How Courts View the Cases Relating To Letter of Credit

The courts in most countries do not like litigation around LCs -especially the hair splitting over the provisions of UCP. The principles followed by the US courts are given in the Article 5 of the Uniform Commercial Code (UCC) governs L/Cs.

Article 5 is founded on two principles: (1) the LC's are independent from the underlying business transaction, and (2) strict compliance with documentary requirements. Any other deviation is strictly frowned upon. This is the standard followed by most countries across the world.

1) Strict Compliance

How strict compliance? Some courts insist upon literal compliance, so that a misspelled name or typographical error voids the exporter's/beneficiary's/seller's demand for payment. Other courts require payment upon substantial compliance with documentary requirements. The bank may insist upon strict compliance with the requirements of the L/C. In the absence of conformity with the L/C, the Seller cannot force payment and the bank pays at its own risk. Sellers should be careful and remember that the bank may insist upon strict compliance with all documentary requirements in the LC. If the documents do not conform, the bank should give the seller prompt, detailed notice, specifying all discrepancies and shortfalls.

2) The Independence Doctrine

Letters of credit deal in documents, not goods. L/Cs are purely documentary transactions, separate and independent from the underlying contract between the Buyer and the Seller. The bank honoring the L/C is concerned only to see that the documents conform with the requirements in the L/C. If the documents conform, the bank will pay, and obtain reimbursement from the Buyer/Applicant. The bank need not look past the documents to examine the underlying sale of merchandise or the product itself.

The letter of credit is independent from the underlying transaction and, except in rare cases of fraud or forgery, the issuing bank must honor conforming documents. Thus, Sellers are given protections that the issuing bank must honor its demand for payment (which complies with the terms of the L/C) regardless of whether the goods conform with the underlying sale contract.