CRITICAL ANALYSIS
OF THE PRINCIPLE OF STRICT COMPLIANCE IN LETTER OF CREDIT OPERATION WITH
RELATION TO THE UCP 600
Ridoan Karim,*1 Md. Zahidul
Islam2
1 Adjunct
Faculty Member of Business Law, School of Business Administration, East Delta University(EDU),
1267/A, Goshaildanga, Agrabad,
Chittagong, Bangladesh.
2 PhD Researcher, Ahmad Ibrahim Kulliyyah (Faculty) of Laws (AIKOL), International Islamic
Malaysia (IIUM); Lecturer, Kulliyyah (Faculty) of Shari’ah and Law, Islamic University of Maldives (IUM).
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ABSTRACT |
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Keywords: Critical
Analysis; Strict Compliance; Letter of Credit; UCP 600; |
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One of the fundamental
principles governing the Letter of Credit operation is the principle of
strict compliance. The
paper is based on the understanding of the “Doctrine of Strict Compliance”
within the context of UCP 600 in international trade. The objectives of this
study are to (i) analyze the current status of
principle of strict compliance in letter of credit system; (ii) identify the
implementation of the doctrine in International Trade; (iii) make an outline
to develop a relation between the principle of strict compliance and UCP 600;
(iv) and conclude the research by answering how the usage of UCP 600 softens
the principle of strict compliance. The whole study of the
paper focuses on how the implementation of UCP 600 softens the doctrine of
strict compliance. The paper shall address the very basic characteristics of
principle of strict compliance and shall find out how the application of the
provisions of UCP 600 changes the characteristics of the doctrine. The
outcome of the paper will bring a proper understanding on how the doctrine of
strict compliance has changed and reformed over the year in international
trade practices and how UCP 600 re-shaped the basic structure of that
doctrine. Publisher
All rights reserved. |
To understand what the ‘principle of strict
compliance’ is, we need to understand what does
‘Letter of Credit’ means. The terms ‘Principle of strict compliance’ and
‘Letter of Credit’ are inter-dependent. Letter of credit (LC) is a payment
mechanism, used to facilitate trade in international sales (Hashim, 2013). It is
commonly applied in cases where the parties involved
are from different jurisdictions. Letter of Credit helps to ensure the
performance of both the parties within the scope of the contract. Generally,
there are four different stages to be observed where the payment is arranged by
the LC (Bal, 2010).
The stages are:
The seller will ship the goods after being
informed by the advising bank if the letter of credit complies with the terms
of the underlying contract. Therefore, the bank will affect the payment only if
the documents strictly comply with the terms of the credit.
PRINCIPLE OF STRICT COMPLIANCE:
AN OVERVIEW
One of the fundamental principles governing
the LC operation is the doctrine of strict compliance. The principle requires
the seller to present the necessary documents in accordance with LC
requirements; in order to claim payment for the goods sold. The principle of
strict compliance is defined as the legal principle that entitles the bank to
reject documents which did not strictly comply with the terms of LC (Alan, 2001).
The bank is the responsible in determining whether the presentation complies
with LC requirements based on the Uniform Custom and Practice for Documentary
Credit (UCP 600) and ISBP (Hashim, 2013). The principle of strict compliance aims to
protect the buyer who has neither the opportunity to examine the physical goods
nor to supervise the process of loading the goods in the seller’s country due
to geographical distance (Hashim, 2013). It also
provides the seller a confirmation of fast payment if the seller complies with
the contract of sale. The Principle also states that the bank is entitled to
reject payment which does not strictly conform to the terms of the LC. Thus,
the principle itself establish a general rule/obligation which ensures that the
bank will only pay if the documents received complies strictly with the terms
and conditions of the LC as stipulated by the buyer, and the seller also knows
that the payment will only be received where the transactions are accordingly
performed by both parties (Krazovska, 2008), thus,
there are no scope of fraudulent performance in against with any parties.
RIGHTS AND DUTIES OF BANKS IN RELATION TO
THE PRINCIPLE OF STRICT COMPLIANCE
Meaning of complying presentation
UCP 600 provides general rules relating to the
document examination in case of LC. It introduces new articles including those
which provide definitions of presentation and complying presentation. As an
example, complying presentation is defined as a presentation that is in
accordance with the terms and conditions of the credit, the applicable
provisions of the UCP rules and international standard (Article 2, UCP 600).
The above clarification removes the existing perceptions of compliant documents
(Bergami, 2007). It states
that the compliance of documents is not only determined by LC requirements and
the rules of the UCP rules; it must also be guided by the International Standard
Banking Practice (ISBP) (Hashim, 2013). Thus, UCP 600 provides a clear
idea about document examination as it describes that in a Letter of Credit the
documents must comply with terms and conditions of the credit and with the
rules of UCP 600 and as well as ISBP.
