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Standby letters of credit and fraud Sigrist, Pierre 1990

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STANDBY LETTERS OF CREDIT AND FRAUD By PIERRE SIGRIST L i c e n c i e en d r o i t , U n i v e r s i t y de N e u c h S t e l , 1987 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS i n THE FACULTY OF GRADUATE STUDIES (FACULTY OF LAW) We a c c e p t t h i s t h e s i s as conforming t o t h e r e q u i r e d s t a n d a r d THE UNIVERSITY OF BRITISH COLUMBIA August 1990 © P i e r r e S i g r i s t , 1990 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of L-a-\AS The University of British Columbia Vancouver, Canada Date / U ^ s i " $) 1 1 3 Q DE-6 (2/88) ii ABSTRACT During the last ten years, there has been a remarkable increase in the number of cases involving incidents of fraud in standby letters of credit. The purpose of this thesis is to examine the effect of fraud on standby letters of credit transactions. This study principally deals with standby letters of credit issued under the 1983 Revision of the Uniform Customs and Practice for Documentary Credits, drafted by the International Chamber of Commerce, which is a set of internationally recognized rules for documentary credit operations. Due to the international character of letters of credit law, I have adopted a comparative approach that deals with materials from the U.S., Canada, U.K., Germany and Switzerland. This thesis will first show that there are two types of standby letters of credit, which have to be distinguished because they involve different obligations and risks for the parties. A device payable against the beneficiary's simple statement will be described as a "simple statement" standby credit, whereas a device payable against a set of documents will be called a "documentary" standby credit. The thesis will then demonstrate why the treatment of fraud should not be the same for "simple statement" standby credits and "documentary" standby credits. iii T A P L E OF CONTENTS Abstract ii Table of Contents iii PARTI LEGAL NATURE AND PURPOSE OF STANDBY LETTERS OF CREDIT 1 Chapter 1 Introductory 2 Chapter 2 Standby Letters of Credit 7 Chapter 3 The "Simple Statement" Standby Credit 1 0 Chapter 4 The "Documentary" Standby Credit 16 Chapter 5 Distinguishing Standby Credits from Letters of Credit and Performance Bonds 2 0 Chapter 6 Sources of Law 2 6 PART II CONTRACTUAL RELATIONSHIPS BETWEEN THE PARTIES 3 4 Chapter 7 The Relationship between the Issuing Bank and its Customer 3 5 Chapter 8 The Underlying Contract and the Rule of Independence 3 9 Chapter 9 Nondocumentary Credit Conditions 4 2 Chapter 10 Fraud and the Issuing Bank 4 8 PART III FRAUD AND STANDBY LETTERS OF CREDIT 55 Chapter 11 Fraud and Court Injunctions 56 Chapter 12 Risks and "Simple Statement" Standby Credits 62 Chapter 13 Risks and "Documentary" Standby Credits 7 1 PART IV CONCLUSION 75 Chapter 14 Proposals for Legislative Changes 76 Chapter 15 Conclusion 78 Bibliography 8 1 1 PART I L E G A L N A T U R E AND PURPOSE O F  STANDBY L E T T E R S O F C R E D I T CHAPTER 1  INTRODUCTORY International trade financing is largely dependent upon the use of letters of credit and standby letters of credit.1 A letter of credit is mainly used as a payment device in international sales contract. A standby letter of credit,2 on the other hand, is a guarantee technique used to secure performance of a contractual obligation. Because standby credits are low-cost and adaptable instruments, they are widely used as security device in a great variety of commercial transactions. Moreover, standby credits can fulfill a very useful function as a substitute for the complex guarantee contracts. There are relatively few studies dealing specifically with standby letters of credit, and commentators apparently prefer to focus on the better known letters of credit. In his famous book The Law of  Bankers' Commercial Credits.3 Gutteridge, a leading expert in the area, dedicates only half a page to standby letters of credit.4 However, American commentators have extensively discussed one specific issue, which is the legality of standby letters of credit. Because of the rule prohibiting U.S. banking institutions from acting as a surety or guarantor,5 some scholars have argued that such a rule cannot coexist with the rule allowing standby letters of credit.6 The question has generated a well known controversy among experts, 1 J.G. Castel et al., International Business Transactions and Economic Relations, 1986, 642. 2 So-called because the device is "standing by" the account party's default to take effect. B.V. McCullough, Letters of Credit, 1989, 1-33, note 3. 3 H.C. Gutteridge, M. Megrah, The Law of Bankers' Commercial Credit, 1984. 4 Ibid., at 15. 5 This limitation on the banks' power to issue guarantees and sureties has often been described as the "no-guaranty rule". See e.g. R.A. Lord, "The no-guaranty rule and the standby letter of credit controversy" (1979), 96 Banking Law Journal 46, at 49. 6 Ibid., at 46. 3 often described as the "standby letter of credit debate."7 This is basically an issue of public banking law, where the discussion focuses on the regulation of banking activities,8 and specifically on the banks' power to issue guarantees.9 The debate has lost some of its interest as U.S. courts have, at several occasions,1 0 reaffirmed that standby letters of credit are authorized by the Uniform Commercial Code . 1 1 In its 1979 report, the United Nations Commission on International Trade Law (UNCITRAL) selected standby credits as a priority topic, and pointed out the problem of fraudulent and abusive calls arising in this type of transaction.12 During the last ten years, there has been a remarkable increase in the number of cases involving incidents of fraud in standby letters of credit transactions.13 When dealing with this vexing problem of fraud, the critical issue is to determine the effect of fraud on the standby letter of credit transaction.14 By issuing a letter of credit or a standby credit, a bank undertakes for the account of its customer15 to make payment to a beneficiary 1 6 7 Cf. H. Harfield, "The standby letter of credit debate" (1977), 94 Banking Law Journal 293. This controversial issue was also discussed by M.R. Katskee, "The standby letter of credit debate - the case for congressional resolution" (1975), 92 Banking Law Journal 697; R.A. Lord, supra note 5; H.J. Arnold, E. Bransilver, "The Standby Letter of Credit - The Controversy Continues" (1978), 10 Uniform Commercial Code Law Journal 272. 8 Cf. K.P. McGuiness, The Law of Guarantee, 1986, 173. 9 Ibid. 1 0 See e.g. Barclays Bank D.C.O. v. Mercantile National Bank, 481 F. 2d 1224 (5th Cir. 1973); National Surety Corp. v. Midland Bank, 551 F. 2d 21 (3d Cir. 1977). 1 1 J.F. Bataille, "Guaranty Letters of Credit : Problems and Possibilities" (1974), 16 Arizona Law Review 822, at 834. 1 2 Cf. U.N. Doc. A/CN. 9/63 (1979). 1 3 H.P. Kee, "The Fraud Rule in Letters of Credit Transactions" in : Current Problems Of International Trade Financing, 1983, 235. 1 4 E.P. Ellinger, "Documentary Credits and Fraudulent Documents" in : Current Problems Of International Trade Financing, 1983, 185. 1 5 In common law, writers generally speak about the "account party" or the "applicant" to designate the bank's customer. The "applicant" is the person who instructs a bank to issue a credit in favor of the beneficiary (§ 5-103(l)(g)). 4 upon compliance with the conditions specified in the credit. A fundamental principle in letters of credit law is that the bank's obligation of payment is independent from the underlying contract between the bank's customer and the beneficiary of the credit. 1 7 Therefore the issuing bank1 8 has to make payment upon compliance with the terms of the credit, regardless of the performance or nonperformance of the underlying contract.19 Nevertheless, courts have established that the beneficiary's fraud may constitute an exception to this principle, known as the fraud exception.20 Courts have consistently held that the fraud exception, developed in the context of letters of credit, should find a similar application in cases of standby credits.21 In this thesis, I will first show that there are two types of standby credits, which have to be distinguished because they involve different obligations and risks for the parties. A device payable against the beneficiary's simple statement will be described as a "simple statement" standby credit, whereas a device payable against a set of documents will be called a "documentary" standby credit. The thesis will then demonstrate that if we take into account the legal nature, purpose and risks of "simple statement" standby credits and "documentary" standby credits, the fraud exception should be 1 6 In a letter of credit transaction, the "beneficiary" is entitled to receive payment of the amount stated in the credit against presentation of a certain documentation (UCP Art. 2(i) and UCC § 5-103(l)(d)). 1 7 This principle is referred to as the principle of independence or the principle of autonomy. See Chapter 8. 1 8 The "issuing" or "opening" bank is the bank undertaking to pay under the credit. 1 9 H.P. Kee, supra note 13, at 237. 2 0 Ibid. The fraud exception recognizes the unfairness of allowing a beneficiary acting fraudulently to call for payment under a credit. Cf. Itek Corp. v. First Nat'l Bank of Boston, 730 F. 2d 19, 24 (1st Cir. 1984). The problem is that the application of the fraud exception undermines the certainty of the issuing bank's obligation of payment. 2 1 See e.g. Enterprise Intern, v. Corporacion Estatal Petrolera, 762 F. 2d 464, 465 (5th Cir. 1985); Rockwell Int'l Systems, Inc. v. Citibank, N.A., 719 F. 2d 583, 589 (2d Cir. 1983). 5 applied to "documentary" standby credits but not to "simple statement" standby credits. My study principally deals with standby letters of credit issued under the 1983 Revision of the Uniform Customs and Practice for Documentary Credits (UCP), Publication No. 400 by the International Chamber of Commerce (ICC), which is a set of internationally recognized rules for documentary credit operations. In the U.S., the UCP is frequently adopted by the banks, especially international institutions, but the law relating to letters of credit is to be found in Article 5 of the Uniform Commercial Code (U.C.C.) . 2 2 Therefore, I want to also comment on the UCC provisions and point out how they differ from the U C P . 2 3 Due to the international character of letters of credit law, I have adopted a comparative approach, and I deal with recent materials from the U.S., Canada, U.K., Germany and Switzerland. Ellinger, 2 4 Kozolchyk 2 5 and Kurkela 2 6 are the only authors who have adopted such a comparative approach. As pointed out by Kurkela, a comparative study is particularly well adapted to the area of letters of credit : "Due to the international character of letters of credit only a comparative approach or an approach of wider international scope than one covering only one national system can... find sufficient justification when dealing with a subject of this kind." 2 7 Standby letters of credit originated in the U . S . 2 8 as a substitute for the prohibited bank guarantees,29 and are now mainly used in North 2 2 H.C. Gutteridge, supra note 3, at 8. 2 3 See e.g. Chapter 9 & 10. 2 4 E.P. Ellinger, Documentary Letters of Credit - A Comparative Study, 1970. 2 5 B. Kozolchyk, Letters of Credit, in : International Encyclopedy of Comparative Law, 1979. 2 6 M. Kurkela, Letters of Credit in International Trade Law : UCC, UCP and law merchant, 1986. 2 7 M. Kurkela, The Liability of Banks under Letters of Credit, 1982, 12. 2 8 E.P. Ellinger, "Standby letters of credit" (1978), 6 International Business Lawyer 604, at 610. 2 9 Ibid., at 610-611. 6 A m e r i c a . 3 0 As most cases and writings are found in the U.S. and Canada, my study essentially focuses on these two countries, but with frequent references to the British, German and Swiss situations. In Part I of this thesis, the legal nature of "simple statement" and "documentary" standby credits will be detailed in order to clearly distinguish the two devices for the purpose of the fraud exception. Moreover, it will be shown how standby credits differ from letters of credit and performance bonds. In Part II, the paper examines the contractual relationships between the parties, with particular attention to the effects of fraud on the bank's obligation of payment. Such an examination will require a discussion of the principle of independence and the fraud exception. Finally, Part III discusses the problems presented by court measures enjoining banks from honoring payment under a credit. It will be followed by an analysis of the nature, purpose and risks of "simple statement" standby credits and "documentary" standby credits. The analysis will show why the fraud exception should be applied to "documentary" standby credits but not to "simple statement" standby credits. 3 0 However, standby credits are increasingly used in Western Europe, India, Australia, South Korea and Japan. Cf. W.F. von Marschall, "Recent Developments in the Field of Standby Letters of Credit, Bank Guarantees and Performance Bonds" in : Current Problems Of International Trade Financing, 1983, 260, at 268. CHAPTER 2  STANDBY LETTERS OF CREDIT A number of different expressions have emerged to designate a letter of credit : Writers speak interchangeably about letters of credit (L/C), commercial letters of credit, bankers' commercial credits, bankers' letters of credit, bankers' documentary credits, documentary letters of credit or documentary credits. The label "documentary" emphasizes the fact that payment under a credit occurs against presentation of a set of documents by the beneficiary. Thus one should not speak about a documentary credit in the case of a "clean" credit, where payment does not require presentation of documents. 3 1 Standby letters of credit are also known as "performance letters of credit"32 or "guaranty letters of credit". 33 The term "standby letter of credit" or simply "standby credit" will be used in this paper because it is the one adopted by the U C P , 3 4 and the one which is used in most standard forms of international banks. The term "performance letter of credit" is frequently used because of the similarities between standby credits and performance bonds. But such a designation introduces confusion, as the two devices differ in several important respects. 3 5 The term "guaranty letter of credit" illustrates well the function of the device but may be misleading, as it has different meanings in common law and civil law. 3 6 3 1 B. Kozolchyk, supra note 25, at 26. 3 2 H. Harfield, Bank Credit and Acceptance, 1974, iii. 3 3 Ibid. 3 4 Cf. UCP Art. 1 and 2. 3 5 Cf. F. Garman, "Standby Letters of Credit and Guarantees : Do We Understand What We're Doing?" (1978), 4 Journal of Commercial Bank Lending 4. See also Chapter 5. 3 6 See J. Dohm, Les Garanties Bancaires dans le Commerce International, 1986, at 30-31. 8 Defining a standby letter of credit is not an easy task. UCP Art. 1 and 2 refer to "standby letters of credit", but the term is not defined and UCC Art. 5 is no more helpful.37 In the U.S., the standby letter of credit has been defined by the Comptroller of the Currency,38 by the FDIC regulations,39 and by the Board of Governors of the Federal Reserve System.40 The definition by the Comptroller of the Currency is often referred to and points out three types of standby letters of credit : 4 1 "[A]ny letter of credit, or similar arrangement however named or described, which represents an obligation to the beneficiary42 on the part of the issuer (1) to repay money borrowed by or advanced to or for the account of the account party4 3 or (2) to make payment on account of any indebtedness undertaken by the account party, or (3) to make payment on account of any default by the account party in the performance of an obligation." This definition does not describe the legal nature and framework of a standby credit, but simply illustrates different functions of the device : 4 4 Types 1 and 2 refer to standby credits issued to support borrowed money,4 5 and Type 3 describes a standby credit issued to provide payment in the event of the account party's nonperformance.4 6 3 7 UCC § 5-103(l)(a) only defines letters of credit. 3 8 12 C.F.R. § 7.1160(a), cited by C.I. Gable, "Standby Letters of Credit: Nomenclature has confounded analysis" (1980), 12 Law & Policy in International Business 903, at 912. 3 9 12 C.F.R. § 337.2(a) 4 0 12 C.F.R. § 208.8(d)(1) 4 1 The definition by the FDIC (supra note 39) and the Federal Reserve System (supra note 40) are almost similar. 4 2 See supra note 16. 4 3 See supra note 15. 4 4 Most commentators tend to discuss the numerous uses and functions of standby credits instead of analyzing properly their legal nature. See e.g. G. Graham, B. Geva, "Standby Credits in Canada" (1984), 9 Canadian Business Law Journal 180, at 184-185; W.F. von Marschall, supra note 30, at 261-263. 4 5 C.I. Gable, supra note 38, at 912. 4 6 P.R. Verkuil, "Bank Solvency and Guaranty Letters of Credit" (1973), 25 Stanford Law Review 716, at 722. Like a traditional letter of credit, a standby letter of credit is basically an undertaking by the issuer47 to pay drafts or a sum of money to a beneficiary, on receipt of certain documentation.48 Thus letters of credit and standby letters of credit are different kinds of documentary credits,49 and they only differ in the type of documents which are required for payment.50 The terms of the credit specify which documents the beneficiary must present in order to obtain payment. Parties to the transaction are relatively free to choose the terms of a credit, and that explains why there are numerous types of standby credits involving different legal frameworks. In my opinion, the designation "standby letter of credit" is too broad to describe properly the obligations of the parties under the credit, and recent developments suggest that a given type of standby letter of credit may require particular legal consideration.51 In the next chapters, I will try to classify these different types of standby credit in order to point out their respective legal characteristics. 4 7 The issuer is usually a bank because the business of letters of credit is in the traditional scope of commercial banking in most states. The business of letters of credit is a banking activity expressly allowed in Canada by § 173(1) of the 1980 Bank Act and in the U.S. by 12 U.S.C. Section 24(7)). 4 8 L. Sarna, Letters of Credit, 1986, 20. 4 9 As mentioned by McCullough, "all letters of credit can be classified as documentary letters of credit." B.V. McCullough, supra note 2, at 1-3. 