Multinational Versus Multidomestic Issues

Assignment 1: Individual Research and Short Paper—Multinational Versus Multidomestic Issues

Using the MNC you selected for individual research in
M1: Assignment 2
, (TOYOTA) discuss some of the issues a company faces when it tries to use a multidomestic or multinational strategy.

What legal or cultural requirements do companies need to consider when adopting a multidomestic strategy?
Who are the major stakeholders of a company using a multidomestic strategy? Do the rules change or does the company always need to ensure they are complying both with local laws and the laws of the parent company? What role does the Foreign Corrupt Practices Act (FCPA) play for U.S. companies operating in foreign markets?

Write a 4-pages report in Word format. Apply current APA standards for writing to your work. Use the following file naming convention: LastnameFirstInitial_M6_A1 .

By Monday, June 10, 2013, submit your assignment to the
M6: Assignment 1

Assignment 2: Course Project Task 6—Current Financial Status and Future Growth (IKEA)

Both multidomestic and multinational companies have to consider legal and cultural requirements when expanding in international markets.

Consider how each of the following impacts your chosen MNC (IKEA)

Comparable financial statements (balance sheet and income statement)

Versus competitorsLast three yearsNoticeable trends

Investments in the specific country or regional area

PastPresentFuture

Recommendations and insights on the company

Express the client company’s current financial state and potential future growth opportunities. BY DISCUSSING the MNC’s current financial status and prospects for future growth and post your

By Monday
, June 10, 2013.

Module 6 Readings

Early in the week, complete the following:

Read the overview for Module 6

· From the textbook, International business law and its environment, read the following chapters:

Bank Collections, Trade Finance, and Letters of Credit

· From the Argosy University online library resources, read:

Brown, J. S. (2002). Research that reinvents the corporation. Harvard Business Review, 80(8), 105–115.

Magee, S. (1970). Multinational business. California Management Review, 13(1), 89–94.

· Moreau, R. (2008). Aldi and Lidl’s global expansion strategies. Retail Digest, 46–51. Retrieved from

http://www.thefreelibrary.com/Aldi+and+Lidl’s+global+expansion+strategies.-a0205910738

· From the Internet, read:

· Stone, A., Levy, B., & Paredes, R. (1996). Public institutions and private transactions: A comparative analysis of the legal and regulatory environment for business transactions in Brazil and Chile. In L. J. Alston, T. Eggertsson, & D. Cecil (Eds.), Empirical studies in institutional change (pp. 95–132). Cambridge University Press. Retrieved from

http://books.google.com/books?id=A29BVt1my9IC& printsec=frontcover#PPA95,M1

Module 6 Overview (1 of 2)

Does a multidomestic strategy, versus a multinational strategy, improve the chances of a company being accepted in an international market? When consumer companies advertise in the local market place, whether on TV or in print, they usually take on the “look and feel” of the local community.

For instance, in 1991, when McDonald’s opened its first restaurant in India, it faced an issue with its signature product, the Big Mac. The product, made with beef, was unsuitable for India where beef sales are very limited due to local customs and religious practices. Today, McDonald’s Big Mac is sold in India as the Maharaja Mac, and is made with chicken. It operates with a local national in a joint venture arrangement and sources its raw materials from local companies. The strategy McDonald’s used aided its expansion to 123 restaurants by the end of 2008.

Multidomestic organizations are known to be more autonomous across countries and use separate marketing strategies based on the market. The multidomestic company tries to present the appearance of a domestic company. Examples of companies that operate as multidomestic organizations include Nestle Foods, LG (the Korean-based manufacturer of electronics and major appliances), and Toyota.

Multinational companies tend to keep technology and decision making concentrated and tend to rely on the hired locals or nationals to understand the regional cultures. Examples of multinational companies include General Electric, HSBC, and Nokia.

Both multidomestic and multinational strategies require compliance with regulatory and local laws and customs, but with different ways of complying. The multidomestic complies as a local citizen, while the multinational complies as if it were operating within both the host country laws and its own country laws.

Module 6 Overview (2 of 2)

Multidomestic or Multinational Strategy

This module discusses some of the issues companies need to consider when choosing a multidomestic or multinational strategy.

Both multidomestic and multinational companies have to consider legal andcultural requirements when expanding in international markets. In your assignment, you will explore the regulatory issues and stakeholder interests associated with each type of strategy. As part of the course project you will assess your chosen MNC’s current financial status and future financial growth opportunities.

CHAPTER 7: Bank Collections, Trade Finance, and Letters of Credit

The previous chapters discussed contracts for the sale of goods, documentary sales, the risk of loss, and the liability of air and sea carriers. This chapter now turns to how the international banking system is used to move money in an international trade transaction. We will see how sellers collect for their shipments and how buyers remit payments for their purchases. We will also learn how sellers are assured of payment for their goods or services through the use of bank letters of credit and will briefly discuss some issues related to financing the sale. Keep in mind that most of the concepts covered here do not just apply to collecting money for the sale of goods but are equally applicable to many different types of international transactions involving the movement of money internationally and the use of banks to provide an assurance of contractual commitments.

THE BILL OF EXCHANGE

An understanding of how international payments or movements of money are made to fulfill contract obligations requires some basic understanding of the law of negotiable instruments. In general, the law of negotiable instruments is covered in courses on business law. For our purposes, we assume the reader has some limited understanding of this field. Here we are not concerned with their technical requirements, but with their use in international trade. A negotiable instrument is a signed writing, containing an unconditional promise or order to pay a fixed sum of money, to order or to bearer, on demand or at a definite time. Common negotiable instruments include promissory notes, which are two-party instruments containing a promise to pay, and drafts, which are three-party instruments containing orders to pay. In this chapter, we are concerned only with drafts. A draft is the signed order of the drawer, given to a drawee who is in possession of money to which the drawer is entitled, to pay a sum of money to a third party, the payee, on demand or at a definite time. A common check is a special form of draft, which is drawn on a bank and payable on demand. The three parties to a check include the drawer, who gave the order to pay, the drawee bank to whom the order to pay is given, and the payee. The bill of exchange is a specialized type of international draft commonly used to expedite foreign money payments in many types of international transactions. A documentary draft is used to expedite payment in a documentary sale. The word draft is more frequently used in U.S. law and banking practice, while the term bill of exchange is more frequently used outside the United States, particularly in England. Generally, the term draft is used in this text except when referring specifically to an English bill of exchange. These negotiable instruments can serve two purposes: (1) they act as a substitute for money and (2) they act as a financing or credit device.

Although it is beyond the scope of this text to offer a thorough treatment of the law of negotiable instruments, an understanding of the importance of the draft is essential to anyone engaged in international trade.

The Origin of Bills of Exchange

The origin of the bill of exchange lies in the history of the merchants and traders of fourteenth- and fifteenth-century Europe. As merchants visited the markets of distant cities to buy and sell their wares, they sought a safer means of transferring their gold or money than by carrying it in their caravans. It might have worked like this: Assume Merchant A delivered goods to Merchant B in a distant city, who became indebted to A for the amount of the purchase. Later Merchant A desires to purchase goods from Merchant C. Merchant A could pay Merchant C for the goods with a written piece of paper—an order—addressed by A to B to pay that money to C. Assume further that Merchant B is wealthy and respected in the trade—one whose credit is highly regarded. Merchant C could present the written order to B for payment immediately, or if he wished, he could simply ask B to sign (or “accept”) the order for future payment. Thus, the written order to pay became an acceptance. With the acceptance in hand, Merchant C could purchase new wares from yet another merchant and use the acceptance in payment. Eventually, merchants turned to wealthy families, Italian banking societies, or medieval bankers spread throughout Europe to transfer money over great distances by issuing payment orders to their correspondents living in distant cities. As merchants recognized that these orders could be bought and sold, the concept of negotiability evolved and negotiable instruments were born. At first, English law did not recognize the validity of negotiable instruments. But merchants accepted them as substitutes for money, and they were enforceable in the merchant’s private courts under the Law Merchant. As their importance and use evolved, so did their validity and treatment under the law. They became formally recognized by statute in England in 1822 in the English Bills of Exchange Act and in the United States in 1866 in the Uniform Negotiable Instruments Law.

Bills of exchange or drafts are today governed in the United States by the Uniform Commercial Code (UCC), in England by the Bills of Exchange Act, and in more than twenty other countries by the 1930 Convention on Bills of Exchange and Promissory Notes. Despite their common history, these laws differ in their treatment of the creation and transfer of negotiable instruments, as well as in the rights of the parties should an instrument be dishonored or refused.

Brief Requirements of a Bill of Exchange

The English Bills of Exchange Act requires that a bill of exchange be (1) an unconditional order in writing, (2) addressed by one person to another, (3) signed by the person giving it, (4) with a requirement that the person to whom it is addressed pay on demand or at a fixed or determinable future time, (5) a sum certain in money, and (6) to or to the order of a specified person, or to bearer. These characteristics are similar to the requirements for a draft set out in the UCC. (The Convention on Bills of Exchange requires that the words “bill of exchange” appear on the instrument, but English and U.S. laws do not.)

Basically, a bill of exchange or international draft is similar to a check, in that it is an unconditional order to pay a sum of money. (Drafts can be made payable in any currency.) In the case of a check, the drawer orders its bank, the drawee, to pay the amount of the check to the payee. However, instead of being drawn against funds held on deposit in a bank (as with a check), an international draft is an order from the seller to the buyer or buyer’s bank to pay the seller upon the delivery of goods or the presentation of shipping documents (e.g., an ocean bill of lading or air waybill). Thus, the seller is both the drawer (the one giving the order to pay) and the payee (the one entitled to payment under the instrument). The drawee is either the buyer or its bank, depending on the arrangements made for payment.

Negotiation and Transfer of Negotiable Instruments.

The commercial use of a draft or other negotiable instrument is derived from its negotiability, the quality that allows it to act as a substitute for money. Negotiation is the transfer of an instrument from one party to another so that the transferee (called a holder) takes legal rights in the instrument. The correct manner of negotiation depends on whether the instrument is a bearer or order instrument. Most drafts used in international trade are order instruments because they are payable to a named payee. In order to negotiate an order instrument, indorsement (by signature) and delivery of the instrument to the holder must take place. References to the negotiation of international drafts appear throughout this chapter.

The Documentary Draft and the Bank Collection Process

Drafts come in several different types. A draft that is to be paid upon presentation or demand is known as a sight draft because it is payable “on sight.” The sight draft is prepared by the seller and is sent to the buyer along with the shipping documents (e.g., the bill of lading) through banking channels, moving from the seller’s bank in the country of export to a foreign correspondent bank in the buyer’s country and city. The draft is sent “for collection,” known as a documentary collection. The banks act as agents of the seller for collection purposes. The draft and documents are accompanied by a collection letter that provides instructions from the seller on such matters as who is responsible for bank collection charges, what to do in the event the buyer dishonors the draft, and how the proceeds are to be remitted to the seller. Thus, the collection letter may specify that in the event of the buyer’s dishonor of the draft, the seller’s agent in the buyer’s country is to be notified, and that the goods are to be properly warehoused and insured pending resolution of the problem or sale of the goods to another party.

Essentially, documentary collections function like a cash-on-delivery (C.O.D.) transaction. When the sight draft is presented to the buyer at its bank or place of business, it is paid, and the payment is remitted to the seller. Only then does the bank turn over the shipping documents with which the buyer can claim its cargo from the carrier. The transaction is somewhat risky, however, because when presented with documents, there is no guarantee that the buyer will actually pay. Assuming the buyer does pay, the average cycle for completing a documentary collection is approximately three weeks (although most banks offer accelerated schedules). If a sales contract between buyer and seller calls for payment upon presentation of a sight draft, the contract terms commonly call for cash against documents (sales contracts with documentary payment terms were covered in Chapter Five).

The Swift System.

International banking transactions are handled through an industry-owned cooperative, the Society for Worldwide Inter bank Financial Telecommunication, commonly known as the SWIFT network. Most international letters of credit are transmitted through the SWIFT network. This worldwide telecommunications system has greatly expedited the remission of payments in a documentary collection. SWIFT is a private, high-speed communications network between banks, set up to transfer funds worldwide. It originated through the cooperative efforts of major banks in Europe, the United States, and Canada in the mid-1970s and is now in use in more than fifty nations. Due to its speed and cost-effectiveness, it has largely replaced the use of telex and mail-in fund transfers. Currently, SWIFT is involved in the Bolero Project, which is designed to eventually replace the paper-based transfer of trade documents with electronic transmissions on a global scale.

Documentary Drafts Used in Trade Finance

Banks and other financial institutions involved in commercial lending provide a wide range of financing packages for international trade, commonly called trade finance. Trade finance not only assists the buyer in financing its purchase but also provides immediate cash to the seller for the sale and is profitable for the lending institution.

