STRICT COMPLIANCE IN LETTERS OF CREDIT: THE BANKER’S PROTECTION OR BANE?

• Citation: (1990) 2 SAcLJ 70
• Date: 01 December 1990
• Published date: 01 December 1990

Introduction and Definition

Letters of Credit have in the last few decades assumed an increasingly important role in trade financing brought about primarily by the tremendous surge in the volume of international transactions since the set up of the General Agreements on Tariffs and Trade (“GATT”) after the Second World War. With further internationalization of trade accelerated by the advances in communication and transportation technology, banks have come to assume a crucial role as intermediaries in the facilitation and consummation of international contracts. This article will focus on the role and function of the doctrine of Strict Compliance, a creature of judicial legislation, presently recognized and embodied in provisions of the Uniform Customs and Practice for Documentary Credits (“UCP”) and the American Uniform Commercial Code (“UCC”) Article 5. In discussing the role and function played by the doctrine, emphasis will be placed on the treatment by the courts and in general on discrepancies in documents with a short commentary on the rejection procedure under the UCP and the alternatives.

The American approach in moderating the harsh effect of the Strict Compliance Rule will be touched upon followed by a short coverage of Stand-By Credits and Strict Compliance. A brief survey will also be made on recent developments in the field including the call for a ‘duty’ on the part of the banks to inform unsuspecting clients to certain transactions where the banks may possess relevant information.

Finally some solutions will be proposed together with an appeal for reform in an area that has been neglected for some time. However, the treatment of the above subject theme should not be considered exhaustive although no effort will be spared to convey a broad sweep of the topic for the benefit of those interested.

In approaching the subject, generations of lawyers have echoed the words of Viscount Sumner in Equitable Trust Company of New York v. Dawson Partners Ltd1 wherein his Lordship stated at page 52:

“It is both common ground and common sense that in such a transaction the accepting bank can only claim indemnity if the conditions on which it is authorized to accept are in the matter of the accompanying documents strictly observed. There is no room for documents which are almost the same, or which will do just as well. Business could not proceed securely on any other lines”.

In the subsequent case of Gian Singh & Co Ltd v. Banque De L’Indochine2, Lord Diplock (at p. 759) had referred to Viscount Sumner’s above dictum and stated that it had “[njever been questioned or improved upon”. This rule has also been affirmed and accepted by Canadian authorities3 and the American cases adopt a similar approach. In the famous dicta of Viscount Surnner earlier cited, the distinguished judge went on to say:

“The bank which knows nothing officially of the details of the transactions financed cannot take upon itself to decide what will do well enough, and what will not. If it does as it is told, it is safe; if it declines to do anything else, it is safe, if it departs from the conditions laid down it acts at its own risk”.

The purpose of the strict compliance rule is evidently to protect the customer, the limitation of discretion on the part of the bank in reviewing the documents tendered reduces the possibility that the unscrupulous beneficiary may be concealing fraud or non-performance in the underlying transaction. The documents must demonstrate that the shipment strictly complies with the underlying transaction as set out in the credit. This determination of conformity is made on a prima facie basis and must be arrived at honestly and in good faith. As an illustration, if a certificate signed by experts is required, a certificate signed by a single expert is a bad tender.4 Again a set is non-conforming if the bill of exchange is drawn on the issuing bank instead of the buyer.5 It must not be forgotten that the doctrine of strict compliance applies in all the contracts which arise in a documentary credit transaction, that is, the contract between the buyer and the banker, the contract of banker and seller and the relationship of issuing and correspondent banker. The American position postulates different approaches to the strictness of the compliance according to the relationship of the parties.6