5 0 J.F. Bataille, supra note 11, at 827. 5 1 As suggested by Mahler, an "indirect" standby credit involves specific risks and obligations for the parties. D.H. Mahler, Rechtsmissbrauch und einstweiliger Rechtsschutz bei der Dokumenten-akkreditiven und "Akkreditiven auf erstes Anfordern", 1986, 6-7. CHAPTER 3 THE "SIMPLE STATEMENT" STANDBY CREDIT A frequently used type of credit is what I describe as the "simple statement" standby credit, where the issuing bank has to pay against presentation of a document stating that an event has occurred.52 This statement is often made by the beneficiary himself, but the terms of the credit may require that the statement be made by a third party. 5 3 The content of the statement varies and depends in fact of the underlying agreement.54 Most often, standby credits are payable against statement by the beneficiary that the account party has failed to perform.55 A very similar type of instrument is the so-called "clean credit" where payment occurs against the beneficiary's simple demand, or by presentation of the beneficiary's draft.56 In the case of a "clean credit", payment occurs "on demand" and without the necessity of presenting documents.5 7 No doubt there is a formal difference between "payment against simple demand" and "payment against simple statement about the account party's default", but one should note that in the case of a "simple statement" standby credit, the beneficiary is not required to prove the truth of its statement. It means that this "statement" is merely an allegation, which may later 5 2 E.L. Symons, "Letters of Credit : Fraud, Good Faith and the Basis for Injunctive Relief (1980), 54 Tulane Law Review 338, at 342. 5 3 The requirement of a certificate of default issued by an independent party may reduce the risk of unjustified or fraudulent demand of payment. See Chapter 12. 5 4 J.F. Bataille, supra note 11, at 827. 5 5 H.A. Getz, "Enjoining the International Standby Letter of Credit : The Iranian Letter of Credit Cases" (1980), 21 Harvard International Law Journal 189, at 195. 5 6 Cf. Republic National Bank v. Northwest National Bank, 578 SW 2d 109 (Tex. 1978). 5 7 H.A. Getz, supra note 55, at 195. 11 appear to be unjustified or even fraudulent.58 This "simple statement" is in fact a "pro forma declaration" 59 used to fit the label "documentary", and therefore a "simple statement" standby is almost equivalent to a "clean credit". 60 Based on the doctrine of strict compliance of the documents, U.S. courts have ruled that a "clean credit" is not the equivalent of a "simple statement" standby credit. In Chase v. E q u i b a n k 6 1 for example, a standby credit was issued by Equibank and payable against a written statement by Chase regarding failure to close a loan agreement.62 Chase simply sent Equibank a telex requiring payment under the credit, and Equibank refused payment arguing that the written statement was missing.63 "Equibank's refusal to pay was held justified by failure to present the draft and documents required by the credit,..."64 But the distinction made by the court in this case is a very artificial one, as we can very well consider that the telex constituted the required written document. The "Iranian cases", 65 involving the Islamic Government of Iran, have shown that "simple statement" standby credits are often used in situations involving very sophisticated factual settings. In fact, a "simple statement" standby credit may be used to secure "directly" or "indirectly" the underlying transaction. Therefore I make a distinction between what I describe as a "direct" standby credit and an "indirect" standby credit. 5 8 See Chapter 10. 5 9 H.A. Getz, supra note 55, at 195. 6 0 See B.V. McCullough, supra note 2, at 1-3, note 2. 6 1 550 F. 2d 882 (3d Cir. 1977), cited by H. Harfield, supra note 32, at 46. 6 2 Cf. H. Harfield, supra note 32, at 46. 6 3 Ibid. 6 4 Ibid., at 47. 6 5 A complete study of the Iranian cases has been made by H.A. Getz, supra note 55. As illustrated by the following diagram, a "direct" standby is issued directly in favor of the ultimate beneficiary. Such a standby involves a tripartite transaction, where the issuing bank's undertaking to pay is directly securing the performance of a given obligation in the underlying contract.66 "Direct" Standby This kind of "one step" guarantee technique is frequently used to secure performance of any obligation in a very wide range of commercial transactions : 6 7 "[SJtandby credits have been used to secure the payment to a lender of a penalty accruing if the developer failed to take up the loan; to cover loss incurred by the land-owner where the builder failed to complete the construction of the building, and to secure repayment of a loan covered by mortgage."68 As 6 6 The following diagram is based on B.V. McCullough, supra note 2, at 1-21. 6 7 Cf. e.g. Recon/Optical, Inc. v. Gov't of Israel, 816 F. 2d 854 (2d Cir. 1987); Paris Sav. & Loan Ass'n v. Walden, 730 SW 2d 355 (Tex. Ct. App. 1987). 6 8 E.P. Ellinger, "Standby Letters of Credit" (1978), 6 International Business Lawyer 604, at 612. In Canada, Graham and Geva have illustrated the growing use of standby credits in domestic and international transactions. G. Graham, B. Geva, supra note 44 at 180. See also G.G. Sedwick, "Aspects of Payment and pointed out by Verkuil, 6 9 standby credits are also widely used in "quasi-performance bond situations."70 Two types of situations must be distinguished : 1. A construction company may want assurance of being paid upon completion of the contract. In such a case, the builder requests its client to provide a standby credit payable against documents certifying that the construction has really been completed.71 2. The construction company's client may want to be sure that the builder will complete the work. In this situation, the client requests the contractor to provide a standby credit payable against statement of default in performance.72 A "simple statement" standby credit may also be used in a "two step" transaction, involving two banks and the issuance of two standby credits. Four parties are involved in this kind of arrangement : 7 3 1. The "first" bank's customer 2. The "first" bank, issuer of the first standby 3. The "second" bank, beneficiary of the first standby and issuer of the second standby 4. The "ultimate" beneficiary74 Financing Mechanisms in the Export Trade" in New Dimensions in International Trade Law : A Canadian Perspective, 1982, 87-88. 6 9 P.R. Verkuil, supra note 46, at 722. 7 0 Ibid. 7 1 Ibid. 7 2 Ibid. See e.g. Victory Carriers, Inc. v. United States, 467 F. 2d 1334 (Ct. CI. 1972), cited by P.C. Reed, "A Reconsideration of American Bell International, Inc. v. Islamic Republic of Iran" (1981), Columbia Journal of Transnational Law 301, note 1. 7 3 H.A. Getz, supra note 55, at 200. 7 4 The following diagram is based on H.A. Getz, supra note 55, at 200. See e.g. Stromberg-Carlson Corporation v. Bank Melli Iran, 467 F. Supp. 530 (S.D.N.Y. 1979). See Chapter 11. "Indirect" Standby ("Iranian Type") Iranian Agency (Buyer) 4 | Iranian Standby L/C . (Second Standby) U.S. Bank Iranian Bank (First bank) U.S. Standby L/C (Second bank) (First Standby) This two step guarantee technique, which I describe as an "indirect" standby credit, is frequently used in international trade. This popularity is due to the fact that many countries, especially developing and Middle East countries, have public law regulations or policies requiring that the standby credit securing the transaction be issued by a bank located in their own jurisdiction. The only way this requirement can be fulfilled is by using an "indirect" standby credit. 7 5 The Iranian cases illustrate well the structure of this kind of "two step" guarantee technique. Prior to the 1978 Iranian revolution, the Iranian government agencies entered into many contracts with U.S. companies. The terms of most contracts provided for an advance payment to be made by the Iranian agencies.76 In order to insure the return of this advance payment in case of dispute, the contracts required the U.S. companies to provide a "simple statement" standby 7 5 As a consequence, the "second" standby credit, which secures the underlying transaction, is subject to the beneficiary's laws and jurisdiction. 7 6 H.A. Getz, supra note 55, at 198. U.S. Company (Seller) 15 credit issued by an Iranian bank in favor of the Iranian agency.77 The issuance of this "Iranian" standby credit was backed by another "simple statement" standby credit issued by a U.S. bank in favor of the Iranian bank.7 8 As illustrated by the above diagram, the issuance of the second standby credit is "backed" by the first standby credit. In other words, the first standby secures the issuance of the second standby, the latter securing the underlying transaction. In such a situation, there are contractual relationships between the first bank and the second bank, and between the second bank and the ultimate beneficiary, but not between the first bank and the ultimate beneficiary. Thus in an "indirect" standby credit, the second bank does not advise or confirm the issuance of a standby credit, but independently issues a second standby credit, bonds or letters of credit. In order for the mechanism to work, the second standby credit is made payable against a declaration certifying the account party's default in the performance of the underlying contract. The first standby is payable against a declaration by the second bank stating that payment under the second standby has occurred. In other words, once the second standby credit has been called for payment, the second bank calls for payment under the first standby credit in order to be reimbursed.79 7 7 Ibid. 7 8 See diagram above. 7 9 Following the 1978 Islamic revolution, the "Iranian" standby credits were called for payment by the Iranian agencies. Many U.S. companies went to court in order to enjoin payment under the U.S. standby credits issued in favor of the Iranian banks. See e.g. Stromberg-Carlson Corporation v. Bank Melli Iran, 467 F. Supp. 530 (S.D.N.Y. 1979). See Chapter 11 for the discussion of the court injunction procedure. CHAPTER 4 THE "DOCUMENTARY" STANDBY CREDIT This type of credit is widely used in banking practice and deserves particular attention, as it is ignored by most commentators. In a "documentary" standby credit,80 payment follows presentation by the beneficiary of a statement declaring the account party's default, in addition to specific documents. Typically these documents are commercial documents referring to the underlying contract, as in a letter of credit transaction. Therefore I describe this type of credit as a "documentary" standby credit, accentuating both its documentary features and its similarity to a letter of credit. Most often, the statement of default is made by the beneficiary's written declaration stating that the account party has failed to fulfill its payment obligation with respect to the underlying transaction. Such a standby credit "secures" the buyer's obligation of payment and may, therefore, be used as an alternative to a letter of credit. One serious disadvantage of a traditional letter of credit is that the mechanism sometimes operates too slowly : For a variety of administrative reasons, the beneficiary may have problems collecting the required documents on time. 8 1 These documents have to be presented to the advising bank, examined, and then transmitted to the issuing bank for another examination.82 All these operations are time-consuming and additional delays may occur if the documents do not comply exactly with the terms of the credit.83 Using a standby credit instead of a letter of credit reduces the cost of the transaction. As there is normally no presentation of documents to the bank under 8 W My terminology. 8 1 For example, the insurance company and the inspection company may need some time to issue the documents. 8 2 F.P. de Rooy, Documentary Credits, 1984, 52. 8 3 Ibid. 17 a standby credit,84 the opening fees charged by the banks are lower. Moreover, there is a saving on the commission for handling of documents. 8 5 A very substantial saving may be made if the amount of the transaction is high, as is the case in the oil trade for example.86 A "documentary" standby credit is issued by the buyer's bank and may for example be payable against presentation of the following documents by the seller : 8 7 1. Copy of the commercial invoice 2. Copy of the bill of lading 3. Copy of the insurance certificate 4. Seller's written declaration stating that the buyer has failed to fulfill its payment obligation with regards to a given sale contract. In Key Appliance Inc. v. First National City Bank 8 8 and J . & K .  Plumbing and Heating Co. Inc. v. International Telephone and  Telegraph Corporation.89 "documentary" standby credits of this type were used to "secure" the payment of the price in a sale t ransac t ion . 9 0 The presentation of the required documents establishes that the seller has performed its obligations under a given contract and that the buyer has not performed its payment obligation. Thus in practice, this kind of "documentary" standby 8 4 Payment under a standby credit is not the expected consequence of the transaction but the exception because a standby credit contemplates payment upon default or nonperformance. 8 5 F.P. de Rooy, supra note 82, at 52. 8 6 Ibid. 8 7 Example based on : Credit Suisse, Documentary Credits, 1982, 41. 8 8 46 A.D. 2d 622, 359 N.Y.S. 2d 886 (1974), cited by E.P. Ellinger, supra note 68, at 612, note 49. 8 9 51 A.D. 2d 638, 378 N.Y.S. 2d 828 (1978), cited by E.P. Ellinger, supra note 68, at 612, note 49. 9 0 E.P. Ellinger, supra note 68, at 612. 1 8 credit appears to be an adequate substitute for a letter of credit, because it greatly simplifies the process and reduces commission costs. A letter of credit is the classic instrument used to finance an international sale; it safeguards the interests of both parties, because the issuing bank pays only against presentation of a set of conforming documents.91 Another method of achieving the same goal is to use a "documentary" standby credit which is "securing" the buyer's obligation of payment.92 It is however essential to note that a standby credit is not a method of payment of the price, 9 3 but a method of "securing" performance of the payment obligation. Both devices may have the same final purpose, but they involve different obligations for the parties and different types of risks, which have to be very carefully analyzed.94 A widely accepted view among scholars95 is to consider that standby credits are not issued in the context of sales transactions. Gable for example characterizes standby letters of credit as follows : "Letters of credit not involving documentary sales of goods are commonly called "standby" letters of credit to distinguish them from the "commercial" letters of credit issued in sale transactions."96 Gable's distinction is not correct because standby credits are indeed often used in the context of sale transactions.97 In fact, it is even sometimes problematic to differentiate letters of credit from "documentary" standby credits, because there are similarities between the two 9 1 Ibid., at 608. 9 2 Credit Suisse, supra note 87, at 41. 9 3 M. Kurkela, supra note 26, at 195. 9 4 See Chapter 13. 9 5 See e.g. J.B. Justice, "Letters of Credit : Expectations and Frustrations" -Part 1 (1977), 94 Banking Law Journal 424, at 428. According to McCullough, "[t]he application for a standby letter of credit... lists no documents whatsoever." B.V. McCullough, supra note 2, at 3-65. The author assumes that a standby credit is exclusively a non-documentary device, and this is not accurate. 9 6 C.I. Gable, supra note 38, at 912. 9 7 Gable has in mind a "simple statement" standby credit and he forgets about other constructions of the device such as the "documentary" standby credit. devices. 9 8 Therefore in the next chapter, I will try to point out the differences between letters of credit and standby credits. The traditional approach has always been to list the functions and uses of standby credits in order to characterize and describe the device. Because standby credits are flexible and adaptable instruments, there is basically no limit on their uses,99 and therefore, such an approach is largely inconclusive. What differentiates one type of standby from another is the kind of documents that are required for payment. What also emerges from my classification is that there is one characterizing document that is common to all types of standby credits, -the beneficiary's declaration stating that an event has occurred. 1 0 0 This document is the only document required in what I call the "simple statement" standby, and is one of the required documents in what I call the "documentary" standby. This document is a fundamental component and characteristic of a standby credit. When I refer to a "declaration stating that an event has occurred", I intentionally use a broad definition that is capable of covering most situations encountered in case law, but most often this document simply is a statement of default certifying a nonperformance. 9 8 M. Kurkela, supra note 26, at 194. 9 9 As pointed out by Murray, the only limits on their use are the creative abilities of those who use them. J. Murray, "Letters of Credit in Nonsale of Goods Transactions (1975), 30 Business Lawyer 1103, at 1123. 1 0 0 E.L. Symons, supra note 52, at 342. CHAPTER 5 DISTINGUISHING STANDBY CREDITS FROM LETTERS OF CREDIT AND PERFORMANCE BONDS As precisely shown before, there are different types of standby credits and that makes the differentiation from letters of credit very c o m p l e x . 1 0 1 Looking at their form, letters of credit and standby credits are almost identical, as both are undertakings of payment against presentation by the beneficiary of conforming documents. Moreover, both devices involve a similar type of credit m e c h a n i s m 1 0 2 and are therefore often described as being "operational equivalents". 1 0 3 Harfield goes even further in considering that standby credits and letters of credits are legally indistinguishable regardless of their different purposes. 1 0 4 Nevertheless, some differences do exist : 1 0 5 1 W 1 Contra, Morisson considers that documentary and standby credits are usually easily distinguishable because of the guaranty-like obligations of standby credits. Cf. P. Morisson, Letters of Credit and Performance Bonds, a conference report, 1986, 7. 