Standard for
examination of documents (Art.14, UCP 600]
In UCP 600, art.14 establishes the
responsibility of the banks to comply with the standard for examination of
documents. It has introduced three new features: examination of the documents
on their face (Article 14(a), UCP 600), the time given to the banks for
examination (Article 14(b), UCP 600) and consistency between documents tendered
(Article 14 (d, e), UCP 600).
The standards for the examination of the
documents according to the Article 14 of the UCP 600 states that the bank is
under an obligation to examine all the documents stipulated in the credit, on
the basis of the documents alone, whether or not the documents appear on their
face to constitute a complying presentation (Bal,
2010). The examination of the documents on their face indicates the review of a
document in line with the ISBP (International Standard Banking Practice) and
features of the document itself. Also the phrase “with reasonable care”, which
was used in art.13 of UCP 500 has been excluded in order to impose stricter
liability on the banks in examining documents (quoted in “UCP 500 to 600: a forward
movement” by Rodrigo, T). In addition to this, “article 14 of UCP 600 provides
that the documents need not be identical between each other but must not
conflict with any other document. Article is considered as a step to reduce the
number of rejections as it allows non-identical documents by clarifying how
similar the documents must be”( Bal,
2010).
Options of Banks in Respect of Strict Documentary Compliance
Complying
presentation: bank must honour
If the credit instructions are clear enough
and the beneficiary has tendered a complying presentation, the bank must honour (or negotiate). However, if the tendered documents
do not comply strictly with the terms of the letter of credit, the bank needs
to decide what to do (Art. 16(a) of the UCP 600). Thus, the article 15 of the
UCP 600 provides the following rules regarding the complying presentation:
“a. When an issuing bank determines that a
presentation is complying, it must honour.
b.
When a confirming bank determines that a presentation is complying, it must honour or negotiate and forward the documents to the
issuing bank.
c.
When a nominated bank determines that a presentation is complying and honours or negotiates, it must forward the documents to the
confirming bank or issuing bank” (Art 15 of the UCP 600).
Discrepant
presentation
If a nominated bank acting on its nomination,
a confirming bank or the issuing bank determines that a presentation does not
comply with the credit, it may refuse to honour or
negotiate. Again, when an issuing bank determines that a presentation does not
comply, it may in its sole judgment approach the applicant for a waiver of the
discrepancies. This option gives the purchaser an opportunity to waive
discrepancies, thus promoting efficiency in a field where as many as half of
the demands for payment under letters of credit are discrepant (Dole, 2006).
The second option for the bank in case of a
discrepant presentation is to refuse to honour or
negotiate. This would also be the course of action in case the applicant would
communicate a refusal to waive the discrepancies, or if the issuer would decide
not to waive even if the applicant would. Article 16(c) of the UCP 600 sets out
the requirements regarding the contents of the rejection notice. Firstly, the
notice must state that the bank is refusing to honour
or negotiate. Secondly, it must specify each of the discrepancies in respect of
which the bank has made the decision to reject. The bank must list literally
“all” discrepancies, failing which it will not have a second chance to
supplement or amend the relevant notice. The bank which does not state all the discrepancies upon which it subsequently seeks to rely, has
failed to act in accordance with the Article 16(c) (ii) of the UCP 600 and is
therefore precluded from later raising those extra discrepancies as grounds for
rejection. Courts over the year in International Trade Practice have treated
the rejection procedure prescribed by the UCP rules with the same degree of
rigidity as the strict documentary compliance doctrine (Ellinger,
2006). Notices which do not manifest a clear intention to reject have been
treated as faulty.
DIFFERENT INTERPRETATIONS OF THE PRINCIPLE
OF STRICT COMPLIANCE
The court’s ability to interpret the principle
of strict compliance is fundamentally important to international trade practice.
Again how a court determines which discrepancies between the documents produced
and the letter of credit constitute grounds for a bank to reject the documents
and refuse payment is important regarding the letter of credit law.