The documentary draft can serve as an important financing or credit device, providing the seller and buyer with a mechanism for financing the international sale. In a competitive marketplace, an exporter must be able to offer its customers credit or other financing for their purchase. Many firms consider their ability to arrange credit a crucial component of their marketing strategy. If an exporter can prearrange financing for the buyer, it has an advantage over a competitor who cannot.

The Use of Time Drafts and Acceptances.

The use of the draft in trade finance works like this: Seller agrees to issue a draft that is due, say, sixty days after shipment of the goods. The draft states that it is due in sixty days or on a future date specified on the instrument. A draft due at a future date or after a specified period is known as a time draft, as shown in Exhibit 7.1. The time draft is sent to the buyer for its acceptance. Typically, acceptance is done by stamping the date and the word “accepted” across the face of the draft, together with the name and signature of the drawee, because no party is obligated on a draft unless its signature appears on it. Under the UCC, the acceptance “may consist of the drawee’s signature alone.” The buyer has thus created a trade acceptance. The buyer’s acceptance indicates the buyer’s unconditional obligation to pay the draft on the date due. A draft payable at “sixty days after date” is payable by the drawee sixty days after the original date of the instrument. A draft payable at “sixty days sight” means that it is due to be paid sixty days after the date of the acceptance.

Exhibit 7.1: Time Draft Drawn under Letter of Credit with Banker’s Acceptance

As with a sight draft, a seller usually sends the time draft together with the shipping documents to the buyer through banking channels with instructions to the banks that the shipping documents should be handed over to the buyer only upon acceptance of the draft. The sales contract would have indicated the parties’ agreement to this arrangement by calling for “documents against acceptance,” or other clear language of similar meaning. After acceptance, the draft is returned through banking channels to the seller. The seller can then hold the draft to maturity or sell it at a discount to a local bank or commercial lending institution for immediate cash. The commercial lender takes the acceptance by negotiation. The greater the creditworthiness of the buyer, the greater the marketability of the trade acceptance. Where the foreign buyer is unquestionably creditworthy, such as a major multinational corporation, the trade acceptance carries little risk and is easily saleable.

Banker’s Acceptances and Acceptance Financing.

A banker’s acceptance is a negotiable instrument and short-term financing device widely used to finance international (as well as domestic) sales. The purpose of an acceptance is to substitute a bank’s credit for that of the buyer in order to finance the sale. A banker’s acceptance is a time draft drawn on and accepted by a commercial bank. The bank stamps its name, date, and signature on the face of the draft to create the acceptance and thereby becomes obligated to pay the amount stated to the holder of the instrument on the date specified. The holder of the acceptance can convert it to cash immediately at a discounted rate or hold it until it matures.

Banker’s acceptances are flexible instruments, with many creative uses. Acceptance financing can be done by either the buyer’s or seller’s bank. Importing buyers can use a banker’s acceptance for short-term borrowing until they can resell and liquidate the goods being purchased. Sellers to export markets can use a banker’s acceptance for short-term, pre-export financing of raw materials and production costs until the goods are sold to the foreign customer and payment received. Exporters can also use acceptances to grant credit terms to foreign customers. For instance, in a sale on open account, an exporter might draw a time draft on its own bank for the amount of its overseas sale. The draft is accepted by the exporter’s bank, the discounted amount is paid to the exporter, and the acceptance is negotiated and discounted in the credit markets. When the importer pays the invoice amount to the exporter, the proceeds are used to satisfy the acceptance at maturity. In another arrangement, the exporter’s draft may be accepted by the importer’s bank, then discounted in the credit markets. In any case, the acceptance is satisfied at maturity through the proceeds of the sale.

In essence, the acceptance financing is self-liquidating because repayment is made from the underlying sales transaction, using credit market monies to finance business. The bank charges the borrower a commission and the discount rate for acceptance financing, which is usually deducted from the face amount of the acceptance when paid to the borrower. Depending on market conditions, acceptance financing is often cheaper for companies than regular credit borrowing.

Banker’s acceptances are generally short-term instruments because they must be for a period of six months or less. An eligible banker’s acceptance is one that qualifies for discount at the U.S. Federal Reserve Bank, which will buy it if it is not sold privately. Acceptances thus serve to finance international trade with outside capital. Because they are created by commercial banks, the use of banker’s acceptances is subject to banking laws and Federal Reserve regulations in the United States.

Credit Risk in Trade Finance Programs.

Institutions regularly involved in trade lending commonly prearrange these financing terms by agreeing in advance to purchase the trade acceptances of the foreign buyer. They must first perform an analysis and evaluation of the buyer’s financial position. Thorough credit checks are done on the buyer, utilizing trade and banking information, the reports of U.S. or foreign credit reporting agencies, and even site visits to the foreign firm. (Although obtaining and verifying credit information is relatively easy in the United States, Canada, Japan, and Western Europe, it is somewhat more difficult, and the information is less reliable, in other regions of the world.) To reduce the credit risk and lower the cost of trade finance, several government agencies in the United States and other countries provide credit guarantees to back trade finance lending by commercial institutions. In the United States, these agencies include Eximbank, the Commodity Credit Corporation, and the Agency for International Development (discussed later in this chapter).

Credit Risk in Acceptance Financing: Rights of the Holder in Due Course.

One of the primary reasons for the popularity of the acceptance as a financing device is the protection it provides to the financial institution or other party who purchases it, provided that party is a holder in due course. The detailed requirements to become a holder in due course are spelled out in the UCC. A holder in due course is a holder in possession of a negotiable instrument (such as a draft or acceptance) that has been taken: (1) for value, (2) in good faith, (3) without notice that it is overdue or has been dishonored, and (4) without notice that the instrument contains an unauthorized signature or has been altered (UCC 3-302). If all of the requirements for transferring a negotiable instrument are met and the transferee qualifies as a holder in due course, the transferee can take greater rights in the instrument than the transferor had.

According to the holder in due course rule, the purchaser of an acceptance, or any negotiable instrument, takes it free from most disputes that might arise between the drawer and drawee—the original parties to the underlying transaction. The most common type of dispute that might arise is breach of contract. For example, assume that DownPillow sells pillows to a Japanese buyer and forwards documents and a draft for acceptance. DownPillow discounts the trade acceptance to a U.S. bank, which then discounts the instrument in the credit markets. If the pillows turn out to be moldy and worthless, the Japanese buyer must still honor and pay the acceptance upon presentation in Japan. It may then assert its separate claim for breach of contract against the seller. This rule ensures the free transferability of commercial paper in international commerce. A financial institution can discount an international draft without fear that it will be caught up in the middle of a breach of contract action between buyer and seller. If drafts did not come with this protection, banks might not be so willing to finance international sales.

Credit Risks in Factoring Accounts Receivable: The Rights of the Assignee

As firms become more globalized and as credit information becomes more widely available, many firms are offering open account terms to their better, long-term foreign customers. These sellers are giving their customers an open credit period, typically from thirty days to several months, to pay for goods received. However, companies engaged in exporting products are not in business to loan money. Thus, banks are providing open account trade finance services, including the factoring of foreign accounts receivable.

An account receivable is no more than a representation of a contract right belonging to the seller—the right to collect money owed by the buyer under the contract for goods shipped. Contract rights can be assigned to another party. In a typical financing arrangement, the seller (assignor) assigns its right to collect the account to the financial institution (assignee). This is also called factoring, and the assignee is sometimes called the factor. Under basic contract law, the assignee “steps into the shoes” of the assignor and acquires only those rights under the contract that the assignor had against the other party to the contract (e.g., the buyer of the goods).

Take the following example: Assume that DownPillow ships an ocean container of pillows to Japan and factors the account receivable with a U.S. bank (the assignee). DownPillow now has its money and the bank is awaiting payment directly from Japan. (Of course, it is important for the Japanese buyer to be notified of the assignment and instructed to pay only the assignee bank.) If a dispute later breaks out over the quality of the pillows, the Japanese buyer may legally assert any claims and defenses against collection by the bank that it otherwise would have had against DownPillow. Thus, for example, the buyer can successfully argue that it does not have to pay the bank because of the breach of warranty by DownPillow. DownPillow will have to repay the bank for money received and resolve the breach of contract suit with the buyer. For this reason, banker’s acceptance financing offers some advantages over accounts receivable financing. Unlike a factor, a holder in due course of a banker’s acceptance is protected by the holder in due course rule. Thus, the fact that the products are defective does not provide a defense against payment to one liable on the negotiable instrument. Some insurance companies today offer commercial credit insurance to protect against accounts receivable that become uncollectible bad debts.

THE LETTER OF CREDIT

We will devote considerable attention to letters of credit issued by commercial banks. These flexible banking instruments are in wide use around the world. As much as $1 trillion in goods is purchased worldwide by letter of credit every year, according to most banking and government sources. In very broad terms, we can say that a letter of credit is an obligation of a bank, usually irrevocable, issued on behalf of their customer and promising to pay a sum of money to a beneficiary upon the happening of a certain event or events. In a sense, it is the substitution of the credit and good name of a bank for that of their customer, permitting the customer to do business with other individuals or firms on terms that otherwise might not be available to them. Letters of credit can be either domestic or international. They can be used in transactions for the sale of goods or services or to guarantee performance of other business obligations. Evidence exists that early forms of letters of credit were used in Renaissance Europe and in ancient Greece and Egypt. Today, almost all large banks can issue a letter of credit, although in practice most are issued by a small fraction of the world’s largest banks located in major banking centers of the world. In this chapter we will study two types of credits: the international documentary letter of credit used in the sale of goods and the standby letter of credit used to guarantee performance or payment obligations of the bank’s customer.

The Documentary Letter of Credit

Suppose that you are an American manufacturer who has been approached by a buyer in a foreign country. The buyer makes initial inquiries about your products, engineering and manufacturing capabilities, and installation and service after the sale. You do some informal background checking within the industry and determine that they are a serious customer. You receive their credit statement, containing banking and trade references. You may even obtain a credit report on them. You learn that they have been in business for relatively few years, so you are not willing to enter the sale without some security. After all, you would be manufacturing these goods to conform to their specifications and shipping them halfway around the world on the basis of their promise to take delivery and remit payment. In earlier chapters we studied some of your options. The risk is too great to ship the goods on thirty-day open account terms and hope for your money, and if you demand cash in advance the customer is not likely to agree. After all, she may not trust you any more than you trust her.

You could use a documentary sale, quoting prices to the customer as “cash against documents,” but even then you might never see payment. If you send the documents to the buyer’s bank for collection, it is still possible for them to weasel out of the deal. The buyer might not be able to pay, may have changed his or her mind, or may even have gone out of business. It is often possible for the buyer to find the same goods for less from another supplier. While probably not an issue in our hypothetical, in cases where substitute goods are freely available (and that might include everything from agricultural commodities to computer chips), a buyer might look for a way out of a contract where there has been a sharp decline in market prices. In any event, your customer could simply disappear, leaving the bank with documents to be returned to you and leaving you with specially manufactured goods in a customs warehouse halfway around the world. Unless you can find another foreign customer, which may be unlikely, you will have to pay the freight costs of returning them to your plant. To add a level of security to the documentary sale, you might propose contract terms calling for the buyer to provide an irrevocable, documentary letter of credit issued by a bank and addressed to you. This substitutes the credit and good name of a bank for that of the buyer and is a fairly good assurance (although nothing is absolute) that if you do your part that will be paid, and paid quickly.

A letter of credit would have another advantage to you in this example. If you ship goods to your customer on open account, you may have to wait several weeks or months to receive your money. By using a letter of credit, you will probably receive payment with a few days. Moreover, because the letter of credit is so secure, it can serve as security, or collateral, for you to obtain a short-term loan to help finance the purchase of materials for manufacturing or other start-up costs.

The Parties to the Transaction.

A buyer that has committed in the sales contract to obtain a letter of credit begins by applying to its bank for a letter of credit to be issued “in favor of” or “for the benefit of” the seller. In this arrangement, the buyer is known as the account party, the buyer’s bank is the issuing bank, or issuer, and the seller is called the beneficiary. A typical documentary sale with a letter of credit is illustrated in Exhibit 7.2.

Exhibit 7.2: The Documentary Sale with a Letter of Credit

A. Sales contract calls for L/C.

B. Application for L/C.

C. L/C forwarded to beneficiary through advising bank.

D. Documents prepared according to L/C—goods shipped.

E. Documents negotiated for payment through nominated, negotiating or confirming bank.

F. Payment or acceptance of draft after documents checked for discrepancies.

G. Negotiation of documents to buyer for reimbursement.

Documentary Letter of Credit Defined.

The documentary letter of credit is defined as:

1. The definite undertaking of a bank,

2. issued in accordance with the instructions of their customer,

3. addressed to, or in favor of, the beneficiary,

4. wherein the bank promises to pay a certain sum of money (or to accept or negotiate the beneficiary’s drafts up to that sum) in the stated currency,

5. within the prescribed time limits,

6. upon the complying presentation,

7. of the required and conforming documents.