Strict or Substantial Compliance- Scope of the Rule

Is there a divergence between the English and American approaches towards the doctrine? The general application of the doctrine was acknowledged as early as 1926 in the American case of Camp v. Com Exchange National Bank.7 However in a later decision, ie Far Eastern Textile Ltd v. City National Bank and Trust Co,8 a dual standard was expounded by the court which supports strict compliance in

respect of the contract between banker and seller but postulates substantial compliance in respect of the contract of banker and buyer. In that case, the credit called for a purchase order signed by one Larry Fannin. When the beneficiary submitted a purchase order signed “Larry Fannin by Paul Thomas” the issuer dishonoured. In a suit by the beneficiary for wrongful dishonour, the court rendered summary judgment for the issuer, holding that to require the issuer to investigate the authority of Thomas “subverts the independent nature of the [credit]” (at page 198). A clear case where the court applied a doctrine of substantial compliance would be First National Bank of Atlanta v. Wynne9 which involved a credit that required that the beneficiary submit a draft reciting that it was drawn under the credit and identifying the credit by number. The Wynne draft failed to include such recitation but the court applying the rule in the earlier Flagship decision10 held that no defect is significant if it does not mislead the issuer. The court in the Wynne case held that since the beneficiary’s cover letter did refer to the credit, the defect did not justify dishonour. A functional rather than a literal approach towards compliance with the documentary credit was adopted but it can be criticised in that such a posture injects too much uncertainty in the bank’s duty to examine documents as to interfere with the orderly conduct of such transactions. Further it may be asked whether the courts may be reading too much into the documents thus displacing the intention of the parties as embodied in the documents. From the perspective of the banks, it perhaps demands rather unrealistically a level of competence quite beyond their primarily ministerial role as document examiners. It would seem that the American courts have sacrificed commercial certainty in place of notions of equity and justice which is at any rate a double standard approach. No doubt, it cannot be denied that the grammar, style, language and form used may sometimes vary heavily, although inconsequentially, from the requirements set out in the credit. The honest beneficiary and the nervous buyer may find their transaction grounded because the bank refuses to make payment on grounds of trite textual deviations. Nevertheless, there may be authority for some latitude in the context of minor variations or discrepancies which may be insufficient to justify a refusal of payment. In the case of Gian Singh & Co Ltd v. Banque De L’Indochine earlier cited, Lord Diplock appeared to hold that the rule of strict compliance did not cover minor discrepancies which were insufficiently material to justify a refusal of payment when he stated: “The relevance of minor variations … depends on whether they are sufficiently material to disentitle the issuing bank from saying that in accepting the certificate it did as it was told.” Implicit in the above statement may be judicial support for the principle of law de minimis non curat lex although it has been stated in other cases that the rule does not apply to documentary credit transactions.11

For transactions governed by the provisions of the UCP, the position is qualified by the applicability of the articles which sanction the acceptance of certain ‘irregular’ documents. For example, article 43(b) of the UCP sanctions under or overshipment of a quantity of goods within the tolerance admitted by the Article. Further Article 29(c) of the UCP authorizes the bank to pay under the credit in disregard of any printed clauses allowing transhipment in the absence of any expressed prohibition.

The Position under the Uniform Customs and Practice for Documentary Credits (1983 Revision) (“UCP”) and the American Uniform Commercial Code (“UCC”) Article 5

Banks throughout the world today apply an agreed international code to all their letter of credit transactions - the Uniform Customs and Practice for Documentary Credits (“UCP”) drawn up by the Renowned International Chamber of Commerce (“ICC”) and most recently updated in 1983. The Code provides a detailed set of guidelines for most practical aspects of the credit operation. In particular, under Article 15 the UCP expressly require banks to examine documents with reasonable care to ascertain whether they appear on their face to be in accordance with the terms and conditions of the credit. Should the set of documents be irregular or if the documents are on their face inconsistent with each other, they have to be rejected. Payment, acceptance or negotiation against documents which appear on their face to be in accordance with the terms and conditions of the credit by a bank authorized to do so binds the party giving the authorization to take up the documents and reimburse the bank.12

Under the American UCC Article 5-114(1), the issuer must honour a draft or demand for payment which complies with the terms of the relevant credit regardless of whether the goods or documents conform to the underlying sale or other contract between the customer and the beneficiary. In addition under Article 5-109(2), the equivalent of Articles 15 and 17 of the UCP, the...