Article

by Sara Younger

A few weeks ago I met with two law students who asked me, among other things, to discuss the compliance rule of documentary credits with them. One of the first statements they made was: "You bankers are technicians. Your job is to compare the documents with the documentary credit, the UCP and the documents with themselves, none of which requires any discretion on your part!"

To give credence to their claims, they quoted the decisive and famous ruling by Judge Viscount Sumner given in the case of Equitable Trust Company of New York v. Dawson Partners (1927). "There is no room for documents, which are almost the same, or which do just as well ... ".

Was this statement, made by the students, just a "teaser" to open the debate? Or did the two actually believe, even though more than 80 years have elapsed since Viscount Sumner's ruling, that the issuing bank - irrespective of the country in which it is located and the nature of the legislation therein - adheres to a strict compliance approach?

There is no doubt that strict compliance is beneficial to the issuing bank for the following reasons:

- it minimizes the bank's exposure to claims by the applicant maintaining that documentary credit payment has been illegally obtained;

- it prevents the bank from being dragged into a conflict between the two sides; and

- it enables maximum efficiency in the work process, as the process is simply technical in nature.

The Israeli decisions

In Israel, a transition took place during the 1990s, moving from a formalist strict compliance approach to one that examines the essence of the issues, as indicated in a number of rulings by the district courts.

The "good faith" principle of Israeli contract law was first implemented in a decision rendered in the case of Bank Leumi Le-Israel B.M. v. Halimex Trade A.G. (1994). In this decision, the court maintained that "One should not accept a strict compliance argument in respect to the conformity of documents with letters of credit, as this constitutes splitting hairs over insignificant details, which reflects failure to act in good faith."

This application of the "good faith" principle signals that a revolution has taken place in Israeli contract law and in the Israeli legal system in general, moving from rigid rules to an approach that expresses the need to examine the essence of the business transaction and its purpose. As to the argument that recognizing the application of the good faith principle as it pertains to documentary credits might "loosen the leash" and generate uncertainty in international trade, the court replied that the implementation of the principle would be carried out by the court carefully and only under special circumstances.

In the Halimex case, the court ruled that the strict compliance rule would apply as is, and that strict conformity would be required. However, it said that balancing the strict compliance mandated by the compliance rule would be achieved by applying the good faith principle.

In the case of Huri v. Bank Leumi Le-Israel B.M., the court determined that, regarding the description of the goods, a more lenient approach should be taken when examining the compatibility of the documents. A degree of leniency, the court said, was also warranted when examining the compatibility of amounts and prices, as long as there were no explicit instructions in the letter of credit which prohibit it. To that end, the court indicated that it was appropriate to interpret the UCP rules in a more flexible fashion, while still giving preference to the strict compliance principle.

The Israeli Supreme Court has not yet directly ruled on this issue. In the case of Bank Leumi Le- Israel B.M. v. Brin (1992), the question arose as to whether substantial or strict compliance was required between the letter of credit and the documents. The then president of the Supreme Court did not decide the issue since, in this particular case, the discrepancies were substantial in nature. It does seem, however, that several decisions rendered by district courts in Israel, which reflect a transition from strict compliance to substantial compliance, have brought a new spirit into the system. This new spirit has been strengthened in light of the new approach set out by the Israeli Supreme Court's ruling in the field of contract law, according to which the essence and content of the issues should be examined without adhering to the language of strict compliance.

This new trend has placed the burden of discretion on the banks in order to determine where there is room for flexibility. These rulings and others have been criticized by Israeli bankers working in the field, as well as lawyers, who have argued that this type of discretion was never intended to be the task of the banks.

What about the UCP?

The UCP itself shows a more flexible approach, especially in the last two versions, UCP 500 and 600. Article 2 of UCP 600, "Definitions", states that a "complying presentation means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice".