The requirement that the bank will pay the seller only on the presentation of documents is what gives the documentary credit its name. In reality, those documents might differ greatly depending on whether the transaction is a domestic one or an international one; on the needs of the parties; or on the method for shipping the goods. Letters of credit can be used for many different types of shipments, including ocean, air, rail, and road shipments, and with multimodal freight. In reality, they can be used with almost any type of document, from simple invoices to postal receipts. However, we are limiting our discussion to letter of credit transactions involving ocean transport, where the most common documents required by the letter of credit are the ocean bill of lading, the commercial invoice, and the marine insurance policy.

Throughout this chapter, we will use the terms “letter of credit,” “credit,” or “documentary credit” interchangeably, although the latter refers only to credits payable on the presentation of documents.

The Legal Nature of the Letter of Credit.

There has long been an academic argument over whether or not the letter of credit is a contract between the issuing bank and the beneficiary. The letter of credit does act like a promise from an issuing bank to a beneficiary, and it seems to be treated at times like a contract and discussed in terms of the principles of contract law. However, the general consensus is that it is not a contract. If you recall the requirements for a contact, a letter of credit does not come about through offer and acceptance or mutual assent, nor is there any requirement for consideration. The basic requirements of a contract are missing. The bank and the beneficiary do not negotiate about anything; in fact, they usually have no contact whatsoever. The letter of credit is not a negotiable instrument, like a check or a promissory note. Nor is it a third-party beneficiary contract because the beneficiary’s rights do not derive from the contract between the buyer/account party and its bank. The letter of credit is a legal animal all of its own species; it is created by statute. It gives the beneficiary a statutory right to enforce the letter of credit against the bank that issued it, rather a contract right. Moreover, both the UCC and banking customs refer to the letter of credit as a “definite undertaking” and not as a contract.

Law Applicable to Letters of Credit

Letters of credit are recognized in all legal systems of the world. In the United States, the law governing letters of credit has been codified in Article 5 (1995 revision) of the Uniform Commercial Code. In addition, in some states, notably New York, letters of credit are responsible for a great body of case law. Perhaps the most important rules affecting letters of credit are not laws at all, but a privately developed set of guidelines based on the customs and commonly accepted practices of merchants and bankers, known as the Uniform Customs and Practice for Documentary Credits.

The Uniform Customs and Practice for Documentary Credits.

The Uniform Customs and Practice for Documentary Credits (UCP) is a document that international bankers know well. It is a set of standardized rules for issuing and handling letters of credit, drafted and published by the International Chamber of Commerce (which also publishes Incoterms, covered in Chapter Five) with the assistance of the international banking community. The UCP establishes the format for letters of credit, sets out rules by which banks process letter of credit transactions, and defines the rights and responsibilities of all parties to the credit. Because banks were the main drafters of the UCP, its provisions tend to protect their rights in any transaction. The UCP was first introduced in the early 1930s, with the latest revision (UCP 600) becoming effective in 2007. The UCP is in use in virtually every nation of the world and applies to most letters of credit issued worldwide.

The International Chamber of Commerce is not a government or lawmaking body, and the UCP is not law. A letter of credit is “governed” by the UCP only to the extent that it states that it is to be “interpreted” according to the UCP (which almost all do). The UCP is used by judges in deciding letter of credit cases, and references to it appear in virtually every reported decision on international letters of credit. The Uniform Commercial Code, Article 5 (1995 revision), now defers to the UCP and specifically states that the UCC is not applicable to any letter of credit to the extent that it is in conflict with the UCP. As a result, the UCP has a far greater impact on the law of international letters of credit than does the Uniform Commercial Code.

Irrevocability of Letters of Credit.

Letters of credit issued under UCP 600 are presumed irrevocable unless clear language is used to make them revocable. Nevertheless, most sales contracts recite that the buyer’s letter of credit is to be irrevocable. An example of an irrevocable documentary letter of credit is shown in Exhibit 7.3. While revocable credits have some uses, they are not used in documentary sales between unrelated parties.

Exhibit 7.3: Irrevocable Documentary Letter of Credit

The Independence Principle of Letters of Credit

The independence principle is a general rule of law that states that the letter of credit is independent of the sales contract between buyer and seller. The issuing bank is not concerned with what the parties had promised to do, or should do, under their contract. The issuing bank is only concerned that the buyer presents to the issuing bank certain “documents” (i.e. invoice, bill of lading, insurance policy, etc.) required by the letter of credit. Think of it as though the bank is purchasing documents for its customer, not goods. The independence principle is found in UCP 600, Article 5, stating, “Banks deal with documents and not with goods …”

The banks are not concerned with the quality or condition of the goods. They have no obligation to inspect goods or to investigate rumors about them. They do not care if the ship on which they are sailing has gone to the bottom of the sea. The following case, Maurice O’Meara Co. v. National Park Bank of New York, is generally considered by scholars in the United States to be the classic statement of the legal nature of letters of credit and the independence principle.

Following a Letter of Credit Transaction

In the following sections, we will see how a typical letter of credit transaction works. Some of the topics include the contract between the buyer and the buyer’s bank to issue a letter of credit, what the seller should do when the letter of credit arrives, rules for the seller to follow in presenting documents for payment, and the process by which the banks inspect documents and honor or dishonor the seller’s request for payment.

The Buyer’s Application and Contract with the Issuing Bank.

Once the buyer has finalized a sales contract calling for payment to the seller under a letter of credit, it is up to the buyer to apply for that letter of credit at a bank. The application for the credit, usually done on the bank’s form and accompanied by an initial fee, contains the buyer’s instructions and conditions upon which the issuing bank may honor the seller’s documents. These instructions are based on the details of the original sales contract between buyer and seller. The application will request the bank to issue a letter of credit to the seller promising to purchase the seller’s documents covering a certain quantity and description of goods, with a value up to a certain amount of money, that are insured and shipped on or before a certain date.

The buyer may impose almost any conditions or requirements on the seller’s performance, as long as they pertain only to the seller’s documents. For example, the buyer could prohibit the bank from taking documents showing a partial shipment, or it could require a document that shows a specific method of shipping, or even name a specific vessel. However, the buyer must remember that this information is based on the buyer’s final agreement with the seller.

The buyer’s application for the credit, when accepted by the bank, becomes a contract between them. It states what the bank must do on the buyer’s behalf. If the bank follows the buyer’s instructions, then it is entitled to purchase the seller’s documents and obtain reimbursement from the buyer. If it does not, or if it violates any terms of its contract, then the buyer need not take the documents or reimburse the bank that took them contrary to instructions. For instance, if the buyer’s application requests the bank to issue a letter of credit calling for the seller to submit documents showing that it shipped “1,000 electric toasters,” and the bank, without approval, purchases documents showing that the seller shipped “1,000 toaster ovens,” then the bank is not entitled to reimbursement. If the buyer instructs the bank to issue a letter of credit showing that the toasters must ship on or before a certain date, and the bill of lading shows the toasters were shipped after that date, the bank is not entitled to reimbursement. Indeed, banking lore is filled with stories of banks getting “stuck” with cargo like this. So (we say only half jokingly), the next time you are in your bank and you see a sign offering a free toaster oven to anyone opening a new account, you might think of this example and wonder whether it was a marketing decision or a way to unload unwanted cargo. If you choose a career in banking, you might want to remember that banks deal with money and documents. They do not like to deal in goods or to be stuck with them.

The buyer may not make any demands on the issuing bank that are not related to the seller’s documents. For example, the application may not attempt to require the bank to inspect goods or to make the letter of credit conditional on an investigative report of the seller, on a criminal background check, on the buyer’s receipt of financing, or on a contract to resell the goods.

Maurice O’Meara Co. v. National Park Bank of New York

146 N.E. 636 (1925) Court of Appeals of New York

BACKGROUND AND FACTS

National Park Bank issued a letter of credit addressed to Ronconi & Millar, beneficiary, at the request of its account party, Sun Herald, “covering the shipment of 1,322 tons of newsprint paper in 72½-inch and 36½-inch rolls to test 11–12, 32 lbs. at 8½ cents per pound net weight—delivery to be made in December 1920 and January 1921.” The letter of credit did not require that a testing certificate from an independent laboratory accompany the documents. When Ronconi & Millar’s invoice and draft were presented to the bank, the documents described the paper as was required in the letter of credit. However, the bank refused payment because it had no opportunity to test the tensile strength of the paper. (Interestingly, the market price of newsprint paper had fallen sharply in the time period between the contract of sale and the presentation of documents, amounting to over $20,000 in this case.) Ronconi & Millar transferred their rights to collect payment to Maurice O’Meara, a financial institution, who brought this action to collect the full amount of the drafts. Maurice O’Meara claims that the issuing bank had no right to test or inspect the paper.

MCLAUGHLIN, JUDGE

[The letter of credit] … was in no way involved in or connected with, other than the presentation of the documents, the contract for the purchase and sale of the paper mentioned. That was a contract between buyer and seller, which in no way concerned the bank. The bank’s obligation was to pay sight drafts when presented if accompanied by genuine documents specified in the letter of credit. If the paper when delivered did not correspond to what had been purchased, either in weight, kind or quality, then the purchaser had his remedy against the seller for damages. Whether the paper was what the purchaser contracted to purchase did not concern the bank and in no way affected its liability. It was under no obligation to ascertain, either by a personal examination or otherwise, whether the paper conformed to the contract between the buyer and seller. The bank was concerned only in the drafts and the documents accompanying them. This was the extent of its interest. If the drafts, when presented, were accompanied by the proper documents, then it was absolutely bound to make the payment under the letter of credit, irrespective of whether it knew, or had reason to believe, that the paper was not of the tensile strength contracted for. This view, I think, is the one generally entertained with reference to a bank’s liability under an irrevocable letter of credit of the character of the one here under consideration.

The defendant had no right to insist that a test of the tensile strength of the paper be made before paying the drafts; nor did it even have a right to inspect the paper before payment, to determine whether it in fact corresponded to the description contained in the documents. The letter of credit did not so provide. All that the letter of credit provided was that documents be presented which described the paper shipped as of a certain size, weight, and tensile strength. To hold otherwise is to read into the letter of credit something which is not there, and this the court ought not to do, since it would impose upon a bank a duty which in many cases would defeat the primary purpose of such letters of credit. This primary purpose is an assurance to the seller of merchandise of prompt payment against documents.

It has never been held, so far as I am able to discover, that a bank has the right or is under an obligation to see that the description of the merchandise contained in the documents presented is correct. A provision giving it such right, or imposing such obligation, might, of course, be provided for in the letter of credit. The letter under consideration contains no such provision. If the bank had the right to determine whether the paper was of the tensile strength stated, then it might be pertinent to inquire how much of the paper must it subject to the test. If it had to make a test as to tensile strength, then it was equally obligated to measure and weigh the paper. No such thing was intended by the parties and there was no such obligation upon the bank. The documents presented were sufficient. The only reason stated by defendant in its letter of December 18, 1920, for refusing to pay the draft, was that—“There has arisen a reasonable doubt regarding the quality of the newsprint paper…. Until such time as we can have a test made by an impartial and unprejudiced expert we shall be obliged to defer payment.”

This being the sole objection, the only inference to be drawn therefrom is that otherwise the documents presented conformed to the requirements of the letter of credit. All other objections were thereby waived.

Judgment should be directed in favor of the plaintiff.

Decision. National Park Bank’s obligation to pay the beneficiary’s drafts submitted under its letter of credit was separate and distinct from the contract of sale between the buyer and seller. Banks deal in documents only. Therefore the defendant, National Park Bank, could not withhold payment of the drafts even if it believed that the paper was not of the weight, kind, or quality ordered by Sun Herald. Defendant also had no right to demand testing of the paper or to inspect it prior to payment.

Case Questions

1. Had the bank been aware that the newsprint shipment did not conform to the requirements of the underlying sales contract, would it have still been required to pay under the letter of credit?

2. If the bank pays for documents that conform to the letter of credit, but the goods themselves turn out to be nonconforming, is the buyer legally justified in refusing to reimburse its bank?

3. Do you think, under current law and banking practice, that bankers should physically inspect the goods when they arrive before honoring their customer’s letter of credit?

The buyer’s international banker and customs broker are two good sources of information and advice on what documents a buyer should require from a seller. Buyers would be well warned to heed their advice or consult an attorney experienced in handling international letters of credit.

The willingness of the bank to issue the letter of credit for the buyer—its customer—depends on the buyer’s creditworthiness and the banking relationship between them. More than likely, the buyer and its bank have an established history of banking and commercial lending. The buyer will be responsible to the bank for fees and a percentage of the value of the letter of credit, so the buyer should have already considered these additional costs when agreeing to original sales contract.

Advising the Letter of Credit to the Beneficiary.

