LETTERS OF CREDIT: A CONFLICT OF LAWS PERSPECTIVE

• Date: 01 December 1990
• Author: PHILIP TEOH OON TEONG
• Citation: (1990) 2 SAcLJ 51
• Published date: 01 December 1990

(I) Introduction

This article proposes to examine conflict of laws issues which may arise under a transaction involving a letter of credit. This area of law is relatively new and unexplored but is of great importance in the Singapore context. The main bulk of the article will focus on choice of law issues arising out of the letter of credit transaction, A section on illegality and currency exchange control is also included in view of their importance.

The conflict of laws rules applied by the Singapore courts in areas of commercial law are mainly English conflict of laws rules by virtue of section 5 of the Civil Law Act.l

Although the adoption of the Uniform Customs and Practice for Documentary Credits (“U.C.P.”)2 has to a large extent ensured an uniformity of law and commercial practice, conflict of laws issues can still arise.

A letter of credit can be defined as a written undertaking given by a bank (the issuing bank) to pay the beneficiary named in the letter of credit or to accept or purchase a bill of exchange drawn or held by him when he presents the documents stipulated in the letter of credit.3 It is most commonly used in international sales. The exporter is often unwilling to send the goods to a foreign buyer solely in reliance on the latter’s personal credit. On the other hand, the buyer may be equally unwilling to pay for goods which may not materialize. By agreeing to pay for the goods by a letter of credit, the buyer is able to postpone payment until he knows that the goods have been sent; payment is usually only made when the exporter presents the shipping documents. In this way, the exporter has the assurance that he will be paid upon presentation of the proper documents.

The letter of credit can be either revocable or irrevocable.4 A revocable letter of credit is seldom used since it can be revoked or altered without any notice to the beneficiary.5 Accordingly, this article will focus only on irrevocable letters of credit.

The doctrine of the autonomy of the letter of credit is crucial in preserving the commercial efficacy of the instrument.6 The doctrine stipulates that the letter of credit transaction is separate from and independent of its underlying transaction except where the fraud exception operates. Thus, obligations under the letter of credit are not affected by the underlying contract. A proper understanding of this principle is crucial in any analysis of conflict of laws issues which may arise under a letter of credit.

(II) Crisis of Identity and Choice of law.

One of the difficulties in analyzing conflict of laws issues in letter of credit transactions is that the legal basis of the instrument vis a vis the parties’ rights and obligations is still uncertain.7

Nonetheless, it is clear that the letter of credit can be seen as a series of autonomous but interconnected relationships8:

1. (1) The underlying contract which gives rise to the letter of credit.

2. (2) The contract between the applicant of the letter of credit and the issuing bank.

3. (3) If payment is to be made through a confirming bank, the contract between the issuing bank and the confirming bank.

4. (4) The relationship (contract) between the issuing / confirming bank and the beneficiary whereby the former undertakes to pay the latter (or his transferee or assignee) upon proper tender of documents.

The first three relationships are reasonably well defined but the problem arises in respect of the fourth. Various theories have been advanced in attempting to explain the true juristic nature of the relationship.9 The difficulty with many of the theories

is that they either fail to explain the absence of any consideration moving from the beneficiary10 or violate the doctrine of the autonomy of the letter of credit. These difficulties arise because the conceptual framework used in contract may not be wholly appropriate to explain the phenomenon of the letter of credit which is sui generis or of its own kind.

Indeed, the courts have assumed that there exists a contract between the beneficiary and the bank under the letter of credit:

“If, on their face, the documents presented to the confirming bank by the seller conform with the [letter of credit]… that bank is under a contractual obligation to the seller to honour the credit.”11

The letter of credit has been in existence for over a century; it would take a brave (but foolhardy) counsel to argue before any court that the bank’s obligation to pay the beneficiary would be unenforceable for want of consideration. The better view is that there is asui generis undertaking which binds the bank to pay the beneficiary. One viable explanation of this undertaking is Professor E.P.. Ellinger’s modern mercantile usage theory.12

(III) Choice of Law.

