1. Eastern Mediterranean University BANK406 Corporate Banking Law and Practice CHP 7

2. The Legal Aspects of the contracts ● Here the problem is to define the nature of the contract created by the issue of the credit and to explain the bank’s promise to pay the draft’s of the beneficiary. ● In credit issue there is a contract for the sale of goods into effect by means of at least two further contracts, which are ancillary to the contract of sale itself. 1) A contract between the buyer and his bank; in this contract the bank undertakes to pay amount of the price to the seller/ beneficiary or the seller’s bank and receives a commission for its services and keeps the documents of title to the goods by way of security. 2) A contract between the bank (issuing/ intermediary bank) and the seller. In this contract the bank agrees to become liable to the seller for the price of the goods.

3. ● Legal problems arise with the second contract; it has been doubted whether the liability of the bank to the seller can be based on a contract entered into directly between them. There are 4 theories to find out bounding relationship between the seller and the bank for legal understanding; 1) The Offer & Acceptance Theory 2) The Guarantee Theory 3) The Assignment and Novation Theories 4) Buyer the Seller’s Agent

4. Offer & Acceptance Theory ● The issue of the L/C in favor of the seller is an offer, which the seller can accept by tendering the documents and a draft to the issuing banker. This suggestion does not meet the situation, which arises in the case of an irrevocable credit. If the credit in such case is an offer there must be an intervening space of time ( until the documents are tendered) during which the banker can withdraw the offer and cancel the credit. In irrevocable this is not possible.

5. The Guarantee Theory ● Here the problem is about banker’s liability whether it is a primary or a secondary liability. Once the L/C is opened the banker agrees to pay independently of whether the buyer is in default or not. This means in documentary credit relationship bank’s liability is primary liability. In guarantee theory the seller directly demands the payment from the buyer; if he doesn’t pay, the seller demands payment from the bank. This theory contracts with the content of the letter of credit.

6. The Assignment and Novation Theories ● According to the Assignment Theory; the benefit of the contract which is indisputably entered into by the buyer with his bank, should be regarded as simultaneously assigned by the buyer to the seller with immediate notice to the bank. This is against to the facts in which the credit is issued directly to the seller. ● According to the Novation Theory; the buyer drops out of the transaction altogether and the contract becomes one between the bank and the beneficiary/seller. The objection is that theory involves the release of the buyer from his liability to pay for the goods.

7. Buyer the Seller’s Agent ● A buyer may be deemed to act as the seller’s agent and there comes into existence a contract ancillary to the contract of sale by which the bank promises to pay the seller when the seller places him in possession of the documents specified in the credit. The bank becomes bound to the seller the moment the credit is communicated to him but that its liability is unenforceable until the seller complies with the conditions laid down in credit.

8. Relationship between Buyer and Seller ● The contract of sale provides for the way in which payment is to be made by the buyer to the seller and the means usually chosen is that of documentary credit. The buyer is responsible to the seller to ensure that within a proper or reasonable time a credit is issued which complies with the conditions laid down in the contract of sale. ● In the case of absolute payment, acceptance by the seller of a commercial credit would debar him ordinary right to pursue the buyer, if he did not receive payment under the credit. It can be sued for breach of the credit contract which imposes on the seller the sole necessity for tendering the proper documents within the time laid down.

9. ● The question whether a credit constitutes absolute and conditional payment was answered in a court decision. According to the decision if the L/C is absolute payment of the price, the seller can only look to the banker for payment. *If the banker does not take up the documents, the seller retain them, resell and sue the banker for damages. If the banker takes up the documents in exchange for time drafts, and the banker afterwards becomes insolvent, the seller must prove in the liquidation. He cannot sue the buyer.

10. Insolvency of Issuing Bank (cont.) ● When the issuing or confirming bank fails, if the time draft is drawn on the bank; the seller must prove in the liquidation. If the draft is drawn on the buyer, the seller has a right of action against the buyer on his acceptance. ● If the L/C is conditional payment of the price, the seller looks in the first instance to the banker for payment; but if the banker does not meet his obligations when the time comes for him to do so, the seller can have recourse to the buyer

11. Seller’s rights against buyer, if no claim under the credit ● Insolvency does not automatically end the contract between the parties nor is it breached, and thus it follows that the seller is not relieved from fulfilling his part of the contract. The matter can be serious for the seller where he exchanges the documents for acceptance of his draft by the issuing bank and so loses his security and if the draft is later dishonored as by reason of the bank’s failure, the seller is left with his right of proof in the liquidation of the issuing bank, and with a claim against the buyer on the sales contract.

