2009
A documentary credit is a method of substituting a bank as a trusted “paymaster” in an international sales transaction. It is an undertaking from a bank that payment will be made against documents which conform to the requirements of the credit.
In an international sale of goods, the credit traditionally required certain core documents: a negotiable bill of lading, a commercial invoice and a policy of marine insurance.
These documents provided the buyer with complete protection. The bill of lading provided title to the goods as well as a right of action against the carrier. The commercial invoice was a complete description of the goods, sufficient to allow resale while in transit, and the policy of marine insurance permitted recovery in the event of loss or damage to the goods.
The most highly developed form of international sales contract was the “CIF” contract. The initials stand for “cost”, “insurance” and “freight”. The price of the goods included all three components, but a CIF contract was much more than merely a means of quoting the price.
The CIF contract was effectively a “sale of documents”. Provided the documents are in order, the buyer must pay, and this is so even if it is known that the goods have been lost at the time that the documents are tendered. The buyers remedy is to pay and then to claim against the insurance: Manbre Saccharine Co Ltd v Corn Products Co Ltd [1919] 1 KB 198.
Documentary credits were so important in this international sales context that Lord Chorley referred to them as “the crankshaft of modern commerce”: (Chorley 1974 at p 225).
The rules for CIF contracts and for documentary credits were established largely through a series of important cases during the 19th and early 20th century.
The international nature of documentary credits led to calls for international rules. The project was undertaken by the International Chamber of Commerce and resulted in the 1933 publication of the Uniform Customs and Practice for Commercial Documentary Credits.
The 1933 publication was not wildly successful. It was immediately adopted by many countries, but the London banks decided against it. As a result, the Commonwealth countries also refused to adopt it. Since the Commonwealth countries dominated international trade at the time, the UCP was generally considered to be unsuccessful in achieving standardisation.
The UCP was revised in 1951, but it was not until the revision of 1962 that Great Britain and the Commonwealth banks adopted the UCP. It was further revised in 1974 and 1993. UNCITRAL, the United Nations Commission on International Trade Law, recommended that the 1993 revision be applied to all documentary credits.
In general, the UCP has been revised to take into account changes in banking practice, in transport methods and documentation and insurance practice. In each revision, the drafting committee has also reviewed the wording of the UCP in an attempt to avoid differing interpretations in application.
The latest revision of the UCP is the UCP600 which applies from 1 July, 2007. The UCP600 is discussed further below.
Before the UCP600, the UCP made a distinction between revocable and irrevocable credits. After reciting that the credit could be revocable or irrevocable, the UCP urged that the credit should clearly indicate to which category it belonged.
But what if the credit was silent on the matter? Until the 1993 revision, the “default” was revocable. That was changed in the UCP500 by Article 6C:
In the absence of such indication, the Credit shall be deemed to be irrevocable.
The UCP500, the 1993 revision, maintained the declaration in Article 8A which showed how dangerous a revocable credit could be for the beneficiary:
A revocable Credit may be amended or cancelled by the Issuing Bank at any moment and without prior notice to the Beneficiary.
Article 8B went on to oblige the revoking bank to reimburse other banks that may have been out of pocket due to reliance on the credit.
The rules relating to revocable credits were established before the publication of the UCP. In Cape Asbestos Co v Lloyds Bank Ltd [1921] WN 274 a credit opened by a Warsaw bank was advised by the defendant bank. The credit was available by sight drafts at the defendant bank. While the credit was still current, the defendant bank received a cable notifying it that the credit was revoked.
The plaintiff company was not informed of the revocation. They shipped asbestos and presented bills to the defendant bank. Payment was refused. The plaintiff sued, arguing that the bank had a duty to notify it of the revocation. Bailhache J held that there was no legal obligation on the bank to notify the plaintiff even though it was customary to give such notification.
Where the credit makes clear that it is revocable, the purchaser of any draft drawn against the credit is taken to have notice that the credit may be revoked. Where the credit does not explicitly state that is revocable, the status of a holder of a draft is uncertain.
The rules on revocation made the revocable credit almost useless as a means of ensuring payment in international trade, and it is hard to see why it survived for so long.
The latest revision of the UCP is the sixth since the original of 1933. The new version, known as the UCP600 since it is published as Publication 600 of the International Chamber of Commerce, came into effect on 1 July, 2007.
The UCP600 is characterised by clearer drafting and by separate definitions and interpretations sections.
From the start, the UCP has been a set of rules which are incorporated by reference into a documentary credit. It might be argued that the rules are so universally applied that they have achieved the force of customary law, but it seems unlikely that such an argument would succeed. This is, in part, because of Article 1 of the UCP.
Article 1 establishes two principles. First, that the UCP are rules that apply when the text of the credit expressly indicates that it is subject to the UCP. Secondly, the rules so included are binding unless expressly modified or excluded by the credit.
Under the first principle, a credit that does not expressly adopt the UCP could scarcely said to be subject to the rules that it does not adopt. Further, a failure to include a reference to the UCP might be argued to itself be an indication that the rules are to be excluded.
As noted above, previous revisions of the UCP had the revocable credit as the “default” in the sense that a credit was revocable if nothing in the credit itself indicated that it was irrevocable.
The UCP600 reverses this situation by its definition of credit. Under Article 2:
Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.
This is reinforced by the interpretation given in Article 3: a credit is irrevocable even if there is no indication to that effect.
Revocable credits, although not very attractive to the beneficiary, might still have some value. One example would be where a series of shipments is contemplated, but where the buyer has little knowledge of the seller. The buyer might wish to be able to cancel the credit if the first shipment or two is not up to expectations. Depending upon the bargaining power of the two parties, a revocable credit might be an acceptable solution.
Assuming that it might be desirable to issue a revocable credit, can it be done under the UCP600? The answer is “probably, but it requires careful drafting”.
The key, of course, is the UCP’s insistence that the parties may expressly modify their obligations. The freedom given by the second limb of Article 1 seems unconstrained, so there is no objection to modifying the definition of “credit”.
The counter-argument relies on a more refined reading of Article 1. The last sentence is “[The rules] are binding on all parties [to the credit] unless expressly modified or excluded by the credit.” A careful reading might support the argument that the applicable rules might be modified, but not the basic definition of a credit.
The first argument is to be preferred since it would seem to be in closer conformity with the intention of the parties. If the parties to the credit, the applicant, the bank and the beneficiary are content with a revocable credit, then there seems no reason in policy or in legal argument why they should not be permitted to engage the bank in a revocable undertaking.
Since the UCP600 no longer has rules for revoking the credit, it would be prudent to include such rules in the credit itself. An alternative might be to make the credit subject to the UCP500 instead of the newer version, a course that is likely to meet with disapproval in the international banking community.