Letters of Credit – Reconciling Legal Rules with
Commercial Realities
Prof Jason Chuah
City University London
A bit of history
* Origins not very clear – Ancient Babylonian (a clay
promissory note dating back to 3000 BC) and Egyptian
(248 BC); Ancient Greece – banks were issuing
documentary letters “ “on correspondents with the view to
obviating the actual transport of specie in payment of
accounts”.
* 13th century Marco Polo reported that the negotiable
letter was a “way... the Great Chan can have and indeed
does have more treasures than all the kings in the world”
* 14th century – Medici banks in Bruges and Italy
* 19th century – virtual monopoly by British banks
What is an LC?
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Method of trade finance
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Sale contract (usually cross border – reason: trust)

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Buyer (applicant)

Seller (beneficiary)
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Issuing Bank (payer)
In order to paid, seller must tender conforming
documents evidencing its performance of the sale
contract.
Two key principles

Principle of Autonomy
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Sztejb v Henry Schroeder Banking Corp
Fraud Exception – narrowly construed (The
American Accord (1983))
Principle of Strict Compliance

A means to control fraud and forgery?

A matter of construction?

No non-documentary conditions can be required by
the LC
Trends and developments

Use of LC in decline in intra-EU trade
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High rate of rejection; fear of fraud
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Protection from credit crunch?

More creative use of the LC
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As a guarantee for conventional (high risk) lending
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As a no-questions asked payment instrument
Legal status of the LC

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Not a negotiable instrument, not a promissory
note, not a bill of exchange
Is is a contract? Requirement for consideration?
Definition of consideration – act for an act, a
promise for a promise, a promise for an act, an
act for a promise
What consideration has been provided by the
beneficiary?
Does it matter?

To enforce a bare promise – issues
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How to construe the promise – presumed intention
test in this context
Legal intent from form
Status or position of the promisor becomes crucial?
Marubeni v Mongolia
Creative use – legal response?

Sirius v FAI [2003] EWCA Civ 470

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Mahonia v Morgan Chase Bank [2003] EWHC
1927

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Use non-documentary conditions admitted
Illegality as a justification for not paying
Marubeni v Mongolia [2005] EWCA Civ 395;
also Meritz Fire and Marine Insurance Co Ltd v
Jan De Nul Nv [2011] EWCA Civ 827

Construction of the documentary requirements –
seems to depend on the status of the issuer
Fear of fraud

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Limits of the research – empirical work needed
Much work concentrates on the problem of fraud and
abusive calls (in the context of demand guarantees)
and makes the following criticisms
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Banks do not police fraud
Misplaced belief that documentary conformity
means absence of fraud
Forgery easy to commit
Large value deals constitute an irresistible
temptation to fraudsters
All or nothing approach – only fraud by the
beneficiary will suffice (bad faith will not)
Commercial Realities

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Any alternatives?Trust in international trade –
thrombosis will occur? (Donaldson LJ)
Why the arm's length approach by banks
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Should liability be attached to the act of giving
money?
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A payment instrument not a method of trading
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Blame not the LC but the system?
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Time is essential
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Commercial certainty
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A new unified code to limit LC law to trade in physical
goods?
Thank you very much.
Questions are very welcome:
Jason.Chuah.1@city.ac.uk