The issuing bank will send the letter of credit to the seller via a foreign correspondent bank (a bank with whom the issuing bank has a reciprocal banking relationship) located in the seller’s country. This bank is called the advising bank. An advising bank merely informs or “advises” the seller that the letter of credit is available to be picked up. An advising bank has no responsibility to honor a draft or purchase the seller’s documents. It is not liable on the credit. It provides the service of forwarding the letter of credit to the seller, but it has no obligation to advise the credit and may refuse if it wishes. Its only responsibility is to satisfy itself that the credit is authentic and accurate as received (e.g., that there were no errors in transmission). For example, it might compare the signature on the credit as advised to them with the authorized signature of the banking officer at the issuing bank. Letters of credit are commonly transmitted between banks using the SWIFT network.

Seller’s Compliance with the Letter of Credit.

Until the seller receives the letter of credit and reads it carefully, he or she might not want to begin manufacturing, packaging, arranging transportation, or preparing the documents. The letter of credit tells the seller what it must do in order to be paid. It tells him or her what to ship, how to ship, when to ship, and more. It contains specific terms and conditions drawn from the original sales contract and included in the letter of credit, such as the quantity and description of the goods, shipping dates, the type or amount of insurance, markings on packages, and so on. The letter of credit also tells the seller what documents are needed in addition to the usual ones. For instance, assume a buyer in California wants to import foreign-made beanbag chairs that must meet California’s strict flammability standards for upholstered furniture. The letter of credit might call for an inspection certificate showing that the chairs “were tested pursuant to and are compliant with California Technical Bulletin 117.” This tells the seller that this test must be performed, probably by an independent laboratory, and the inspection certificate obtained before the shipping date.

The seller will want to decide if the letter of credit is in keeping with his or her agreement with the buyer in the underlying contract of sale. If the letter of credit shows any significant differences from the sales contract, the seller would want to contact the buyer to inquire why. For instance, assume that a sales contract called for shipment of “4,000 lbs. washed white goose down in machine-compressed bales,” and the letter of credit reads “3,000 lbs. washed white goose down in machine-compressed bales.” The seller must stop and inquire why a difference appears in the quantities expressed. Did the buyer change its mind and decide to purchase only 3,000 lbs. instead of the 4,000 lbs. agreed to? If so, why was the seller not contacted to reconfirm the new order? Perhaps the bank erred in transmitting the letter of credit. Whatever the reason, the seller should do nothing until the problem is resolved or until an amended letter of credit is received. If the seller ships 4,000 lbs., its drafts may be refused and it may only get paid for 3,000 lbs.; if it ships 3,000 lbs., it may be losing a sale for the 1,000 lbs. difference.

The seller should examine other conditions of the credit to be certain they can be met. Can the seller acquire materials and manufacture on time for the shipment deadline in the letter of credit or before the expiry date of the credit? Does the credit call for a particular shipping method or route or specify a particular carrier or ship that cannot be used? If an export license is needed in order to export the products from the seller’s country, can it be processed and received on time from the government agency?

The seller should also review the credit for accuracy. Is the total amount of the letter of credit sufficient to cover the drafts? Is it in the currency called for in the sales contract? Do the provisions for insurance and the payment of freight charges meet the terms of the contract of sale, and are they agreeable to the seller? Does the letter of credit allow partial shipments?

If the seller is unable to comply with the letter of credit for any reason, the buyer must be contacted immediately, before shipment, so that an amended credit can be issued. In one case, a U.S. furniture manufacturer received a letter of credit from Kuwait calling for the shipment of furniture in “one 40’ ocean container.” Only after packaging and loading did the manufacturer realize that some of the furniture would not fit into one container. If the manufacturer’s documents had shown two containers, or had it shown less furniture than was called for in the letter of credit, the bank would have rejected the documents. An amended credit had to be issued before it was safe for the furniture to be crated and shipped.

Complying Presentation.

A presentation is the delivery of the seller’s documents and draft to the nominated bank or directly to the issuing bank. A complying presentation is one in which

1. The seller delivers all of the required documents,

2. within the time allowed for presentation and prior to the expiry date of the credit,

3. containing no discrepancies, and

4. which complies with all other terms of the letter of credit, the provisions of the UCP, and standard banking practices.

The nominated bank is that bank, usually in the seller’s country, that has been appointed or “nominated” by the issuing bank to honor the documents. The nominated bank is often the advising bank that originally transmitted the documents to the seller. If no bank is nominated, then the letter of credit is said to be “freely available” and can be negotiated through any bank of the seller’s choice.

The UCP requires, in most cases, that presentation be within twenty-one days of the date of shipment (determined by the date of the bill of lading) and before the expiry date stated in the credit. Documents will be refused for late presentment unless waived by the buyer.

Examination of Documents for Discrepancies.

If the seller’s presentation is complying, the nominating bank will purchase the seller’s documents and honor the draft. If the credit calls for payment on sight, the nominated bank will honor and pay the seller’s draft on sight. If the credit calls for the draft to be paid at some other time, the nominated bank will honor the draft by acceptance. However, if the seller’s documents do not comply with the terms of the letter of credit or if they contain irregularities or discrepancies, the documents will be held pending instructions from the buyer or rejected by the banks. If the banks purchase noncomplying documents, they cannot seek reimbursement from the buyer.

UCP 600 gives banks up to five banking days to examine the seller’s documents to determine if they conform to the requirements of the letter of credit, or if they contain any discrepancies or irregularities. A discrepancy is any difference, no matter how minor, between the terms of a required document and the terms required by the letter of credit. The discrepancy may be caused by some wording or data in a document that is not exactly what was required in the credit. The seller’s documents and letter of credit are literally put side by side and compared by a bank’s professional document checker. Each term in the documents is matched to the requirement of the letter of credit. For instance, a discrepancy exists if the quantity or description of the goods in the invoice does not match that in the credit, if the bill of lading is dated later than required, if any documents are missing, or if they show signs of fraud, forgery, tampering, or missing signatures.

A bank may not try to interpret the wording of a document. The UCP permits banks only to examine the documents “on their face” to see whether they comply with the letter of credit or whether there is a discrepancy. Banks may not look to any outside sources or conduct any independent investigation to see if the seller’s shipment to the buyer is in good order. It is the documents alone that must be in good order and compliant with the letter of credit. For example, assume a letter of credit calls for the shipment of “1,000 blood pressure monitoring kits.” The shipper’s invoice shows the sale and shipment of “1,000 sphygmomanometers and cuffs.” The document checker may or may not know if they are the same, nor does it matter. The document checker may not consult dictionary definitions, encyclopedias, medical textbooks, or other outside references. The bank is not responsible for interpreting technical or foreign language. The bank may not telephone the seller and ask what was meant in their invoice. In this case there is a discrepancy, and the documents will be rejected, unless the discrepancy is waived by the buyer. Neither the buyer nor his or her bank is obligated to take them.

In the following sections, we will look at the most important documents required under a letter of credit, and some common discrepancies. These derive from the UCP, standard international banking practices, and common requirements on letters of credit. The most common discrepancies found in documents are related to descriptions, time, amounts, missing documents, missing signatures, and contradictions among documents. (See Exhibit 7.4). Other documents frequently required in a letter of credit are a packing list, certificate of origin, consular invoice, and many others. The seller should not submit documents that are not required by the letter of credit; under the UCP, they will be disregarded by the banks and may be returned to the seller.

Exhibit 7.4: Common Discrepancies Found in Documentation

Bill of Lading/Air Waybill

• Incomplete set of bills (originals missing)

• Onboard notations not dated and signed or initialed

• Time for shipment has expired

• Unclean bill of lading shows damage

• Indorsement missing

• Evidence of forgery or alteration

• Does not show freight prepared if required under the letter of credit

• Description of goods differs substantially from letter of credit

• Name of vessel differs from one required

• Shows partial shipment or transshipment where prohibited by the letter of credit

Commercial Invoice

• Description of goods does not conform to description in letter of credit

• Does not show terms of shipment

• Amount differs from that shown on draft

• Amount exceeds limits of letter of credit

• Weights, measurements, or quantities differ Draft

• Draft and invoice amounts do not agree

• Draft does not bear reference to letter of credit

• Evidence of forgery or alteration

• Draft not signed

• Maturity dates differ from letter of credit

• Currency differs from letter of credit

Insurance Policy

• Description of goods differs from invoice

• Risks not covered as required by the letter of credit

• Policy dated after date of bill of lading

• Amount of policy insufficient

• Certificate or policy not indorsed

• Certificate presented instead of policy, if required in letter of credit

General Discrepancies

• Letter of credit has expired

• Letter of credit is overdrawn

• Draft and documents presented after time called for in letter of credit

• Incomplete documentation

• Changes in documents not initialed

• Merchandise description and marks not consistent between documents

The Commercial Invoice.

The commercial invoice is required by buyers, banks, and customs authorities on every international sale. The commercial invoice must be made out by the seller and addressed to the buyer and be in the same currency as the letter of credit. It need not be signed, notarized, or verified, unless the credit requires. Where a commercial invoice is required, a preliminary “pro forma” invoice will not be accepted.

Perhaps the most important requirement is that the description of the goods in a commercial invoice must correspond to that in the credit. Most courts hold that the description must be exactly the same. As we will see in the next section, sellers are encouraged to use the same description in the invoice as the issuing bank used in the letter of credit, misspellings and all. Where bulk items are involved, the invoice should be for the quantity of goods ordered, or within 5 percent of the amount specified in the credit. However, the 5 percent rule does not apply to letters of credit covering a specific number of items or packages. In such a case, the amount of the invoice cannot exceed the amount of the letter of credit. For example, a seller may ship and bill for 5 percent more grain than was ordered, but not for more cases of soft drinks, or tractors.

The Ocean Bill of Lading.

For transactions in which the letter of credit calls for presentment of an “on-board” bill of lading, the seller must present to the issuing bank a bill of lading showing the actual name of the ship, and containing the notation “on board,” indicating that the goods have been actually loaded. Where the buyer and seller have agreed, and where it is approved in the letter of credit, it is acceptable for the bill of lading to show that the carrier has received the goods for shipment (but are not yet loaded on board). The dates of receipt or loading must be shown. The seller must present the original bill of lading, and if it was issued in a set of more than one original, then all originals must be presented. When all originals are present, this is known as a full set. The bill of lading must be dated within the time set in the credit for shipping. It must show the name of the carrier and be signed by the carrier’s agent or ship’s master. It must state either that the goods have been taken in charge for shipment, or that they were shipped “on board.” It must be a “clean” bill—one that has no wording or notations indicating that damage to the goods or packaging was apparent or visible at the time of loading. In transactions where the seller has agreed to arrange and pay for the cost of international freight, the bills of lading must be marked “freight prepaid.” Similar requirements exist for road, rail, inland waterway, or air transportation.

The Insurance Policy.

The insurance policy should be of the type and coverage required by the letter of credit, and in the same currency and in the amount specified in the credit or, if none specified, in the amount of the invoice, plus 10 percent. It should be effective on or before the date of the bill of lading, to show that the goods were insured during loading. The policy itself should be used; alternatively a certificate of insurance may be used unless a certificate is not permitted by the letter of credit. Declarations are used by companies that have open policies that “float” over many shipments. They must be signed by an agent for the company. Cover letters from agents are not acceptable.

Certificates of Analysis or Inspection.

Although these certificates are not required for letter of credit transactions, they are very common and deserve to be mentioned. Frequently, a buyer will require the seller to submit documentary proof of inspection from an independent inspection firm. A seller may require submission of a certificate of inspection for merchandise, a certificate of laboratory analysis, or a certificate of compliance with health, safety, or technical standards from an approved testing lab. Analysis or inspection certificates can be required for almost any product, such as an inspection of the sewing quality of blue jeans, an analysis of the mold content of grain, or a laboratory analysis of the lead content of the paint on children’s toys. Sellers should ensure that certificates they include with their documents meet all the terms required by the letter of credit.

The Rule of Strict Compliance

The prevailing standard established by the courts for examining documents is found in the rule of strict compliance. According to this view, the terms of the documents presented to the issuing bank must strictly conform to the requirements of the letter of credit and the UCP. This rule is almost as old as letter of credit law itself. It was stated in the famous words of Lord Sumner in Equitable Trust Co. of New York v. Dawson Partners Ltd. [1997] 2 Lloyd’s Rep 49: “There is no room for documents which are almost the same, or which will do just as well.” This does not mean that every “i” must be dotted and every “t” crossed. As one court stated, it’s not a discrepancy if Smith is spelled “Smithh.” Some typographical errors are excusable, of course. But the thrust of the rule is that every provision of the bill of lading, invoice, insurance policy, and any other required shipping document must match the letter of credit. Even a small discrepancy can cause the bank to reject the documents. The reason for such a harsh rule is simple; it relieves bankers from the duty of interpreting the meaning of the discrepancy or its possible impact on their customer, and it relieves them of the liability of interpreting it incorrectly.

In the following case, Courtaulds North America, Inc. v. North Carolina National Bank, the court considered a discrepancy between the description of the goods on the letter of credit and on the invoice.