1 0 2 Like letters of credit, standby credits are either revocable or irrevocable (UCP Art. 7(a) and UCC § 5-103(a)). If a credit is revocable, it may be cancelled or modified by the issuing bank at any time prior to the acceptance of the documents (UCP Art. 9(a) and UCC § 5-106(3)). Standby credits are generally made irrevocable, which means that the issuing bank's undertaking to pay is binding and may be cancelled or modified only with the consent of the parties (UCP Art. 10 and UCC § 5-107(2)). Like letters of credit, standby credits may be advised, confirmed or issued directly in favor of the beneficiary (UCP Art. 8 and UCC § 5-107(l)(2)). If a credit is confirmed, the correspondent bank advises the beneficiary, acting as an intermediary on behalf of the issuing bank. If a credit is confirmed, the correspondent bank enters a commitment to pay that is independent of, and in addition to, the issuing bank's undertaking to pay (UCP Art. 10b and UCC § 5-103(l)(f)). 1 0 3 Report, "An Examination of U.C.C. Article 5 (Letters of Credit)" (1990), 45 The Business Lawyer 1521, at 1531, 1 0 4 Cited by M. Kurkela, supra note 26, at 195. 1 0 5 See the distinctions made by H.A. Getz, supra note 55, at 194-195, and E.L. Symons, supra note 52, at 342-343. 1. The documentation required for payment is not identical : 1 0 6 In a letter of credit transaction, the documents evidence "title to goods"1®7 and constitute "a prima facie proof' 106 that the seller has performed its obligation under the contract. Under a standby credit, the beneficiary may have to present title documents as in the case of a "documentary" standby, but in any case he has to present a document "stating that an event has occurred." 1 0 9 Most often this latter document certifies a nonperformance of a given obligation in the underlying transaction and is often described as a "certificate of default".110 Therefore, it has often been said that a letter of credit contemplates payment upon performance, whereas a standby credit contemplates payment upon failure to perform. 1 1 1 2. A second important distinction is that the risk of the issuer of a letter of credit greatly differs from that of the issuer of a standby credi t . 1 1 2 The risks of abuse for the issuer, and consequently for its customer, are much greater in the case of a standby credit because the certificate of default is often drawn up by the beneficiary himself, increasing thus the risk of a fraudulent, unfair or unjustified statement. Moreover, standby credits and letters of credit differ significantly in the method of allocation of the risk among parties,1 1 3 and I will discuss this important issue in greater detail later in this paper. 1 1 4 1 0 6 Generally speaking, standby credits require presentation of fewer documents than letters of credit. 1 0 7 E.L. Symons, supra note 52, at 342. 1 0 8 M. Kurkela, supra note 26, at 189. 1 0 9 E.L. Symons, supra note 52, at 342. 1 1 0 This designation is used by E.P. Ellinger, supra note 68, at 640. 1 1 1 M.R. Katskee, supra note 7, at 702. 1 1 2 C.I. Gable, supra note 38, at 917. 1 1 3 M. Stern, "The Independence Rule in Standby Letters of Credit" (1985), 52 University of Chicago Law Review 218, at 222. 1 1 4 See Chapter 12 & 13. 22 It is also a difficult task to clearly differentiate standby credits from performance bonds, as both devices often have the same function, for example to secure the due performance of a construction contract. Nevertheless, there are some important differences between standby credits and performance bonds : 1. Standby letters of credit are generally issued by banks, whereas performance bonds are most often issued by surety or insurance companies. 1 1 5 This is not an absolute rule, because there is no universal agreement on what is a bank, and the scope of commercial banking is not the same in each country. 1 1 6 Moreover, the scope of banking activities is constantly evolving and the delimitation between banks and other types of financial institutions has become blurred in recent years. 1 1 7 2. Both standby credits and performance bonds involve three or four party transactions, but they differ in their respective mechanisms of payment. A performance bond is basically a secondary engagement of payment undertaken by the issuer, most often a surety company1 1 8 or a bonding company.1 1 9 The consequence is that the issuer has to pay only when the account party has not performed its obligations under the contract. "If the surety determines that the seller has fulfilled the contract, then it may refuse to pay the buyer. The surety may also assert 1 1 5 M. Stem, supra note 113, at 223. 1 1 6 For example, the scope of business activities of a Canadian chartered bank that operates under "Schedule A" of the 1980 Bank Act, does not include trust investment, whereas in the U.S., "banking" includes trust services, but excludes institutions that make no commercial loans. See § 3823 of the 1956 Bank Holding Company Act. 1 1 7 In a deregulated financial system such as in West Germany, the so-called "universal banks" offer insurance services as well. For example, in 1989, Deutsche Bank (Germany's biggest and best-capitalized bank) started to sell insurance. Thus a "universal" bank may issue documentary credits as well as performance or surety bonds. For details, see P. Cheeseright, "The competition intensifies", Financial Times, London, July 12, 1989, 4. 1 1 8 See M. Stem, supra note 113, at 223. 1 1 9 See J. Dohm, supra note 36, at 32-33. any defenses against the buyer that would be available to the principal [the account party]." 1 2 0 Under a standby credit, payment follows presentation of conforming documents and there is no investigation by the issuing bank of the truth of the beneficiary's statement or about the performance of the underlying agreement. Therefore an issuer is primarily liable under a standby credit, 1 2 1 and secondarily liable under a performance bond. Unfortunately, the situation is not always that simple, as practitioners have developed commercial devices that are a complex mixture of standby credits and performance bonds. A good illustration is the performance bond with a "first demand" or "on demand" clause, which is often used in transactions with Middle East countries.1 2 2 In this type of bond, payment is due "at any time, regardless of reason and without arbitration"123 and that makes the distinction from a standby credit very difficult, if not impossible. The "on demand" performance bond is in fact the Anglo-American equivalent of the European "first demand" bank guarantee, and both instruments involve a primary and independent undertaking by the issuer 1 2 4 as in the case of a standby credit. Letters of credit, standby credits, performance bonds and bank guarantees are all instruments used to secure trade financing. All these devices are creations of merchant and banking practices and are thus not governed by specific legal provisions in most jurisdictions. 1 2 5 Much of the confusion is due to the fact that the 1 2 0 M. Stern, supra note 113, at 223. 1 2 1 Cf. Republic National Bank v. Northwest National Bank, 578 SW 2d 109 (Tex. 1978). 1 2 2 See F.N. Roussakis, Commercial Banking in an area of deregulation, 1984, 362. 1 2 3 Ibid. 1 2 4 See E.P. Ellinger, supra note 68, at 619. 1 2 5 See Chapter 6. designation of a device as a standby credit, performance bond or bank guarantee is not always sufficient to describe the legal nature of the instrument, and especially the parties' obligations.126 The legal value of a given commercial device essentially depends on the conditions agreed upon by the parties, and more precisely on the conditions attached to the issuer's obligation of payment. The analysis of these conditions of payment shows that we have in fact three different types of instruments : 1. "First demand" instruments, in which payment follows a demand or a statement made by the legitimate beneficiary. 2. "Documentary" instruments, in which payment follows presentation of a number of documents, such as specified by the terms of the credit. 3. "Secondary" instruments, in which payment requires an evaluation or determination of the beneficiary's demand. As mentioned above, a performance bond is generally a secondary engagement, but it may be drafted in such a way as to make it an independent and principal engagement. Bank guarantees are most often payable against the beneficiary's first demand, and as such they involve an independent undertaking of payment for the issuer. But they become secondary engagements when payment is subordinated to the performance of the underlying contract. A standby credit is a very adaptable device because the parties select the terms of payment that are most appropriate for their transactions. As a consequence a standby credit may be used as a "first demand" instrument or as a "documentary" instrument. 1 2 7 1 2 6 The parties' intent is manifested by the terms of the agreement, not by its label. Cf. Wichita Eagle & Beacon Publishing Co. v. Pacific National Bank, 493 F. 2d 1285, 1286 (9th Cir. 1974). 1 2 7 In Chapter 9, I will show why standby credits should rather not be used as "secondary" instruments. When a standby credit is payable against simple statement, the device is almost undistinguishable from a first demand bank guarantee or a clean credit, because the issuer must pay against the beneficiary's conforming statement. Therefore a "simple statement" standby credit is typically an independent guarantee technique and may as such easily be used in a two-step guarantee scheme. 1 2 8 When the standby credit's conditions call for presentation of additional documents, the device becomes very similar to the traditional letter of credit. Therefore a "documentary" standby credit is often used as a substitute for a letter of credit. 1 2 8 I describe this type of credit as an "indirect" standby credit. Cf. Chapter 3. CHAPTER 6 SOURCES OF LAW Most states have no specific legislation on standby letters of credit, and standby credits are, therefore, usually governed by any general law on letters of credit.1 2 9 But only a few states have such legislation on letters of credit. In his very detailed comparative study, 1 3 0 Kozolchyk mentions that statutory law on letters of credit exists in some civil law systems,131 such as "Colombia, El Salvador, Greece, Guatemala, Honduras, Lebanon, Mexico and Syria." 1 3 2 Looking at common law countries, the U.S. is the only country which has specific provisions on letters of credit. 1 3 3 In the U.S., provisions dealing with letters of credit are found in Art. 5 of the UCC, which was implemented with some minor variations in all 50 states.134 UCC Art. 5 is not mandatory and thus parties are free to adopt other rules. 1 3 5 According to UCC § 5-102, documentary credits are automatically covered by the UCC, but three states (New York, Alabama and Missouri) 1 3 6 have adopted an amendment 1 2 9 Report, "Stand-by Letters of Credit and Guarantees", Part II (1988), 6 Butterworths Journal of International Banking and Financial Law, 508 1 3 0 B. Kozolchyk, supra note 25. 1 3 1 Ibid., at 10. 1 3 2 Ibid. 1 3 3 Ibid. 1 3 4 Cf. Report, supra note 129, at 511. UCC Art. 5 has also been adopted by the District of Columbia and the Virgin Islands. Cf. B.V. McCullough, supra note 2, at 2-22. 1 3 5 In the U.S., most international banks have adopted the UCP because of the wide acceptance of these ICC rules. Standby credits may also be made subject to both UCP and UCC, but in such a case parties should clearly indicate which rules take precedence in case of conflicting provisions, as for example : "This credit shall be governed by the 1983 Revision of the UCP and by Article 5 of the UCC, except to the extent that Article 5 is inconsistent with the UCP". A similar clause is proposed by B.V. McCullough, supra note 2, at 3-120. 1 3 6 B.V. McCullough, supra note 2, at 2-24.2 providing that the UCC is not applicable if the credit is made subject to the U C P . 1 3 7 Standby credits may be made subject to the 1978 Uniform Rules for Contract Guarantees (hereinafter URCG), publication no. 325 of the International Chamber of Commerce. The URCG constitutes an attempt by the International Chamber of Commerce to propose a set of uniform rules for standby credits, guaranties, bonds and sureties (URCG Art. 1(1)). URCG Art. 9 requires a judicial or arbitral determination of entitlement to payment : 1 3 8 "If a guarantee does not specify the documentation to be produced in support of a claim or merely specifies only a statement of claim by the beneficiary, the beneficiary must submit : (a) ... (b) in the case of a performance guarantee or of a repayment guarantee, either a court decision or an arbitral award justifying the claim, or the approval of the principal in writing to the claim and the amount to be paid." This latter provision is not adapted to standby credits, because the requirement of a judicial determination is incompatible with the legal nature and purpose of standby credits. One of the main features of a standby credit is that payment follows presentation of conforming documents, and not a determination of the beneficiary's entitlement to payment. 1 3 9 The URCG rules are supposed to create "a fair equ i l ibr ium" 1 4 0 among the parties' interests,141 but in fact they 1 3 7 Ibid. 1 3 8 Report, supra note 129, at 509-510. 1 3 9 Cf. e.g. Banco Espanol de Credito v. State Street Bank & Trust Co., 385 F. 2d 230 (1st Cir. 1967); Association de Azucareros v. United States National Bank, 423 F. 2d 638 (9th Cir. 1970). 1 4 0 C.I. Gable, supra note 38, at 943. 1 4 1 According to Gable, "standby letters of credit in aim, function and business context are more analogous to contract guarantees than to commercial letters of credit. The rules [the URCG] applicable to contract guarantees similarly are more apt referrents than those applicable to commercial letters of credit, unilaterally protect the interests of the account party by requiring a court decision justifying the beneficiary's call for payment.142 Banks issuing guarantees or standby credits have neither accepted nor introduced the URCG rules, fearing to be continuously involved in litigation between their customers and the beneficiaries. The URCG rules have consequently been recognized by very few countries,1 4 3 and are rarely incorporated by the parties in their contracts. Financing devices such as bonds, guarantees and sureties are very poorly regulated at the international level and are thus a source of difficulties for international business transactions. After the failure of the URCG, the International Chamber of Commerce is presently preparing the Uniform Rules for Guarantees (URG). "The Joint Working Party decided, after extensive discussions, to take as the basis of its work a Code of Practice for Demand Guarantees and Bonds drawn up by the Committee of London and Scottish Bankers and to incorporate certain provisions of the 1978 ICC Uniform Rules for Contract Guarantees." 1 4 4 Unfortunately, this area of law is characterized by varied development of national laws, and that makes a unification process very difficult. Moreover, guarantees, bonds and standby credits have different legal frameworks, and I think therefore that it is too ambitious to seek coverage for all these devices under the same uniform rules. The most important set of international rules in the area of letters of credit is the Uniform Customs and Practice for Documentary Credits because the contract guarantees rules are founded on a balancing of interests similar to those at stake in standby credits." C.I. Gable, supra note 38, at 944. In my view, this search for a "fair equilibrium" among the parties' interests is an impossible task in a guarantee technique such as a standby credit. See Chapter 12. 1 4 2 As mentioned in URCG Art. 9(b), the bank's customer may give his approval for payment instead of a court decision or an arbitral award, but it appears that he will give this approval only in exceptional cases. See J. Dohm, supra note 36, at 228. 1 4 3 J. Dohm, supra note 36, at 229. 1 4 4 Report, supra note 129, at 510. (UCP). The 1983 revision of the UCP (fourth revision), in force since October 1984, was elaborated by the International Chamber of Commerce Commission on Banking Technique and Practice, the United Nations' Commission on International Trade Law ( U N C I T R A L ) , 1 4 5 and the foreign Trade Banks of the Socialist countries. 1 4 6 The ICC represents the interests of the countries having chambers of commerce,147 whereas UNCITRAL reflects the interests of those not having chambers of commerce.148 Since its creation in 1966, UNCITRAL has always showed a strong interest in the harmonization and unification of international commercial transactions, and has continuously encouraged the acceptance of the ICC rules throughout the world. 1 4 9 The 1983 revision of the UCP covers standby letters of credit, as Art. 1 provides : "These articles apply to all documentary credits, including, to the extent to which they may be applicable, standby letters of credit, and are binding on all parties thereto unless otherwise expressly agreed." The wording "to the extent to which they may be applicable" is vague and unfortunate. As pointed out by Ventris, 1 5 0 courts in each jurisdiction will decide whether a given provision is applicable to 1 4 5 J.E. Byrne, "The 1983 Revision of the Uniform Customs and Practice for Documentary Credits" (1987), 102 Banking Law Journal 151. 1 4 6 H.C. Gutteridge, supra note 3, at 6. The foreign banks of the socialist bloc were represented by the ICC Ost-West Comitee. Cf. J.C.D. Zahn, Zahlung and Zahlungssicherung im Aussenhandel, 1986, 9. 1 4 7 J.E. Byrne, supra note 145, at 151. 1 4 8 Ibid. 1 4 9 F. Eisemann, Das Dokumentenakkreditiv im Internationalen Handelsverkehr, 1989, 45. 1 5 0 F .M. Ventris, Bankers' Documentary Credits, 1983, in Supplement, 44. Ventris has been very critical about this new coverage of the 1983 Revision : "In including Standby Letters of Credit in the Rules which previously had legislated only for Bankers' Documentary Credits the I.C.C. has complicated a situation which was already sufficiently complex." Ibid. standby credits or not. 1 5 1 As a consequence, it is not surprising to have divergent interpretations.152 Ventris has been very critical about this new coverage of the 1983 Revision : "In including Standby Letters of Credit in the Rules which previously had legislated only for Bankers' Documentary Credits the I.C.C. has complicated a situation which was already sufficiently complex."153 According to the latest available ICC data, (Publication No. 470/508), 1 5 4 the 1983 revision of the UCP has been accepted by 80 countries. In another 64 countries, mostly developing countries, the UCP has been accepted by banks. That means that banks in some 144 countries have adopted the 1983 revision of the UCP. According to the ICC, the previous 1974 revision (ICC Publication No. 290), was "adhered to by banks in 162 countries."155 The lower number of adherents to the 1983 version is due to the fact that application forms of some banks still refer to the 1974 revision of the U C P . 