12. ● If the buyer fails to provide the credit, the seller can treat himself as discharged from any further performance of the contract and can sue the buyer for damages for not providing the credit. He has to give a notice, giving the other side what is a reasonable time in all the circumstances to comply with their obligations, and it is only after they fail to do that he is entitled to cancel the contract. ● Credit instruction and the credits themselves must be complete and precise; for ambiguity can only render the liability of the parties uncertain. Yet credits often contain phrases the precise significance of which is unclear in their bearing on the responsibility of the issuing bank, even though they may show what the applicant for the credit is expecting.

13. Contractual relationships arising under a commercial credit ● A bank is authorized to pay or accept under a credit by being specifically nominated in the credit. A beneficiary can in no case avail himself of the contractual relationships existing between banks or between the applicant for the credit and the issuing bank. ● If the bank uses an intermediary bank in order to give effect to the credit, the intermediary is bound by the terms of the credit, unless it refuses to act on it. Similarly with the beneficiary, he must accept the credit as he finds it or refuses it altogether unless he can obtain from the issuing bank whatever amendment he desires.

14. Relief to Banks ● Banks assume no liability or responsibility for the form or legal effect of any documents, or for the general and/or particular conditions stipulated in the documents thereon; nor do they assume any liability or responsibility for the description, quantity, weight, quality, condition of the goods represented. ● Banks assume no liability or responsibility for the consequences arising out of delay and/or loss in transit of any messages, letters or documents, or of delay. Also banks are not responsible for errors or interpretation of technical terms. ● There is no liability for banks for consequences arising out of the interruption of their business by Acts of God, riots, civil commotions, wars and so on.

15. ● No liability should the instructions they transmit not be carried out, even if they have themselves taken the initiative in the choice of such other bank. ● The applicant for the credit shall be bound by and liable to indemnify the banks against all obligations and responsibilities imposed by foreign laws and usages. ● When the documents do not comply with the letter of credit are received bank refuses to pay.

16. Four parties in Commercial Credit Transaction 1) The buyer who procures the issue of the credit 2) The bank which issues the credit 3) The correspondent bank which is the intermediary between the issuing bank and the seller and which pays or negotiates documents or drafts tendered with documents or which merely advises the credit to the beneficiary. 4)The seller/beneficiary in whose favor the credit is normally issued.

17. The Buyer and The Issuing Bank ● The buyer signs a form of application requesting the bank to issue a L/C in favour of the seller. The terms on which the bank undertakes to issue the credit are set out in full in this document, which also contains a statement of the conditions on which the bank is authorized to pay the price of the goods to the seller and the applicant’s indemnity to the bank. Application for Credit; The form begins with a request that a credit be established authorizing payment against certain specified documents. There than follows an indication whether the insurance is to be provided by the buyer or the beneficiary, whether part shipment or transshipments are to be allowed and any other shipping stipulation which the buyer wishes to make. It further states in what place and until what date the credit is available. Lastly includes reliefs and indemnities.

18. Availability of Credit; The centre of availability of a credit is normally understood to mean the place in which the seller may operate the credit generally speaking where he may tender his draft and documents, for that is the place where he contemplates that he will perform his part of the credit contract. Restraint of Payment; In view of the bank’s obligation under an irrevocable credit to pay, its buyer-customer can not require it not to pay. The opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods which imposes on the banker an absolute obligation to pay.

