#11171 - Financing The International Sale - International Law II

Financing the International Sale

1. Letters of Credit

   1. Types of Actions that Can Arise out of Fraud in the letter of credit transaction:

      1. (1) The applicant (customer) can sue the issuing bank to enjoin payment under the letter of credit.

         1. The burden of proof will be on the applicant to show (1) that a preliminary injunction is proper and (2) that there was fraud in the transaction

         2. Enjoining an Issuing Bank from paying on a letter of credit:

            1. UCC §5-109(b): sue for an injunction against the bank prohibiting payment

               1. TEST: To obtain a preliminary injunction, the movant must show (1) that it will suffer irreparable harm absent the injunction and (2) either (a) that it is likely to succeed on the merits or (b) that the motion presents sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting the preliminary relief. Archer Daniels Midlands Co. (CB 326).

                  1. In actions to enjoin honor on the basis of fraud, court usually find that the applicant has an adequate remedy at law where the alleged injury is capable of being measured in pecuniary terms. Mid-America Tire, Inc. (CB 274).

                  2. Most courts find that the availability of a monetary damage award for fraud in the underlying contract constitutes an adequate remedy at law, even if the applicant must travel overseas and submit to the uncertainties of foreign litigation in order to obtain it. Mid-America Tire, Inc. (CB 274-75).

                  3. BUT On the other hand, the availability of a damage award is usually held to be inadequate (1) where resort to foreign courts would be futile or meaningless, (2) where the beneficiary is insolvent or may abscond with the money drawn, (3) where honoring a draft would likely force the applicant into bankruptcy, or (4) where the determination of damages would be difficult or speculative. Mid-America Tire, Inc. (CB 275).

                  4. THUS in determining the propriety of injunctive relief, adequate remedy at law means that the legal remedy must be (1) as efficient as the indicated equitable remedy would be; (2) that such legal remedy must be presently available in a single action; and (3) that such remedy must be certain and complete. Mid-America Tire, Inc. (CB 275).

                  5. When a letter of credit expressly incorporates the terms of the UCP, but the UCP does not contain any rule covering the issue in controversy, the UCP will not replace the relevant provisions of UCC Article 5. Mid-America Tire, Inc. (CB 277).

                     1. In Mid-America Tire, Inc., the court held that the express incorporation of the UCP into the contract did not displace the fraud provisions of Article 5 of the UCC, that is, “[UCC § 5-109(b)] remains applicable in credit transactions made subject to the UCP. (CB 277)

         3. “Fraud in the transaction” exception

            1. TEST: Establishing Fraud Under UCC § 5-109

               1. Notwithstanding the independence principle, material fraud committed by the beneficiary in either the letter of credit transaction or the underlying sales transaction is sufficient to warrant injunctive relief under UCC § 5-109(b). Mid-America Tire, Inc. (CB 278).

               2. Under UCC § 5-109(b), only “material fraud” by the beneficiary will justify an injunction against honor. Mid-America Tire, Inc. (CB 278).

                  1. “Material fraud” means fraud that has so vitiated the entire transaction that the legitimate purposes of the independence of the issuer’s obligation can no longer be served. Mid-America Tire, Inc. (CB 278).

                     1. Another court explained that the applicant must show that the letter of credit was, in fact, being used by the beneficiary “as a vehicle for fraud,” or in other words, that the beneficiary’s conduct, if rewarded by payment, would deprive the applicant of any benefit of the underlying contract and transform the letter of credit into a means of perpetrating a fraud. Mid-America Tire, Inc. (CB 278).

            2. “Fraud in the transaction” constitutes a “well established exception to the rule that banks must pay a beneficiary under a letter of credit when documents conforming on their face to the terms of the letter of credit are presented.” Archer Daniels Midlands Co. (CB 327).

               1. Under this exception, an issuing bank may refuse to honor documents which “appear on [their] face strictly to comply with the terms and conditions of the letter of credit” but which are “forged or materially fraudulent,” or if “honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or applicant.” Archer Daniels Midlands Co. (CB 328).

               2. However, the fraud exception to the independence principle “is a narrow one” that is only available on a showing of “outright” and “intentional fraud.” Archer Daniels Midlands Co. (CB 328).

               3. Courts in the Second Circuit enjoin payments under letters of credit “only rarely” and only upon a strong showing that the request for payment was fraudulently made.” Archer Daniels Midlands Co. (CB 328).

      2. (2) The issuing bank can refuse to pay and be sued by the beneficiary for wrongful dishonor.