1 5 6 The legal status of the UCP is a question of great importance. Given the worldwide diffusion and acceptance of the UCP, the question of its legal status acquires particular importance.157 If the UCP rules are international uniform law or customary law, they are binding on the parties even when they have not been expressly included in the credit contract. "A contrario", if the UCP is not law or custom, it is binding only on those who have adopted it. Almost the entire world volume of letters of credit and standby credits is now issued with reference to the UCP, but it does not mean that the UCP is binding in 1 5 1 Ibid. No indications are offered for determining which of the UCP articles are applicable to standby credits. 1 5 2 This lack of uniformity creates confusion and legal uncertainty which in the long run could destroy the standby credit as a valuable commercial device. 1 5 3 F.M. Ventris, supra note 150, in Supplement, at 44. See Chapter 15. 1 5 4 Cited by F. Eisemann, supra note 149, at 298. 1 5 5 J.E. Byrne, supra note 145, at 151. 1 5 6 A.W. Zeitler, "Letters of Credit : Problems with Nonconforming Documents" (1987), 15 International Business Lawyer 250, at 250. 1 5 7 R. Eberth, "The Uniform Customs and Practice for Documentary Credits", in : Current Problems Of International Trade Financing, 1983, 21, at 28. 3 1 nature or carries the force of law. Both the ICC and UNCITRAL promote the idea that the UCP is a codification of international customary law, which is autonomous and independent from national laws. 1 5 8 This is certainly an appropriate strategy to achieve greater uniformity and acceptance among the international community, but it is not the correct description of the legal nature of the UCP. The International Chamber of Commerce is a private international organization which has no legislative power, and therefore the UCP does not amount to international law. 1 5 9 In a recent article, Dolan tried to show that the law of letters of credit "is derived from the law merchant [lex mercatoria] as distinct from either the common law or civil law."1 6 0 Dolan notably based his conclusions on a 1983 Canadian Supreme Court decision in Bank of Nova Scotia v. Angelica- Whitewear L t d . . 1 6 1 where the Court said that the letters of credit rules must be determined by the lex mercatoria and not by the local l aw. 1 6 2 This approach has the advantage of suppressing the possible conflict between the civil law of Quebec and common law, but it fails to take into account the origin of the UCP and the nature of the provisions. The UCP's elaboration process clearly shows that there were divergent practices in the different countries before the publication of the first ICC draft, 1 6 3 which suggest that there did not previously 1 5 8 F. Eisemann, supra note 149, at 51-52. See also F. Eisemann, Le credit documentaire dans le droit et la pratique, 1963, 48, cited by B. Kozolchyk, supra note 25, at 17. The wording of UCP Art. 1 is somewhat misleading, and as pointed out by McCullough, "[t]his article should not be read as implying that the UCP provisions apply even though the credit does not refer to the UCP,..." B.V. McCullough, supra note 2, at 2-31. 1 5 9 J. Hartmann, Der Akkreditiv-ErOffnungsaufrag, 1974, 3. 1 6 0 J.F. Dolan, "Documentary Credit Fundamentals : Comparative Aspects" (1989), 2 Banking & Finance Law Review 121. 1 6 1 (1987), 36 D.L.R. (4th) 161 (S.C.C), cited by J.F. Dolan, ibid. 1 6 2 J.F. Dolan, ibid., at 124. 1 6 3 The first draft of the UCP (ICC Publication No. 82) was elaborated in 1933 at the seventh meeting of the ICC in Vienna. This first text appears to be the result of a compilation of diverse agreements in force among banks at the exist an international customary law in this area. 1 6 4 The UCP is in fact the result of a consensus reached after long negotiations among the various parties. The text mainly comprises a compilation of diverse existing banking guidelines, 1 6 5 and is the "product of the views of the international banking community".166 Moreover, the simple fact that the UCP has been revised four times since its adoption, strongly contradicts the idea of an established or settled customary law. 1 6 7 The UCP therefore is neither the statement of an international uniform law 1 6 8 nor an international customary law. Although it is clear that the UCP, as a whole, does not codify established customs, I think that it would be excessive and simplistic to conclude that there is no expression of customs and trade usages at all in the UCP : There may well be some provisions of the UCP which should, after a detailed analysis, be considered as customary law or as trade usage. Therefore as pointed out by McCullough, the fact that the UCP is neither law, nor lex mercatoria "does not preclude a court, however, from considering the U.C.P. when fashioning a necessary rule of law. It also does not prevent a party from showing through adequate proof that the U.C.P. constitutes an usage of trade or a course of dealing making the U.C.P. applicable to a particular issue." 1 6 9 national level. More precisely, the 1923 German "Regulativ des Akkreditivgeschafts des Berliner Stempelvereinigung", which was recognized by most German banks, seems to have been the main source for the original UCP draft. Cf. J.C.D. Zahn, supra note 146, at 7. This first draft was immediately adopted by the existing bank associations in Belgium, Germany, France, Holland, Italy, Rumania and Switzerland. As mentioned by Gutteridge, England and other members of the Commonwealth did not adhere until the 1962 Revision. Cf. H.C. Gutteridge, supra note 3, at 6. 1 6 4 Contra, see H.A. Getz, supra note 55, at 201. The author considers that the UCP is "a compilation of accepted practice". 1 6 5 Cf. B. Kozolchyk, supra note 25, at 18. 1 6 6 Ibid. 1 6 7 Cf. R. Eberth, supra note 157, at 28. 1 6 8 See B. Kozolchyk, supra note 25, at 14. Contra, see F. Eisemann, supra note 149, at 76. 1 6 9 B.V. McCullough, supra note 2, at 2-31. For the purpose of this study, I will assume that the UCP rules are binding on the parties, as such is the case when the rules have been expressly adopted by the parties in their credit contract. Nevertheless, it is important to keep in mind throughout this paper that the UCP does hot have force of law. Therefore the exact scope of the UCP provisions will depend on their acceptation and interpretation by the national jurisdictions. 34 P A R T I I C O N T R A C T U A L R E L A T I O N S H I P S  B E T W E E N T H E P A R T I E S CHAPTER 7 THE RELATIONSHIP BETWEEN  THE ISSUING BANK AND ITS CUSTOMER In order to create a standby credit relationship, the customer will instruct his bank to issue a standby credit in favor of the other contracting party. In practice, most banks have a special application form to be signed by their customers.!70 This application form contains a request to issue a standby credit, the specific conditions of the credit, as well as the customer's account to be debited in case of payment. Logically, the selected terms of the credit refer to the provisions agreed upon by the customer and his contractant. Once the customer has presented this application form to its bank, the bank may approve the credit and provide its client with the facilities, 1 7 1 or decline the customer's offer. 1 7 2 The credit application therefore is not a bilateral contract between the issuer and its customer, but only a request to issue a credit. UCC § 5-106(l)(a) provides that there is a binding contract between the issuer and its customer "as soon as a letter of credit is sent to him or the letter of credit or an authorized written advice of its issuance is sent to the beneficiary;..." When issuing the credit, the bank should strictly follow its customer's instructions, as requested in the application form, in order to avoid any liability. The legal nature of the relationship between the applicant and the issuing bank is not defined in the UCP or in the UCC, and therefore it 1 7 0 See e.g. Credit Suisse, supra note 87, at 56. Most banks have standard application forms but there is no universally adopted form. In order to promote greater uniformity at the international level, the ICC has proposed a standard form (Publication No. 416), but this form has not yet been adopted by the major international banks. 1 7 1 W. Hedley, Bills of Exchange and Bankers' Documentary Credits, 1986, 228. 1 7 2 The issuing bank is of course not bound to open the credit. See e.g. Samuel Kronman & Co. v. Public National, 218 App. Div. 624, 218 N.Y. Supp. 616, 622 (1926). 36 is up to the courts in each jurisdiction to qualify this relationship, according to their national laws. Under common law, the relationship between the issuing bank and its client has generally been described as an agency agreement,173 as the bank is remunerated by its commission and charges.1 7 4 The main obligation of the bank's customer is to reimburse the bank if the standby credit is called for payment. There is generally an express provision for reimbursement in the application form, which indicates the customer's account to be debited in case of payment under the credit. 1 7 5 Some banks, especially in the U.S., incorporate a loan agreement in the application form. 1 7 6 But even without contractual provisions, the bank has a legal right to be reimbursed (UCP Art. 16(a) and UCC § 5-114(3)).177 An interesting question is to know whether the issuing bank should inform its customer about the beneficiary's demand of -payment. The risk of a fraudulent demand of payment is particularly high in the 1 7 3 F.M. Ventris, supra note 150, at 65; L. Sarna, Letters of Credit, a conference report, 1985, 36. Under German law, the contractual relationship is considered to be a "Werkvertrag", and as such governed by § 665 and 675 of the BGB. See F. Eisemann, supra note 149, at 43. The Swiss Supreme Court has described the relationship as a "contrat d'assignation", Art. 466 CO. See D. Guggenheim, Les contrats de la pratique bancaire suisse, 1984, 201, note 6. 1 7 4 F.M. Ventris, supra note 150, at 65. Does it constitute valid consideration? There is no problem in the U.S., because UCC § 5-105 provides that "[n]o consideration is necessary to establish a credit or to enlarge or otherwise modify its terms." This issue seems to be much more complex under English law, especially in the case of modifications in the terms of the credit. For a detailed discussion, see H.C. Gutteridge, supra note 3, at 26-30. See also the Canadian approach discussed by L. Sarna, supra note 48, at 36-45. 1 7 5 Application forms of most banks incorporate the banks' standard conditions of contract within the agreement. These conditions generally contain a clause of reimbursement. See e.g. Art. 1 and 2 of the Standard Conditions of Contract, Royal Bank of Canada, 1983, printed in J.G. Castel et al., supra note 1, at 658; see also the reimbursement agreement for standby letters of credit of the Bank of Nova Scotia, printed in J.G. Castel et al., supra note 1, at 698-700. 1 7 6 Cf. B.V. McCullough, supra note 2, at 3-117. 1 7 7 Cf. Security Fin. Group, Inc. v. Northern Ky. Bank & Trust Co., 858 F. 2d 304 (6th Cir. 1988). 37 case of standby credits, because documents to be presented for payment are most often drawn up by the beneficiary himself.1 7 8 If the bank's customer is not informed of a demand of payment, he is denied the opportunity to discuss the matter with the beneficiary or to seek a court injunction enjoining payment under the credit. 1 7 9 Because of the particular relationship existing between the banks and their corporate clients, in practice most banks do inform their customers about a demand of payment under a standby credit. During the Iranian crisis, U.S. courts often granted notice injunctions, 1 8 0 requiring the issuing banks to give its customer notice of any demand for payment. The granting of these "notice injunctions" was justified by the precarious circumstances prevailing in Iran, 1 8 1 and such a practice clearly implies that U.S. courts do not consider that there is a legal right for the bank's customer to be informed of a demand for payment. In the case of Williams & Glyus  Bank Ltd v. Barnes. 1 8 2 the court expressly stated that the bank has no duty to inform its customer about a demand for payment. Neither the UCP nor the UCC expressly imposes a duty on the issuing bank to inform its customer. This is in fact not surprising if we remember that both UCP and UCC have been primarily elaborated to regulate traditional letters of credit. In the case of a commercial letter of credit, payment under the credit is a natural and logical consequence of the transaction, as payment is a counterpart for the seller's shipment of the goods. Therefore it is not particularly important for the bank's customer to be informed. The situation is 1 7 8 See Chapter 12 & 13. 1 7 9 Courts have established that, under certain circumstances, fraud constitutes an exception to the principle of independence. The fraud exception, which is recognized by both the UCP and UCC, becomes a useless right if the bank's customer is not informed of a demand of payment. See Chapter 11. 1 8 0 Cf. e.g. Stromberg-Carlson Corporation v. Bank Melli Iran, 467 F. Supp. 530 (S.D.N.Y. 1979). 1 8 1 Harris International Telecommunications, Inc. v. Bank Melli Iran, No. 79-802 (S.D.N.Y. 1979). 1 8 2 [1981] Com. L.R. 205. different with a standby credit, because payment is not the expected consequence of the transaction, but indeed the exception. In the normal course of events -that is if the account party executes its obligations- there will be no demand of payment under the credit. 1 8 3 Because payment under a standby credit is the exception, it is certainly not inappropriate for the account party to be informed about a demand for payment.184 There is in my view a legal basis for such an obligation in both UCP and UCC, in that the issuing bank's obligation includes good faith, as mentioned in UCC § 5-109(1), and implied in UCP Art. 15. The concept of good faith is defined in UCC § 1-201(19) as "honesty in fact in the conduct or transaction concerned."185 I think that there is violation of the good faith obligation if the bank does not inform its customer of a demand of payment under a standby credit. 1 8 6 As less than one percent of the "first demand" instruments issued are called for payment, 1 8 7 such an obligation to inform would not be burdensome for the banks. 1 8 3 According to a recent German study, demands for payment were made in about 0.64% of the guarantee instruments issued. Cf. F.W. von Marschall, supra note 30, at 280, note 83. 1 8 4 The customer may require that the credit contract imposes such a duty to inform on the bank. But banks often hesitate to deviate from the UCP provisions. 1 8 5 Cited by E.L. Symons, supra note 52, at 349. 1 8 6 The contractual relationship between the bank and its customer requires the bank to protect the interest of its client. This solution has been recognized in Germany and Switzerland. Cf. J. Dohm, supra note 36, at 82-83. Art. 8(2) of the Uniform Customs for Contract Guarantees (URCG) provides that the bank has the obligation to inform immediately its customer about a demand of payment. As mentioned before, this is not the courts' view. Therefore an amendment to the UCP and UCC may be necessary in order to modify the existing practice. See Chapter 14. 1 8 7 Cf. supra note 183. CHAPTER 8  THE UNDERLYING CONTRACT AND THE RULE OF INDEPENDENCE A fundamental principle in the law of letters of credit is that the letter of credit contract is independent and separate from the underlying agreement. This principle is often referred to as "the independence rule", 1 8 8 or "the principle of abstraction",189 and is mentioned in both the UCP and UCC. UCP Art. 3 states : "Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the credit." The same principle is restated in UCP Art. 4 : "In credit operations all parties concerned deal in documents, and not in goods, services and/or other performances to which the documents may relate." Looking at the UCC, § 5-114(1) provides : "An issuer must honor a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying contract for sale or other contract between the customer and the beneficiary." For a long time, courts have uniformly held that the issuing bank's obligation under a standby letter of credit is independent from the underlying transaction,190 and this principle has two very important consequences for the contractual relationships between the parties : 1 8 8 M. Stern, supra note 113, at 218. 1 8 9 B. Kozolchyk, supra note 25, at 115. 1 9 0 See e.g. Pan American Bank & Trust Co. v. National City Bank, 6 F. 2d 762 (2d Cir. 1925); Republic National Bank v. Northwest National Bank 578 SW 2d 109 (Tex. 1978). 1. The letter of credit itself is independent from the relation between the issuing bank and its customer.191 The consequence is that no defence based on the relationship between the issuer and its customer may be used to avoid payment under a documentary credit. In the case of insolvency of the account party, a bank which did not require sufficient collateral could be tempted to raise defenses in order to avoid payment under the credit. In the case of Roglino v. Webster, the court held that the issuing bank "cannot justify its refusal to honor its obligations by reason of the contract relations existing between the bank and its depositor."1 9 2 In Fidelity Bank v. Lutheran Mutual Life  Insurance Co.. the court held that a defense of mistake of fact arising from the contract between the issuer and its customer does not affect the issuing bank's obligation of payment.193 2. The letter of credit is independent from the relation between the bank's customer and the beneficiary, relationship also known as the underlying transaction. Thus, the obligations created by a letter of credit are completely separate from the underlying transaction. 1 9 4 More precisely it means that all defences arising from the underlying contract, such as illegality, frustration, or breach of contract, have no relevancy to the issuing bank's obligation of payment.195 1 9 1 The German doctrine defines the relationship between issuer and customer as the "Deckungsverhaltnis". Cf. D.H. Mahler, supra note 51, at 76. 1 9 2 217 A.D. 282, 216 N.Y.S. 225, 235-236 (1926), cited by B. Kozolchyk, supra note 25, at 113. 1 9 3 465 F. 2d 211 (10th Cir. 1972). Courts have consistently held that the letter of credit is separate from the contract between the issuing bank and its customer. See e.g. Chase Manhattan Bank v. Equibank, 550 F. 2d 882 (3d Cir. 1977); Baker v. Nafl Blvd. Bank of Chicago, 399 F. Supp. 1021 (N.D. 111. 