Courtaulds North America, Inc. v. North Carolina National Bank

528 F.2d 802 (1975) United States Court of Appeals (4th Cir.)

BACKGROUND AND FACTS

The defendant bank issued an irrevocable letter of credit on behalf of its customer, Adastra Knitting Mills. It promised to honor sixty-day time drafts of Courtaulds for up to $135,000 covering shipments of “100% Acrylic Yarn.” Courtaulds presented its draft together with a commercial invoice describing the merchandise as “Imported Acrylic Yarns.” The packing lists that were stapled to the invoice contained the following description: “Cartons marked: 100% Acrylic.” The bank refused to accept the draft because of the discrepancy between the letter of credit and the commercial invoice. (The buyer had gone into bankruptcy, and the court-appointed trustee would not waive the discrepancy.) The documents were returned and the plaintiff brought this action. The lower court held that the bank was liable to the plaintiff for the amount of the draft because the packing lists attached to each carton stated that the cartons contained “100% Acrylic,” and the bank appealed.

BRYAN, SENIOR CIRCUIT JUDGE

The defendant denied liability chiefly on the assertion that the draft did not agree with the letter’s conditions, viz., that the draft be accompanied by a “Commercial invoice in triplicate stating (inter alia) that it covers … 100% acrylic yarn”; instead, the accompanying invoices stated that the goods were “Imported Acrylic Yarn.”

… [T]he District Court held defendant Bank liable to Courtaulds for the amount of the draft, interest, and costs. It concluded that the draft complied with the letter of credit when each invoice is read together with the packing lists stapled to it, for the lists stated on their faces: “Cartons marked: 100% Acrylic.” After considering the insistent rigidity of the law and usage of bank credits and acceptances, we must differ with the District Judge and uphold Bank’s position.

In utilizing the rules of construction embodied in the letter of credit—the Uniform Customs and state statute—one must constantly recall that the drawee bank is not to be embroiled in disputes between the buyer and the seller, the beneficiary of the credit. The drawee is involved only with documents, not with merchandise. Its involvement is altogether separate and apart from the transaction between the buyer and seller; its duties and liability are governed exclusively by the terms of the letter, not the terms of the parties’ contract with each other. Moreover, as the predominant authorities unequivocally declare, the beneficiary must meet the terms of the credit—and precisely—if it is to exact performance of the issuer. Failing such compliance there can be no recovery from the drawee. That is the specific failure of Courtaulds here.

… [T]he letter of credit dictated that each invoice express on its face that it covered 100% acrylic yarn. Nothing less is shown to be tolerated in the trade. No substitution and no equivalent, through interpretation or logic, will serve. Harfield, Bank Credits and Acceptances (5th ed. 1974), commends and quotes aptly from an English case: “There is no room for documents which are almost the same, or which will do just as well.” Although no pertinent North Carolina decision has been laid before us, in many cases elsewhere, especially in New York, we find the tenet of Harfield to be unshaken.

At trial Courtaulds prevailed on the contention that the invoices in actuality met the specifications of the letter of credit in that the packing lists attached to the invoices disclosed on their faces that the packages contained “cartons marked: 100% acrylic.” … But this argument cannot be accepted.

The district judge’s pat statement adeptly puts an end to this contention of Courtaulds: “In dealing with letters of credit, it is a custom and practice of the banking trade for a bank to only treat a document as an invoice which clearly is marked on its face as ‘invoice.’” This is not a pharisaical or doctrinaire persistence in the principle, but is altogether realistic in the environs of this case; it is plainly the fair and equitable measure. (The defect in description was not superficial but occurred in the statement of the quality of the yarn, not a frivolous concern.) Bank was not expected to scrutinize the collateral papers, such as the packing lists. Nor was it permitted to read into the instrument the contemplation or intention of the seller and buyer….

Had Bank deviated from the stipulation of the letter and honored the draft, then at once it might have been confronted with the not improbable risk of the bankruptcy trustee’s charge of liability for unwarrantably paying the draft monies to the seller, Courtaulds, and refusal to reimburse Bank for the outlay. Contrarily, it might face a Courtaulds claim that since it had depended upon Bank’s assurance of credit in shipping yarn to Adastra, Bank was responsible for the loss. In this situation Bank cannot be condemned for sticking to the letter of the letter.

Nor is this conclusion affected by the amended or substituted invoices which Courtaulds sent to Bank after the refusal of the draft. No precedent is cited to justify retroactive amendment of the invoices or extension of the credit beyond the August 15 expiry of the letter.

For these reasons, we must vacate the decision of the trial court, despite the evident close reasoning and research of the district judge….

Reversed and remanded for final judgment.

Decision. The judgment is reversed for the defendant bank. The description of the goods in the invoice did not match the description of the goods in the credit, and the defect was not cured by a correct description in the packing list.

Case Questions

1. Why did the bank refuse to accept the draft upon presentation of the documents?

2. Had the bank known that the yarns described in the invoice as “imported acrylic yarns” were actually 100% acrylic, as called for in the letter of credit, would the outcome of the case have been different?

3. What is the liability of a bank for paying or accepting a draft when the documents contain a discrepancy?

Apply the strict compliance rule of the Courtaulds case to the following situation: Suppose that a seller receives a letter of credit from a foreign buyer covering “1,000 standard-size bed pillows.” Seller’s export manager completes an invoice for “1,000 bed pillows, size 20 × 26 in.” A discrepancy would exist. Bankers are not expected to know that a “standard” bed pillow is 20 × 26 inches, and even if the banker did know, he or she would still have to refuse the document because of the discrepancy. Assume now that the invoice matches the letter of credit, but that the bill of lading shows shipment of “1,000 pillows.” On this point the UCP is very clear: the description in a document other than an invoice may be “in general terms not conflicting with their description in the credit.” Here the documents show no discrepancy.

The Functional Standard of Compliance.

While the strict compliance rule remains the prevailing view in most jurisdictions, some courts in the United States and in some European countries have used a more practical “functional standard” of compliance. These courts would not require a bank to reject documents with obviously minor typographical errors. Voest-Alpine Trading Co. v. Bank of China, 167 F.Supp.2d 940 (S.D.Tex. 2000), aff’d 288 F.2d 262 (5th Cir. 2002), involved a shipment of styrene from Voest-Alpine to a customer in China under a $1.2 million letter of credit issued by the Bank of China. Apparently the market value of the styrene at the time the documents were presented for payment had fallen well below the contract price. Voest-Alpine refused a price concession requested by the buyer, and the bank started looking for discrepancies. There was no question that the documents contained discrepancies. The question was whether they were sufficient to justify the bank’s refusal to pay for the documents. The beneficiary’s name in the letter of credit, Voest-Alpine Trading USA, was transposed in the documents to “USA Trading.” The letter of credit required three “original” bills of lading, but none were stamped “original,” one was stamped “duplicate” and another “triplicate.” All three, however, contained original hand signatures in blue ink. The survey report for damage was dated a day after the bill of lading, even though the report stated that the goods had been inspected upon loading. Although the reference number of the letter of credit was incorrect on the cover letter prepared by Voest-Alpine, it was correct elsewhere. Finally, the name of the port city, Zhangjiagang, was spelled several different ways in various documents. The Bank of China argued that under a strict compliance standard it was justified in rejecting the documents. Voest-Alpine argued for a “functional standard” of compliance, contending that the bank should have looked at documents as a whole. In agreeing with Voest-Alpine, the court rejected the notion that the documents should be a “mirror image” of those called for in the letter of credit, and adopted a more moderate approach. The district court stated:

A common sense, case-by-case approach would permit minor deviations of a typographical nature because such a letter-for-letter correspondence between the letter of credit and the presentation documents is virtually impossible. While the end result of such an analysis may bear a strong resemblance to the relaxed strict compliance standard, the actual calculus used by the issuing bank is not the risk it or the applicant faces but rather, whether the documents bear a rational link to one another. In this way, the issuing bank is required to examine a particular document in light of all documents presented and use common sense but is not required to evaluate risks or go beyond the face of the documents. The Court finds that in this case the Bank of China’s listed discrepancies should be analyzed under this standard by determining whether the whole of the documents obviously relate to the transaction on their face.

The UCP 600 Rule.

The general principles of letter of credit law that we have discussed up to this point have been developed by courts in countries around the world. Often, these decisions are based on the courts’ interpretation of the UCP because the UCP contains its own standards for gauging when documents comply with the letter of credit. Article 14 of UCP 600 takes a modified strict compliance approach by stating that, “data in a document” (here “data” means such things as the description of the goods, names of the parties, quantities and weights, addresses, and similar relevant terms) does not have to be “identical” to other data in the same document, or to data in any other required document, or data in the credit itself – but it may not conflict with it. The UCP has specific provisions regarding the description of the goods – one of the key terms in any letter of credit. The UCP states that a document (other than an invoice) may describe the goods “in general terms not conflicting with their description in the credit.” However, the rule of strict compliance is retained in Article 18 with regard to the invoice, which states, that, “The description of the goods … in a commercial invoice must correspond with that appearing in the credit.” The UCP also requires that the name, address, and contact details for the consignee or notify party on the transport documents must appear exactly as in the letter of credit. Thus a warning to export managers and to bankers that advise them: Be certain that you describe your goods in your invoice in the exact wording and form that is used in the letter of credit. Be consistent in your data throughout all documents, and conform your data and wording to that used in the credit itself.

Every export manager, freight forwarder, carrier’s agent, and international banker should have their own reference copy of the UCP readily at hand when drafting documents or dealing in transactions governed by the UCP.

An Ethical Issue in Handling Letters of Credit.

In most cases, buyers will waive a minor discrepancy. However, sellers and bankers must beware. If a buyer is looking for a reason to reject the documents (e.g., if the ship has gone down at sea, the market price of similar goods has fallen dramatically, etc.), a discrepancy will give the savvy (or unscrupulous?) buyer a way out. If the buyer is looking for a way to chisel a better price out of the deal, then a discrepancy will give him or her the leverage. The buyer can reject the documents, and only later reluctantly agree to waive the discrepancy—but only for a huge discount off the contract price! Issuing banks may on occasion want to find discrepancies. If they discover that their customer—the buyer—is going to back out of the deal, they can use the discrepancy to reject the documents. (An old adage states that any banker who cannot find a discrepancy is not worth his or her salt.) Of course, almost all discrepancies are honest accidents or commercial mistakes and are easily resolved.

Procedures for Dishonor.

A bank must follow the UCP guidelines for rejecting or dishonoring a presentation. The first step is to ask the buyer for a waiver. If the buyer decides to refuse the documents, the bank must give notice of its refusal to the presenting bank by telecommunication within five banking days. The notice must inform the presenter whether the documents are being held pending further instructions or are being returned. If the issuing bank fails to do this, it is precluded from claiming that the documents were properly presented.

Enjoining Banks from Purchasing Documents in Cases of Fraud

Earlier in this chapter you read the case of Maurice O’Meara, which illustrated the important principle that letters of credit are independent of the underlying sales contract. An issuing bank is responsible only for the seller’s documents and is not concerned with the quality of the goods or whether the seller shipped the correct goods. If they are defective or nonconforming, the buyer’s remedy is against the seller for breach of contract.

What if the buyer’s problem is not that the quality or condition of the goods is defective, but that he or she has fallen victim to a fraud or a scam? What good would a breach of contract suit be against the perpetrator of a fraud who had disappeared with the cash? To address these situations, a partial exception to the independence principle exists where documents presented by the seller (the beneficiary of the credit) are fraudulent, or forged, or if fraud in the transaction exists in the underlying sales contract. For instance, suppose that the buyer in a letter of credit transaction learns, almost too late, that the purported bill of lading is actually a fake, that no ship or carrier exists by that name, and that the goods the buyer was awaiting do not exist. Here the issuing bank would be justified in refusing to pay for fraudulent documents. Similarly, consider the case where an unscrupulous seller places worthless junk into a sealed ocean container and delivers it to an ocean carrier, obtains a bill of lading, and presents it to the issuing bank for payment under a letter of credit. Here too, the issuing bank would be justified in dishonoring the letter of credit because of fraud in the transaction. Of course, banks do not want to refuse documents without cause (especially where they have already been purchased by a nominated bank that is looking for reimbursement). After all, their international reputation is at stake, and no bank wants to be known for refusing to honor its letters of credit. One solution that will preserve the reputation of the bank is for the buyer to obtain a court injunction stopping the bank from honoring its letter of credit.

The UCP is silent on the question of when a court may enjoin a letter of credit for fraud. This is left to the law of individual jurisdictions. In the United States, the authority of a court to enjoin payment under a letter of credit is found in the case law and in Article 5 of the Uniform Commercial Code. According to UCC Section 5-109 (1995 revision), the standard for enjoining payment under a letter of credit is whether or not “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.” Courts may not enjoin payment if the documents are presented by a holder in due course or by a nominating bank that “has given value in good faith and without notice of the forgery or material fraud.” Although the line between what is fraud and what is not fraud is unclear, the fraud must be material and significant to the parties. Such would be the case where worthless rubbish is shipped in lieu of genuine goods. On the other hand, if the seller intentionally ships only 998 pounds of goose feathers but presents a draft and documents for 1,000 pounds, it is probably neither material nor significant. Some of the cases have said that the fraud must be “egregious,” or that the seller’s demand for payment has “no basis in fact,” or to allow him to collect payment would be “unjust.”

