International Business Transactions Fall 2011

1. International Business TransactionsFall 2011 Professor Ronald A. Brand University of Pittsburgh School of Law Class #6 1

2. Basic Concepts inLetter of Credit Law 1) The separate contract rule 2) The concept of irrevocability 3) Strict compliance principles 2

3. The Separate Contract Rule Maurice O�Meara Co. v. National Park Bank of New York, 239 N.Y. 386 (1925) Urquhart Lindsay and Co. v. Eastern Bank, Ltd., [1922] 1 K.B. 318 3

4. The Separate Contract Rule UCC ��5-103 Scope . . . . (d) Rights and obligations of an issuer to a beneficiary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary. 4

5. The Separate Contract Rule UCC ��5-108 Issuer�s Rights and Obligations . . . . . (f) An issuer is not responsible for: (1) the performance or nonperformance of the underlying contract, arrangement, or transaction, (2) an act or omission of others, or (3) observance or knowledge of the usage of a particular trade other than the standard practice referred to in subsection (e). 5

6. The Separate Contract Rule UCP 600 � Article 4 Credits v. Contracts a. A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank. b. An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like. 6

7. The Separate Contract Rule Remedies under the Separate Contract Rule: Urquhart Lindsay and Co. v. Eastern Bank, Ltd., [1922] 1 K.B. 318: �[T]he credit was irrevocable; and the effect of that was that the bank really agreed to buy the contemplated series of bills and documents representing the contemplated shipments just as the buyer agreed to take and pay for by this means the goods themselves. Now, if a buyer under a contract of this sort declines to pay for an installment of the goods, the seller can cancel and claim damages upon the footing of an anticipatory breach of the contract of sale as a whole. These damages are not for non-payment of money. It is true that non-payment of money was what the buyer was guilty of; but such non-payment is evidence of a repudiation of the contract to accept and pay for the remainder of the goods; and the damages are in respect of such repudiation. 7

8. The Separate Contract Rule Remedies under the Separate Contract Rule: UCC ��5-111 (a) If an issuer wrongfully dishonors or repudiates its obligation to pay money under a letter of credit before presentation, the beneficiary, successor, or nominated person presenting on its own behalf may recover from the issuer the amount that is the subject of the dishonor or repudiation. If the issuer�s obligation under the letter of credit is not for the payment of money, the claimant may obtain specific performance or, at the claimant�s election, recover an amount equal to the value of performance from the issuer. In either case, the claimant may also recover incidental but not consequential damages. The claimant is not obligated to take action to avoid damages that might be due from the issuer under this subsection. If, although not obligated to do so, the claimant avoids damages, the claimant�s recovery from the issuer must be reduced by the amount of damages avoided. The issuer has the burden of proving the amount of damages avoided. In the case of repudiation the claimant need not present any document. 8

9. The Concept of Irrevocability Sztejn v. J. Henry Schroder Banking Corp., 31 N.Y.S.2d 631 (1941) -initiated �fraud in the transaction� exception to separate contract rule and irrevocability doctrine United Bank Ltd. V. Cambridge Sporting Goods Corp., 4 N.Y.2d 254 (1976) -held that former UCC 5-114(2)(b) was a �codification� of Sztejn 9

10. The Concept of Irrevocability Mid-America Tire, Inc. v. PTZ Trading Ltd., 768 N.E.2d 619 (Ohio 2002) Who are the parties to the dispute? -Seller(s):PTZ (Guernsey, Channel Islands) Sievers (German tire broker) -Buyers: Mid-America (Ohio) and Jenco (Tenn.) -Seller�s Bank: First National Bank of Chicago -Buyer�s Bank: Barclay�s Bank PLC (Guernsey) 10

11. The Concept of Irrevocability Mid-America Tire, Inc. v. PTZ Trading Ltd., 768 N.E.2d 619 (Ohio 2002) What law governs the letter of credit? Did the parties choose a law? Does any other law also apply? -if so, why and how? -how did the court get to the Ohio version of the UCC? 11