1975). 1 9 4 Philadelphia Gear Corp. v. Central Bank, 717 F. 2d 230, 235 (5th Cir. 1983). 1 9 5 See D.H. Mahler, supra note 51, at 76-77. This fundamental principle has been very often stated by the courts. See e.g. Bossier Bank & Trust Co. v. Union Planters Nat'l Bank of Memphis, 550 F. 2d 1077 (6th Cir. 1977); Shanghai Commercial Bank Ltd. v. Bank of Boston Int'l, 53 A.D. 2d 830, 385 N.Y.S. 2d 548 (1976). The principle of independence gives letters of credit and standby credits their great attraction, which is that parties deal in documents and not in goods. 1 9 6 A strict application of the independence rule means that the issuing bank and the confirming bank are not involved in disputes regarding the underlying contract. That explains why fees charged by the banks for the issuance and negotiation of a standby or letter of credit are lower than those charged for the issuance of performance or surety bonds. In the U.S., "[m]any banks charge an issuance fee of 0.125 percent of the amount of the credit upon issuance of the credit..., and a negotiation fee of another 0.125 percent upon payment or negotiation of the drafts."197 In the case of a secondary engagement like the performance bond, the commission fees are generally higher because the issuer has to investigate the underlying contract, thus increasing the risk of being involved in litigation. 1 9 6 See UCP Art. 3. 1 9 7 B.V. McCullough, supra note 2, at 3-93. Based on my own experience, the fees charged by most Swiss and German banks are in the same range. However, the fees may be higher if the risks involved in the transaction are greater. See Chapter 12. CHAPTER 9  NONDOCUMENTARY CREDIT CONDITIONS As mentioned before, U.S. banks are prohibited from issuing guaranties and sureties, but are allowed to issue letters of credit. 1 9 8 The prohibition is meant to protect bank depositors and shareholders by limiting excessive risk-taking by banks in the suretyship field. 1 9 9 U.S. banks are trying to get around this prohibition on guarantees by issuing standby credits. Thus in the U.S., a very controversial issue has arisen as to whether standby credits are bank guaranties or letters of credit. 2 0 0 "Some issuing banks have raised ultra vires defenses to avoid liability on the theory that guaranties issued by banks are outside a bank's power to issue and therefore unenforceable."2 0 1 There are two fundamental differences between standby credits and guaranties. First, standby credits involve a primary obligation of payment, 2 0 2 whereas guaranties involve a secondary obligation of payment. A guarantor promises to answer for the debt, default of another and therefore the liability of a guarantor is secondary, and arises upon non performance of the principal obligator. 2 0 3 The liability of the issuer of a standby credit is primary and arises upon presentation of documents, regardless of the performance or nonperformance of the parties to the underlying transaction.204 In 1 9 8 Japanese banks are also prohibited to issue guarantees. Cf. M. Kurkela, supra note 26, at 193. This prohibition on guarantees does not apply outside the U.S. and Japan. 1 9 9 J.F. Bataille, supra note 11, at 831-832. 2 0 0 M.R. Katskee gives a good summary of the controversy, see supra note 7. 2 0 1 C.C. Jobe, "Write Nondocumentary Conditions Out Of Article 5 : A Proposal" (1989), 11 George Mason university Law Review 69, at 77. See Chapter 1. 2 0 2 Cf. Republic National Bank v. Northwest National Bank, 578 SW 2d 109, 115. 2 0 3 Cf. B.V. McCullough, supra note 2, at 4-8. 2 0 4 Ibid. U.S. courts have generally held that standby credits are not ultra vires. The argument most often put forward by the courts is that "the standby credit is a primary obligation, whereas the state statute prohibiting banks to other words, a guarantee is dependent upon the underlying transaction, whereas a standby letter of credit is independent of the underlying transaction. Secondly, a standby credit has "documentary" features that differentiates it from a guarantee. When distinguishing letters of credit from the prohibited guarantees, the Comptroller of the Currency, in Interpretative Ruling 7.7016, required that "the bank's obligation to pay should arise only upon the presentation of a draft or other documents...."205 But these distinctions become blurred when the terms of the credit require the beneficiary to establish "a particular factual situation"206 in order to draw under the credit. For example, credits frequently contain the following formulations : 1. "Funds will be available if the contractor does not perform his obligation." 2 0 7 2. "Payment only in case of the principal's breach of contract."208 Such conditions are often described as nondocumentary conditions, 2 0 9 because the credit does not call for documents but for a factual situation. Nondocumentary conditions generally refer to the underlying transaction, and thus they bring the underlying contract into the letter of credit. The problem under the UCP and the UCC is to decide how to treat these nondocumentary conditions. UCP Art. 4 suggests that nondocumentary conditions are not within the scope of the UCP. If a credit contains such conditions, banks should treat them issue guarantees refers to guarantees of the obligation of others." J.D. Becker, "Standby Letters of Credit and the Iranian Cases : Will the Independence of the Credit Survive?" (1981), 13 Uniform Commercial Code Law Journal 335, at 341. 2 0 5 Cited by M.R. Katskee, supra note 7, at 698. 2 0 6 C.C. Jobe, supra note 201, at 75. 2 0 7 Report, supra note 129, at 511. 2 0 8 Ibid. 2 0 9 See e.g. C.C. Jobe, supra note 201, at 69. as surplusage and ignore them, 2 1 0 as UCP Art. 3 provides that banks are not concerned with references to the underlying contract. But in the U.S., the liberal nature of UCC § 5-102(l)(b)(c) suggests that a letter of credit may contain nondocumentary conditions, and that makes difficult if not impossible the differentiation between standby credits and guaranties. If the device is labelled "standby credit" or "guarantee", that may well be an indication about what the parties intended. However, as said in the case of Wichita Eagle & Beacon Publishing Co. v. Pacific  National Bank. 2 1 1 "the relevant intent is manifested by the terms of the agreement, not by its label." 2 1 2 This ruling is in contradiction with the UCC, as § 5-102(l)(c) provides that Article 5 is applicable to a credit which "conspicuously states that it is a letter of credit or is conspicuously so entitled."213 If the device is issued by a bank, it is likely to be a standby credit and not a guarantee, because the business of letters of credit is mainly done by banks. But that should clearly not be a decisive criterion, because non-banking institutions also issue letters of credit, 2 1 4 and banks also act as guarantors. In a few cases, courts have ruled that an instrument involving nondocumentary conditions was a guarantee and not a letter of c r e d i t . 2 1 5 For example in the Wichita case, 2 1 6 the device was payable if the account party had failed to perform provisions of the underlying contract. 2 1 7 The court considered that "where, as here, the substantive provisions require the issuer to deal not simply in 2 1 0 Cf. Andy Marine, Inc. v. Zidell, 812 F. 2d 534, 535 (9th Cir. 1987). 2 1 1 493 F. 2d 1285 (9th Cir. 1974). 2 1 2 Ibid., at 1286. 2 1 3 UCC § 5-102(l)(c) 2 1 4 See e.g. Barclays Bank D.C.O. v. Mercantile Nat'l Bank, 481 F. 2d 1224 (5th Cir. 1973). 2 1 5 Cf. C.C. Jobe, supra note 201, at 87 and cases listed under note 120. 2 1 6 Cf. supra note 211. 2 1 7 Ibid., at 1286 documents alone, but in facts relating to the performance of a separate contract (the lease, in this case), all distinction between a letter of credit and an ordinary guarantee contract would be obliterated by regarding the instrument as a letter of credit."2 1 8 Case law shows that U.S. courts have a clear tendency to consider nondocumentary devices as letters of credit or standby credits in order to avoid the consequences of the ultra vires defense : "If the undertaking were found to be ultra vires and unenforceable, such a result would be unfair to the beneficiary... and impair the credibility of the credit, as well." 2 1 9 The argument most often put forward by the courts is the primary nature of the issuing bank's obligation of payment. 2 2 0 Once the court has decided that the device is a letter of credit or a standby credit and not a guarantee, it must then decide how to treat these nondocumentary credit conditions. There are three different approaches adopted by the courts : 2 2 1 1. In the cases of NMC Enterprises. Inc. v. Columbia Broadcasting  System. Inc . . 2 2 2 and Raiffeisen-Zentralkasse Tirol v. First  National B a n k . 2 2 3 the courts decided to enforce the nondocumentary conditions, arguing that a credit should be enforced in accordance with its specific conditions. Thus the bankers are supposed to determine whether the underlying contract was properly performed or not. But a banker is not in a situation to assess the underlying transaction : "By definition, a non-documentary condition cannot be fulfilled to the satisfaction 2 1 8 Ibid. 2 1 9 Report, supra note 103, at 1547-1548. 2 2 0 Cf. e.g. Fidelity Bank v. Lutheran Mut. Life Ins. Co., 465 F. 2d 211 (10th Cir. 1972); Prudential Ins. Co. of Am. v. Marquette Nat'l Bank, 419 F. Supp. 734 (D. Minn. 1976). 2 2 1 Cf. C.C. Jobe, supra note 201, at 83. 2 2 2 14 UCC Rep. Serv. 1427 (NY Sup. Ct. 1974), cited by B.V. McCullough, supra note 2, at 5-36. 2 2 3 671 P. 2d 1008 (Colo. Ct. App. 1983), cited by C.C. Jobe, supra note 201, at 83. of a bank clerk acting in a ministerial role within a three day period " 2 2 4 The proposed approach has the important advantage of respecting the parties' expectations. But it transforms a letter of credit into a "secondary" instrument, because payment is subordinated to the fulfillment of a factual situation or to the performance of the underlying transaction. Such an approach totally neglects the independence rule and the fact that banks have to deal in documents only. 2. Another approach is to consider the nondocumentary conditions as surplusage and ignore them, as the court did in Bossier Bank  & Trust v. Union Planters National Bank 2 2 5 and in United States  v. Sun Bank. 2 2 6 As mentioned before, that is the solution expressly provided by Art. 3 of the UCP. In the Bossier Bank case, payment under the credit required a certification that the beneficiary was entitled "to draw against this letter of credit in reduction of the loan made... pursuant to the terms of your commitment letter."227 The court refused to discuss the terms of the commitment letter, ignoring thus the credit condition. This approach is perhaps logical, but it totally neglects the parties' intention expressed by the conditions of the credit. 2 2 8 3. The third approach is to treat nondocumentary conditions as documentary conditions. 2 2 9 In other words, "a nondocumentary condition that the buyer actually be in default on the underlying contract would be construed as a documentary condition requiring the beneficiary to present a document stating that the buyer is in default."230 This solution was adopted in the cases of 2 2 4 Report, supra note 103, at 1548. 2 2 5 550 F. 2d 1077 (6th Cir. 1977). 2 2 6 609 F. 2d 832 (5th Cir. 1980). 2 2 7 550 F. 2d 1077, 1081 (6th Cir.1977). 2 2 8 Cf. C.C. Jobe, supra note 201, at 83. 2 2 9 Ibid. 2 3 0 Ibid. Pringle-Associated Mortgage Corp. v. Southern National B a n k 2 3 1 and in Banque de L'Indochine et de Suez v. J.H. Rayner (Mincing  Lane) L t d . 2 3 2 This approach appears to be the most attractive one, because it respects the principle of independence without totally ignoring the content of the nondocumentary conditions. Nevertheless, and as pointed out by Jobe, "this approach may fictionize the clear meaning of some conditions."233 Nondocumentary credit conditions nullify the main differences between standby credits and guaranties. As a consequence of the ultra vires defense, there is a great legal uncertainty associated with the use of nondocumentary conditions. A device containing nondocumentary conditions is likely to result in litigation and courts may decide that the conditions are unenforceable. As pointed out by Bataille, it appears that bank solvency could be safeguarded by other means rather than by the prohibition on U.S. banks to issue guarantees. 2 3 4 2 3 1 571 F. 2d 871 (5th Cir. 1978), cited by C.C. Jobe, supra note 201, at 83. 2 3 2 [1983] Q.B. 711, cited by C.C. Jobe, supra note 201, at 84. 2 3 3 C.C. Jobe, supra note 201, at 83. 2 3 4 J.F. Bataille, supra note 11, at 833-834. C H A P T E R 10 F R A U D A N D T H E I S S U I N G B A N K When dealing with incidents of fraud in documentary credits, two distinct questions must be addressed. The first one, which will be discussed in this chapter, is to find out the effect of allegations of fraud upon the bank's duty to honor payment. The other question, which will be dealt with in the next chapter, is to determine whether, and at which conditions, the account party may obtain a court injunction restraining payment. In the 1941 case of Sztejn v. Henry Schroder Banking Corp. . 2 3 5 the Supreme Court of New York carved out an important exception to the independence principle, by ruling that the issuer may dishonor a demand for payment if there is fraud in the transaction : 2 3 6 [W]here 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." 2 3 7 Sztejn is the landmark case and is also cited by the Courts in England as the most illustrative case dealing with the concept of fraud. 2 3 8 The fraud exception developed in the Sztejn case has since been codified in the UCC § 5-114(2) and provides : "Unless otherwise agreed when documents appear on their face to comply with the terms of the credit but a required document does not in fact conform to the warranties made on negotiation or transfer 2 3 5 177 Misc 719, 31 N.Y.S. 2d. 631 (Sup. Ct. 1941). 2 3 6 The so-called fraud exception is derived from the Bills of Exchange Act, 1882, ss. 24 and 64, as no title may be obtain through forgery. Cf. H.C. Gutteridge, supra note 3, at 180, note 212. 2 3 7 Supra note 235, at 634. 2 3 8 See e.g. Edgar Owen Engineering Ltd. v. Barclays Bank Ltd. 1978 Q.B. 159 (CA. 1977). of a document of title... or of a security... or is forged or fraudulent or there is fraud in the transaction (a) the issuer must honor the draft or demand for payment.... (b) an issuer acting in good faith may honor the draft or demand of payment despite notification from the customer of fraud, forgery or other defect not apparent on the face of the documents but a court of appropriate jurisdiction may enjoin such honor." There is no specific mention of fraud in the UCP, but case law shows that courts read the UCP in a way that does not negate the fraud exception created in Sz te jn . 2 3 9 Under UCP Art. 15, fraudulent documents are "considered as not appearing on their face to be in accordance with the terms and conditions of the credit." The so-called fraud exception covers three types of situation : 1. Forged documents (UCC § 5-114(2)) : A document is forged if it contains "a forged or otherwise unauthorized signature." 2^ 2. Fraudulent documents (UCC § 5-114(2)) : A document is fraudulent if it appears on its face to be authentic, but is in fact false or counterfeit.241 For example, a transport document may contain a false date of shipment like in the case of Kwei Tek Chao  v. British Traders and Shippers. 2 4 2 or a misdescription of the goods like in Sherakate Sahami Khass Rapol v. Henry R. John &  Son. Inc. 2 4 3 2 3 9 See e.g. Rockwell Int'l Systems, Inc. v. Citibank, N.A., 719 F. 2d 583, 588 (2d Cir. 1983). 2 4 0 B.V. McCullough, supra note 2, at 5-21. For an example of a forged bill of lading, see Guaranty Trust Co. of New York v. Hamey, [1918] 2 K.B. 623. 2 4 1 As pointed out by B.V. McCullough, forged documents are most often fraudulent, whereas fraudulent documents are not necessarily forged. Cf. B.V. McCullough, supra note 2, at 5-21. In the famous Sztejn case, the documents were fraudulent because they described the goods as "bristles", whereas rubbish was in fact shipped. 2 4 2 [1954] 2 Q.B. 459. For another example of a false date on a bill of lading, see United City Merchants (Investments Ltd.) v. Royal Bank of Canada, [1979] 1 Lloyd's Rep 267. 2 4 3 701 F. 2d 1049 (1983), cited by B.V. McCullough, supra note 2, at 5-23. 50 3. Fraud in the transaction (UCC § 5-114(2)) : Neither UCP nor UCC gives any definition of fraud, but courts in the U.S. have generally adopted "the traditional concept and definition of fraud, that is, any deliberate misrepresentation of the truth or a fact in order to profit from another."244 The concept of "fraud in the transaction" has created great confusion, as it is unclear whether the fraud refers to the letter of credit itself or to the underlying contract. 2 4 5 Once the bank has issued a standby credit, its main obligation is to honor a demand of payment, if the documents presented by the beneficiary comply with the terms of the credit. 2 4 6 If the bank's customer is alleging fraud, the issuer is in a very difficult position : On the one hand, the bank may be tempted to protect its customer's interests in order to maintain a good and prosperous business relationship. On the other hand, the bank has to keep its financial standing and may, therefore, not easily take the risk of dishonoring a demand for payment.2 4 7 Under the UCP, payment by the bank must be made within a "reasonable time" (UCP Art. 16(c)), but there is no indication in the 2 4 4 B.V. McCullough, supra note 2, at 5-23. For an illustration, see e.g. West Virginia Housing Development Fund v. Sroka, 415 F. Supp. 1107 (W.D. Pa. 1976), cited by B.V. McCullough, supra note 2, at 5-23, note 40. 2 4 5 See Chapter 11. 2 4 6 Under a standby credit, the issuing bank should always carefully verify the identification of the beneficiary, because payment has to be made to the legitimate beneficiary as designated in the credit. This is a very important operation in the case of a "simple statement" standby credit, as the only required document is drawn up by the beneficiary himself. One of the problem in the Iranian cases was to designate the legitimate sovereign beneficiary during a revolutionary period. Under a traditional letter of credit, there is no real problem of identification, as payment follows presentation of a set of documents. 2 4 7 In the case of wrongful dishonor, the bank may have to pay damages. The beneficiary may either sue the issuing bank, based on the standby credit contract, or the bank's customer for breach of the underlying contract. Most often, the beneficiary will decide to sue the issuing bank, which generally is more solvent than its customer. See e.g. Atari Inc. v. Harris Trust & Sav. Bank, 599 F. Supp. 592 (N.D. 111. 