Payment Systems
Letters of Credit
Basic Concepts
Basic Concepts
Basic Concepts
• UCC Article 5 US L/Cs and those that
incorporate it.
• Uniform Customs and Practices Act (UCP)
incorporated by most international L/Cs
The Actors
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Applicant
Asks for L/C
Beneficiary
Makes demand
Issuing Bank
Issues L/C
Advising Bank
Informs of L/C
Confirmer
Agrees to honor
Nominated Person Authorized to honor
Basic Concepts
• Documents must strictly comply
• Issuing bank must pay if the documents
comply
• Issuing bank can only get reimbursed if it
was permitted to pay
Problem 9-1.1
• Jodi presented with an L/C stating it will
provide payment for goods shipped
‘‘during the first half of February 2010.’’
• She received a draft this morning including
an invoice for goods shipped on February
16, 2010.
• She tells you that the letter of credit
incorporates the UCP by reference. Can it
be possible that the draft complies?
UCP Article 3
• “the term first half and second half of a
month shall be construed respectively as
the 1st to the 15th and the 16th to the last
day of the month, inclusive. “
Problem 9-1.2
• Cliff Janeway (your book-dealer friend is
frustrated because he is having trouble
collecting on L/C
• The confirming bank (SecondBank) told him that
it was not obligated to pay Cliff because the
issuing bank (FirstBank) had closed. Thus, the
officer explained to Cliff, SecondBank would not
be able to obtain any reimbursement if it paid
Cliff. SecondBank’s confirmation of Cliff’s letter
of credit was unenforceable for lack of
consideration.
UCC 5-105
“Consideration is not required to issue,
amend, transfer, or cancel a letter of
credit, advice, or confirmation.”
Problem 9-1.3
• Ben’s bank received a draft on January 5 but
misfiled it and did nothing.
• In early February the Beneficiary wrote
demanding payment again.
• Ben found L/C and draft and discovered L/C
called for payment based on documents
covering a shipment of 100 cases of Llano
Estacado wine at a price of ‘‘around $140 per
case.’’ The draft seeks payment of $120 per
case.
• Must Ben honor?
Problem 9-1.3
• Ben found L/C and draft and discovered
L/C called for Ben saw that the letter of
credit called for payment based on
documents covering a shipment of 100
cases of Llano Estacado wine at a price of
‘‘around $140 per case.’’ The draft seeks
payment of $120 per case.
• Does the Draft strictly comply?
UCP Article 30
[a] The words “about” or “approximately”,
used in connection with the amount of the
Credit or the quantity or the unit price
stated in the Credit are to be construed as
allowing a difference not to exceed 10%
more or 10% less than the amount or the
quantity or the unit price to which they
refer.
Problem 9-1.3
• 10% of 140 = 14
• 140 – 14 = 126
• $120 > 10% less than $140
The Credit does not comply
But can Ben raise this issue to
refuse to honor?
UCC 5-108
(b) An issuer has a reasonable time after presentation,
but not beyond the end of the seventh business day of
the issuer after the day of its receipt of documents:
(1) to honor,
(2) if the letter of credit provides for honor to be
completed more than seven business days after
presentation, to accept a draft or incur a deferred
obligation, or
(3) to give notice to the presenter of discrepancies in
the presentation.
(c) Except as otherwise provided in subsection (d), an
issuer is precluded from asserting as a basis for
dishonor any discrepancy if timely notice is not given,
or any discrepancy not stated in the notice if timely
notice is given.
UCP 14.b
• Provides a window of five banking days to
decide if a presentment complies.
Problem 9-1.3
• The Credit does not comply
• But can Ben raise this issue to
refuse to honor?
Problem 9-1.4.
• FSB received initially by an authenticated
electronic-mail message from Portland State
Bank requesting FSB advise the beneficiary of
the issuance of the credit and, if willing, also
serve as a confirming bank.
• The message satisfied FSB’s security
procedure for transmissions from PSB.
• Ben printed out the letter of credit, added an
indication that FSB confirmed the letter of
credit, and had the original confirmed letter of
credit delivered to the beneficiary.
Problem 9-1.4.
• Last week Ben honored a draft on the letter of
credit in the amount of $500,000 (the stated
face amount of the credit that Ben delivered).
• When Ben sought reimbursement from PSB,
Ben learned that the letter of credit should have
been for $50,000. The $500,000 figure was a
typo.
• Ben received a written copy of the letter of
credit with the correct $50,000 amount in the
mail the day after Ben delivered the letter of
credit to the beneficiary.
UCC 5-107
(a) A confirmer is directly obligated on a
letter of credit and has the rights and
obligations of an issuer to the extent of its
confirmation. The confirmer also has rights
against and obligations to the issuer as if
the issuer were an applicant and the
confirmer had issued the letter of credit at
the request and for the account of the
issuer.
UCC 5-108(a)
(i) An issuer that has honored a
presentation as permitted or required by
this article:
(1) is entitled to be reimbursed by the
applicant in immediately available funds
not later than the date of its payment of
funds;
UCC 5-106
(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 . . . .
UCP 11
An authenticated teletransmission of a
credit . . . will be deemed to be the
operative credit . . . and any subsequent
mail transmission shall be disregarded.
Problem 9-1.5
• Jane Halley from Boatmen’s Bank has a
customer, Toy Importing Company (TIC), for
whom she has issued a letter of credit in the
form set forth in Figure 9.1.