The following pre-UCC case, Sztejn v. J. Henry Schroder Banking Corp., presents a clear distinction between a mere breach of warranty and fraud. Recall that the last case, O’Meara, involved a breach of warranty—the seller shipped newsprint paper of inferior quality. Sztejn involves fraud in the transaction—the presentation of documents covering goods and the shipment of bales of worthless rubbish. The Sztejn case is one of the most widely cited cases in U.S. letter of credit law. Today, the UCC provisions largely follow the rule first set out by the Sztejn case.

Fraud in the transaction can take many forms. In Regent Corp., U.S.A. v. Azmat Bangladesh, Ltd., 686 N.Y.S.2d 24 (1999), a textile company located in Bangladesh represented to a U.S. buyer that bed-sheets and pillowcases were to be manufactured in Bangladesh. In fact, the seller knew that the goods were a product of Pakistan but provided a fake certificate of origin because they were trying to circumvent U.S. import quotas on Bangladeshi linens. The New York court ruled that there was sufficient fraud in the transaction to justify the bank’s refusal to honor the draft under the letter of credit.

Confirmed Letters of Credit

In most cases, a letter of credit is adequate assurance for payment. In certain instances, however, a seller may want an additional layer of security. Where a seller is uncertain about the soundness of an issuing bank in a foreign country, or of the integrity of the banking system there generally, or the stability of the government, the seller may want to request that the letter of credit be confirmed by a bank in its own country. A confirmed letter of credit is one in which a second bank, usually in the seller’s country, has agreed to purchase documents and honor drafts on the same terms as the original issuing bank. Suppose a seller is shipping to a country that has a shortage of foreign currency, large foreign debts, and a poor balance of payments record. It is always possible that foreign government currency restrictions, imposed between the time the contract is agreed to and the time the drafts are tendered for payment, could prevent the issuing bank from honoring its letter of credit in dollars. A letter of credit confirmed by a bank in the seller’s country will ensure prompt payment regardless of financial or political instability in the country where the issuing bank is located. Additionally, should legal action ever be necessary to collect on a letter of credit, a seller can much more easily sue a U.S. confirming bank in the United States than a foreign bank in foreign courts. Of course, a confirmed credit is far more expensive than one that is unconfirmed because two banks are exposed to the risk of the transaction. These costs must be weighed by the parties in determining the level of acceptable risk in the transaction.

Sztejn v. J. Henry Schroder Banking Corp.

31 N.Y.S.2d 631 (1941) Supreme Court, Special Term, New York County

BACKGROUND AND FACTS

The plaintiff contracted to purchase hog bristles from Transea Traders in India. The defendant bank issued an irrevocable letter of credit to Transea covering a shipment of hog bristles and payable upon presentation of the proper documents. Transea filled fifty cases with cow hair and other worthless rubbish in order to obtain an ocean bill of lading from the steamship company showing the shipment of fifty cases of hog bristles. The documents and draft were presented to the defendant bank by The Chartered Bank of India, acting as agent for Transea. The plaintiff brought this action against the issuing bank to restrain it from paying on the letter of credit.

SHIENTAG, JUSTICE

One of the chief purposes of the letter of credit is to furnish the seller with a ready means of obtaining prompt payment for his merchandise. It would be a most unfortunate interference with business transactions if a bank before honoring drafts drawn upon it was obliged or even allowed to go behind the documents, at the request of the buyer and enter into controversies between the buyer and the seller regarding the quality of the merchandise shipped…. Of course, the application of this doctrine presupposes that the documents accompanying the draft are genuine and conform in terms to the requirements of the letter of credit.

However, I believe that a different situation is presented in the instant action. This is not a controversy between the buyer and seller concerning a mere breach of warranty regarding the quality of the merchandise; 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 seller’s fraud has been called to the bank’s attention before the drafts and documents have been presented for payment, the principle of the independence of the bank’s obligation under the letter of credit should not be extended to protect the unscrupulous seller. It is true that even though the documents are forged or fraudulent, if the issuing bank has already paid the draft before receiving notice of the seller’s fraud, it will be protected if it exercised reasonable diligence before making such payment. However, in the instant action Schroder has received notice of Transea’s active fraud before it accepted or paid the draft….

Although our courts have used broad language to the effect that a letter of credit is independent of the primary contract between the buyer and seller, that language was used in cases concerning alleged breaches of warranty; no case has been brought to my attention on this point involving an intentional fraud on the part of the seller which was brought to the bank’s notice with the request that it withhold payment of the draft on this account. The distinction between a breach of warranty and active fraud on the part of the seller is supported by authority and reason. As one court has stated: “Obviously, when the issuer of a letter of credit knows that a document, although correct in form, is, in point of fact, false or illegal, he cannot be called upon to recognize such a document as complying with the terms of a letter of credit.” Old Colony Trust Co. v. Lawyers’ Title & Trust Co., 297 F. 152 at page 158 (2nd Cir.1924).

No hardship will be caused by permitting the bank to refuse payment where fraud is claimed, where the merchandise is not merely inferior in quality but consists of worthless rubbish, where the draft and the accompanying documents are in the hands of one who stands in the same position as the fraudulent seller, where the bank has been given notice of the fraud before being presented with the drafts and documents for payment, and where the bank itself does not wish to pay pending an adjudication of the rights and obligations of the other parties. While the primary factor in the issuance of the letter of credit is the credit standing of the buyer, the security afforded by the merchandise is also taken into account. In fact, the letter of credit requires a bill of lading made out to the order of the bank and not the buyer. Although the bank is not interested in the exact detailed performance of the sales contract, it is vitally interested in assuring itself that there are some goods represented by the documents. * * *Accordingly, the defendant’s motion to dismiss the supplemental complaint is denied.

Decision. The court held in favor of the plaintiff and enjoined the bank’s payment. A court can enjoin an issuing bank from honoring a draft if the bank learns that its customer will suffer irreparable harm as a result of fraud in the transaction.

Case Questions

1. What basic principle of letter of credit law does this decision challenge?

2. How would the result be different if the draft and documents had been sold and negotiated to a holder in due course who took with no knowledge of the fraud, and who then presented the documents to the issuing bank for payment?

3. Explain the misrepresentation that took place in this case. How was this “fraud in the transaction”? Can you think of other examples of how fraud could occur in a documentary letter of credit transaction between foreign parties?

4. What steps could a buyer and seller take to avoid falling victim to an international fraud? How could they learn more about each other, and what sources could they consult?

Banks in the United States that confirm foreign letters of credit continuously monitor the economic and political conditions in those foreign countries. If a foreign buyer is unable to have its bank’s letter of credit confirmed by a U.S. bank, then that may be a signal that the political and credit risks are too high. After all, if no U.S. bank will confirm a foreign letter of credit, why would the seller want to accept it? In this case, the seller might want to reconsider requesting some amount of cash in advance or other secure arrangement.

Standby Letters of Credit

A standby letter of credit (also called a standby credit, or simply a standby) is one in which the issuer is obligated to pay a beneficiary upon the presentation of documents indicating a default by the account party in the payment of a debt or the performance of an obligation. The documents might be as simple as a notice of default by the account party, signed by the beneficiary, and accompanied by a demand for payment. A standby letter of credit is a backup payment mechanism that the parties hope they will never have to use. It can be used to guarantee performance under a service or construction contract, to guarantee repayment of a loan, or as security for almost any other type of contract. The standby works much like the “performance guarantee” used by banks in other countries (or the “performance bond” in the UK) but is legally different. A standby is subject to the International Standby Practice (ISP 98), a set of rules and standards published by the International Chamber of Commerce.

A standby letter of credit is flexible and can be tailored for almost any use. Most are used in large, complex transactions. Assume that a construction firm enters into a contract with a foreign government to construct a public works project. The government wants assurances that the firm will complete the work as promised by being named as beneficiary of a standby credit. The credit could be payable upon the government’s presentation of a written demand for payment and a notice of default to the issuing bank stating that the construction firm has failed to complete the required work in the manner and within the time called for in the contract. Like the documentary requirements we have already studied, the language of default must strictly comply with the language used in the standby letter of credit. Documentary requirements will depend on the transaction and the needs of the parties, but could include independent testing reports, architect’s reports, court judgments, certified public accounting statements, or a signed statement by the beneficiary or an authorized corporate officer.

In the sale of goods, a standby can be used in lieu of a conventional letter of credit. Assume that a seller agrees to grant thirty-day open account terms to a buyer. In a standby credit, the bank is “standing by” as a backup, ready to purchase the documents if the buyer does not remit payment within thirty days. A standby can also be used to guarantee the seller’s performance, i.e., that the seller will ship conforming goods within the time called for.

Standby letters of credit can be used to ensure the repayment of a loan. Suppose, for example, that a subsidiary of a U.S. company operating in Latin America borrows money from a local bank. The bank can require a standby letter of credit from a U.S. bank that would allow it to draw against the credit should the subsidiary default on its obligation.

A standby can be used to ensure compliance with almost any obligation. In the Exxon Valdez oil spill that occurred in Alaska in 1989, the court required that Exxon provide a $6 billion standby letter of credit to ensure that they would meet its obligations of environmental cleanup and payment of damages.

Not surprisingly, standby letters of credit have led to a great deal of litigation in the courts. To protect an account party under a standby credit from an “unfair” demand by the beneficiary, many international business lawyers will structure the standby credit to require that the beneficiary’s request for payment be accompanied by a written, independent confirmation of the account party’s default by a third party.

Middle East Politics and Standby Letters of Credit: The Iranian Claims.

The politics of the Middle East have caused a great deal of litigation in this area. Prior to 1979, U.S. companies enjoyed lucrative business contracts with the Imperial Government of Iran, under the rule of the Shah of Iran. Many of these contracts involved the supplying of the latest armaments, consumer goods, and construction projects to this Islamic nation. These contracts had often been obtained using illegal payments to the Shah and his family. At the time of the revolution and the seizing of hostages at the U.S. embassy in Tehran, many U.S. firms had outstanding commitments to the government of Iran that were guaranteed with standby letters of credit. For example, in 1978, five banks alone had $12.6 billion in outstanding standby letters of credit. The following American Bell case clearly illustrates that the political risks of international business can even affect letter of credit transactions.

In KMW International v. Chase Manhattan Bank, 606 F.2d 10 (2d Cir. 1979), the court held that the unsettled situation in Iran was insufficient reason for releasing the bank from its obligation under a letter of credit. The court in KMW gave perhaps the real reason for the decision in the Iranian cases when it stated, “Both in the international business community and in Iran itself, Chase’s commercial honor is essentially at stake. Failure to perform on its irrevocable letter of credit would constitute a breach of trust and substantially injure its reputation and perhaps even American credibility in foreign communities. Moreover, it could subject Chase to litigation in connection with not only this matter, but also other banking affairs in Iran.”

American Bell International Inc. v. Islamic Republic of Iran

474 F. Supp. 420 (1979) United States District Court (S.D.N.Y.)

BACKGROUND AND FACTS

In 1978, American Bell International, a subsidiary of AT&T, entered into a contract with the Imperial Government of Iran to provide consulting services and telecommunications equipment. The contract provided that all disputes would be resolved according to the laws of Iran and in Iranian courts. The contract provided for payment to Bell of $280 million, including a down payment of $38 million. Iran had the right to demand return of the down payment at any time and for any reason, with the amount returned to be reduced by 20 percent of the amounts that Bell had invoiced for work done. At the time of this action, about $30 million remained callable. In order to secure the return of the down payment on demand, Bell had been required to arrange for Manufacturers Bank to issue a standby letter of credit to the Bank of Iranshahr, payable on the demand of the Iranian government. However, in 1979, a revolution resulted in the overthrow of the imperial government. The Shah of Iran fled the country, and a revolutionary council was established to govern the country. The nation was in a state of chaos, and Westerners fled the country. Having been left with unpaid invoices, Bell ceased its operations. Fearing that any monies paid to Iran would never be recouped, Bell brought this action asking the court to enjoin Manufacturers Bank from honoring Iran’s demands for payment under the letter of credit.

MACMAHON, JUDGE

Plaintiff has failed to show that irreparable injury may possibly ensue if a preliminary injunction is denied. Bell does not even claim, much less show, that it lacks an adequate remedy at law if Manufacturers makes a payment to Bank Iranshahr in violation of the Letter of Credit. It is too clear for argument that a suit for money damages could be based on any such violation, and surely Manufacturers would be able to pay any money judgment against it….