1984), cited by B.V. McCullough, supra note 2, at 4-77. 5 1 UCP "General provisions and definitions"248 about the meaning of "reasonable time". It is generally considered that payment is due within 2-3 banking days after reception of conforming documents , 2 4 9 as it is a sufficient time to carefully examine the documents. In some exceptional cases and due to the complexity of the required documentation, this period may be extended. A decision of the Paris Court of Appeal has considered that a delay of 8 days was still "a reasonable time". 2 5 0 The UCP "reasonable time" has showed to be a vague concept which brings uncertainty and slow processing. Therefore the strict 3-day time period adopted by UCC § 5-114(4)(b) seems preferable. During the Iranian crisis, U.S. companies often obtained so-called "notice injunctions", requiring the bank to inform its customer about the demand of payment, and to wait an additional 3-10 days before payment , 2 5 1 like for example in the case of Stromberg-Carlson  Corporation v. Bank Melli Iran. 2 5 2 But this additional delay imposed by the U.S. courts in some Iranian cases is certainly not justified. Three banking days is indeed a sufficient time to carefully check the documentary compliance, as banks are not supposed to investigate fraud by going behind the documents.253 UCP Art. 15 provides that "[b]anks must examine all documents with reasonable care...." 2 5 4 Under UCC § 5-109(2), banks "must examine 2 4 8 UCP Art. 1-6. 2 4 9 J.C.D. Zahn, supra note 146, at 202. 2 5 0 Ibid., at 201. In the case of Bank Melli Iran v. Barclays Bank (Dominion, Colonial & Overseas), judge McNail considered that a delay of 8 days was still "reasonable". Cf. [1951] 2 Lloyd's Rep. 367. This decision must be criticized, because a documentary credit should remain a quick and reliable method of achieving payment. Cf. H.C. Gutteridge, supra note 3, at 208. 2 5 1 B.V. McCullough, supra note 2, at 5-41. 2 5 2 467,F. Supp. 530 (S.D.N.Y. 1979). The court imposed a 10 days delay before making payment. 253 Moreover, a delay of more than three days may put the bank at risk of being in default and sued for damages in a court of foreign jurisdiction. 2 5 4 The 1974 UCP Revision has introduced an additional requirement, providing that the banks also have to check that the tendered documents do the documents with care...." One cannot conclude that there is any difference between the UCP and U C C . 2 5 5 It is difficult to establish what "reasonable care" or "care" means exactly, and the courts clearly have adopted a case by case approach.256 The bank's duty is limited, as it only has to check whether the tendered documents "appear on their face" 2 5 7 to comply with the terms of the credit (UCP Art. 15). This rather liberal requirement is justified by the significant volume of credits handled daily by the banks, by the necessity of maintaining low transaction costs, and by the fact that bankers deal in documents only (UCP Art. 4). The bank only has the obligation, and in fact the ability, to formally control the compliance of the documents.258 As said by the House of Lords in United City Merchant (Investments) Ltd. and Glass Fibres  and Equipments Ltd. v. Royal Bank of Canada. Vitrorefuerzos S.A. and  Banco Continental S .A . . 2 5 9 "[t]he bank is under no duty to investigate an allegation of fraud." If the bank's customer is an important and reliable client, the bank may pay particular attention to an allegation of fraud, but the bank basically cannot do much better than very carefully checking that the tendered documents strictly comply with the terms of the credit. According to Zahn, fraud could be more often discovered if the banks adopted a stricter standard of documentary compliance.2 6 0 But in not appear on their faces to be inconsistent with one another (UCP Art. 15). See also UCP Art. 41(c) which provides that "[t]he description of the goods in the commercial invoice must correspond with the description in the credit." 2 5 5 Cf. M. Kurkela, supra note 27, at 33. 2 5 6 See H.C. Gutteridge, supra note 3, at 122, note 21. 2 5 7 Similar wording in UCC § 5-109(2). Moreover, the issuing bank is not responsible for defects in any document that is regular on its face (UCC § 5-109(2)). 2 5 8 Cf. e.g. United States of America v. Sun Bank of Miami, 609 F. 2d 832 (5th Cir. 1980). 2 5 9 [1983] 1 A.C. 168. 2 6 0 Cf. J.C.D. Zahn, supra note 146, at 161. The concept of strict compliance was adequately described in the case of Equitable Trust Co. v. Dawson Partners : "There is no room for documents which are almost the same, or which will do fact, fraud is most often not apparent on the face of the documents, and therefore a stricter standard of compliance would not allow the bank to detect fraud more often. More accurately and as suggested by Kozolchyk's study, "40 per cent or more of the presentations [of documents] would have to be rejected if a "really strict standard" [of compliance] were applied."261 Banking practice shows that it is often possible to find insignificant differences between the documents and the terms of the credit, such as synonymous terms, equivalent designations, translations, abbreviations or typing mistakes. Thus in my view, the adoption of a stricter rule of compliance would not encourage banks to detect more often fraud, but rather to reject documents more frequently because of some insignificant differences with the terms of the credit. The bank's payment against non-conforming documents constitutes a wrongful honor, whereas the bank's failure to pay against a complying documentation constitutes a wrongful dishonor.2 6 2 There are very few cases of wrongful honor 2 6 3 but quite a number of cases of wrongful dishonor,2 6 4 and McCullough has suggested that it may just as well...." 27 Lloyd's List Law Rep. 49, 52 (1927), cited by B.V. McCullough, supra note 2, at 4-27. A recent Article by McLaughlin suggests that the courts have adopted a strict standard of compliance, softened by principles derived from contract law, equity and banking customs. G.T. McLaughlin, "On the periphery of letter of credit law : Softening the rigours of strict compliance" (1989), 106 Banking Law Journal 4. 2 6 1 B. Kozolchyk, supra note 25, at 78. My own experience also confirms that if we adopted a strict and formalistic standard of compliance, about half of the payment demands could be rejected. According to a recent British survey, "60 percent of letters of credit were returned by banks when first presented because of apparent inconsistencies." Cf. Charles Batchelor's advice for small exporters, Financial Times, June 4, 1990. 262 T n e bank is in a difficult position : On the one hand it may be liable for an improper payment, and on the other hand it may be liable for an unjustified refusal to pay. See M. Kurkela, supra note 27, at 36. 2 6 3 See e.g. Anglo-South American Trust Co. v. Uhe, 261 N.Y. 150, 184 N.E. 739 (1933), cited by McCullough, supra note 2, at 3-91; American Employers Insurance Co. v. Pioneer Bank & Trust Co., 538 F. Supp. 1353 (ND 111. 1981). 2 6 4 See e.g. Bossier Bank and Trust v. Union Planters National Bank, 550 F. 2d 1077 (6th Cir. 1977); Bank of Canton, Ltd. v. Republic National Bank of New York, 636 F. 2d 30 (2d Cir. 1980). be due to the diligence of the banks. 2 6 5 That may well be a factor, but I think that it is mainly a consequence of UCC § 5-114(2)(b) and UCP Art. 17 which provide that a bank acting in good faith may pay despite notification from the customer of fraud. The bank may thus honor a demand for payment as long as it acts in good faith, and "a contrario" the bank is prevented to pay only if it has actual knowledge of a fraud which is revealed by the documents. These provisions create a situation in which the bank's risk of wrongful dishonor is indeed greater than the risk of wrongful honor, because the issuer paying in good faith is protected.266 Therefore banks generally do not take the risk of dishonoring a demand for payment when they are not totally convinced of the fraud. In a doubtful situation, the bank should suggest to its customer to seek a court injunction restraining payment under the credit. 2 6 7 In this way, the bank avoids the risk of wrongful dishonor and the risk of taking sides in a dispute about the underlying contract.268 2 6 5 B.V. McCullough, supra note 2, at 3-91. 2 6 6 Bankers should keep that in mind when they are in a doubtful situation. 2 6 7 E.P. Ellinger, supra note 14, at 210. 2 6 8 Ibid, 55 P A R T I I I  F R A U D A N D S T A N D B Y C R E D I T S CHAPTER 11  FRAUD AND COURT INJUNCTIONS If the account party wants to avoid payment under a documentary credit, he may seek a court measure enjoining the bank to pay. Such a measure will generally be a preliminary injunction, which precludes payment before the determination of the fraud issue. "The purpose of a preliminary injunction is to maintain, throughout the litigation, the relationship between the parties as it existed before the litigation."269 In various jurisdictions, other court measures such as sequestration of funds, arrest of the proceeds and attachment of the beneficiary's right are also available.2 7 0 The critical issue is to determine at which conditions a court may issue a preliminary injunction to prevent the honoring of a documentary credit. This chapter will show the problems faced by courts in analyzing the required criteria for granting an injunction. In order to obtain a preliminary injunction from a U.S. court, the plaintiff must be able to show : 2 7 1 1. Irreparable harm if the injunction is not granted. 2. A balance of hardships tipping decidedly toward the party requesting preliminary relief. 3. Likelihood of success on the merits, or sufficiently serious questions going to the merits to make them a fair ground for litigation. 2 6 9 C.I. Gable, supra note 38, at 927. 2 7 0 Report, supra note 129, at 512. 2 7 1 See e.g. Recon/Optical, Inc., v. Gov't of Israel, 816 F. 2d 854, 857 (2d Cir. 1987); Rockwell International Systems, Inc. v. Citibank, N.A. and Bank Tejarat, 719 F. 2d 583, 586 (2d Cir. 1983). Looking at the first condition, U.S. courts have well established what constitutes irreparable harm. The imminent insolvency of the credit's beneficiary is considered to be a sufficient ground to establish irreparable harm. 2 7 2 However, a showing of potential damages is not sufficient. 2 7 3 The plaintiff must also show that he has no adequate remedy at law. 2 7 4 For instance, during the Iranian crisis, the relations between the United States and Iran indicated that there was no longer adequate remedy at law to reclaim money in an Iranian court. 2 7 5 No court injunction will be granted if a satisfactory remedy at law, such as an action for damages is available.276 After showing irreparable harm, the applicant has to establish that the balance of hardship weighs in his favor. Thus the court has to consider whether the harm to the issuing bank from the issuance of an injunction outweighs the potential injury to the plaintiff if the injunction is denied. 2 7 7 Once irreparable harm is proved, courts generally consider that the balance of hardship tips decidedly toward the plaintiff. 2 7 8 Finally, the court has to assess the plaintiffs probabilities of ultimate success at final hearing. In order to succeed on the merits, the moving party must show by preponderance of evidence2 7 9 that the presented documents are forged or fraudulent, or that there is fraud in the transaction (UCC § 5-114(2)).280 An important source of divergence in the courts' response is that the proper standard of 2 7 2 See e.g. Placid Oil Co. v. United States Dept. of Interior, 491 F. Supp. 895, 905. 2 7 3 Cf. Apple Barrel Productions, Inc. v. Beard, 730 F. 2d 384, 386 (5th Cir. 1984). 2 7 4 Cf. Itek Corp. v. First Nat'l Bank of Boston, 730 F. 2d 19, 22 (1st Cir. 1984). 2 7 5 Ibid. 2 7 6 Ibid. 2 7 7 Cf. Enterprise Intern, v. Corporacion Estatal Petrolera, 762 F. 2d 464, 470 (5th Cir. 1985). 2 7 8 See e.g. Benda v. Grand Lodge of Int'l Ass'n of Machinists & Aerospace Workers, 584 F. 2d 308, 315 (9th Cir. 1978); Itek Corp. v. First Nat'l Bank, 511 F. Supp. 1341, 1351 (d. Mass. 1981), cited by B.V. McCullough, supra note 2, at 5-52. 2 7 9 B.V. McCullough, supra note 2, at 5-45. 2 8 0 Cf. Chapter 10 & 11. fraud is not clearly established. Courts have varied requirements about the degree of certainty2 8 1 and the degree of intensity2 8 2 of the alleged fraud. The courts' conflicting decisions in response to allegations of fraud is also due to the fact that it is not clear whether the concept of "fraud in the transaction" (UCC § 5-114(2)) refers to the credit transaction or extends to the underlying contract.283 In a recent article, Andrews gave a very good summary of this long-lasting "fraud in the transaction" controversy : "Although the text of section 5-114(2) does not expressly define the term "the transaction", proponents of a limited fraud defense reason that it refers only to the credit transaction. Therefore, reference to an underlying transaction would require explicit mention. In contrast, proponents of an expansive fraud defense maintain that since section 5-114(2) delineates three distinct defenses -forgery, fraud, and fraud in the transaction- "the transaction" necessarily refers to the underlying contract. Any other interpretation, they reason, would make the section redundant."284 The Sztejn case 2 8 5 is very ambiguous on this point and the legislative history of UCC Art. 5 is not conclusive.286 After some 30 years of intense debates among leading U.S. scholars, nothing has really changed, as some courts consider that fraud only refers to the credit contract, whereas other argue that fraud refers to the underlying 2 8 1 There is a large range between a suspicion of fraud and conclusive evidence, thereof: Suspicion of fraud, reasonable ground to suspect fraud, prima facie evidence of fraud, strong prima facie evidence of fraud, clear evidence of fraud and conclusive evidence of fraud. See generally, K.P. McGuiness, supra note 8, at 392-393. 2 8 2 There is also a large range between a slight fraud and an egregious fraud. 2 8 3 Cf. M.D. Andrews, "Standby Letters of Credit: Recent Limitations on the Fraud in the Transaction Defense" (1989), 35 The Wayne Law Review 119, at 141. 2 8 4 Ibid., at 126. 2 8 5 Cf. Supra note 235. 2 8 6 M.D. Andrews, supra note 283, at 126-127. 59 transaction. 2 8 7 In two recent cases, Enterprise International. Inc. v.  Corporacion Estatal Petrolera Ecuatoriana 2 8 8 and Foxboro Co. v.  Arabian American Oil C o . . 2 8 9 U.S. courts have adopted a narrow reading of the fraud defense that is limited to the credit transaction.2 9 0 But in the case of Airline Reporting Corp. v. First Nat.  B a n k . 2 9 1 the court considered that fraud in the underlying contract may be used as part of the fraud exception. In Recon/Optical. Inc. v.  Government of Israel 2 9 2 and Rockwell International Systems. Inc. v.  Citibank. N . A . . 2 9 3 the Second Circuit clearly looked for fraud in the underlying transaction, as the court discussed the performance of the underlying contract. 2 9 4 The same kind of legal uncertainty also exists under the UCP, because there is nothing in the rules about the scope of the judicial scrutiny in case of alleged fraud. In Canada, the British Columbia Supreme Court in Henderson v. Canadian Imperial Bank of Commerce.2 9 5 then the Supreme Court of Canada in Bank of Nova Scotia v. Angelica- Whitewear L t d . . 2 9 6 have adopted the liberal approach to the fraud issue, arguing that fraud in the underlying transaction is within the scope of the fraud exception. German and Swiss courts have also 2 8 7 Unlike most commentators, I wish to avoid using the Iranian cases in the discussion of the fraud issue, because I think that they involve extraordinary times and a very particular situation. The Iranian cases' controversy was mainly an issue of international public law with strong political connotations: The U.S. court decisions have been very different before and after the seizure of the American hostages in Iran. 2 8 8 Supra note 277. 2 8 9 805 F. 2d 34 (1st Cir. 1986). 2 9 0 Cf. M.D. Andrews, supra note 283, at 142. 2 9 1 832 F. 2d 823 (4th. Cir. 1987). Same approach in Baker v. National Boulevard Bank, 399 F. Supp. 1021 N.D. 111. 1975. 2 9 2 816 F. 2d 854 (2d Cir. 1987). 2 9 3 719 F. 2d 583 (2d Cir. 1983). 2 9 4 Supra note 292, at 857-858; Supra note 293, at 589. 2 9 5 (1982), 40 B.C.L.R. 318, B.C.S.C., cited by T.L. McDorman, "International Letters of Credit: Fraud, Documentary Compliance and the Supreme Court of Canada - Bank of Nova Scotia v. Angelica-Whitewear Ltd." (1988), 2 Review of International Business Law 253, at 257. 2 9 6 [1987] 1 S.C.R. 59 (S.C.C), cited by T.L. McDorman, supra note 295, at 253. defined the fraud defense to include fraud in the underlying contract. 2 9 7 But in the U.K., the concept of "fraud in the transaction" has not been recognized by the courts2 9 8 and therefore the exception of fraud is only available if there is fraud in the credit contract. The fraud exception has been recognized in all jurisdictions, but its scope of application differs from place to place in various respects. 2 9 9 The challenge faced by the courts is to combine two principles inherently at odds, which are the rule of independence and the exception of fraud. 3 0 0 The result depends on which policy consideration courts place more weight on. Harfield is well-known for his narrow reading of the fraud exception : "There are, and there will continue to be, cases in which judicial intervention in the performance of a letter of credit is justified. There are cases which combine egregious fraud, discovered before the issuer or confirmer has paid, when there is no remedy at law, and when the rights of no innocent parties are prejudiced."301 A narrowly defined standard of fraud keeps the rule of independence alive, but makes the exception of fraud without real scope of application. Therefore a majority of courts and commentators seem to prefer a liberal view of the fraud exception : "A more liberal approach to the effect of fraud would be more compatible with equitable principles available in contract law generally, would more correctly reflect the increasing knowledge and consequent responsibilities of businessmen and their bankers, and would permit the law to respond flexibly to varying circumstances in 2 9 7 For Germany, see generally J .CD. Zahn, supra note 146, at 226-235, and the court decisions cited by D.H. Mahler, supra note 51, at 78-79. See also, F.W. von Marshall, supra note 30, at 279. For Switzerland, see generally D. Guggenheim, supra note 173, at 189-198, and the Federal Court Decisions 96 III 107 and 82 III 63. 