Article

by Chang-Soon Thomas Song

Every day, bank document checkers check documents under letters of credit for discrepancies. Although this is a routine job for many, the decisions resulting from the job affect people the world over and, by extension, the credibility and the future of the letter of credit.

The standard for the determination of discrepancies was "reasonable care", which was the application of international standard banking practice. In the current UCP 600, the words "reasonable care" are deleted, but the application of the international standard banking practice remains, denoting that both the spirit and the letter of "reasonable care" are still in place but with more elaboration.

Types of discrepancies

I would classify discrepancies under four types: 1) discrepancies that can be corrected by the remitting bank, e.g., one copy of a packing list when the credit requires four; 2) discrepancies that can be corrected by the beneficiary; 3) discrepancies that must be corrected, e.g., if a bill of lading is issued to order of shipper but not endorsed; 4) discrepancies that cannot be corrected, for example when a credit has expired1.

These kinds of discrepancies could also be classified as 1) de minimus 2) minor and 3) major discrepancies. The factors involved in the above classification are related to the fact that some defects are curable while others are not. De minimus defects do not need to be cured to be acceptable, e.g., a misspelling in a document when the misspelling is irrelevant. Minor defects require a cure that can be supplied by the beneficiary, for example a missing signature on an invoice required to be signed by the beneficiary or an additional copy of an invoice. Major discrepancies are those which are incurable. In this case, the defect results from a threat to the efficacy of the document2.

Current state of affairs

Despite the ICC Banking Commission's efforts - either through the text of the UCP articles, commentaries on the articles or the ISBP - to differentiate between de minimus discrepancies that do not justify refusal of payment from discrepancies that do justify such refusal, there remains a tendency on the part of banks and the courts to treat even de minimus discrepancies as discrepancies justifying refusal.

The reason is that it is simple to do so. To argue that a discrepancy is not de minimus is much more complicated; it requires careful reasoning on the part of the bank making the case. This is not peculiar to letter of credit law and practice; it is also reflected in the general application of law.

General laws and letter of credit law

Laws are directed to specific fact situations, and it is not possible to understand the rule of law unless one knows the context in which the law was formulated. However, it is often the case that people forget the fact situations and only remember and apply the rule without reflecting on the context.

When one is mindful of the context in which letter of credit law was formulated, perhaps he/she will have a better basis on which to determine discrepancies.

Fundamental to the letter of credit is the certainty of payment. Whatever other principles are involved, the certainty of payment should be the overriding one, since it was the primary reason letters of credit were created.

Bankers who deal in letters of credit are not concerned with the underlying transaction: thus, the independence principle, which says that the bankers only deal in documents and not the underlying transaction, was born, protecting bankers from any obligations which may result from their involvement in the underlying transaction.

Conflicts

Most discrepancies arise by virtue of the independence principle as applied by banks as well as courts. Both banks and courts assume that since banks are not obliged to know the underlying transaction, and that the banks are only entrusted with the handling of documents, any difference in the documents, either in contrast with the credit or with other documents, is frequently regarded as a discrepancy which can justify refusing payment.

However, this line of reasoning tends to ignore the fundamental reason letters of credit were created: certainty of payment. How can one resolve this conflict between these two important principles underlying the letter of credit?

The banking view

Banks handle documents all the time, and therefore have an idea of the function of the documents they handle each day. There might be a special document included in a credit with which a banker is not familiar, but all he/she has to check is that the document has been submitted and that its contents are in line with what is stipulated in the credit.

Most of the discrepancies that banks cite are found in the usual documents, i.e., documents of transport, drafts, invoices, packing lists, weight lists, insurance documents, and certificates of origin, all of which are familiar to them.

Following are some examples of discrepancies which should not be fatal to payment:

1. The letter of credit requires the full address of the forwarding agent in the bill of lading, and the presented bill of lading only lists the name, telephone number and the fax number. [The street address can be obtained by a simple phone call if necessary.]

2. The letter of credit requires a certificate of origin issued by the Council for Promotion in International Trade. The presented certificate of origin is issued by the chamber of commerce. [In the country of the issuing bank, the Council for Promotion of International Trade is the chamber of commerce, with both names officially used by the institution.]

3. The letter of credit requires a quality report issued by the applicant and signed by a named individual. The quality report presented contains the name of individual and his signature. [The letter of credit has designated the named individual to issue and sign the said quality certificate on its behalf.]

4. The letter of credit requires the L/C number on all documents. The bill of lading does not have the L/C number. [The L/C number is used for a bank reference to the file.]

Based on what we know about these documents, we can pretty much tell what a certain discrepancy in a document can do to the underlying transaction. Yet bankers do not simply rely on what they know, but on what they do not know, i.e., the legal aspect of the discrepancy: what will the courts say? And since the banker does not know what the courts may say, he/she often takes the safer course and declares a discrepancy. Consider now the legal side.

Legal side

As a banker with a legal background, I have been curious about how courts have dealt with discrepancies. After some research, I found that judges who reviewed letter of credit case were generally interested in how bankers approached the issue. Since most judges had little or no banking experience, generally they applied their legal knowledge of contract law to the case at hand. Some judges looked at precedents in letter of credit cases to guide them in the law merchant, which is not contract law but customary law in this area recognized by courts over time.

Some courts consider all of the possibilities that may arise from the discrepancy, and when they are sure it will not affect the underlying transaction, they declare the said discrepancy invalid. Other courts simply refer to the independence principle and consider it paramount, regardless of the effect of the discrepancy on the underlying transaction. In doing so, they simply regard all discrepancies as justified and refuse to order payment. On the whole, my sense is that courts end up declaring most discrepancies valid, even though, from time to time, they will consider some to be inconsequential and therefore invalid.

Conclusion

What is the lesson here for bankers? One would do well to heed the words of Gary Collyer, Technical Adviser to the ICC Commission on Banking Technique and Practice in his article "A look back at the UCP revision" published in DCInsight Vol. 12 No.4 October-December 2006: " ... above all, to look at the presentation, the parties involved and the goods before refusing documents for reasons that have no real bearing on the underlying transaction, the credit or the rules in UCP 600".

Chang-Soon Thomas Song is an Attorney at Law (Arizona), and Senior Manager, International Dispute Resolution (Letters of Credit), Trade and Services Division, Korea Exchange Bank, Seoul, Korea. His email address is thomas@keb.co.kr

1. See Boris Kozolchyk, U.C.C. Article 5 Symposium: Strict Compliance and the Reasonable Document Checker , 56 Brooklyn L. Rev. 45, FN 56 (1990).

2. Ibid. at pp. 61-62.