12. The Concept of Irrevocability Mid-America Tire, Inc. v. PTZ Trading Ltd., 768 N.E.2d 619 (Ohio 2002) Does the UCP provide for a fraud in the transaction exception to the rule requiring payment upon conforming documents? 12

13. The Concept of Irrevocability UCP Article 7 Issuing Bank Undertaking . . . . b. An issuing bank is irrevocably bound to honour as of the time it issues the credit. Article 8 Confirming Bank Undertaking a. Provided that the stipulated documents are presented . . . the confirming bank must: 1. honour, . . . 13

14. The Concept of Irrevocability UCP Article 14 Standard for Examination of Documents a. A nominated bank . . . a confirming bank . . . and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation. 14

15. The Concept of Irrevocability UCP Article 15 Complying Presentation a. When an issuing bank determines that a presentation is complying, it must honour. 15

16. The Concept of Irrevocability Mid-America Tire, Inc. v. PTZ Trading Ltd., 768 N.E.2d 619 (Ohio 2002) Does the UCC provide for a fraud in the transaction exception to the rule requiring payment upon conforming documents? -former 5-114(2)(b) (p. 154) -current 5-108 and 5-109 16

17. UCC ��5-108 Issuer�s Rightsand Obligations (a) Except as otherwise provided in Section 5-109, an issuer shall honor a presentation that, as determined by the standard practice referred to in subsection (e), appears on its face strictly to comply with the terms and conditions of the letter of credit. Except as otherwise provided in Section 5-113 and unless otherwise agreed with the applicant, an issuer shall dishonor a presentation that does not appear so to comply. 17

18. UCC ��5-108 Issuer�s Rightsand Obligations (e) An issuer shall observe standard practice of financial institutions that regularly issue letters of credit. Determination of the issuer�s observance of the standard practice is a matter of interpretation for the court. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice. 18

19. UCC ��5-109 Fraud and Forgery (a) If a presentation is made that appears on its face strictly to comply with the terms and conditions of the letter of credit, but a required document is forged or materially fraudulent, or honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant: (1) the issuer shall honor the presentation, if honor is demanded by (i)�a nominated person who has given value in good faith and without notice of forgery or material fraud, (ii)�a confirmer who has honored its confirmation in good faith, (iii)�a holder in due course of a draft drawn under the letter of credit which was taken after acceptance by the issuer or nominated person, or (iv)�an assignee of the issuer�s or nominated person�s deferred obligation that was taken for value and without notice of forgery or material fraud after the obligation was incurred by the issuer or nominated person; and (2) the issuer, acting in good faith, may honor or dishonor the presentation in any other case. 19

20. UCC ��5-109 Fraud and Forgery (b) If an applicant claims that a required document is forged or materially fraudulent or that honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant, a court of competent jurisdiction may temporarily or permanently enjoin the issuer from honoring a presentation or grant similar relief against the issuer or other persons only if the court finds that: (1) the relief is not prohibited under the law applicable to an accepted draft or deferred obligation incurred by the issuer; (2) a beneficiary, issuer, or nominated person who may be adversely affected is adequately protected against loss that it may suffer because the relief is granted; (3) all of the conditions to entitle a person to the relief under the law of this State have been met; and (4) on the basis of the information submitted to the court, the applicant is more likely than not to succeed under its claim of forgery or material fraud and the person demanding honor does not qualify for protection under subsection (a)(1). 20

21. The Concept of Irrevocability As bank counsel, what is your advice to a bank�s letter of credit officers when a client asks that your bank refuse to honor a letter of credit on the basis of fraud, when the documents, on their face, comply with the letter of credit? 21

22. Strict Compliance Principles J.H. Rayner & Co., Ltd. V. Hambro�s Bank Ltd., [1943] K.B. 37 (C.A.) Dixon, Irmaos & Cia v. Chase National Bank of New York, 144 F.2d 759 (2d Cir. 1944) 22