         1. If the bank dishonors: if the seller-beneficiary then brings a lawsuit against the bank for wrongful dishonor, the bank must defend its dishonor in the litigation by proving forgery or material fraud

         2. The burden of proof will be on the issuing bank to show fraud.

      3. (3) The issuing bank can pay and then be sued by the applicant for wrongful payment.

         1. If the bank honors: the bank is protected and entitled to receive reimbursement of the letter of credit from the buyer-applicant so long as the bank acts in good faith.

         2. The burden will be on the applicant to show that the bank didn’t act in good faith.

      4. (4) The issuing bank can pay and then sue the beneficiary for fraud.

         1. The burden of proof will be on the issuing bank to show fraud.

      5. (5) The issuing bank can pay and charge the applicant’s account, and the applicant then sues the beneficiary.

         1. The burden of proof will be on the issuing bank to show fraud.

   2. Overview of the Letter of Credit Transaction:

   3. Commercial Letters of Credit vs. Standby Letters of Credit

      1. IF the beneficiary is the seller:

         1. Commercial Letter of Credit

      2. IF the beneficiary is the buyer

         1. Standby Letter of Credit

   4. Letter of Credit Basics: Who?

      1. Applicant: party establishing the credit

      2. Beneficiary: party entitled to payment under the L/C

      3. Issuing Bank: Applicant’s bank, undertakes to honor the credit

      4. Advising Bank: Makes reasonable efforts to check authenticity of credit, but no obligation to pay

      5. Confirming Bank: usually in the locality of beneficiary; independently assumes the Issuing Bank’s obligation and adds its own undertaking to pay on the credit

      6. Nominated Bank: authorized by Issuing Bank to pay under the L/C but no obligation to pay.

   5. Core Principles

      1. (1) Independence

         1. The principle of independence establishes that each contract is completely independent of the next.

            1. A letter of credit is independent of the underlying sales contract.

            2. Both the banks and the parties must construe and perform the letter of credit on accordance with their own terms, without reference to any other agreement or transaction.

            3. The independence principle is codified in UCC Art. 5

               1. It has been acknowledged by the courts.

      2. (2) Strict Compliance

         1. The strict compliance principle dictates that documents presented to the bank must comply with the letter of credit requirements.

            1. Document examination and rejection is one of the most important topics concerning letters of credit.

            2. BUT notwithstanding this principle, empirical studies have shown that document discrepancies are the rule and perfect tenders are the exception.

   6. Letters of Credit Basics: What?

      1. Revocable or Irrevocable Credits?

         1. Revocable: applicant can terminate

         2. Irrevocable: Credit subject to expiration if not exercised within a stated period of time

      2. Straight or Negotiation Credits?

         1. Straight: credit is an undertaking from the bank that runs only to the named beneficiary

            1. Beneficiary presents draft to issuing bank directly

         2. Negotiation: undertaking from the bank runs to the beneficiary and to any nominated bank that negotiates or purchases the credit.

            1. Beneficiary presents a draft (drawn on issuing bank) to a nominated bank (or confirming bank)

            2. Nominated/confirming bank purchases the draft (face value or discounted) and beneficiary endorses it to them nominated/confirming bank is the new beneficiary

            3. Nominated/confirming bank sells the draft to the issuing bank.

   7. Letters of Credit Basics: Settlement

      1. Payment instrument: Sight or Time (Usance) Drafts?

         1. Sight Draft: Beneficiary is paid as soon as the paying bank has determined that all necessary documents are in order.

         2. Time Draft: payment can be 30 to180 days after the bill of lading date.

   8. Back to Back Letter of Credit:

9. Law Governing Letters of Credit

   1. (1) Domestic Law: UCC Article 5

      1. Fraud exception to the independence principle: UCC §5-109

         1. 2 types of fraud situations:

            1. (a)(1) the honor is demanded by third parties who have given value in good faith and without notice of the fraud

               1. lssuing bank must honor the presentation even if forgery or a material fraud exists

                  1. Buyer/Applicant must reimburse the Issuing Bank

                  2. Buyer/Applicant’s remedy is to then sue the seller for fraud

            2. (a)(2) all other cases

               1. The bank may, acting in good faith, choose to honor or dishonor

                  1. If the bank honors, then subsequent payment obligations are triggered (see above)

                  2. If the bank dishonors:

Seller can sue the bank for wrongful dishonor

Bank bears the burden of proof of showing fraud

2. Payment by innocent parties

   1. UCC §5-109(a)(1): Issuer...