• TheL/C was to pay for a shipment of toys
from Toy Manufacturing Company (TMC) in
Hong Kong. Because TIC is dissatisfied with
the toys, TIC wants Boatmen’s to reject the
draft.
Problem 9-1.5
• TMC on September 21, 1996, submitted a
draft with the appropriate documents to its
main bank, Bank of Hong Kong. Bank of
Hong Kong processed those documents,
paid TMC on the letter of credit, and
submitted the draft to Boatmen’s on
September 24, 1996. Jane wants to know if
she can reject the draft because it was
presented to her after the letter of credit had
expired.
Problem 9-1.5
• She could understand if she was obligated to
accept a draft presented to Hang Seng Bank
(the advising bank) in a timely manner, but
how can she possibly be obligated to respect
a draft presented to some bank with which
she has not had any prior dealings?
Problem 9-1.5
• What must TMC due by expiration date?
• To whom must they present?
5-102 Comment 7
Unless the letter of credit provides
otherwise, the beneficiary need not
present the documents to the issuer
before the letter of credit expires; it need
only present those documents to the
nominated person.
UCP 7
a. Provided that the stipulated documents
are presented to the nominated bank or
the issuing bank and that they constitute a
complying presentation, the issuing bank
must honor
c. An issuing bank undertakes to reimburse
a nominated bank that has honoured . . . a
complying presentation.
Problem 9-1.5
• What must TMC due by expiration date?
• To whom must they present?
• Is BHK a “nominated person”? It is not
mentioned in the Credit.
§ 5-102(a)(11)
Defines nominated person as a party
that the issuer has “undertake[n] by
agreement or custom and practice to
reimburse.”
UCP Article 2
In a Credit “available with any bank,”
any bank is a Nominated Bank.
UCC 5-102 Comment 7
Under the UCP any bank is a nominated
bank where the letter of credit is ‘freely
negotiable.” [Example of a “freely
negotiable credit is one] “available with
any bank by negotiation.”
5-102 Comment 7
“a nominated person that gives value in
good faith has a right to payment from
the issuer despite fraud,”
UCC § 5-108 comment 1
“[A] nominated person that has
honored a demand or otherwise given
value before expiration will have a right
to reimbursement from the issuer even
though presentation to the issuer is
made after the expiration of the letter of
credit.”
§ 5-108 comment 1
“[A] nominated person that has
honored a demand or otherwise given
value before expiration will have a right
to reimbursement from the issuer even
though presentation to the issuer is
made after the expiration of the letter of
credit.”
Problem 9-1.6
• The April Company and Boatmen’s
established special procedures for drafts
submitted under L/Cs issued to some of
April’s regular suppliers. April and
Boatmen’s agreed that Boatmen’s would
provide same-day service on drafts for
less than $25,000 submitted on
designated “Express Draft” letters of
credit.
Problem 9-1.6
• April agreed that Boatmen’s would not be
obligated to review any of the documents
submitted with such drafts, and Boatmen’s
agreed to reduce its normal processing fees
by 50 percent for those drafts.
• Jane’s problem comes from a $20,000 draft
submitted last week on an “Express Draft.”
• Jane’s department honored the draft in a
few hours, without even looking at the
underlying documents.
Problem 9-1.6
• When the documents got to April, April
noticed that the documents did not include
the bill of lading called for by the L/C.
• April has discovered that the
supplier/beneficiary (a small Indonesian
company) in fact did not ship the goods in
question; indeed, that company has become
insolvent and stopped operations.
Problem 9-1.6
• April’s shipping clerk called Jane yesterday
and said that under the circumstances April
did not want to reimburse Boatmen’s for that
draft.
• Jane wants to know whether she has a right
to payment from April. What do you say?
UCC 5-108
(i) An issuer that has honored a presentation
as permitted or required by this article:
(1) is entitled to be reimbursed by the
applicant in immediately available funds
not later than the date of its payment of
funds;
UCC 5-103
• (c) With the exception of this subsection,
subsections (a) and (d), Sections 5102(a)(9) and (10), 5-106(d), and 5114(d), and except to the extent prohibited
in Sections 1-102(3) 1-302 and 5-117(d),
the effect of this article may be varied by
agreement or by a provision stated or
incorporated by reference in an
undertaking.
UCC 5-103 Comment 2
• Neither the obligation of an issuer under
Section 5-108 nor that of an adviser under
Section 5-107 is an obligation of the kind
that is invariable under Section 1-102(3).
Section 5-103(c) and Comment 1 to
Section 5-108 make it clear that the
applicant and the issuer may agree to
almost any provision establishing the
obligations of the issuer to the applicant.
UCC 5-108 Comment 1
“In some circumstances standards may be
established between the issuer and the
applicant by agreement or by custom that would
free the issuer from liability that it might
otherwise have. For example, an applicant
might agree that the issuer would have no duty
whatsoever to examine documents on certain
presentations (e.g., those below a certain dollar
amount).
UCC 5-108 Comment 1
Where the transaction depended upon the
issuer's payment in a very short time period
(e.g., on the same day or within a few hours of
presentation), the issuer and the applicant
might agree to reduce the issuer's responsibility
for failure to discover discrepancies. . . . Neither
those agreements nor others like them explicitly
made by issuers and applicants violate the
terms of Section 5-108(a) or (b) or Section 5103(c).”
To prevent paying forgeries banks
• Require the person presenting the draft be
a specified person known to them.
• Require funds to be paid to accounts
known to belong to the beneficiary.