To be sure, Bell faces substantial hardships upon denial of its motion. Should Manufacturers pay the demand, Bell will immediately become liable to Manufacturers for $30.2 million, with no assurance of recouping those funds from Iran for the services performed. While counsel represented in graphic detail the other losses Bell faces at the hands of the current Iranian government, these would flow regardless of whether we ordered the relief sought. The hardship imposed from a denial of relief is limited to the admittedly substantial sum of $30.2 million.

But Manufacturers would face at least as great a loss, and perhaps a greater one, were we to grant relief. Upon Manufacturers’ failure to pay, Bank Iranshahr could initiate a suit on the Letter of Credit and attach $30.2 million of Manufacturers’ assets in Iran. In addition, it could seek to hold Manufacturers liable for consequential damages beyond that sum resulting from the failure to make timely payment. Finally, there is no guarantee that Bank Iranshahr or the government, in retaliation for Manufacturers’ recalcitrance, will not nationalize additional Manufacturers’ assets in Iran in amounts which counsel, at oral argument, represented to be far in excess of the amount in controversy here.

Apart from a greater monetary exposure flowing from an adverse decision, Manufacturers faces a loss of credibility in the international banking community that could result from its failure to make good on a letter of credit.

Bell, a sophisticated multinational enterprise well advised by competent counsel, entered into these arrangements with its corporate eyes open. It knowingly and voluntarily signed a contract allowing the Iranian government to recoup its down payment on demand, without regard to cause. It caused Manufacturers to enter into an arrangement whereby Manufacturers became obligated to pay Bank Iran shahr the unamortized down payment balance upon receipt of conforming documents, again without regard to cause.

Both of these arrangements redounded tangibly to the benefit of Bell. The contract with Iran, with its prospect of designing and installing from scratch a nationwide and international communications system, was certain to bring to Bell both monetary profit and prestige and goodwill in the global communications industry. The agreement to indemnify Manufacturers on its Letter of Credit provided the means by which these benefits could be achieved. One who reaps the rewards of commercial arrangements must also accept their burdens. One such burden in this case, voluntarily accepted by Bell, was the risk that demand might be made without cause on the funds constituting the down payment. To be sure, the sequence of events that led up to that demand may well have been unforeseeable when the contracts were signed. To this extent, both Bell and Manufacturers have been made the unwitting and innocent victims of tumultuous events beyond their control. But, as between two innocents, the party who undertakes by contract the risk of political uncertainty and governmental caprice must bear the consequences when the risk comes home to roost.

So ordered.

Decision. The court refused to issue the injunction. The letter of credit was not enjoined because there was no clear showing of irreparable injury and because the plaintiff had an adequate legal remedy against Iran for the return of the monies that would be paid. Such a rule protects the sanctity of a bank’s reputation for honoring its letters of credit. The plaintiff was aware of the risks involved and must bear the consequences.

Case Questions

1. What is a standby letter of credit, and how does it serve as a performance guarantee?

2. What was the political mood in the United States during the time of this litigation? In this light, do you find the result of the court surprising?

3. In negotiating the deal, why did American Bell agree to the contract terms Iran demanded?

Other Specialized Uses for Letters of Credit

Many specialized types of letters of credit provide a mechanism for financing a sale or other business transaction. Some of these types are discussed here.

Transferable Credits.

Transferable credits are usually used by international traders. Traders buy and sell goods in international trade quickly and with no view to actually using the goods themselves. They bear considerable risk every day. Traders operate on little capital, buying merchandise or commodities in one country, taking title through the documents, and then, through their business contacts built up over years of experience, selling at a profit. Some traders specialize in trade with the developing world, often trading commodities for raw materials or merchandise when dollars or hard currency is not available. For instance, assume a Swiss bank issues a letter of credit for the account of an African country in favor of the trader, with a part of the credit transferred to the trader’s supplier in the Philippines for the cost of the goods it is supplying to the African country. This letter of credit can be split up among many suppliers around the world, each presenting documents for payment, with the trader taking its profit out of the balance of the credit. Shipments of crude oil are often bought and sold in this fashion.

Red Clauses in Credits.

The red clause is a financing tool for smaller sellers who need capital to produce the products to be shipped under a letter of credit. A red clause in a letter of credit is a promise (usually written or underlined in red ink) by the issuing bank to reimburse the seller’s bank for loans made to the seller. The loan, then, is really an advance on the credit. Loans can be used only for purchasing raw materials or for covering the costs of manufacturing or shipping of the goods described in the credit. Ultimately, the liability will fall on the buyer if the seller defaults on shipment or repayment of the amounts taken under the credit. This form of financing is very risky for the buyer and its bank.

Revolving and Evergreen Credits.

When a buyer is planning on purchasing on a regular basis from a foreign seller, a revolving letter of credit may be used. Instead of having to use several different credits, one may be used with a maximum amount available during a certain period. As the draws against the credit are paid, the full amount becomes available again and continues until the expiration of the credit. An evergreen clause provides for automatic renewal of the letter of credit until the bank gives “clear and unequivocal” notice of its intent not to renew.

Back-to-Back Letter of Credit Financing.

A back-to-back letter of credit is a special type of financing device. In certain circumstances, an exporter is selling goods to a buyer in one transaction and is buying supplies in another. Under a back-to-back credit, the exporter can use its credit with the buyer to finance the purchase of goods from the supplier. Thus, a back-to-back credit is really two credits, one representing the security for the second. The bank that issues the second credit requires that it be assigned the proceeds of the original credit. Many banks will issue the second credit only if they had opened the first one (known as a countercredit). Back-to-back letters of credit are usually used by traders who are not manufacturers or by other intermediaries with minimal capital resources who buy and sell goods for delivery to others.

Electronic Data Interchange and the eUCP

Like funds transfers, letters of credit have been issued and transmitted to advising banks electronically for many years (and from advising bank to beneficiary usually by mail). Now it appears that the use of electronic documentation will soon increase and that beneficiaries in the near future will be presenting documents electronically to banks for payment.

In 2002, the International Chamber of Commerce published the eUCP, a set of rules that extends the UCP to electronic documents. When documents are submitted electronically, eUCP rules apply by agreement of the parties. The eUCP addresses the format for electronic documents (the rules are flexible and include signed e-mail attachments or secured transfer), authentication and digital signatures, transmission errors, the manner of presentation, and other issues.

Bolero is a technical infrastructure created by the world’s banking and logistics firms for exchanging electronic documents in a common format, including bills of lading, letters of credit, and other bank documents. Identrus is a private company founded by a small consortium of the world’s largest banks to provide secure “digital identities” or signatures for confidentiality and authentication of financial and legal documents. Both Identrus and Bolero represent technological innovations necessary to move the centuries-old banking and shipping industries to the paperless age.

Letters of Credit in Trade Finance Programs

Letter of credit financing plays an important role in export financing by government and intergovernmental agencies. U.S. exports are financed by such agencies as the Agency for International Development (AID), the World Bank (which provides financial and technical assistance to developing countries to stimulate economic growth), the Commodity Credit Corporation (which assists with commerce in surplus agricultural products), and the Export-Import Bank of the United States (Eximbank). These agencies often insure payments made to U.S. sellers under letters of credit that are confirmed by U.S. banks using a letter of commitment from the agency to the issuing bank.

AID Financing.

A typical AID financing situation might include a letter of credit. A country wishing to import U.S. products, usually to be used in developmental projects such as building roads, power-generating facilities, and the like, applies to AID for financing. AID then issues its commitment to a U.S. bank that issues its letter of credit for the benefit of the U.S. supplier of eligible goods used in the project. The issuing bank receives reimbursement for payments under its letter of credit from AID.

Eximbank Financing.

Eximbank is the largest U.S. export financing agency. It can provide guarantees on loans made by commercial banks and insurance on credit extended by U.S. exporters to their foreign customers. It also makes loans directly from Eximbank funds, including fixed-rate loans to creditworthy foreign buyers of American-made exports. Under another Eximbank loan program, a U.S. bank designated by the foreign buyer opens a letter of credit on behalf of the buyer for the benefit of a U.S. supplier. Eximbank guarantees the issuing bank repayment of sums that it pays out under the credit. Eximbank then receives its payments under the loan agreement worked out in advance between it and the foreign buyer. Eximbank programs cover both the risk of nonpayment and political risk (such as the outbreak of war or government controls that prohibit currency exchange). Despite the importance of the U.S. Eximbank, only a small percentage of U.S. exports are financed by Eximbank. The U.S. air transportation industry received the largest amount of Eximbank support of any industry. Others included oil and gas, power plants, and manufacturing. In 2009, Eximbank authorized almost 2,900 export sales for over $21 billion in export loans, guarantees, and export-credit insurance. In the past, Eximbank had been subject to criticism for not having assisted small business U.S. exporters. In 2009, however, 88 percent of total transactions, representing 21 percent of Eximbank total financial support went to aid small business. Eximbank has increased its lending guarantees for U.S. goods going to developing countries. Other countries have export–import banks of their own to assist in financing their exports.

Commodity Credit Corporation.

The U.S. Department of Agriculture’s Commodity Credit Corporation provides payment assurances to U.S. sellers of surplus agricultural products to approved foreign buyers. Standby letters of credit are often used, whereby the seller can draw under the credit for invoices that remain unpaid by the overseas buyer.

CONCLUSION

The letter of credit is a very flexible banking arrangement that can be structured according to the needs of the parties. It is a security device and a tool for financing. It provides enough security for companies to do business safely over great distances. One indirect result of using the letter of credit is that it gives the parties an opportunity to experiment with doing business with each other. It allows them to build trust, which is essential to generating repeat business. If the buyer and seller are both pleased with each other’s performance, they may eventually be able to omit the letter of credit from future transactions. The seller may be satisfied by selling on documentary terms alone, and then eventually on open account terms. Each step becomes easier and less expensive for the buyer, and that in turn may translate into additional business for the seller.

Chapter Summary

1. The bill of exchange or international draft is a specialized type of negotiable instrument commonly used to expedite foreign money payments in many types of international transactions.

2. The commercial and financing use of a draft or other negotiable instrument is derived from its negotiability, which is the quality that allows it to act as a substitute for money. When a draft is negotiated to a holder in due course, that party takes it free from most disputes that might arise between the drawer and drawee (the original parties to the underlying transaction). This protection for the holder in due course allows banks and other parties to purchase or accept drafts without fear of becoming embroiled in litigation over the original contract for which the draft was drawn.

3. A draft that may be paid upon presentation or demand is known as a sight draft because it is payable “on sight.” The sight draft is prepared by the seller and presented with the shipping documents through banking channels, moving from the seller’s bank in the country of export to a foreign correspondent bank in the buyer’s country and city. The draft is thereby sent “for collection,” a process known as a documentary collection.

4. Banks and other financial institutions involved in commercial lending provide a wide range of financing packages for international trade, commonly called trade finance. A draft due at a future date or after a specified period of time is known as a time draft. The buyer’s acceptance indicates the buyer’s unconditional obligation to pay the draft on the date due.

5. A banker’s acceptance is a negotiable instrument and short-term financing device widely used to finance international (as well as domestic) sales.

6. The documentary letter of credit is defined as the definite undertaking of a bank, issued in accordance with the instructions of their customer, addressed to, or in favor of, the beneficiary, wherein the bank promises to pay a certain sum of money (or to accept or negotiate the beneficiary’s drafts up to that sum), in the stated currency, within the prescribed time limits, upon the complying presentation of the required and conforming documents.

7. The Uniform Custom and Practice for Documentary Credits (UCP No. 600, 2007) is a set of standardized rules for issuing and handling letters of credit, drafted and published by the International Chamber of Commerce.

8. The letter of credit is a separate transaction and independent from the underlying sales contract on which it was based. Bankers deal in documents and not in goods, so they are not concerned with the quality or condition of goods represented in the credit.

9. The buyer’s application for a credit forms a contract between the buyer and the issuing bank.

10. Credits are transmitted to the beneficiary through an advising bank (or through a confirming bank, in the case of a confirmed letter of credit).

11. The seller must make a complying presentation to the nominated bank within the time limits of the credit and according to the terms of the credit, the provisions of the UCP, and standard banking practices.

12. Documents containing discrepancies will be rejected and held for the buyer’s instructions or returned to the seller. A discrepancy exists if the seller’s documents, on their face, do not conform to the terms of the letter of credit. The description of the goods in the commercial invoice must correspond exactly to that in the credit. Documents are usually interpreted according to the strict compliance rule.

13. Courts have the power in certain cases to enjoin banks from honoring documents that are fraudulent or where there was fraud in the transaction.

14. Confirmed letters of credit contain the additional obligation of a second bank, usually in the seller’s country, to honor a complying presentation. They are the next best alternative to receiving cash in advance for an international sale.

15. A standby letter of credit is one in which the issuer is obligated to pay a beneficiary upon the presentation of documents indicating a default by the account party in the payment of a debt or the performance of an obligation.

