Article

by John F. Dolan

In at least three situations it is important to know which party is the "applicant" for the letter of credit as UCP 600, the US Uniform Commercial Code (UCC) Article 5 and ISP98 define that term: (1) when the beneficiary and the issuer seek to amend an issued letter of credit; (2) when the issuer or nominated bank's document checkers find documentary discrepancies and seek the applicant's waiver of them; and (3) when the issuer reimburses the nominated bank and seeks reimbursement from the applicant. Frequently, however, unless the parties give the matter careful attention before the fact, the question may not have an easy answer when that answer becomes crucial and when time is short. In most cases, banks protect themselves by careful drafting of the application agreement, but applicants, whoever they may be, are often unprotected.

UCP 600 article 2 defines "Applicant" as "the party on whose request the credit is issued". UCC section 5-102(a)(1) defines "applicant" as "a person at whose request or for whose account" the credit issues and includes an arranger if the arranger is obligated to reimburse. In rule 1.09a, ISP98 adopts a similarly broad definition that includes both the person who applies for the credit and the person for whose account it issues.

Identity of the applicant

In the simplest transaction, the buyer in an international sale of goods or services approaches his bank, a bank with an international department, and asks the bank to issue the credit. The bank's application makes it clear that the buyer is indeed the applicant, that he may agree to amendments, may waive discrepancies and, without question, is liable to reimburse the issuer when it honours the credit or reimburses the nominated bank.

Many cases do not follow that simple paradigm, however. In one illustrative transaction, the buyer does not have a relationship with a bank that regularly issues letters of credit. While some smaller banks will issue credits without the experience and expertise necessary for any bank that issues a letter of credit, most inexperienced banks decline to issue the credit but prevail upon one of their larger correspondents to issue it. In that case, the bank that issues the credit must determine the identity of the "applicant" from its own records.

There are good reasons for the issuing bank's records to show the smaller correspondent as the applicant, for it is on the financial strength of the smaller correspondent that the issuer relies when it issues the credit and undertakes to honour the beneficiary's presentation. Unless the issuer has evaluated the creditworthiness of the buyer, an unlikely and wasteful exercise, the issuer knows little or nothing about the buyer and cannot, as a matter of sound banking practice, rely on the buyer to reimburse.

Yet, in this transaction while the buyer is not the applicant for reimbursement purposes, the buyer, rather than the smaller correspondent, is the appropriate party to decide whether to waive discrepancies. The buyer knows whether the discrepancies matter or whether, documentary discrepancies notwithstanding, the buyer wants the seller/beneficiary's goods.

Amendments

To an extent, though not to the same extent, the buyer should decide whether to accept amendments to the credit. UCP article 10 lists the issuer, the beneficiary and the confirmer, if any, as necessary parties to amendments. Amendment rules in UCC Article 5 and ISP98 parallel those of UCP 600. It is a point of law, however, that applicants for whom the credit issues are not liable to reimburse if amendments devalue their expectations in the underlying transaction. Beneficiaries and issuers may amend a credit, but the issuer acts at its own peril if it does not obtain the applicant's consent. To the extent of such devaluation, the buyer would be relieved of its reimbursement obligation.

Third parties

In a second transaction illustrating the problems of determining which party is properly the "applicant", smaller buyers approach third parties to help arrange issuance of the letter of credit. While this intermediation by a non-bank may take many forms, often a merchant with excess bank credit, "sells" a portion of that excess to the smaller merchant/buyer that either has no relationship with a bank that issues credits or has insufficient credit standing to support its request for an L/C. In this transaction, once again the issuer relies on the creditworthiness of the larger merchant and insists that that merchant be liable on the application. That documentation answers the reimbursement question, and the larger merchant must reimburse. But the documentation must also identify the party the issuer must contact when the issuer seeks approval of an amendment or a waiver of documentary discrepancies, for the larger merchant often is not in position to evaluate the effects of amendments or documentary discrepancies on the buyer's expectations.

In this second illustrative transaction, some banks insist in the application agreement that the smaller merchant and the larger merchant are both "applicants". That argument will fail unless both parties actually sign the application, however, for a non-signer is not bound by that definition, though he enjoys the benefit of the UCP 600 definition and, in a proper case, enjoys the benefit of the UCC Article 5 or ISP98 definitions. The parties' application agreement's definition of "applicant," may not work as a modification of those definitions when the issuer or the nominated bank seeks waivers of documentary discrepancies or acceptance of amendments.

Guarantors

The third transaction illustrating the problematic nature of the "applicant" definition involves guarantors. It is not uncommon for, say, a corporate cognate of the buyer to guarantee its subsidiary/ buyer's reimbursement obligation to the issuer. In this setting, the guarantor might claim that it too is an applicant, that it has the right to veto amendments and that the issuer must consult the guarantor in order to obtain a waiver of documentary discrepancies.

Banks can resolve these problems by careful drafting of the application agreement. That agreement can recite that the bank is authorized to consult a designated party for purposes of securing the "applicant's" acceptance of amendments or its granting of waivers. Surely, bank letter of credit issuers know how to make all parties (those who apply for the credit, those for whose accounts it is issued and those who guarantee the issuer's reimbursement obligation) liable to reimburse or to exclude from that obligation a guarantor that has executed a separate guarantee. Banks also know enough to take waivers of suretyship defences from those who guarantee obligations. Failure to address these problems could have serious adverse consequences for issuers. Careful drafting can avoid the problems that stem from these legal consequences.

As a matter of contract law, the issuer that agrees to an amendment without acceptance by all of the applicants will lose its reimbursement right to the extent the amendment damages an applicant.

As a matter of contract law, the issuer that accepts discrepant documents with out securing a waiver from all of the "applicants" will lose its reimbursement claim to the extent the discrepancy causes the applicants damage. (In fact, some have argued that the issuer loses all of its reimbursement rights if its pays against discrepant documents.)

Finally, as a matter of suretyship law, the issuer that fails to obtain the guarantor's approval of amendments or waivers that have the effect of extending, expanding or otherwise altering the obligation that the guarantor undertakes to satisfy, loses all rights against that guarantor.

Crafting the agreement

Issuers must craft their application agreements with these problems in mind, and one cannot doubt their ability to do it. In fact, most already have. Yet, such drafting care by the issuer does not protect the buyer and the other commercial parties or banks that participate in the application or that guarantee it. The letter of credit industry ought to be, and surely is, concerned that its customers have faith in the integrity of the letter of credit as a commercial bank product. Issuers that rely on carefully crafted application agreements to hold a buyer to amendments or waivers to which the buyer's agents have consented - but to which the buyer has not assented - may satisfy the lawyers, but they will not satisfy letter of credit users.

In the best interests of the letter of credit as a commercial bank product and of banks that play the role of issuer or arranger, L/C transactions should be structured with regard for the interests of the applicant. Issuers can structure the issuer/applicant relationship so that all parties can avail themselves of modern telecommunications to ensure that all "applicants", however defined, have an opportunity to participate in amendment and waiver decisions. Applicants cannot complain if issuers give them short deadlines; celerity is crucial in these transactions. Applicants and courts have no grounds to complain if the application agreement requires the applicant to give a prompt response to the issuer's requests for waivers or amendment authority, and courts and applicants cannot, in good faith, object to application agreements that demand them.

John Dolan is Distinguished Professor of Law, Wayne State University Law School, Detroit, Michigan, US. His e-mail is j.dolan@wayne.edu