23. UCP 600 Introduction When work on the revision started, a number of global surveys indicated that, because of discrepancies, approximately 70% of documents presented under letters of credit were being rejected on first presentation. This obviously had, and continues to have, a negative effect on the letter of credit being seen as a means of payment and, if unchecked, could have serious implications for maintaining or increasing its market share as a recognized means of settlement in international trade. The introduction by banks of a discrepancy fee has highlighted the importance of this issue, especially when the underlying discrepancies have been found to be dubious or unsound. Whilst the number of cases involving litigation has not grown during the lifetime of UCP 500, the introduction of the ICC�s Documentary Credit Dispute Resolution Expertise Rules (DOCDEX) in October 1997 (subsequently revised in March 2002) has resulted in more than 60 cases being decided. 23

24. UCP 600 Article 5 Documents v. Goods, Services or Performance Banks deal with documents and not with goods, services or performance to which the documents may relate. 24

25. UCP 600 Article 7 Issuing Bank Undertaking a. Provided that the stipulated documents are presented to the nominated bank or to the issuing bank and that they constitute a complying presentation, the issuing bank must honour if the credit is available by: i. sight payment, deferred payment or acceptance with the issuing bank; ii. sight payment with a nominated bank and that nominated bank does not pay; 25

26. UCP 600 Article 8 Confirming Bank Undertaking a. Provided that the stipulated documents are presented to the confirming bank or to any other nominated bank and that they constitute a complying presentation, the confirming bank must: i. honour, if the credit is available by a. sight payment, deferred payment or acceptance with the confirming bank; . . . . b. A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the credit. 26

27. UCP 600 Article 14 Standard for Examination of Documents a. A nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation. . . . . d. Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit. e. In documents other than the commercial invoice, the description of the goods, services or performance, if stated, may be in general terms not conflicting with their description in the credit. 27

28. UCP 600 Article 15 Complying Presentation a. When an issuing bank determines that a presentation is complying, it must honour. b. When a confirming bank determines that a presentation is complying, it must honour or negotiate and forward the documents to the issuing bank. c. When a nominated bank determines that a presentation is complying and honours or negotiates, it must forward the documents to the confirming bank or issuing bank. 28

29. UCP 600 Article 16 Discrepant Documents, Waiver and Notice a. When a nominated bank acting on its nomination, a confirming bank, if any, or the issuing bank determines that a presentation does not comply, it may refuse to honour or negotiate. b. When an issuing bank determines that a presentation does not comply, it may in its sole judgement approach the applicant for a waiver of the discrepancies. This does not, however, extend the period mentioned in sub-article 14 (b). c. When a nominated bank acting on its nomination, a confirming bank, if any, or the issuing bank decides to refuse to honour or negotiate, it must give a single notice to that effect to the presenter. 29

30. UCP 600 Article 18 Commercial Invoice c. The description of the goods, services or performance in a commercial invoice must correspond with that appearing in the credit. 30

31. UCP 600 Article 34 Disclaimer on Effectiveness of Documents A bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document, or for the general or particular conditions stipulated in a document or superimposed thereon; nor does it assume any liability or responsibility for the description, quantity, weight, quality, condition, packing, delivery, value or existence of the goods, services or other performance represented by any document, or for the good faith or acts or omissions, solvency, performance or standing of the consignor, the carrier, the forwarder, the consignee or the insurer of the goods or any other person. 31

32. Strict Compliance Principles As bank counsel, what is your advice to a bank�s letter of credit officers when a client asks that your bank refuse to honor a letter of credit without any claim of fraud in the documents or the transaction? 32

33. Basic Concepts inLetter of Credit Law 1) The separate contract rule 2) The concept of irrevocability 3) Strict compliance principles 33

34. International Business TransactionsFall 2011 Professor Ronald A. Brand University of Pittsburgh School of Law Class #6 34