Key Terms

negotiable instrument 216

draft 216

documentary draft 216

bill of exchange 216

acceptance 218

banker’s acceptance 218

holder in due course 220

drawer 217

drawee 217

payee 217

negotiation 217

indorsement 217

sight draft 217

time draft 218

trade finance 218

Eximbank 240

letter of credit 241

issuer or issuing bank 222

account party 222

beneficiary 222

complying presentation 228

nominated bank 228

rule of strict compliance 230

fraud in the transaction 234

confirmed letter of credit 236

standby letter of credit 236

transferable credits 239

red clause 239

revolving letter of credit 239

evergreen credit 239

back-to-back letter of credit 239

Questions and Case Problems

1. Wade entered into a contract to sell irrigation equipment to Ribadalgo, its Ecuadorian distributor. Ribadalgo obtained an irrevocable letter of credit in the amount of $400,000 from Banco General Runi-nahui, S.A. (Banco), a bank in Quito, Ecuador. The letter of credit provided that Wade was to ship by July 30, 1992. Wade was to present documents for payment “no later than 15 days after shipment, but within the validity of the credit.” The expiry date of the letter of credit was August 21, 1992. Partial shipments were acceptable. The letter of credit stated that it was governed by the UCP. Citibank confirmed the letter of credit. Wade shipped a portion of the goods on July 7. On July 21, just before the document presentment deadline, Wade presented the requisite documents to Citibank for payment. Two days later, on July 23, Citibank informed Wade that the documents contained discrepancies and that it therefore would not honor Wade’s request for payment. In response, Wade forwarded amended documents to Citibank on July 24 and July 27. Although Citibank conceded the documents as amended contained no discrepancies, it nevertheless rejected them as untimely because they were not received within fifteen days of the July 7 shipment date as required by the credit. On July 17, the Ecuadorian government issued an order freezing all Ribadalgo’s assets and precluding payment on any lines of credit made available to Ribadalgo due to alleged drug trafficking. Four days later, Ecuadorian banking authorities entered an order barring Banco from making payment under the letter of credit. In turn, Banco advised Citibank not to honor any request for payment made by Wade thereunder. Is Wade entitled to payment under the letter of credit from Citibank? Wade argues that the documents did not have to be conforming before the presentment deadline, but only before the expiry date of the credit. Is Wade correct? Why do you think Citibank rejected the documents on July 21? Banco General Runi-nahui, S.A. v. Citibank, 97 F.3d 480 (11th Cir. 1996).

2. The rule of strict compliance in New York is best illustrated by Beyene v. Irving Trust Co., 762 F.2d 4 (2d Cir. 1985). The letter of credit specified that payment be made on presentation of a bill of lading naming “Mohammed Sofan” as the party to be notified when the goods arrive. However, the bill of lading submitted to the bank with the demand for payment misspelled the name as “Mohammed Soran.” The confirming bank refused payment because of this discrepancy, and the beneficiary sued. Was this a “material” discrepancy, or was it “so insignificant as not to relieve the issuing and confirming bank of its obligation to pay”? The court compared and contrasted the misspelling of “Sofan” as “Soran” to the misspelling of “Smith” as “Smithh.” The court stated that the misspelling of “Smith” is not a discrepancy because the meaning is “unmistakably clear despite what is obviously a typographical error.” How did the court decide? Is there a difference between the misspellings of “Smith” and “Sofan”?

3. Hambro Bank, Ltd., an English bank, received a cable from a Danish company, A.O., requesting that an irrevocable letter of credit be opened in favor of J. H. Rayner and Company. A.O. instructed Hambro Bank that the letter of credit be for “…about \P16,975 [pounds] against invoice full straight clean bills of lading…covering about 1,400 tons Coromandel groundnuts.” The bill of lading presented to Hambro by J. H. Rayner stated “… bags machine-shelled groundnut kernels,” with the abbreviation “C.R.S.” in the margin. Hambro refused to pay on the letter of credit. J. H. Rayner sued Hambro. The custom of trade holds that C.R.S. is short for Coromandel groundnuts. Why did the bank not want to pay on this letter of credit? Was the bank correct in denying payment on this letter of credit? J. H. Rayner and Co., Ltd. v. Hambro’s Bank, Ltd. [1943] 1 K.B. 36.

4. The buyer, a Peruvian company, entered into a contract to purchase glass fibers from an English seller. Payment was to be made under an irrevocable letter of credit confirmed by Royal Bank of Canada. The letter of credit called for a bill of lading dated no later than December 15, 1976. The goods were in fact loaded onto the vessel on December 16, but the loading brokers wrongfully issued a bill of lading dated December 15, 1976. Unaware of the false statement, the sellers submitted documents to Royal Bank, who refused to pay because it suspected fraud in the documents. How does this situation differ from that in the Sztejn v. J. Henry Schroder Banking Corporation case? Does this case involve “fraud in the transaction”? Why or why not? Should the bank be permitted to refuse payment on the documents for apparently conforming documents where it has reason to believe a third party, here the loading broker, committed an act of fraud? See, United City Merchants (Investments), Ltd. v. Royal Bank of Canada, [1982] 2 W.L.R.1039 (HL).

5. The seller of goods has a right to proceed judicially against an issuing bank that dishonors its obligation under an irrevocable letter of credit, just as the seller has the right to proceed directly against the buyer. Should the issuing bank also be liable for consequential damages that are reasonably foreseeable? See Hadley v. Baxendale [1854] 9 Ex. 341.

6. A South African firm applied for a revolving letter of credit in favor of a German exporter at a branch of Barclays Bank in Johannesburg. The letter of credit was issued covering shipments of pharmaceuticals and was confirmed by Deutsche Bank in Germany. Shipments proceeded with no problem, growing larger and more frequent. Barclays increased the amount of the letter of credit on several occasions to accommodate the growing business. To Barclays’ knowledge, their account party had always taken possession of the goods and sold them quickly for a profit. Barclays was pleased with their customer’s history and increased their financing. In the last shipment, the largest of all, Deutsche Bank honored the seller’s sight draft for the full amount of the letter of credit and presented the documents to Barclays. While Barclays was inspecting the documents, it learned that the South African buyer had ceased business. In the meantime, Deutsche Bank discovered that the seller has ceased business also. On inspection by Barclays, the cargo containers were found to contain only worthless junk. Investigative reports placed both buyer and seller in Brazil. What happened? What are the rights and liabilities of the advising and confirming bank? How do banks handle problems like this?

Managerial Implications

1. Your firm regularly sells to customers in Germany, Poland, Japan, Canada, and Venezuela. How would you evaluate the creditworthiness of firms in each of these countries? How would the credit risk differ in each of these countries? What sources of information would you use? Under what circumstances would you consider selling to firms in these countries without a letter of credit? In which of these countries would you want the buyer’s letter of credit to be confirmed by an American bank? Why? What additional protection does the confirmed credit provide?

2. An advising bank presents documents to you for payment. How would you respond to each of the following discrepancies? Explain your answer.

a. The letter of credit calls for an ocean bill of lading. The seller presents a trucker’s bill of lading showing shipment to an ocean port.

b. The sales contract and the letter of credit call for shipment of “Soda Ash Light.” The invoice shows shipment of “Soda Ash Light,” but the bill of lading describes the shipment as “Soda Ash.”

c. The letter of credit calls for shipment of 1,000 kilograms. The invoice shows shipment of an equal amount in pounds.

d. The CIF contract with the letter of credit calls for onboard bill of lading to be dated by December 20. The bill of lading is dated December 20, but the insurance policy is dated December 21.

Ethical Considerations

1. Corby, an experienced tire broker in Wales, offered to sell tires to Chappell, a tire broker in California. Chappell contacted two U.S. tire distributors, Jenkins in Tennessee and Hein in Ohio, and agreed to act as their agent in negotiations with Corby. Corby claimed that he had a large client who had negotiated an arrangement directly with Michelin to handle all of its overstock blemished tires from France and who could offer 50,000 to 70,000 Michelin tires per quarter at 40 to 60 percent below the U.S. market price on an exclusive and ongoing basis. Corby faxed a list of tires, showing that the tires bore the designation “DA/2C.” Chappell faxed the list to Jenkins and Hein. They knew that the “DA” meant “defective appearance.” When Chappell asked Corby about the “/2C” he was told that it meant the tires were located at a different warehouse. Chappell told Corby on several occasions that since it was October 1998, the season for selling winter tires was almost over and that he required summer tires as well, to bundle with the winter tires. A second list showed no summer tires and nowhere near the 50,000 tires promised. In November and December, Corby pressured Chappell and Jenkins to open the letter of credit, asserting that if they did not do so the deal would be ended, thus preventing the buyers from being able to procure the requested summer tires. In late December, Jenkins began having reservations regarding the deal because Corby’s representations were becoming suspicious. Jenkins requested to speak to Corby’s source. Corby put him in touch with Evans, a tire distributor in England. In January, Evans sent the following fax to Jenkins:

There are large stocks of Michelin summer pattern tyres being made available within the next 7/10 days and we will be pleased to offer these to you when an acceptable Letter of Credit is received for the winter pattern tyres. We will be very happy to work with you on Michelin tyres on a long term basis and give you first option on offers. May we once again stress the urgency of letting us have the Letter of Credit for the Michelin winter tyres so that we can commence business on a long term basis.

Evans faxed a pro forma invoice requesting a letter of credit in favor of PTZ Trading Company in Guernsey as the beneficiary. Evans said that the letter of credit had to be sent immediately. The buyers felt that they had to comply as a show of good faith. An irrevocable credit was issued by an Ohio bank according to the terms of the pro forma invoice and stated:

Covering shipment of: “14,851 Michelin tyres at usd 34.83 per tire in accordance with seller’s pro forma invoice 927-98 dated 11-19-98. Shipping terms: EXWORKS any European location. The credit is subject to UCP Publication 500. Expiry date April 2, 1999. The credit was advised to the sellers through Barclays Bank.

Shortly later, the negotiations broke down over the issue of summer tires, and the parties became hostile. In February, Corby sent a list of summer tires that had fewer units than promised, contained sizes not used in the United States, included various tires not manufactured by Michelin, and specified prices that were often higher than the cost of purchasing the tires one at a time from most dealers in the United States. In March, the buyers discovered that the “DA/2C” designation, attached to many of the tires, actually meant that the U.S. Department of Transportation serial numbers had been buffed off those units, rendering them illegal for import to or sale in the United States. Just before the letter of credit expired, Jenkins was informed by Sievers, a German tire distributor who was shipping the tires for PTZ Trading Co., that the tires were about to ship. Jenkins protested that he had not given permission to ship the tires because there was no agreement on summer tires. He threatened legal action. Sievers responded that he did not need permission and proceeded to ship. Sievers obtained a bill of lading and presented all documents to Barclays Bank for payment. The documents strictly complied with the credit. Jenkins petitioned an Ohio court for a restraining order preventing the issuing bank from honoring the credit. Barclays Bank learned of the order and refused Sievers’ presentment. The carrier billed Jenkins for the ocean freight, and the tires remained in a warehouse in Savannah, Georgia. After a hearing in July, the court denied the buyer’s petition for the restraining order. The Ohio Court of Appeals reversed, and the buyer appealed to the Ohio Supreme Court. See Mid-America Tire, Inc. v. PTZ Trading Ltd., 768 N.E.2d 619 (2002).

a. What are the buyer’s legal arguments supporting their petition for a restraining order? How do the facts support that argument? What precedent can they cite?

b. What are the seller’s arguments opposing the petition for a restraining order?

c. What do you think about the way the buyer handled this from the beginning? What does this say about their level of expertise in international business? Explain.

d. If you had been in the buyer’s position, what would you have done differently?

e. If the documents had not strictly complied with the credit, would this case have turned out differently?

f. This court’s decision only addressed the petition for a restraining order. How will the parties finally resolve the dispute on the underlying sales contract? What do you think will happen to the tires? Who is responsible for their warehousing fees?

2. Your firm has contracted to purchase silk from overseas suppliers on letter of credit terms. After contracting but before presentment of the seller’s documents, China expands its production and floods the market with raw silk. The price of silk plummets on world markets. Comment on whether you should try to find a minor discrepancy in the documents to justify rejecting the documents. Is it ethical for a buyer to reject documents presented under a letter of credit that contains only a minor discrepancy between the documents and the credit? Do the reasons matter? Does it matter that the buyer may know that the shipment actually conforms to the requirements of the contract and of the letter of credit? What is meant by the following statement: “Buyers and their banks have on occasion been known to ‘invent’ discrepancies; to make a ‘mountain out of a molehill.’”

(Schaffer 216)

Schaffer, Agusti, Dhooge, Earle. International Business Law and Its Environment, 8th Edition. South-Western, 2011-01-01. .

Turn in your highest-quality paper
Get a qualified writer to help you with

“ Multinational Versus Multidomestic Issues ”

Get high-quality paper

Guarantee! All work is written by expert writers!

Still stressed from student homework?

Get quality assistance from academic writers!

Order now