Typing errors and misspellings
The UCP rules, by themselves, do not regulate
misspellings or typing errors in the presented documents. For the first time
this issue was addressed in 2003 only when the ICC Banking Commission published
the ISBP for the examination of documents under documentary credits. The
respective paragraph 25 of the 2007 revision of the ISBP provides that: “a
misspelling or typing error that does not affect the meaning of a word or the
sentence in which it occurs does not make a document discrepant. For example, a
description of the merchandise as “mashine” instead
of “machine”, “fountan pen” instead of “fountain pen”
or “modle” instead of “model” would not make the
document discrepant. However, a description as “model 123” instead of “model
321” would not be regarded as a typing error and would constitute a
discrepancy”. Till the publication of the ISBP it was left completely in the
discretion of courts to decide which misspelling or typing error constituted a
discrepancy and which did not. Over time, courts have developed their own
standards how to decide which discrepancy renders the presented documents
non-compliant and which does not. Unfortunately, these have been different
standards which have often brought different court rulings, if applied to
similar typing mistakes. However, these have also been different standards
which have brought similar case outcomes. Therefore, it is necessary to find
out whether it could be only one optimal standard to avoid these
inconsistencies, and what would it be (Kraĺovska,
2008).
Deviations in the description of goods in commercial invoices
The description of goods in commercial
invoices is regulated by Article 18(c) of the UCP 600 which states that “the
description of goods, services or performance in a commercial invoice must
correspond with that appearing in the credit”. The ISBP adds that in a
commercial invoice “there is no need for a mirror image. For example, details
of the goods may be stated in a number of areas within the invoice which, when
collated together, represent a description of the goods corresponding to that
in the credit”.
Discrepant dates
Incorrect data in presented documents is one
of the most frequent discrepancies leading to rejection of letters of credit (SITPRO,
Report on the Use of Export Letters of Credit 2001/2002). Besides the
misspellings already analyzed previously in this paper, it can be any
information on the set of documents which is not in conformity with the letter
of credit, i.e., discrepant dates. Article 14(d) of the UCP 600 in this matter
says that “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, any other
stipulated document or the credit”.
STRICT COMPLIANCE
Different standards of compliance with the credit
Strict compliance
The doctrine of strict compliance was first
established in 1927 by English courts with the well-known words of Lord Sumner
in Equitable Trust Company of New York v Dawson Partners Ltd as;
"There is no room for documents which are almost the same, or which will
do just as well... if the bank 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''. Lord Sumner's argument was based on the fact
that “the banks know nothing regarding the underlying transaction they financed
thus they cannot distinguish between which document will do well enough and
which will not. He also emphasized that if banks were to be concerned with the
underlying transaction as well, it would be unlikely for business practice to
proceed” (Bal, 2010). Again,
in a case named Moralice (London) Ltd v E D & F Man [1954] 2
Lloyd’s Rep 526 it is found that “the contract was for the sale of 5000
bags but the bill of lading tendered to the bank indicated that only 4997 bags
had been shipped. The bank was held to be entitled to reject the documents. The
de minimus
rule is not applicable to documentary credits”. In that case it was also
established by the Justice Mc Nair that the documents
must be such which will strictly comply with the terms of the letter of credit.
According to the above cases the reasons for establishing the doctrine of
strict compliance in order to fulfill a payment by Letter of Credit are:
First, the rule of strict compliance itself
establishes the law of agency between the banker and the buyer. The Advising
Bank is a special agent of the Issuing Bank and the latter is the special agent
of the buyer. Thus, “if an agent with limited authority acts outside that
authority (i.e. his mandate) the principal is entitled to disown the act of the
agent, who cannot recover from him and has to bear commercial risk of the
transaction.”
“The second reason for the rule of strict
compliance lies in the bank’s position in relation to the sale contract. The
bank is not a dealer in goods; it cannot be expected to know why the buyer has
stipulated for a particular item and what importance he might attach to that
item” (Hamid, 2015).
Common-sense approach
Again, In Voest-Alpine International Corporation v. Chase Manhattan Bank, N.A. (New
York, USA, 1982) the beneficiary brought an action to recover amounts
allegedly due under two letters of credit issued by
Bank of Baroda and confirmed by the defendant Chase Manhattan Bank, N.A.
(“Chase”). The letters of credit as issued and amended required that the drafts
submitted by the beneficiary be accompanied by (i) on-board bills of lading
evidencing current shipment dated no later than January 31, 1981; (ii)
certificates of inspection indicating the date of the shipment; and (iii)
weight certificates issued by an independent inspector. The presented bills of
lading were dated January 31, 1981 and stated that the goods were on board the
ship on that date. However, the weight certificates and certificates of
inspection stated that the goods had been loaded aboard the vessel between
February 2 and February 6, 1981, which was why the bank denied payment. The
court resolved the case based on Article 7 of the UCP 290 (1974 Revision), the
predecessor of Article 14(d) of the UCP 600, which provided in part that
documents which appear on their face to be inconsistent with one another will
be considered as not appearing on their face to be in accordance with the terms
and conditions of the credit. Accordingly, the court held that regardless of
when the goods were in fact loaded aboard the motor vessel, there can be no
doubt that the documents required for presentation were inconsistent on their
face and, therefore, Chase was entitled to conclude that the presented
documents did not conform to the letters of credit and to deny payment. In the
light of the rephrased Article 14(d) of the UCP 600 which now requires data in
the document “not conflict” (instead of “to be consistent”) with other
presented documents and the credit, the case would probably be decided the same
way in nowadays.
