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Applicability of the independence principle and fraud exception rule in letters of credit.
What the LoC is NOT:
- The relationship between the beneficiary and the issuer of a letter of credit is not strictly
contractual, because both privity and a meeting of the minds are lacking, yet strict
compliance with its terms is an enforceable right.
- Nor is it a third-party beneficiary contract, because the issuer must honor drafts drawn
against a letter regardless of problems subsequently arising in the underlying contract.
- Since the banks customer cannot draw on the letter, it does not function as an assignment
by the customer to the beneficiary.
- Nor, if properly used, is it a contract of suretyship or guarantee, because it entails a primary
liability following a default.
- Finally, it is not in itself a negotiable instrument, because it is not payable to order or bearer
and is generally conditional, yet the draft presented under it is often negotiable.
Standby Credits - However, credits are also used in non-sale settings where they serve to
reduce the risk of nonperformance. Generally, credits in the non-sale settings have come to be
known as standby credits
1. Payment:
a. Commercial credits involve the payment of money under a contract of sale.
2. Standby type, the credit is payable upon certification of a party's nonperformance of the
agreement.
4. Beneficiary:
a. Commercial credit must demonstrate by documents that he has performed his contract.
b. standby credit must certify that his obligor has not performed the contract
Definition: a letter of credit is a written instrument whereby the writer requests or authorizes
the addressee to pay money or deliver goods to a third person and assumes responsibility for
payment of debt therefor to the addressee
Change of nature: A letter of credit, however, changes its nature as different transactions occur
and if carried through to completion ends up as a binding contract between the issuing and
honoring banks without any regard or relation to the underlying contract or disputes between
the parties thereto.
Mode of international trade transaction: Since letters of credit have gained general
acceptability in international trade transactions, the ICC has published from time to time
updates on the Uniform Customs and Practice (UCP) for Documentary Credits to standardize
practices in the letter of credit area. the observance of the UCP is justified by Article 2 of the
Code of Commerce which provides that in the absence of any particular provision in the Code of
Commerce, commercial transactions shall be governed by usages and customs generally
observed.
In both cases the payment may be enjoined if in the light of the purpose of the credit the
payment of the credit would constitute fraudulent abuse of the credit
Effect of when credit is stipulated as irrevocable, there is a definite undertaking by the issuing
bank to pay the beneficiary provided that the stipulated documents are presented and the
conditions of the credit are complied with.[41] Precisely, the independence principle liberates the
issuing bank from the duty of ascertaining compliance by the parties in the main contract. As the
principles nomenclature clearly suggests, the obligation under the letter of credit is independent
of the related and originating contract. In brief, the letter of credit is separate and distinct from
the underlying transaction.
While it is the bank which is bound to honor the credit, it is the beneficiary who has the right to
ask the bank to honor the credit by allowing him to draw thereon