2 9 8 Cf. H . C Gutteridge, supra note 3, at 183. 2 9 9 Cf. Report, supra note 129, at 511-512. 3 0 0 As pointed out by the court in the case of Rockwell International Systems, Inc. v. Citibank, N.A., no bright line separates the rule of independence from the exception of fraud. 719 F. 2d 583, 588 (2d Cir. 1983). 3 0 1 H. Harfield, "Enjoining Letter of Credit Transactions" (1978), 95 Banking Law Journal 596, at 614-615. 61 particular cases."302 A liberal approach to the effect of fraud creates a broad or elastic standard of fraud based on the courts' case by case analysis, weakening thus the principle of independence. When dealing with the effects of fraud, courts do not really make any difference between cases involving letters of credit, "documentary" standby credits or "simple statement" standby credits. The Recon case, 3 0 3 for example, involves a "simple statement" standby credit. The court first describes the device as a standby credit, 3 0 4 but then considers the device as a letter of credit when discussing the issue of fraud. 3 0 5 American, Canadian and English courts have consistently held that the fraud exception, which has been developed in the context of commercial letters of credit, 3 0 6 should find a similar application in cases of "simple statement" and "documentary" standby credits. 3 0 7 At first sight, this conclusion is logical because these three financing devices are governed by the same bodies of rules (UCP or UCC). However and as pointed out in Part I of this paper, there are important differences between a letter of credit, a "simple statement" standby credit and a "documentary" standby credit. Thus, it is doubtful if it is legitimate to take the reasoning made in regard to fraud situations involving letters of credit and transpose it into the field of standby credits. 3 0 8 The next chapters will show that if we take into consideration the legal nature, purpose and risks of "simple statement" and "documentary" standby credits, the fraud exception appears to be justifiable for "documentary" standby credits, but not for "simple statement" standby credits. 3 0 2 S.H. van Houten, "Letters of Credit and Fraud : A Revisionist View" (1984), 62 Canadian Bar Review, 372, at 372. 3 0 3 Cf. supra note 287. 3 0 4 Ibid., at 855. Same reasoning adopted by the court in the Rockwell case, cf. supra note 288, at 586-589. 3 0 5 Cf. supra note 292, at 857-858. 3 0 6 Cf. Chapter 10 & 11. 3 0 7 Cf. e.g. cases mentioned by I.F.G. Baxter, International Banking and Finance, 1989, 53, note 22. 3 0 8 Ibid., at 34. CHAPTER 12 RISKS AND "SIMPLE STATEMENT" STANDBY CREDITS In standby credits transactions, it is important to determine exactly what the risks involved are, and how these risks are allocated between the parties. During the last ten years, there has been a significant increase in the number of cases involving fraud, and fraud now clearly constitutes the main source of risk for the parties to the transaction. 3 0 9 The potential risk of fraud involved is different in a "simple statement" standby credit and in a "documentary" standby credit. In the case of a "simple statement" standby credit, the beneficiary is in a strong position, as he may obtain payment by presenting a statement of default, most often drawn up by himself. The beneficiary of a "simple statement" standby credit is actually in the same favorable situation as the beneficiary under a first demand bank guarantee. Therefore, the beneficiary can possibly profit from his position and abuse his rights by wrongfully calling under the credit. Practice shows that most cases of abuse involve beneficiaries of developing countries, who call for payment by inexperience or in an attempt to safeguard their position. 3 1 0 In any first demand guarantee technique, the issuing bank's obligation of payment is unconditional, and therefore there is an inherent risk that the beneficiary may call wrongfully for payment. 3 1 1 Thus a "simple 3 0 9 Cf. E.P. Ellinger, supra note 68, at 185. 3 1 0 According to a 1980 German study, only 0.1% of the guarantee instruments issued by German banks are subject to litigation due to possible abuse. Cf. F. Graf von Westphalen, Die Bankgarantie im internationalen Handelsverkehr, 1982, 155, cited by J. Dohm, supra note 36, at 184. 3 1 1 As pointed out by von Marshall, "the 'first demand' undertaking necessarily involves the risk for the principal that a demand may turn out to be unjustified." F.W. von Marshall, supra note 30, at 269. statement" standby credit appears to be some kind of a blank cheque that puts the account party at the beneficiary's mercy. 3 1 2 According to Gable, "[fundamental theory demonstrates that application of the doctrine of independent contracts [the independence rule] is justified for commercial letters of credit because rapid consummation of the underlying commercial transactions would otherwise be frustrated. That rationale is obviously innapplicable to demands under... standby letters of credit, because in such cases the underlying commercial transactions have, by definition, already been frustrated;..." 3 1 3 A majority of commentators has argued that because the risks of abuse are greater in a guarantee technique than in a payment technique, there should be an increased protection of the account party in case of standby credits. In other words, as the risks of fraud and abuse are greater in standby credits than in letters of credit, the scope of the fraud exception should be broader under standby credits. 3 1 4 At first sight this kind of proposal may appear to be logical, but in fact it fails to take into account the numerous consequences of a violation of the independence rule in a guarantee technique like such as the "simple statement" standby credit : 1. The adoption by the court of a broad scope of fraud exception destroys the predictability of the "simple statement" standby credit mechanism. One of the great attractions of this type of standby credit is that the beneficiary knows for sure that he will be paid by the bank, whatever happens between himself and the 3 1 2 It is argued that a strict application of the independence rule in "simple statement" standby credits creates unfair situations, in which the account party eventually has to suffer a loss. 3 1 3 C.I. Gable, supra note 38, at 944. 3 1 4 See e.g. C.I. Gable, supra note 38, at 944-945; Note, "Fraud in the Transaction : Enjoining Letters of Credit During the Iranian Revolution" (1980), 93 Harvard Law Review 992, at 1014-1015; Comment, "Enjoining the International Standby Letter of Credit : The Iranian Letter of Credit Cases" (1980), 21 Harvard International Law Journal, 189, at 204-208. 64 bank's customer. The fact that the beneficiary may call "on demand" and without any justification for payment gives first demand instruments their great attraction and utility in international commercial transactions. For a guarantee technique such as the standby credit, an essential and indispensable feature is its certainty and predictability. 2. The frequent granting of court injunctions restraining payment under "simple statement" standby credits creates a situation in which it is no longer possible to establish which party bears the risks involved in the transaction. As it is not possible to determine for sure when a court will intervene and break the independence rule, the initial allocation of risks between parties is no longer clear. 3 1 5 It should not be up to a court to shift the risks involved in the transaction from one party to the other. 3. As pointed out by Stein 3 1 6 and von Marschall, 3 1 7 a standby credit (in fact a "simple statement" standby) has an analogous function to the cash deposit.318 In the case of a cash deposit, the beneficiary may take possession of the fund "on demand" and there is nothing the account party can do to prevent him from doing so. The system of cash deposit as a security device may be best described as a "pay first - litigate later" kind of mechanism. The cash deposit involves a permanent and costly immobilization of cash, and that constitutes a serious disadvantage for business entities, especially in a period of high cost capital. The great advantage of a "simple statement" standby credit is that the account party keeps its fund until payment is called under the 3 1 5 Cf. M. Stern, supra note 113, at 238. This argument has also been put forward by the courts. See e.g. Colorado Nat'l Bank v. Board of County Comm'rs, 634 P. 2d 32 (Colo. 1981), cited by M. Stem, supra note 113, at 225, note 41. 3 1 6 Cf. M. Stern, supra note 113, at 226. 3 1 7 Cf. F.W. von Marschall, supra note 30, at 280-281. 3 1 8 For an example of a standby credit used instead of a cash deposit, see Dade Nat'l Dev. Corp. v. Southeast Invs. of Palm Beach County Inc., 471 So. 2d 113 (Fla. Dist. Ct. App. 1985). credit. By adopting an historic perspective, we can clearly see that first demand instruments like the "simple statement" standby or the first demand bank guarantee have almost totally replaced the cash deposit and the down payment. 3 1 9 Thus a violation of the independence principle is incompatible with the basic function of cash deposit fulfilled by "simple statement" standby credits. 4. As mentioned in the first part of this paper, "simple statement" standby credits are frequently used in a two step guarantee technique. If the second bank honors the beneficiary's demand for payment under the second standby, the bank should always be allowed to collect payment under the first standby in order to be reimbursed. Any court intervention seems unacceptable, as it could destroy the useful mechanism of the "indirect" standby credit. 5. Courts' injunctions restraining payment under "simple statement" standby credits have important implications for the banks . 3 2 0 A bank prohibited from paying often faces a loss of credibility in the commercial world, a competitive disadvantage vis-a-vis the other banks, 3 2 1 as well as a risk of economic sanctions from the beneficiary's country. Two recent Swiss cases cited by D o h m , 3 2 2 clearly show that these economic consequences should not be underestimated. In the first case, a Geneva based Swiss bank had issued a first demand bank guarantee securing a second bank guarantee issued by a 3 1 9 Cf. J. Dohm, supra note 36, at 30. For an example of a standby credit used as a down payment, see FSLIC v. Sandor, 684 F. Supp. 403 (D.V.I. 1988). 3 2 0 Contra, E.P. Ellinger, "Fraud in Documentary Credit Transactions" (1981), Journal of Business Law 258, at 265. 3 2 1 Especially vis-a-vis the banks located in a jurisdiction in which there is no granting of court injunction restraining payment. 3 2 2 Cf. J. Dohm, supra note 36, at 187-188. correspondent bank located in Saudi A r a b i a . 3 2 3 Following the account party's allegation of fraud, the High Court of Geneva granted an injunction restraining payment under the bank guarantee. Since that day and according to D o h m , 3 2 4 the bank is on a black list in Saudi Arabia and has been excluded from business activities with this country for more than three years. The other case involves a similar first demand bank guarantee issued by a Geneva based American bank in favor of a Syrian bank. Following an injunction granted by the High Court of Geneva, this American bank, and not just the Geneva branch, has been subject to intense pressures from Syria for a significant period of t i m e . 3 2 5 Moreover, as a consequence of a court injunction, the bank may be liable for wrongful dishonor in the foreign jur isdic t ion, 3 2 6 and face a possible confiscation of its assets located in the beneficiary's jurisdiction. Faced with these serious potential risks, banks have to choose between two different policies : The first is to increase the fees charged for the issuance of first demand bank guarantees or "simple statement" standby credits in order to cover the political and commercial risks involved. Higher fees charged by the banks would increase the overall cost of the transaction and make standby letters of credit less attractive as a financing device. The second solution for the banks is simply to refuse to issue first demand instruments in favor of "high risk" beneficiaries. 3 2 7 This policy means that banks will consider the commercial standing of the beneficiary as well as the potential political risks in his country. As a result, the exporters could have more difficulties in 3 2 3 This is typically a two step guarantee technique similar to the indirect standby credit. Cf. Chapter 3. 3 2 4 J. Dohm is a leading banking lawyer practicing in Switzerland and was most probably the bank's legal adviser in the reported case. 3 2 5 Cf. J. Dohm, supra note 36, at 187-188. 3 2 6 See Chapter 10. 3 2 7 As a matter of fact, some banks already have adopted such a policy. finding a bank willing to finance a transaction with a beneficiary located in a developing or politically unstable country. 6. A court injunction restraining payment under a credit has not only consequences for the bank's commercial standing, but also for the account party's long range business reputation. Thus an injunction may prejudice the account party for future business deals . 3 2 8 7. Because standby credits are simple, practical, low-cost and adaptable devices, they constitute a very advantageous substitute for ordinary guarantees in all kinds of commercial transactions.3 2 9 As pointed out by Becker, a violation of the rule of independence in standby credits transactions will "drive creditors back to twenty-pages guarantees containing elaborate clauses by which the guarantor waives all the defenses of his principal." 3 3 0 A strict application of the independence rule in "simple statement" standby credits enhances the commercial utility of the device and brings advantages for all the parties : The banks are not involved in litigation, and have no difficulty in assessing the risks of the transaction. The account party is better off than if he had advanced cash to the beneficiary, 3 3 1 and he takes advantage of low commission fees resulting from a strict independence rule. The beneficiary is sure to be paid, as he may call for payment without any justification. Moreover, "[t]he reduction in the cost of the standby letter of credit may in turn be passed on to [the] [bjeneficiary through a reduction in the price of the underlying contract."332 Thus 3 2 8 Cf. Foxboro Co. v. Arabian Am. Oil Co., 805 F. 2d 34, 37 (1st Cir. 1986). 3 2 9 J.D. Becker, supra note 204, at 339. 3 3 0 Ibid., at 347. 3 3 1 Cf. D.G. Baird, "Standby Letters of Credit in Bankruptcy" (1982), 49 University of Chicago Law Review 130, at 134. 3 3 2 M. Stern, supra note 113, at 235. if we take into account the risks, the mechanism, the commercial utility and the purpose of "simple statement" standby credits, any court intervention seems unacceptable. Therefore the fraud exception, which is recognized by the UCP and the UCC, is not adapted to the nature and purpose of a first demand guarantee technique such as the "simple statement" standby credit. As a consequence of a strict application of the independence rule, we may have to face a few cases of fraud or abuse in transactions involving "simple statement" standby credits. 3 3 3 But after all, the parties should know what they are doing and whether a standby credit with its risks constitutes the appropriate financing device. As said by Lane L.J. in the case of Edward Owen Engineering Ltd. v.  Barclays Bank International Ltd.. the sellers must be aware of the dangers involved in an unconditional guarantee technique. 3 3 4 Therefore if the account party agrees to minimal documentary requirements, it has to assume the inherent risks involved in this kind of transaction. In response to the risks involved in "simple statement" standby credits, the account party may request that the statement of default, which is the only required document for payment, be made by a third party . 3 3 5 If the third party is reliable, independent and neutral, it certainly reduces the potential risk of unjustified or fraudulent demand of payment, and therefore this solution should always be recommended.336 The parties' bargaining power and the market conditions are likely to determine whether the credit will be 3 3 3 As mentioned earlier, there is apparently only a low percentage of unfair calls under standby credits, and there are very few cases where the account party is unable to litigate in a foreign jurisdiction in order to recover the amount unfairly paid to the beneficiary. 3 3 4 [1978] Q.B. 159, 164 Lloyd's Rep. 3 3 5 See e.g. E.P. Ellinger, supra note 68, at 640; G.T. McLaughlin "Structuring Commercial Letter of Credit Transactions to Safeguard the Interests of the Buyer" (1989), 4 Uniform Commercial Code Law Journal 318, at 318-319. 3 3 6 It is important to indicate precisely the identity of the person who is to provide the certificate of default. payable against the beneficiary's "simple statement" or against a third party's certificate of default. Practice shows that beneficiaries of standby credits are generally not ready to accept the intervention of a third party in the transaction, because they do not want to see their position weakened. Another strategy is to insure the standby credit transaction against the risk of a fraudulent or wrongful call. The private sector provides such a coverage, but the premium cost may be high in the case of a "simple statement" standby credit, as the risks involved are substantial. Most countries have programs of "government export assistance" available to exporters, covering "inter alia" the risk of fraud in documentary credit operations.337 The availability of the export assistance is subject to a certain number of conditions, thus it would be unrealistic to assume that a free coverage is always available. Irrespective of whether the coverage is provided by the private or public sector, this solution increases the overall cost of the transaction. From the banker's perspective, the main concern is not so much the risk of fraud involved in standby credits transactions, but rather the risk of customer's insolvency. A bank paying in good faith against conforming documents keeps its right to be reimbursed, even if it is later established that the documents were in fact forged or fraudulent . 3 3 8 Thus the bank passes the risks of fraud and the commercial risks on to its customer. The smooth functioning of the credit mechanism implies that the bank is able to execute its payment obligation under the credit, and that the customer is able to 3 3 7 See generally E.H. Brau, C. Puckahtikom, Export Credit Cover Policies and Payment Difficulties, 1985. In Canada, this type of service is offered by the Export Development Corporation (EDC), which is a crown corporation; all provinces have their own services to assist the resident exporters. Cf. J.G. Castel et al., supra note 1, at 371, 381. 