Doctrine of ‘strict compliance’ under the general contexts
of UCP 600
It is important to understand how UCP 600
rules made simpler and clearer wording in order to reduce the ambiguity and
differences in interpretation of LC. “UCP was first introduced to remove the
different applications by individual countries and to avoid endorsing national
rules on letter of credit practice. The first set of rules was published in
1933 which has been updated throughout the years, UCP 600 being the most up to
date version. It should be noted that the previous version, which is UCP 500 is
still often encountered in practice as it is the parties' choice to choose
which set of rules governs the credit transaction” (Bal,
2010). The very basis of the doctrine clearly states that the banks deal in
finance and not in goods (UCP 600, article 5). “According to this doctrine,
every single party under a letter of credit transaction is required to tender
strictly complying documents in order to be entitled to receive payment. The
underlying ground for this doctrine is that the letter of credit is established
on an agent collaborated transaction, thus the principal should be entitled to
disown the act of its agent” (Bal,
2010). In order to sustain the credit transaction, banks are only required to
check the compliance of the documents with the credit terms.
Thus it remains as a tentative ground for a
bank when it comes to the question that which document should be accepted and
which one should be disregarded. Even UCP 600 did not provide any clear idea on
that ground which leads those different courts from different jurisdiction may
interpret the doctrine accordingly in relation to facts of the cases. A crucial question arises to all the parties
involved with regard to the term ‘strict compliance’ that how strictly the
documents must conform to the LC terms. According to UCP 600 “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 the
international standard banking practice”(article 2, UCP600).
UCP 600: softening the principle of strict compliance
It is important for us to examine how the term
‘strict compliance’ has implemented in case of LC. Surprisingly, the word
“strict” is not UCP expression; however, it is the result of judicial
interpretation of the UCP rule of compliance. Again, analyzing the Italian
court decisions one scholar concludes that the courts in Italy follow the
principle of “substantial compliance” in place of “strict compliance” (Hamid,
2015). The scholar also thinks that the trend established by the Italian courts
is in compliance with the current banking practice as reflected in the UCP.
The expressions in Article 14 imply the
substantial compliance as the main principle and supplemented the application
of ‘strict compliance’ in the case of commercial invoice. Thus, when we interpret
article 14 which says “Data in a document need not be identical but must not
conflict with”, we can find out that UCP has certainly softens the doctrine of
‘strict compliance’. Again, article 18(c) UCP says “the description of the
goods, services or performance in a commercial invoice must correspond with
that appearing in the credit”, but talking of the invoice amount it says in
article 18 (b) that ‘bank may accept a commercial invoice issued for an amount
in excess of the amount permitted by the credit, and its decision will be
binding upon all the parties, provided the bank in question has not honored or
negotiated for an amount in excess of that permitted by the credit”.
“The article 18(c) speaks of strict compliance
in matters of goods description and substantial compliance with the documentary
amount description but strict compliance with the amount to be honored or
negotiated. This means the rule of strict compliance is now restricted to the
specified documents and not extended to all the required documents as used to
be. The restriction implies that the strict compliance doctrine stands softened
by the new UCP” (Mehta, 2007).
CONCLUSION
UCP 600 encourages fair, equitable and
transparent trade so far ‘compliance’ is concerned. However, ‘UCP 600 limits
the depth of examination of documents by banks and provides leniency in
resolving issues on discrepant documents where the trading parties, namely the
buyer and the seller, equally have some binding say on how the discrepant
documents should be dealt with’ (Hashim, 2013). UCP
600 widens the scope of compliance where data in any document may differ
expressly with one another but should not contradict each other. Thus, UCP 600
softens or restrains the doctrine of strict compliance and at the same time it
also encourages an equitable and transparent international trade.
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Davidson. (2001). Commercial Laws in Conflict - An
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R.F., Jr., Applicant Ad Hoc Waiver of Discrepancies in the Documents Presented
under Letters of Credit, 2006 Annual Survey of Letter
of Credit Law & Practice Handbook, edited by James E. Byrne and Christopher
S. Byrnes, The Institute of International
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Kyle Roane
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