Guide to New Rules on International Letters of Credit

©1994 New Jersey Law Journal

Most international letters of credit (referred to here as LC's or credits) are governed by rules developed under the auspices of the International Chamber of Commerce, or ICC. These rules are known as the Uniform Customs and Practices for Documentary Credits (UCP). A newly revised edition of the UCP known as ICC Publication No. 500, 1993 Revision, or more commonly, UCP 500, is effective as of January 1, 1994. It replaced ICC Publication No. 400, 1983 Revision (UCP 400).

UCP 500 is the "law" governing an international LC when the credit itself so provides. Most banks include as part of a standard form international LC a provision that the Credit is governed by the UCP. (As of January 1994, these printed forms should have been updated to provide that the LC is subject to UCP 500 rather than UCP 400. Users should read the fine print to ensure the change has been made. If the form says UCP "current revision", it refers to the version of the UCP in effect on the date the LC was issued.)

Courts will apply the UCP as the law of the LC, since it has been chosen by the parties, and since it is a codification of international customs and practices. It must be noted, however, that if litigation is brought in a country where there is a conflict between the UCP and national law, some foreign courts may apply that country's national law. United States courts will apply the UCP.

It is important for New Jersey lawyers and their clients to be familiar with the UCP 500. The UCP is a curious form of "law". It was not created by an elected body of representatives accountable to constituents. It essentially was written by bankers, and it tends to serve the interests of the banking community. The working group which drafted the UCP 500 included an American law professor who represented the U.S. Council on International Banking, an Italian law professor who represented the Italian Banking Association, three bank officers from banks in London, Frankfurt and Oslo, the president of the United State Council on International Banking, a lawyer representing a German Bank, the Honorary Chairman and the Chairman of the ICC Commission on Banking Technique and Practice, and one member of the ICC staff. Absent from this group were representatives of companies who regularly do business by means of letters of credit.

Since the "law" governing LC's is primarily protective of banking interests, it behooves users of LC's, and their attorneys, to have a good working knowledge of the UCP. It is possible, for example, to override certain provisions of the UCP simply by stating in the text of the LC itself that different provisions are applicable. Since few parties ever stipulate to other provisions, however, it is most important to have a good understanding of the basic rules. A lack of understanding will work to the detriment of the non-bank parties.

The UCP 500 working group had an announced goal of simplifying the rules, articulating banking practices and facilitating development of those practices, clarifying the primary responsibilities of the issuing bank and the confirming bank, addressing non-documentary conditions, and listing the elements of acceptability for each type of transport document presented under a documentary credit.

An analysis of the changes in the rules shows that the Working Group went a long way toward accomplishing these goals. While a complete analysis of the changes incorporated in UCP 500 is beyond the scope of this article, some of the major changes will be examined, as well as some of the salient provisions, changed and unchanged, which users of international LC's need to know.

Article 3 - The Independence Principle

Article 6 - Revocable v. Irrevocable Credit

Article 9(d) - Amendments

If a beneficiary receives notification of an amendment, he should communicate his acceptance or refusal of the amendment to the bank which sent the notification. If he refuses the amendment, the credit, as originally issued, remains intact. If the beneficiary does not communicate acceptance or refusal, then tenders to the nominated bank (that is, the bank identified in the LC as the bank which will review the documents presented and certify as to their conformity) or issuing bank documents that conform to the credit and to the amendment, that tender will be deemed to be notification of acceptance [Article 9(d) iii].

There can be no "partial acceptance" of an amendment, even if all parties, including the banks, agree [Article 9(d) iv]. This is to ensure that if an amendment is only partially accepted, a new amendment shall be issued, which will provide in writing for only the agreed-upon portion. A "partially accepted" amendment is thus totally ineffective under UCP 500.

Article 13 - Standard for Examination of Documents

(a) The Standard.

An LC lists and describes documents which must be presented in order for the beneficiary to be entitled to payment. The beneficiary must produce documents which comply with those described in the LC. There has been extensive litigation over whether or not documents complied, and how strict the compliance must be.

If a bank determines that there are "discrepancies" in the documents, that is, that the documents presented to the bank do not match the documents described in the LC, it will not honor the LC unless the applicant (buyer) agrees to waive the discrepancies, or unless the beneficiary (seller) can correct the discrepancies. Courts have held that misspelling the name of the party to be notified was a discrepancy which justified a bank's refusal to pay under an LC. Beyene v. Irving Trust Co., 596 F. Supp. 438 (S.D.N.Y.), affirmed, 762 F.2d 4 (2nd Cir. 1985).

Section (a) of Article 13 attempts to establish a "standard" for the bank's examination of documents, stating: "Compliance of the stipulated documents on their face with the terms and conditions of the Credit, shall be determined by international standard banking practice as reflected in these Articles."

