Article

by Sheilar T. Shaffer

Under UCP 600, cancellation is the termination of a bank's obligation under a credit by the agreement of all parties affected1. UCP 600 never defines cancellation; it has only one provision that mentions it , sub-article 10 (a), which states that "except otherwise provided by article 38, a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary." This leaves the impression that a cancellation of a credit requires the agreement of all concerned parties.

This wording can be easily understood if the cancellation is initiated by the issuing bank; however, under a transferred credit, in rare cases where the cost of production is soaring and the currency risk is too high to bear for the second beneficiary, what happens if the second beneficiary does not want to make a presentation and even initiates the cancellation? Does this necessarily require the consent of other parties?

L/C characteristics

To determine the answer, one should consider the unique nature of a letter of credit compared with that of a contract.

L/C practice has some characteristics of a contract. Some commentators contend that an L/C is a contract for the purchase of documents. The Official Comment on a prior UCC Article 5 even described a letter of credit as "essentially a contract between the issuer and the beneficiary".

However, in the case of Amoco Oil Co V. First Bank & Trust Co. (Missouri Court of Appeal, 1988), Judge Crist held that "In fact, a letter of credit is not defined as a contract but 'an engagement by a bank or other person made at the request of a customer ... that the issuer will honor drafts or other demands for payment upon compliance with the conditions specified in the credit." (ILL.REV.STAT. ch. 26, § 5-103(1)(a) (1961)). He added: "It has been held that 'letters of credit are not formal contracts which mandate the standard contractual requirements of offer, acceptance and consideration' (Data General Corp. v. Citizens National Bank of Fairfield, 502 F.Supp. 776, 7847 (D.Conn.1980)."

A credit under UCP 600 is defined as "any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation". By virtue of UCP 600 article sub-article 7 (b), an issuing bank is irrevocably bound to honour as of the time it issues the credit.

It follows that a letter of credit is basically the issuing bank's payment promise; there is no need for consideration from the beneficiary to the issuing bank for the credit to be binding. Instead, it becomes effective as of the time the issuing bank issues the credit. The issuing bank is irrevocably bound by the credit upon its issuance without the necessity for acceptance on the beneficiary's part.

From this, we can infer that though an L/C binds the issuing bank as of the time it is issued, it would not bind the beneficiary until the latter makes a presentation. And whether or not to make a presentation is an issue to be solely decided by the beneficiary.

Transferred credit

UCP 600 sub-article 10 (a) states: "Except otherwise provided by article 38, a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary." Is there an exception in the case of a transferable credit? According to article 38, the first beneficiary may retain its rights to refuse advising of amendments (under a transferable credit) to the second beneficiary. Some question whether the second beneficiary enjoys the same status as a beneficiary,

In this regard, ICC Banking Commission Opinion R 375, even though it related to UCP 500, considered similar issues. In the query, Bank B, the transferring bank, failed to increase the amount of insurance cover for a transferred credit. The presentation by the second beneficiary was complying, but the substituted documents by the first beneficiary were not. The Banking Commission analysis and conclusion stated: "The documents, as received by Bank B, would appear to have met the terms of the transferred credit. The presentation of non-conforming invoices and draft in substitution for those of the second beneficiary did not change the acceptability of the initial presentation ... On the basis that the second beneficiary's documents conformed to the transferred credit, Bank B should have acted in accordance with the provision of subarticle 48 (i), and, if necessary, utilized the second beneficiary's documents as tender under the credit."

The Opinion reminded us that the second beneficiary under a transferred credit is as protected as the beneficiary. When the transferable credit is duly transferred, the issuer is obliged to honour a presentation of the second beneficiary that complies with the terms and conditions of a duly transferred transferable credit even if the first beneficiary is unable to present complying documents2. Moreover, the second beneficiary's rights as the beneficiary under a transferred credit are independent of those of the first beneficiary.

Specifically, a transferred credit renders the second beneficiary able to draw on a complying presentation, but does not ultimately bind the second beneficiary to make a presentation. This brings us back to the point that a transferred credit is not a contract between the issuing bank and the second beneficiary. As noted, whether to make a presentation is an issue to be decided solely by the second beneficiary.

Cancellation

Banking Commission Opinion R 207 addressed the issue of re-transferring a transferred credit. A transferable credit was partly transferred to a second beneficiary by curtailing the expiry date by a month. However, the second beneficiary did not make a presentation and simply let the transferred credit expire. It remained un-utilized.

In the Opinion, the question arose: since there was one month left before the expiry date of the primary credit, could the first beneficiary re-transfer the nonutilized credit to another second beneficiary, even though no notification was received by the transferring bank from the previous second beneficiary? The Opinion stated that it could do so as long as the original credit had not expired; however, it continued: "The transferring bank should obtain explicit confirmation from the original second beneficiary that he has not utilized, or will not utilize the available balance under the transferred credit and request that the original advice of the transferred credit be returned."

It was obvious that UCP did not impose the obligation on the second beneficiary to obtain the other parties' consent with regard to its inaction. Instead, it required the transferring bank to obtain the second beneficiary's confirmation re its non-utilization before the transferred credit was treated as void. This position was consistent with the irrevocable nature of the L/C, in that it was the beneficiary who had the final say regarding the L/C's termination.

All of this raises another question: since the second beneficiary had decided not to make a presentation, was it necessary for others to wait till the expiry date? What if the second beneficiary did not keep silent but proposed cancellation of the transferred credit to the transferring bank, which could then do a retransfer earlier and benefit others? Under the UCP, did the second beneficiary necessarily need the other parties' consent?

As noted, a credit under UCP 600 is the issuing bank's irrevocable payment undertaking, which is not a contract between the issuing bank and the beneficiary. It only binds the issuing bank as of the time of issuance without the need for acceptance on the part of the beneficiary. This remains the same under a transferred credit. Considering the nature of a credit, the second beneficiary is entitled to decide whether to make a presentation under a transferred credit. Thus, in my view not to make a presentation or even to initiate the cancellation of a transferred credit is not a question necessarily requiring the other parties' consent.

Looking ahead

It does not appear that sub-article 10 (a) covers the case where the beneficiary initiates a cancellation. One thing to consider is whether a future UCP or a revised ISBP could expressly state that a credit can be terminated upon the beneficiary's express request, since this would avoid unnecessary procrastination in case the beneficiary decides not to make a presentation.

Under URDG 758, a bank guarantee can be terminated (i) on expiry, (ii).when no sum remains payable under it or (iii) on presentation to the guarantor of the beneficiary's signed release from liability under the guarantee. The condition that a bank undertaking can be terminated upon the beneficiary's express request could cast a light on the L/C cancellation issue. l

Sheilar T. Shaffer is Manager of International Settlements in the International Department of the Agricultural Bank of China (ABC), Shantou Br. Her e-mail is sheilar@sina.com

1. UCP 600: An Analytical Commentary by Professor James E. Byrne with Vincent M. Maulella, Soh Chee Seng, Alexander Zelenov.

2. See note 1.