Letters of Credit, Principle of Autonomy Based on the UCP 600 and Exceptions

Introduction

With Article 4 of the UCP 600, it has created autonomy for the letter of credits as a separate transaction from trade contract. Granting this power to the said instrument helps to flow the international trade in a good way by creating the trust between vendors and purchasers. However, leaving such a authority to a document have created several issues such as ability to gain money from fraudulent or illegal manner. Here we will discuss the said issues and whether the UCP 600 had address the said issues. And what are the concepts that have developed to fight against such issues.

Letter of credit, principle of autonomy and exceptions

In international trade, letters of credit are considered as a widespread mode of payment. When negotiating the trade documents between of importer and exporter, they contact the banks and address most of the problems of the buying and selling. To put it simply, a letter of credit is an agreement between a purchaser and his bank that allows paperwork and money to travel in the other direction, providing the purchaser full documented view before making a payment. A letter of credit, on the other hand, is viewed as a separate contract. When a letter of credit is established, it generates a number of relationships between the parties to the contract.¹ In a letter of credit transaction, there are at least three parties as the vendor or beneficiary; the purchaser or applicant; and the issuing bank, which issues the letter of credit on request of the purchaser^.2 Vendor’s bank is known as nominated bank. When the relevant documentation is presented to the issuing bank, the nominated bank is authorized by the issuing bank to make payment to the Vendor under the letter of credit. Beneficiary credit is made accessible by the nominated bank, unless otherwise specified, upon presentation of appropriate documentation.³ However is was required a set of rule to govern the letter of credit and therefore the international trade authorities were worked together for make it reality.

The International Chamber of Commerce (ICC) has produced a set of standards that govern the use of documentary letters of credit on a global basis and its first publication was in 1933, the set of rules were named as ‘Uniform Customs and Practices for Documentary Credits’. The UCP has undergone a series of adjustments in order to keep pace with the ever-changing realities of international trade. Banking institutions are not obligated to or concerned with any contract that may be referenced in a letter of credit under UCP 600, despite the fact that the letter of credit may include some reference to that contract. A bank's promise to honour, negotiate, or fulfil any other obligation arising from the credit isn't really subject to claims or objections by the application because of the applicant's ties with the issuing and beneficiary banks. And the agreements between the banks or among the purchaser and the issuing bank cannot be used by the vendor. If the purchaser attempts to add copies of the contract or preformed invoice as part of the credit, the granting bank should dissuade them from doing so. It's also important to note that banks deal with paperwork and not with the actual goods or services to which they are attached.⁴ Since the above article given the independence to the letter of credit it is clear the Principle of autonomy is addressed in Article 4 and 5 of UCP 600.⁵

To put it another way, the letter of credit's stated payment commitment is not contingent on whether or not the beneficiary, such as a retailer, fulfils their part of the bargain or whether or not the applicant has any other contractual obligations to that retailer. No defense to a claim on the letter of credit can be argued that the beneficiary has breached an underlying contract, the agreement has been declared unenforceable by a court, or that the purchaser has failed to deposit cash with the issuing bank. This bank is unconcerned about a probable breach of the contract it issued the note under.⁶ Since the parties cannot agree on how to proceed in the event of a disagreement over how the underlying contract should be performed, they are forced to pay the beneficiary upon submission of compliant documents and seek redress through legal action. Consequently, the Autonomy Concept has been viewed as an approach to encouraging international trade by adopting the "pay first, debate later" rationale. Many researchers suggest that the autonomy principle is essential to the smooth operation of letters of credit. When it comes to the concept of autonomy, Article 5 of UCP 600 states that "banks deal with documentation and not with traded goods, services, or performance."⁷ Therefore it is clear that UCP 600 promotes autonomy principle with its Articles, especially in Article 4.

However this nature which have arisen with the principle of autonomy there are couple of issues that have to identify clearly.  ‘Fraud’ is the most discussed such issue when it comes to autonomy principle of letter of credit. In the fight against fraud, the fraud exemption can recognise as the most significant legal tool. The purchaser may be able to obtain an injunction against the bank, stopping it from paying the vendor on the credit in this situation.⁸ The fraud exception may be invoked to allow an issuing bank to choose not to go ahead with the payment under letters of credit, or it may be invoked to allow an account party to seek to prevent the issuing bank from making payment or to prevent the vendor from seeking payment under the said letter of credit. The actual range and existence of the fraud exception in reality is based on a number of factors, the most of which appear to be determined by the jurisdiction in which the fraud occurs.⁹ The UCP600 does not address the impact of fraud on a documentary credit arrangement, and as a result, the subject is left to the jurisdiction of the relevant country.¹⁰ It appears to be widely acknowledged that American courts were the first to recognize the fraud exception and in the case of Sztejn v J Henry Schroder Banking   it has claimed fraud in this case was that the vendor supplied worthless material and trash rather than the things that were purchased. Having described the autonomy principle as "necessary to preserve the effectiveness of the letter of credit as an instrument for the sources of finance of trade,  Shientag J went on to consider the situation in which it had to be assumed for the purposes of this case that the vendor had purposefully failed to deliver the necessary goods.¹¹ Hence, it is possible to conclude from instances that have engaged with fraud under both English Common law and US federal law that the two most important conditions are that the fraud must be proven to the bank's knowledge by clear and convincing evidence beyond any reasonable doubt, and this must be done before the beneficiary vendor is paid. Even if there are charges of fraud, this does not justify the denial of payment, and the vendor must agree to and be conscious of the material representation in the documents that they give to the bank, otherwise the bank is obligated to pay the vendor.¹²