3 3 8 Cf. F.W. von Marschall, supra note 30, at 275-276. reimburse the bank. 3 3 9 In the case of a "simple statement" standby credit, the bank has no security to cover its commercial risk, because it has no possession of a document of title such as a negotiable bill of lading or airway b i l l . 3 4 0 Therefore, from a commercial standpoint, a "simple statement" standby is the equivalent of a loan because the beneficiary may dispose of the funds simply by calling under the credit. In the event of the customer's insolvency, the bank could be unable to obtain reimbursement, unless it holds sufficient collateral. Therefore the careful banker should assess its customer's commercial trustworthiness before issuing a "simple statement" standby credit, because the operation is not "self liquidating". 341 3 3 9 Practice shows that the credit beneficiary may have to face the bank's insolvency. This question and its complex consequences are not discussed in this paper. See generally D.G. Baird, supra note 331. 3 4 0 In other words, the underlying contract does not provide any collateral for the issuing bank. . 3 4 1 The term "self liquidating" is often used by bankers and means that the credit may be repaid out of the proceeds of the underlying sale contract. However, if the goods are damaged or devalued, the proceeds of sale will not be sufficient to repay the total amount of the credit. CHAPTER 13 RISKS AND "DOCUMENTARY" STANDBY CREDITS A "documentary" standby credit has indeed a complex legal nature, as it has some features of the traditional letter of credit and some of the "simple statement" standby credit : Like a letter of credit, a "documentary" standby is payable against presentation of several documents drawn up by third parties. Like a "simple statement" standby, payment under a "documentary" standby generally requires a statement by the beneficiary about the principal's default. Due to the complex nature of this device, it is quite difficult to assess the potential risk of fraud involved, because the risk varies depending on the specific conditions of the credit. Like in a letter of credit transaction, there is a risk of fraud in the documents, but this risk is relatively low, as the documents are generally drawn up by independent third parties. 3 4 2 The beneficiary's declaration stating that the account party has defaulted, which characterizes standby credits, involves a much greater risk of fraud, as the document is drawn up solely by the beneficiary. Therefore and generally speaking, a "documentary" standby credit involves a lower risk of abuse than a "simple statement" standby credit because it requires a greater number of supporting documents.343 But the device involves a greater potential risk of fraud than a traditional letter of credit, and parties should always keep that in mind when they decide to use a "documentary" standby credit as a substitute for a letter of credit. 3 4 4 3 4 2 But the risks of fraud are still existent. The modern transmittal of documents and the issuance of electronic documentation have generated new and sophisticated risks of fraud. See generally B. Kozolchyk, "Is Present Letter of Credit Law up to Its Task?" (1986), 8 George Mason University Law Review 285, at 287-303. 3 4 3 As suggested by Kee, "the smaller the number of supporting documents stipulated, the higher is the risk level assumed by the account party." H.P. Kee, supra note 13, at 248. 3 4 4 Cf. Chapter 4. A "documentary" standby credit is basically a guarantee technique, 3 4 5 and therefore at first sight, the fraud exception seems to be as much questionable as it is in the case of a "simple statement" standby credit. But such a quick conclusion does not take into account the important existing differences between the two devices. Under a "documentary" standby credit, payment requires the presentation of a statement of default and additional supporting documents which prevent the beneficiary from drawing under the credit before having fulfilled a number of obligations. The additional credit conditions agreed upon reflect the parties' intention and indicate that the parties have not chosen a "blank cheque" or first demand type of financing device. 3 4 6 According to Graham and Geva, the language of a credit is not always a reliable indicator of the parties' intention, because the letter of credit often is a standard form imposed by the issuing bank. 3 4 7 It is correct that banks do indeed use standard forms for their business of letters of credit and standby credits. Nevertheless, these standard forms are incomplete and it is up to the applicant to fill the form and to mention the suited conditions of payment, as agreed upon by the parties in their underlying contract.348 In fact, practice and case law clearly show that parties do indeed select the terms of their credits, and that explains why it is almost impossible to find two credits that contain the same conditions. Then Graham and Geva suggest that "[t]he parties' intention should perhaps be determined primarily on the basis of underlying agreement and the business function that the standby credit fulfils in the context."3 4 9 A reference to the 345 T n e credit generally secures the performance of an underlying obligation. See Chapter 4. 3 4 6 As said in the case of Wichita Eagle and Beacon Publishing Company, Inc., v. Pacific National Bank of San Francisco, "the relevant intent is manifested by the terms of the agreement,..." 493 F. 2d 1285, 1286 (9th Cir. 1974). 3 4 7 Cf. G.B. Graham, B. Geva, supra note 44, at 207. 3 4 8 For an illustration of the standard forms used by most international banks, see the "Irrevocable Standby letter of credit" of Bank of Nova Scotia, with Accompanying Agreement, printed in J.G. Castel et al., supra note 1, at 697. 3 4 9 G.B. Graham, B. Geva, supra note 44, at 207. underlying agreement in order to determine the parties' intention is not acceptable because such an approach is in violation of the independence principle. 3 5 0 Referring to the business function of the credit is not more appropriate, as it neglects the legal nature of the device and the credit conditions selected by the parties. As long as there is no ambiguity in the credit contract,351 courts should give effect to the parties' intent as expressed by the terms of the credi t . 3 5 2 A "documentary" standby credit is a device meant to prevent the beneficiary from being paid before he has fulfilled the conditions set by the credit. Under a "documentary" standby credit, and very much like under a commercial letter of credit, payment constitutes in fact a counterpart for the execution of a number of obligations represented by the required documentation. The greater the number of supporting documents required, the higher should be the protection for the account party. The documentary requirements preclude the beneficiary from making a discretionary demand for payment. 3 5 3 Thus in the case of a documentary device, the fraud exception defense does not deprive the beneficiary of a benefit for which he bargained. Rather, the fraud exception recognizes the unfairness of allowing a beneficiary to be paid under circumstances showing that he acted fraudulently to fulfill the conditions set by the credit. 3 5 4 If the account party is able to establish fraud before payment with a sufficient degree of certainty, there is enough reason to authorize a court to enjoin payment on a "documentary" standby credit, because the independence rule should not protect unscrupulous beneficiaries. 3 5 5 3 5 0 In a letter of credit transaction, parties deal in documents (UCP Art. 4). 3 5 1 Any ambiguity in the credit must be resolved by application of the traditional methods of interpretation for contracts. See e.g. Venizelos, S.A. v. Chase Manhattan Bank, 425 F. 2d 461 (2d Cir. 1970). 3 5 2 Cf. B.V. McCullough, supra note 2, at 2-41. 3 5 3 G. Graham, B. Geva, supra note 44, at 209. 3 5 4 Cf. Itek Corp. v. First Nat. Bank of Boston, 730 F. 2d 19, 24 (1st Cir. 1984). 3 5 5 177 Misc 719, 31 N.Y.S. 2d. 631 (Sup. Ct. 1941). Looking at the situation of the issuing bank, its commercial risk level assumed in a "documentary" standby credit directly depends on the documentation which is required by the terms of the credit. If the credit calls for a negotiable bill of lading or air waybill, then the bank has a security interest in the goods involved in the transaction.356 In such a case, the risk assumed by the bank is exactly the same as in a traditional letter of credit, and the transaction may be described as "self liquidating",357 because the credit is collateralized by documents of title. If the bank has no security interest in the goods, then the risk level assumed by the bank is the same as in the case of a "simple statement" standby credit 3 5 8 3 5 6 Cf. D.G. Baird, supra note 326, at 134. 3 5 7 Cf. supra note 341. 3 5 8 Cf. Chapter 12. 7 5 P A R T I V C O N C L U S I O N CHAPTER 14  PROPOSALS FOR LEGISLATIVE CHANGES As suggested earlier, the banks should have the obligation to inform their customers about a demand of payment under "simple statement" and "documentary" standby credits. In my opinion, there is a legal basis for such an "obligation to inform" in both UCP and U C C , 3 5 9 but this is clearly not the courts' view in the different jurisdictions considered. Therefore an amendment to the UCP and UCC appears necessary in order to modify the existing practice and to impose a duty of information on the bank. Such an amendment would be easily realizable, as it constitutes a purely technical matter which is typically within the UCP and UCC scope. As stated before,3 6 0 the fraud exception should be applied in cases involving letters of credit and "documentary" standby credits, but not in cases involving "simple statement" standby credits. Is such an approach possible under the UCC and UCP? The UCC provisions dealing with the fraud question are of a liberal nature,3 6 1 and there is certainly room for interpretation. Nevertheless, the fraud exception is stated in UCC § 5-114 and courts have consistently held that the exception applies to all types of letters of credit, including standby credits. Thus the realization of my proposal would require an amendment providing that the fraud exception is not applicable in situations involving a first demand guarantee technique such as the "simple statement" standby credit. More precisely, a provision should state that no objections other than those following the credit conditions may be raised to the payment of a "simple statement" standby credit. As a result, objections relating to the underlying 3 5 9 Cf. Chapter 7. 3 6 0 See Chapter 12 & 13. 3 6 1 See especially UCP Art. 15. 7 7 contract would no longer legitimate a court injunction restraining payment under this type of credit. A similar amendment could be adopted in the UCP, but its effectiveness may be more limited. 3 6 2 At this point, it is important to keep in mind that the UCP has not force of law. 3 6 3 Therefore and as mentioned by UNCITRAL in its 1988 Report of the Secretary General, the problem of fraud cannot be completely dealt with by contractual rules or uniform rules. 3 6 4 Even if the UCP has a great impact on letters of credit law and commercial practices, 3 6 5 the final recognition of UCP provisions dealing with the exception of fraud will depend on their acceptance by the law of the land. 3 6 6 Despite the proposed amendment, court measures blocking payment may therefore still be available based on mandatory national rules. If a standby credit is backing illegal or immoral transactions, public policy may be a ground for an exception to the independence rule. 3 6 7 But the exception of public policy has an extremely narrow scope of application and is therefore unlikely to threaten the commercial utility of the device. 3 6 2 As mentioned before, the concept of fraud remains subject to mandatory law in most jurisdictions. Moreover, the availability of injunctive relief depends on the particular requirements of the procedural law. Cf. Report, supra note 129, at 512. 3 6 3 See Chapter 6. 3 6 4 Report, supra note 129, at 512. Only a uniform law could possibly produce a complete unification of the law. One should not underestimate the difficulties of agreeing, at the international level, on the scope of the fraud exception and the availability of injunctive relief. Ibid. 3 6 5 P.J. Davidson, "The UCP and the Need for Amendment in the light of Technological Advances" in : Current Problems Of International Trade Financing", 1983, 38, at 44. The UCP has created a remarkable legal uniformity in some areas of letters of credit law. 3 6 6 Cf. Report, supra note 129, at 512. 3 6 7 In the case of United City Merchants (Investments) Ltd. et al. v. Royal Bank of Canada, [1979] 2 Lloyd's Rep. 498, the court ruled that the issuer was not obliged to pay under a credit securing illegal monetary operations. (The transaction was in contravention of the Peruvian exchange control regulations). CHAPTER 15 CONCLUSION According to Ventris, standby credits are guaranties that have nothing in common with letters of credit. 3 6 8 The author then concludes that standby credits should not be governed by the U C P . 3 6 9 But Ventris does not tell us where to find the appropriate r u l e s 3 7 0 for the billions of standby credits outstanding in the w o r l d . 3 7 1 UCP Art. 1 to 21 are technical rules which are mainly dealing with the mechanism of the credit. 3 7 2 As letters of credit, "simple statement" standby credits and "documentary" standby credits involve a similar type of credit mechanism, most provisions of the UCP are adapted to these three devices.373 Therefore we have to recognize that the UCP rules, supplemented by case law, provide a sound legal scheme for letters of credit and standby credits. 3 7 4 3 6 8 F .M. Ventris, supra note 150, in Supplement, at 1. As shown in Chapter 9, standby credits are not guaranties. However, it is true that the use of nondocumentary credit conditions may blur the essential distinctions between standby credits and guaranties. Therefore, as a sound banking practice, bankers should refrain from issuing credits with conditions referring to a factual situation or to the underlying transaction. 3 6 9 Ibid. 3 7 0 According to Ventris, bank guarantees should be used instead of standby credits. Cf. supra note 150, in Supplement, at 44. This proposal is not very helpful because in some jurisdictions, as in the U.S. and Japan, banks are not allowed to issue bank guarantees. Moreover, the use of bank guarantees in international trade often creates complex conflict of law problems, because there is no international body of rules dealing with bank guarantees. 3 7 1 According to a 1986 official statistic, there were over US$ 250 billion of standby credits outstanding in the U.S. Cf. G.T. McLaughlin, "On the Periphery of Letter-of-Credit Law : Softening the rigors of strict compliance" (1989), 106 Banking Law Journal 3, at 4. 3 7 2 Other important issues, such as conflicts of laws, the conditions of contract validity, the consequence of a bankrupt issuer are not covered by the UCP. Therefore the missing answers have to be found by reference to the national laws. 3 7 3 UCP Art. 22 to 53 dealing with transport documents, insurance documents and commercial invoices exclusively apply to documentary devices, such as letters of credit and "documentary" standby credits. But these provisions do not make sense for "simple statement" standby credits. 3 7 4 Cf. Report, supra note 103, at 1532. Nevertheless, the UCP rules need adjustments taking into account the differences between letters of credit, "documentary" standby credits and "simple statement" standby credits. Under both "documentary" and "simple statement" standby credits, payment is not the expected consequence of the transaction, but indeed the exception.375 Banks should therefore have a duty to inform their customers about a demand for payment before to make payment to the beneficiary. A "documentary" standby credit is meant to preclude the beneficiary from being paid before he has fulfilled the documentary requirements set by the credit. The fraud exception should be applied in the case of a "documentary" standby credit, because the exception recognizes the unfairness of allowing the beneficiary to be paid under circumstances showing that he acted fraudulently to fulfill the credit conditions. A "simple statement" standby credit, on the other hand, is a first demand guarantee technique. The fact that the beneficiary may call for payment without justification gives a first demand instrument its commercial utility. Any court intervention in this kind of transaction would destroy the predictability, certainty and utility of the device. Therefore the fraud exception should not be applied in transactions involving "simple statement" standby credits. "Simple statement" standby credits are useful and adaptable devices, but they involve the risk of wrongful calling of "first demand" instruments. Case law shows that "simple statement" standby credits are mainly used by large multinational corporations as a security device in construction contracts, works contracts and oil trade contracts. 3 7 6 These corporations are advised by competent legal counsel, thus one may reasonably assume that they understand what 3 7 5 Because payment occurs only in case of the account party's default or nonperformance. 3 7 6 "Simple statement" standby credits are mainly used by sophisticated investors in situations involving complex factual settings. Parties using letters of credit and "documentary" standby credits are generally not as sophisticated as those using "simple statement" standby credits. they are do ing . 3 7 7 As said by the court in American Bell  International. Inc. v. The Islamic Republic of Iran. "Bell, a sophisticated multinational enterprise well advised by competent counsel; entered into these arrangements with its corporate eyes open." 3 7 8 Thus it is up to the parties, especially the issuing bank and its customer, to decide whether a standby credit with its inherent risks is suited for a given transaction. If the account party wants to have control over the underlying transaction and to have a right to refuse payment, a secondary type of instrument like the performance bond is more appropriate. If the account party agrees to minimal documentary requirements, he has to assume the risk that the beneficiary may make an unjustified call for payment. 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