This definition omitted the final clause "as reflected in these articles" in UCP 500. UCP 600 widened the scope so that standard banking practice is now a part of the test of compliance, even if some of these practices are beyond those related to examination of documents in the rules and that appear instead in the ISBP (ICC Publication No. 681).This broader scope leaves more room for discretion than the strict compliance approach.

Another important clause which already showed an easing of the strict compliance approach appeared in UCP 500's sub-article 37 (c), which stated:

"The description of goods in the commercial invoice must correspond with the description in the credit. In all other documents, the goods may be described in general terms not inconsistent with the description of goods in the credit."

UCP 600 in sub-articles 14 (d) and (e) adheres to this more lenient approach in stating in (d): "Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document or the credit." In sub-article (e): " ... the description of the goods, services or performance, if stated, may be in general terms not conflicting with this description in the credit."

These clauses (and others I have not mentioned, such as article 30 in UCP 600) reflect the fact that the UCP Drafting Group acknowledged the existing reality, that a reasonable and cautious amount of flexibility is required. Needless to say, these clauses were approved and supported by ICC national committees.

The common law countries

In the autumn 2009 issue of DCInsight, Professor John Dolan, in his article "The strict compliance rule: documentary compliance in a recession" discusses the problems surrounding the strict compliance rule, taking into consideration the recent financial and economic crisis.

The final months of 2008 and the initial months of 2009 saw a plummeting of prices worldwide. This situation led to the exploitation of marginal discrepancies on the part of buyers, as well as banks, in order to escape payment for goods that were purchased at a high price, the value of which had declined. Using the strict compliance approach, there is nothing easier than clinging to minute discrepancies in order to refuse documents. In his article, Professor Dolan indicated that, in many instances, the courts in common law countries never took "international banking standards" into consideration. In fact, I would contend that the courts described by Professor Dolan created document examination "standards" of their own, which were completely removed from actual practices in the field.

Professor Dolan proposed three remedies to prevent a recurrence of cases in which courts create their own standards, and it is these remedies that I would like to address:

1. Solution through arbitration, whereby the arbitrators are expert bankers in the field of international trade

I assume (it was not explicitly written) that the author referred to cases in which the applicant has claims against the issuing bank, or the beneficiary has claims against either the issuing or confirming bank, concerning the compatibility of the documents with the credit.

The arbitration solution is only suitable when applied essentially to complex transactions, for which arbitration is one of the letter of credit's conditions. It is important to take into account the cost of this process, which, as I understand it, is substantial.

2. Testimony by expert bankers in court proceedings in lieu of expert witnesses who are lawyers

One can question whether courts generally accept the testimony of expert witnesses in trade as they do in specialty fields, such as the medical profession. I recognize that expert witnesses are often used in trade disputes - indeed ICC Banking Commission members are often called upon as experts - but I wonder whether this is widely practiced in many countries.

3. Exclusion of the UCP clauses which refer to "international standard banking practice".

In other words, the decision as to whether the documents are compliant would be made according to the terms of the credit and the strict compliance rule, without referring to international standards and practices. In my view, implementing this proposal would not reflect the realities of the marketplace, as in standards and practices which relate to the shipping guarantee, as only one example.

Conclusion

Even today, in the 21st century, it is not a simple matter to unify the different approaches and to arrive at the ideal solution concerning the compliance rule. Of course, the ideal situation would be one in which the applicant, the bene fi- ciary and the issuing bank were all protected. There is no doubt that the strict compliance rule (a technical approach) protects both the applicant and the bank, especially in times of crisis. We have witnessed this over the past year. Is it the case that using a certain flexibility provides an effective balance to strict compliance? Does it, in fact, protect the beneficiary, as it was intended to do, just as the principle of compliance pro tects the interests of the applicant and the issuing bank? I believe that, judiciously applied, it does.

Sarah Younger is the Head of International Trade and Payments at Bank Leumi Le-Israel. She is also the Chair of the ICC-Israeli Banking Committee.
Her e-mail is sarahy@bll.co.il