Examination of the Letter of Credit and the Fraud Exception Principle

ABSTRACT The study was carried out on the examination of the letter of credit and the fi'aud exception principle. In this case the research expounded the documentary credits and its effectiveness in relation to the prescribed laws and the provisions of the conventions against the documentary credits. A letter of credit is a financial device developed by merchants as a convenient and relatively safe mode of dealing with sales of goods to satisfy the seemingly irreconcilable interests of the seller, who refi.1ses to part with his goods before he is paid, and a buyer, who wants to have control of the goods before paying. This study was guided by the following; • to explore the Law relating to the Letter of credit, • to examine the challenges relating to Letters of Credit • to evaluate the law relating to fraud Exception. On the findings upon the need for an exception to the Autonomy Principle in the UCP 600, common law courts have developed one, called the Fraud Exception. According to the exception, if there is a fraud allegation from buyers, banks should consider and assess it. If buyers can present sufficient evidence of malerial or established fraud, banks may withhold the payment to sellers. If buyers cannot, banks have discretionary power whether to pay. Developments to exceptions for letter of credit and bank guarantees are focused on concretizing the practicality of dealing with conflicts arising from them. English Courts continued to distance itself from direct regulation of merchant and banking relationship and dealings. In conclusion therefore it is submitted that since the UCP 600 failed to address the fraud exception, after much anticipation that it would, the Commission should amend the provisions of the UCP 600 to include the exception. It should give clear guidance as to the criteria applicable when the fraud exception is called into play.

TABLE OF CONTENTS

DECLARATION ............................................................................................................................. i

APPROVAL ................................................................................................................................... ii

TABLE OF CONTENTS .................. : ............................................................................................ iii

DEDICATION ................................................................................................................................ v

ACKNOWLEDGEMENT ............................................................................................................. vi

ABSTRACT .................................................................................................................................. vii

CHAPTER ONE ........................................................................................................................... 1

1.0 Introduction ............................................................................................................................. 1

1.1 Background to the study ........................................................................................................... 1

1.1.1 Nature of a Letter of Credit Transaction ................................................................................ 3

1.1.2 Mechanics of the Letters of credit ......................................................................................... 5

1.1.3 Fraud Exception ..................................................................................................................... 5

1.2 Statement of problem ................................................................................................................ 7

1.3 Purpose of the study .................................................................................................................. 8

1.4 Specific objectives .................................................................................................................... 8

1.5 Research questions .................................................................................................................... 8

1.6 Scope of the study ..................................................................................................................... 9

1.6.1 Geographical scope ................................................................................................................ 9

1.6.2 Content scope ......................................................................................................................... 9

1.6.3 Time scope ............................................................................................................................. 9

1.7 Doctrinal Methodology and Qualitative methodology ........................................................... 10

1. 7 .I Reliability of the instrument ................................................................................................ I 0

1.7.2 Methods ofdatacol!ection ................................................................................................... IO

1.8 Significance of the Study ........................................................................................................ II

1.9 Literature review ..................................................................................................................... 11

CHAPTER TWO ........................................................................................................................ 16

THE LETTER OF CREDIT AND ITS USAGE IN COMMERCIAL PRACTICE ............ 16

2.0 Introduction ............................................................................................................................. 16

2.1 Objective and function of letter of credit ................................................................................ 16

2.2 Stages in a Letter of Credit Transaction ................................................................................. 17

2.3 Letters of credit ....................................................................................................................... 18

2.4 Principles underlying Documentary Letters of Credit ............................................................ 19

2.4.1 Independence and Autonomy of the Credit ......................................................................... 20

2.4.2 The stating of UCP 600 ............ : ........................................................................................... 22

2.5 UCP have the status of law ..................................................................................................... 23

2.5.1 Standard of compliance and the UCP 600 ........................................................................... 24

2.5.2 Bank's risk under UCP (exemption clauses) ........................................................................ 25

2.5.3 The relevance ofUCP guidelines and standards .................................................................. 26

iii

CHAPTER THREE .................................................................................................................... 28

EXAMINE DEVELOPMENT AND IMPLEMENTATION OF THE FRAUD

EXCEPTION RULE ................................................................................................................... 28

3.1 Fraud Rule in General ............................................................................................................. 28

3 .2. The Fraud Rule in the USA ................................................................................................... 29

3.2.1. Before the UCC ................................................................................................................... 29

3.2.2. The UCC ............................................................................................................................. 31

3.1.3. After Revision ..................................................................................................................... 33

3.3. The Fraud Rule in the UK ...................................................................................................... 34

3.3.1. The Traditional Approach ................................................................................................... 34

3.3.3. The Move Away From the Traditional Approach .............................................................. 37

3.3.4. Back to the Traditional Approach ....................................................................................... 38

CHAPTER FOUR ....................................................................................................................... 41

CAUSES OF THE INCONSISTENCY AND SOLUTIONS FOR PREVENTING FRAUD

....................................................................................................................................................... 41

4.1. Causes of the inconsistency ................................................................................................... 41

4.1.1. No rule in the UCP 600 ....................................................................................................... 41

4.1.2. Different Applications ........................................................................................................ 42

4.2 Solutions for Preventing Fraud ............................................................................................... 44

4.1.1 General ................................................................................................................................. 44

4.2.2. Reviewing the UCP .................................................................... : ........................................ 44

4.2.3. The UNCITRAL Convention .~ ........................................................................................... 45

CHAPTER FIVE ........................................................................................................................ 46

CONCLUSIONS AND RECOMMENDATION ...................................................................... 46

5.0 Introduction ............................................................................................................................. 46

5.1 Conclusion .............................................................................................................................. 46

5.2 Recommendation .................................................................................................................... 49

5.2.1 Use of Independent Inspectors ............................................................. : ............................... 51

5.2.2 Check Capacity and Location of Contract Vessel ............................................................... 51

5.2.3 Checking the Credibility of the Seller ................................................................................. 51

5.2.4 Performance Bonds .............................................................................................................. 51

5 .2.5 Deferred Letters of Credit .................................................................................................... 52

5.2.6 International Chamber of Commerce Services .................................................................... 53

5.2.7 Bank's Contribution ............................................................................................................. 53

REFERENCES ............................................................................................................................ 54