However, the expansion of the 'fraud exception' on public policy grounds, and particularly the concept of "ex turpi causa" maxim, will almost certainly impact the future to serve as an example for the formation of further exceptions to the autonomy notion. This instantly raises the question of whether or not criminality is an exception in the first place.¹³ Many of the debate around the applicability or acknowledgment of illegality as an exception is narrow, generally to a subset of a larger issue. Illegality in the context of a letter of credit can be viewed from two perspectives. The first refers to a circumstance in which the letter of credit itself is in violation of the law. When a letter of credit is not unlawful in itself, but the relevant contract is illegal under either legislation or the common law is the second scenario. Both of these scenarios are dealt with primarily through the lens of the English legal system, which appears to have acted as the primary source of inspiration for developing the illegality exception.¹⁴ 

Therefore it is important to seeks the of English Courts on the issue. Someone who using a letter of credit to gain out of his own fraud should be avoided and therefore the said person should not be allowed to use the court system to implement part of the relevant contract which would have been impossible to enforce on basis of illegality. This was the view of Colman J in Mahonia Ltd v JP Morgan Chase Bank case. In a similar spirit, Professor Nelson Enonchong claims that if fraud against a bank's private interest is substantial enough to replace the notion of autonomy, then illegality against the public interest should have the same prominent impact. As previously stated, for the formation of the illegality exception English jurisprudence appears to have functioned as a breeding ground.¹⁵ Hence it can be say that the English courts have recognize the illegality as an exception to the autonomy principle of letter of credit by being a extension of ex turpi causa concept.

It can also point out another exception as recklessness of the beneficiary. Beneficiary's irresponsibility stems from judicial dicta in the case of Lambias (Singapore) and has been positively noted on by the English Judges in Montrod's case. In the case of BDS Bank Ltd v Carrier Singapore, the court stated that if a bank can rely on negligent misrepresentation, which includes reckless behaviour by a beneficiary, to recover any amount it has paid out to the beneficiary, then the law must accept that the banks, and by extension the applicant, can plead reckless behaviour by the beneficiary or the vendor as a reason for not transferring the money to the beneficiary.¹⁶

The exception of Nullity is also recognises as an exception to the autonomy principle of the letter of credit. The issue of nullity in letter of credit usually expresses itself in the form of documents that are regarded to be fabricated, worthless, or untrue in such a way that the essence of the document is destroyed. The Singapore courts have recognized nullity as a distinct exemption from fraud. However, it has been determined in England that the nullity exception is not a component of English law.¹⁷

Unconscionability, as an exception to the Autonomy principle, contemplates a situation in which a beneficiary's or the vendor’s conduct, while not being fraudulent in the sense of dishonesty, may be tainted with bad faith to the extent that a court is willing to enjoin either the beneficiary from claiming or the bank from transferring the money. Following the establishment of the standard of proof required for determining unconscionability, it is important to note that establishing unconscionability to the required level of proof is dependent on a proper understanding of the critical elements that distinguish the unconscionability doctrine in letter of credit. When referring to Multiservice Bookbinding v Marden and Alec Lobb v Total Oil, both instances from the English Court of Appeal demonstrate a broader application of the principle of unconscionability in the sense that it can be applied in any type of transaction. According to these two cases, English law recognizes a fundamental principle entitling a court to intervene on the basis of unconscionability, which is described as follows: Because the principles established in these judgments are not limited to specific types of bargains with specific groups of vulnerable class members, they are thought to be broadly applicable in almost any type of transaction. This is in contrast to the Court's view in the Earl of Chesterfield case. As a result, these cases show a broad application of unconscionability in English law.¹⁸ 

Conclusion

The fact that the principle of autonomy in letter of credit commands such significance despite the fact that it functions with recognized exceptions, such as the exceptions of fraud, illegality, nullity, recklessness, and unconscionability of the beneficiary, must be highlighted. The UCP 600, on the other hand, does not explicitly address the concerns that are at the root of these exceptions. As a result, it is apparent that the exclusions described above have developed as a result of court of law decisions.

Reference list

1. Ferrero S, ‘Some Considerations on the Doctrine of Strict Compliance and the Autonomy Principle in Documentary Credit’ 1–2.
2. Mueller FRH (2013), Letters of Credit with Focus on the UCP600 and the Exceptions to the Principle of Autonomy with Emphasis on the “Fraud Rule” under the Laws of the USA, the UK and the RSA, 5.
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4. Alavi H (2016), ‘Contractual Restrictions on Right of Beneficiary to Draw on a Letter of Credit; Possible Exception to Principle of Autonomy’, 69–70.
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8. Ferrero S, ‘Some Considerations on the Doctrine of Strict Compliance and the Autonomy Principle in Documentary Credit’, 4.
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12. Al-Tawil T, ‘Letters of Credit and Contract of Sale: Autonomy and Fraud’, 189.
13. Afolabi OO (2017), ‘Beyond Fraud: A Critical Analysis of Illegality as Potential Exception to the Autonomy Principle in the Law of Demand Guarantees and Letters of Credit’, 26.
14. Afolabi OO (2017), ‘Beyond Fraud: A Critical Analysis of Illegality as Potential Exception to the Autonomy Principle in the Law of Demand Guarantees and Letters of Credit’, 28.
15. Afolabi OO (2017), ‘Beyond Fraud: A Critical Analysis of Illegality as Potential Exception to the Autonomy Principle in the Law of Demand Guarantees and Letters of Credit’.
16. Amaefule C (2011), The Exceptions to the Principle of Autonomy of Documentary Credits, 156.
17. Amaefule C (2011), The Exceptions to the Principle of Autonomy of Documentary Credits, 92.
18. Amaefule C (2011), The Exceptions to the Principle of Autonomy of Documentary Credits, 163–207.