Failure to Honour Letters of Credit

Regardless of whether you are a buyer or a seller, being certain about the intentions of the other parties, and having security that they will honour their part of the deal is critical when trading overseas. Letters of credit are a necessary part of the documentary credit system, especially in international commodities trading at costs of circa $100 billion USD per annum. Although letters of credit have traditionally been used in trade transactions, they have proven to be very adaptable and are increasingly being used in non-traditional roles. Today, they are one of the most important tools of international finance.

Although a letter of credit on its face is an irrevocable written obligation from a Bank to fulfil an obligation, it is a misconception to assume that a Bank issuing a Letter of Credit is giving you an ironclad guarantee of payment as although the whole function of a Letter of Credit is to honour an underlying contractual agreement, there are many potential pitfalls for those entering into a letter of credit with a financial institution which requires legal advice, for example where the Bank refuses to honour the agreement.

What is a Letter of Credit?

Letters of Credit are a commonly used trade financial instrument provided by a third party, usually a financial institution such as a bank to ensure that the payment of the goods and services will be fulfilled between a buyer and a seller.

A standard Letter of Credit is an irrevocable written commitment by a Bank to make payment to the seller, in connection with the export of specific goods, against the presentation of specified documents identified in the Letter of Credit and relating to those goods.

Why is a Letter of Credit used?

Letters of credits are typically utilised when the parties involved in the financial transaction are based in different countries. In international trade, given the large distances and differing laws, a letter of credit has become an important mechanism for a bank to guarantee a buyer’s payment to a seller will be received on time and for the correct quantum.

The Letter of Credit is an important mechanism to assure a seller that a buyer has guaranteed payment and that the contractual provisions will be honoured.

What are the types of Letters of Credit?

There are a number of labels used to describe the different types of Letters of Credit. What type is used will depend on the relative negotiating positions of the parties and the surrounding commercial circumstances:

  • Revocable credits: A revocable credit is one which may be amended or revoked by the issuing bank at any time without notice to the seller.
  • Irrevocable credits: An irrevocable credit, on the other hand, can only be amended or revoked with the consent of all parties (the buyer, issuing bank, seller and any confirming bank).
  • Confirmed: A Confirmed Letter of Credit adds more security for the seller. This addition stipulates that if the issuing bank from the buyer does not pay the requested amount of money, the seller’s bank guarantees payment.
  • Letter of Credit at Sight: This article of the Letter of Credit specifies that all payments will be fulfilled as soon as there is documentation verifying that the goods or services have been received by the buyer.
  • Red Clause: A Red Clause Letter of Credit provides an obligation towards the buyer’s issuing bank to provide partial payment to the seller prior to the shipping of the goods in question or providing the service.

Regulation of Letters of Credit

Most letters of credit are governed by rules promulgated by the International Chamber of Commerce (“ICP”), who has produced a standard set of guidelines known as Uniform Customs and Practice for Documentary Credits, used by producers and traders worldwide.

The current version, UCP 600, became effective July 1, 2007.

What are my options if a Bank does not honour or delays payment of a Letter of Credit?

In the event that the buyer Bank is unable to make payment on the purchase, the seller is able to make a demand for payment on the Bank. The Bank will examine the beneficiary’s demand and if it complies with the terms of the letter of credit, is required to honour the demand.

The obligation of both the issuing bank and confirming bank to pay is irrespective of disputes under the underlying contract for sale. The banks pay strictly in accordance with the terms of the Letter of Credit and should not need to concern themselves with whether or not the buyer and seller have met their contractual obligations to each other.

In what circumstances will a Bank not honour a Letter of Credit

There are two significant exceptions to the principle that a confirming bank or issuing bank is obliged to pay under a Letter of Credit even when the documents presented appear to be satisfactory.

  • Illegality: It is a defence (if proven) for the Bank not make payment pursuant to the Letter of Credit if making such payment would be illegal in accordance with the operating jurisdiction of the said bank.
  • Fraud: A bank is not obliged to pay under a Letter of Credit if the documents presented by the beneficiary are found to be fraudulent (for example if they have been forged) or, in the case of a standby Letter of Credit, if the beneficiary had no honest belief in the validity of its demand.

Case Study: Letters of Credit

Our client was in the business of international maritime exporting of goods and commodities on a large scale basis. We received instructions on an urgent basis after a major London Bank dishonoured irrevocable Letters of Credit and refused to pay a £multimillion sum after our client exported goods from a European port to a north African trade hub and following valid documentary presentation by our client.

Despite our client adhering to the terms of the irrevocable documentary credit, the Bank refused to honour the Letters of Credit. The Bank alleged this was due to purported links to a country which at the time was under imposed trade sanctions.

The use of embargo or sanctions clauses in financial instruments subject to rules drafted by the ICC Banking Commission have become more common in documentary credit agreements. The effect of which is that even with an irrevocable and complying Letter of Credit, if the agreement contains a sanctions clause, an issuing or confirming Bank may be prohibited from dealing with certain embargoed countries, persons or assets. We submitted on behalf of our client that the Letters of Credits had no such sanctions clauses which would ordinarily have allowed the Bank to refuse to pay (if links to an embargoed country could be proven) despite a complying presentation under the Letters of Credit. 

Our experienced financial services solicitors and barristers can often assist in cases involving breaches of the documentary credit system in international commodities trading. Our expert lawyers:

  • thoroughly reviewed the underlying transaction, the letters of credit and the documentary evidence provided by the client;
  • prepared and issued a protective Claim Form and Particulars of Claim at the High Court within 24 hours of being instructed (we advised our client to issue a claim immediately to protect its’ legal rights and to strengthen its’ bargaining position with the Bank); and
  • successfully presented our client’s case and held without prejudice negotiations with the Bank and its’ legal representatives.

Given that the client was owed significant funds and was suffering loss to the business and livelihood as a result of the Bank’s refusal to honour the Letters of Credit, we achieved a highly successfully outcome within just 10 days of being instructed:

  • the Bank agreed to honour its’ Letters of Credit and paid the entire sum it owed our client;
  • we secured our client £tens of thousands in interest;
  • we negotiated that the Bank waived the entire commissions and fees it would have been due under the Letters of Credit; and
  • we achieved the fantastic result of getting the Bank to agree to pay 100% of our client’s legal costs (including disbursements i.e. the cost of issuing the Claim Form).

Our client was delighted with this outstanding result and the astute tactical nouse and negotiation skills exhibited by our expert Letter of Credit litigators.

City of London specialist Letter of Credit Lawyers

We specialise in banking litigation and Letter of Credit claims and have years of experience in handling and resolving financial services claims. Our lawyers have market-leading experience of providing bespoke legal advice and bringing complex claims to settlement.  As a leading law firm regularly featured in the news and media and with a track record of success, you can be assured your litigation claim will proceed with precision and care.

We ensure that we provide the best possible outcome for our clients by conducting an in depth investigation and research into the realistic prospects of a case before advising on the appropriate course of action in order to reduce time and expense. Where appropriate we encourage the use of alternative dispute resolution (such as mediation and without prejudice negotiation) and our negotiation skills are first-class. If required, we are extremely experienced and capable at navigating our clients through the litigation process.

Clients hire us because of our extensive experience in litigation disputes – when necessary, we know when to go to court and we know how to litigate.