually the advising bank. Letters of credit may be either revocable or irrevocable. In international sales, as the Saida and the Khalil are in different countries, there is a common problem of payment due to the difference of time between dispatch and delivery. Obviously, Saida would like to receive payment for the goods when delivering them to the carrier and the Khalil would prefer to delay the payment of the price until receipt of the goods. Therefore, a letter of credit solves this problem between the Saida and the Khalil. Generally, there are three separate transactions in a the relevant case of Khalil and Saida. 1. The first is between a Saida and a Khalil, called an underlying transaction, by which the Saida provides contracted goods to the Khalil. 2. The second transaction is between the Khalil-applicant and the bank (issuer of the letter of credit), in which the bank issues a letter of credit to the Saida-beneficiary. 3. Finally, the letter of credit itself creates a relationship between the issuer and the beneficiary, in which, the issuer makes payment for goods upon the beneficiarys presentation of the required documents, in accordance with the terms and conditions of the letter of credit as agreed between Saida and Khalil. The banks performance of payment is conditional on the delivery of conforming documents by the beneficiary. The banks are called issuers and are usually the applicants bank. Normally the Small bank plc opens a letter of credit in its own name and requests its correspondent bank to notify the Saida about the letter of credit. Sometimes, the Small bank plc instructs the correspondent bank not only to notify the Saida of the Small bank plcs undertaking but also to add a confirmation. In this case, the credit is known as a confirmed credit and the correspondent bank as a confirming bank. The payment obligation of the Small bank plc depends upon the beneficiarys presentation of complying documents to the confirming bank or to any other nominated bank, in accordance with the terms and conditions of the credit. Under general practice, presenting “complying documents” means that they comply with the conditions of the credit “on their face”. From banking point of view, compliance “on their face” of the presented documents is sufficient. The “independence principle” (which will be discussed later) is the fundamental principle of the letter of credit system, which prohibits banks from looking beyond facial compliance of the documents, and therefore exclude whether or not there is actual performance by the Saida-beneficiary. In fact, letters of credit system has emphasised the independence principle to such an extent that banks are ignoring the performance of the underlying contract very confidently. As a result, all the risk is on the honest Khalils, who are sometime paying for goods that they had not contracted for. In case of Saida and Turhan, no transaction is passed as the seller refused to ship the goods. In this scenario, Turhan can not ask for indemnity from the issuing bank under English law. A sight over other case laws : The development of English case law in relation to the fraud exception is based on an American case: Sztejn v. Henry Schroder Banking Corporation, this was a decision of Judge Shientag. The applicant of the letter of credit sought an injunction against the Small bank plc in order to prevent that bank from paying on documents which had been presented by the beneficiary. The Seller was a merchant in India. The applicant alleged that the shipped goods were not the goods, which he had contracted for, but packing cases filled with rubbish. In the New York Court of Appeal, Judge Shientag stated that it was well established that a Letter of Credit is “independent of the primary contract of sale between a buyer and a Seller. The issuing bank agrees to pay upon presentation of documents not goods. This rule is necessary to preserve the efficiency of the Letter of Credit as an instrument for the financing of trade”. The Judge went on to say that, on the particular facts of the case, the situation was different because: “On the present motion, it must be assumed that the Seller has intentionally failed to ship any goods ordered by the buyer. In such a situation, where the Saidas fraud has been called to the banks attention before the drafts and documents have been presented for payment, the principal of the independence of the banks obligation under a Letter of Credit should not be extended to protect the unscrupulous Seller.” That decision of an American Court given some 60 years ago has been often quoted in the English Courts. Indeed, Lord Diplock in the United City Merchants case referred to Sztejn as “the landmark American case”. English cases show that, where the fraud exception applies, banks may be justified in refusing to make payment (and have a defence if they are sued by the beneficiary or other party tendering documents). The basis of the fraud exception is that the Courts will not permit their processes to be used by fraudsters in pursuit of their fraudulent activities. Conclusion : What lessons can banks learn from the decisions of the English Courts? (1) Basically, banks can feel safe in England. Although the Courts will not permit their processes to be used in furtherance of fraud, nevertheless, save in “exceptional circumstances”, the integrity of the banking system must be upheld. (2) Given that many cases come before Court at a pre-trial stage, banks have the further benefit that the “balance of convenience” is likely to be in their favour. (3) The position of banks is further supported by the view expressed in at least one decided English case that, where fraud is alleged, it is not for a bank to investigate such allegations. (4) Even where a bank has itself been guilty of making a false claim against another bank, apportionment of loss will not be made by way of contributory negligence in circumstances where false documentation is tendered in support of an application for payment. (5) However, one area where banks must take care is in relation to the discounting of deferred payment letters of credit: the decision of the Court of Appeal in the Banco Santander case contains serious warnings to banks. Read More