Two main areas involving choice of law issues may be identified:

1. (1) Where the particular issue is specifically covered by the U.C.P.

2. (2) Where the particular issue is not covered by the U.C.P.. Most of the issues arise in this area; the resolution of such an issue would depend on:

   1. (i) Whether the parties have expressed a choice of law.

   2. (ii) If the parties have not expressed a choice of law, the relationship under the letter of credit where the issue arose.

Since the problem of illegality and currency exchange control can arise at any stage of the letter of credit transaction, it will be treated separately later in this article.

(1) The particular issue is covered by the U.C.P..

Where the particular issue is covered by the U.C.P., the court has to merely construe the relevant provision of the U.C.P. to resolve the dispute at hand. The application of normal conflict of laws rules has to be modified where the particular issue concerns the interpretation of an expression in the U.C.P..

While the meaning of any expression is a question of fact, its legal effect is a question of law. On this basis, it may be argued that the interpretation of any particular expression under a letter of credit should be governed by the proper law of the instrument.13 While this approach may accord with the normal conflict of laws rules, there is a fundamental objection. It would run counter to the express purpose of the U.C.P. which is to secure uniformity of practice in this area; the approach envisages a situation where different courts might construe a similar expression of the U.C.P. differently.

The court may construe the expression according to its literal meaning. For instance, the expression “payment under reserve” occurs in the U.C.P.14but is not defined therein. In the absence of statutory definition, the English Court of Appeal in Banque de l’ Indochine et Suez S.A. v. J.H. Rayner (Mincing Lane) Ltd.15 construed it according to the probable intentions of the parties. Kerr J. said:

“What the parties meant, I think, was that payment was to be made under reserve in the sense that the beneficiary would be bound to repay the money if the issuing bank should reject the documents, whether on its own initiative or on the buyer’s instructions.”16

The literal meaning approach, however, may not always be appropriate in construing expressions in the U.C.P.. A purposive approach would give better effect to the commercial purpose of the U.C.P..17 The expressions should not be construed as

if they were merely terms of a contract between two parties. The U.C.P. falls to be construed in many countries and forms the basis of transactions involving letters of credit. Its international usage requires both certainty and uniformity of interpretation no matter where it is construed. This means that where foreign courts have interpreted a particular expressiondue regard should be given to their decisions; the weight to be given would, of course, depend on the status of such courts within their respective legal systems. The local court should desist from departing from such decisions especially if they are long-standing and have been understood by the international community as establishing or reinforcing a particular mode of practice. Where the particular term is ambiguous an important aid to the interpretation of expressions in the U.C.P. would be the pronouncements by the International Chamber of Commerce Commission on Banking Technique and Practice, the drafters of the Code.

(2) The particular issue is not covered under the U. C.P.

Conflict of laws issues assume greater importance where the particular issue cannot be resolved under the U.C.P.. Differences in substantive and procedural laws between the countries involved may produce markedly different outcomes.

It is important to first characterize the issue in order to determine the choice of law. The English conflict of laws rule is that matters of procedure are governed by the lex fori, i.e., the law of the forum court hearing the dispute.18 The rule also stipulates that matters of substance are governed by the law to which the court is directed by its choice of law rule, i.e. lex causae. It should be noted that the fact that a particular

issue has been characterized as procedural by a foreign court does not necessarily mean that the same characterization will be followed by the local court. The characterization will be decided by the lex fori. It is noted in Dicey & Morris19 that the primary purpose of the rule is to obviate the inconvenience of the local court in conducting a trial of a case containing foreign elements in a manner with which the court is unfamiliar. Accordingly, if it is possible to apply a foreign rule, or to refrain from applying a local rule, without causing such inconvenience, those rules should not necessarily be classified as procedural.

For instance, “fraud” is not mentioned in the U.C.P, but allegations of fraud frequently arise in disputes involving letters of credit.

In United City Merchants (Investment) Ltd. v. Royal Bank of Canada20,Peruvian buyers purchased a manufacturing plant from English sellers. The...