In other words, in making the decision whether or not there are any discrepancies in documents presented for payment, banks should rely on the standard practice of international banks, as reflected in the UCP. But what standard banking practices are reflected in the UCP? One example is noted in a book published by the ICC, UCP 400 and 500 Compared, at 39-40. It states that UCP 500 sub-Article 37(c) distinguishes between the description of goods in the invoice and that in other documents, and requires the description in the invoice to correspond with the description in the credit. It concludes that in all other documents, the goods may be described in general terms not inconsistent with the description of the goods in the credit. This is useful guidance for courts which have insisted on a "mirror image" version of strict compliance. It remains to be seen, however, what other examples of "international standard banking practice" are reflected in the UCP. It would be useful if the ICC would specifically designate other examples of such standard practice it believes are reflected in the UCP. Otherwise, there is a real risk that "international standard banking practice" will turn out to be whatever a particular international bank claims it is in a given case.

(b) The Duty to Examine within a Reasonable Time.

Article 16(c) of UCP 400 provided that the issuing bank would have a "reasonable time" to examine documents and determine whether to accept or refuse them. Unlike the UCC, which provides that a "reasonable time" is three banking days (UCC 5-112), the UCP 400's "reasonable time" was diversely construed by the courts. The UCP 500 provides more definitive guidelines. Section (b) of Article 13 provides that the Issuing Bank, the Confirming Bank, if any, or a Nominated Bank, each have a reasonable time, not to exceed seven banking days following the day of receipt of the documents, to examine the documents and determine whether to take up or refuse the documents, and to so inform the party who presented the documents.

The commentary from the ICC (UCP 500 and 400 Compared) notes that under this provision, a "reasonable time" may mean less than seven days, but in no event can it be more than seven days. This time limitation should somewhat strengthen the hand of a beneficiary under the UCP. If the time period is exceeded by a bank, that is, if the bank does not give notice within the seven day period that the documents are defective, then the bank will be required to honor the LC.

(c) Conditions without Documents.

On occasion, an LC will include a condition which does not require a document to be presented. If for example, the LC required that goods had to be inspected before being loaded on the ship, but no document was required showing such inspection had taken place, what should the bank do?

According to UCP 500 Article 13(c), the bank should deem such conditions as not stated, and disregard them. Parties should understand that any condition in the LC can only be imposed by way of documents which must be presented to the bank. Thus, an inspection certificate, signed by an authorized party, can be a way of imposing a condition, if the certificate is one of the documents required to be presented to the bank.

Article 41 - Installment Shipments/Drawings

This result can be prevented only if the beneficiary is familiar with Article 41 of UCP 500, and incorporates in the text of the LC a provision specifically stipulating that the Credit will be available for subsequent installments despite any failure of earlier shipment or drawings.

An understanding of the effect of Article 41 is even more critical with respect to a stand-by LC. Unlike commercial LC's, which are intended to be drawn down as a matter of course, a stand-by LC, which functions somewhat like a performance bond, is generally drawn down only in the event that the transaction does not proceed as expected.

Thus, in an installment situation, the expectation is that the parties will perform without drawing down the LC. Nonetheless, absent a specific stipulation in the text of the Credit, a stand-by LC that is not drawn upon during the first installment period cannot be drawn upon during any subsequent installment period. Article 41 as written thus totally thwarts the proper function of a stand-by LC in an installment situation.

The ICC working group did not attempt to exclude stand-by LC's from the application of Article 41. It did recommend that parties to a stand-by LC "be aware of the implications" of Article 41. Any party to a stand-by LC which is supposed to remain valid through several installments should, therefore, stipulate in the credit that Article 41 of UCP 500 is not applicable to the credit, and/or that the credit will be available for any and all installment periods.

Article 43 - The Twenty-One Day Rule

For example, a typical LC could state that goods must be shipped no later than June 1st, documents must be presented no later than June 15th, and the expiry date for the LC is June 30. If, however, the LC only states only that (1) goods must be shipped by June 1st, and (2) the expiry date is June 30, and does not provide a date by which documents must be presented, can the beneficiary wait until June 30 to present documents? Not if he wants to be paid under the LC. The unsuspecting beneficiary who waits until June 30 is one who is not familiar with Article 43 of UCP 500, which provides that if no time period after shipment is given in the credit, then banks will not accept documents presented to them later than twenty-one days after shipment. It should be apparent that this is a trap for the unwary. New Jersey lawyers, should alert their clients to the twenty-one day rule of Article 43.

Transport and Other Documents.

This separation and clarification should greatly facilitate the proper use of these documents in connection with an LC. The addition of headings for each Article of the UCP 500 also aids in making this version of the UCP more accessible to the user.

UCP 500 is a step forward in many ways. It still, however, contains a number of traps for the unwary. New Jersey practitioners, in counseling clients with LC transactions, must be knowledgeable about this arcane but important area of the law.