19. The Issuing Banker and The Seller ● A bank which has issued its irrevocable credit must if the terms of the credit are complied with, pay the beneficiary unless it is authorized to pay someone else, such as an agent. The effect of an irrevocable credit is to substitute the issuing banker for the buyer as the person who undertakes to buy the shipping documents. ● The responsibility of the issuing banker under the Uniform Customs is stated in Article 3 which defines an irrevocable credit as; -an irrevocable credit constitutes a definite undertaking of the issuing bank. -an irrevocable credit may be advised to a beneficiary through another bank without engagement on the part of that bank, but when an issuing bank authorizes or requests another bank to confirm its irrevocable credit and the latter does so, such confirmation constitutes a definite undertaking on the part of the confirming bank in addition to the undertaking of the issuing bank.

20. ● The banker’s responsibility is absolute, dependent only upon the tender of the proper documents within the period of availability of the credit. The irrevocable credit; The Issuing Bank’s Obligations; if the tender is of conforming documents they must be paid for even if the bank is in possession of knowledge that as between buyer and seller, the seller is in breach and the buyer entitled to repudiate. Exception related with the confirming bank; where the seller for the purpose of drawing on the credit fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representation of fact that to his knowledge are untrue.

21. Contract of Sale; Banks issuing irrevocable credits subject to the Uniform Customs are not concerned with the sales contract or the goods; if it were otherwise credit business would be impossible. According to Uniform Customs credits by their nature are separate transaction from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts. Bank’s Refusal to Pay; Bank may be entitled to refuse payment on grounds which are; - non-compliance by the seller with such of the terms of the credit contract as are in the nature of conditions precedent to the liability of the bank, -fraud on the part of the seller, -mutual mistake on the part of the seller and the bank leading to the issue of the credit

22. The Issuing and Intermediary Banks ● Where a credit is issued in respect of a foreign trade transaction, a bank in the seller’s country usually accepts the instructions of the issuing bank. It may be called upon merely to advise the credit to the beneficiary or to pay, accept or negotiate the beneficiary’s draft and documents; or, again to confirm the credit thereby making itself liable to the beneficiary on the same terms as does issuing bank. The intermediary may be chosen by the buyer or more often by the issuing bank. ● Relationship between the issuing bank and the intermediary, unless otherwise agreed, is that of principal and agent. Confirmation; Confirmation should be given only at the requirement of the issuing bank. Beneficiary may ask for confirmation this does not terminate responsibility of the issuing bank. Revocable credit would never be confirmed.

23. The Intermediary Bank and Seller ● This relationship differs according to the role of the intermediary bank. Whether it acts as agent of the issuing bank or whether it is a principal acting on its own. Advising Banker; If it is an advising banker it accepts no obligation to the seller. The bank should note its intention. If the advising bank confirms the credit it undertakes all obligation. It should ne noted that responsibility of an advising bank should be settled by the Uniform Customs or made clear in the credit; or the advising bank could make its position clear when advising. Intermediary Confirming; It is stated by confirming the credit, bank does not guarantee the fulfillment of the obligation of issuing bank, confirmation arises an independent undertaking for the confirming bank. As a result the beneficiary can look both issuing and confirming bank.

24. Direct Tender; If the documents with a time draft are presented to the issuing bank not to the confirming bank this is called direct tender. When the issuing bank after accepting the draft fails, the seller should prove the liquidation of the issuing bank and he cannot pursue confirming bank as the documents are no longer available to him. Recourse; If the credit is open to negotiation by any bank, an intermediary bank purchasing or negotiating drafts may make whatever terms it likes as a condition and may retain recourse to the beneficiary in case the issuing bank fails to meet its obligation. That obligation is dependent upon the seller’s compliance with the terms of the credit. If the seller wants to escape liability, he can sign his draft ‘without recourse’.

25. Appear on their face; A bank has to act quickly, having a limited time in which to satisfy itself that documents are in order. It is difficult to know whether documents are those called for by the credit. Appear on face means, exact compliance with the description of the documents as laid down in the credit. It is a matter of description, not quality, correctness or validity ; documents may be false, yet if they appear on their face to be consistent with the credit description both as a whole and as consistent,they constitute a good tender. The Seller’s Draft; In irrevocable credit the seller can draw a sight or term draft on the issuing bank or the buyer. Sight draft calls for payment at sight, in such cases documents are going to be delivered to the issuing bank against payment. If the documents are required to be accompanied by a ‘ time’ draft it means a buyer obtains credit from the seller. In such cases the documents would be left if the draft is accepted.