DCW maintains a list of recently-decided court cases involving commercial letters of credit, demand guarantees, and other trade finance instruments.
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Explores the legal intricacies of letters of credit in bankruptcy through notable Chinese court cases, highlighting the risks banks face and the importance of collateral in LC transactions.
This article attempts to provide a brief overview of the legal practice regarding letters of credit in the context of bankruptcy law and procedures, along with an analysis of notable past cases in Chinese courts.
When a bank issues an LC based on an applicant’s request to a beneficiary, it raises a significant issue for the bank if the applicant encounters financial difficulties and cannot repay the bank’s advances except for the previously collected deposit or other form of collateral or guarantees. The issuing bank is primarily concerned with the rights it holds on the documents of title it has handled, such as a bill of lading.
We will find that when issuing an LC, banks often only collect a 10% or 20% cash deposit of the LC amount from the applicant or even no deposit at all. Why do banks issue LCs with such a small deposit? It is because of the self-liquidating nature of commercial LCs. For the entire transaction, the bank has two types of collateral: one is the applicant’s deposit and the other is “documents of title,” such as the bill of lading submitted by the beneficiary or presenting bank, and warehouse receipts.[^1] The bank’s rights and interests on these documents are particularly important. So, the reason why an LC is self-liquidating is because the bank already holds very appropriate collateral. If the LC supports a transaction involving bulk commodities such as oil, soybeans, or metals, it typically requires presentation of all original documents, such as bills of lading and warehouse receipts, to the issuing bank which controls all the documents and the rights represented by these documents to extract the goods.
If a bank has a security interest on the documents and the goods represented by those documents, and this security interest is perfected through delivery, transfer, registration, control, or possession, then the bank not only enjoys a priority right on the documents and the goods they represent but also has the ability to assert this right against third parties (third party effectiveness). In this scenario, the reason the bank only collects a cash deposit of 50% or less is because the bank effectively controls these documents of title.
In practice, many banks do not have well-designed letter of credit agreements. Therefore, this article will focus on legal and operational issues that arise for the issuing bank prior to sending its letter of credit acceptance message or making a payment advance. This may include situations where the customer needs to add additional margin or collateral or when the bank has to pursue recovery in the event that the customer, i.e. the LC applicant, declares bankruptcy.
In the first of his series of DCW articles on major issues surrounding potential revision of UCP, ICC Banking Commission Senior Technical Advisor Dave Meynell examines the concept of negotiation.
Letter of credit cases can reveal a great deal about how the industry's practice rules and standards are viewed and interpreted by the courts.
When issuing banks insert complex reimbursement terms and self-serving conditions into their credits, it distorts the purpose of the product, causes problems for confirming banks, and drives exporters away from using LCs.
DCW Editorial Note: This previously unpublished material reflects the thinking and writing of Professor James E. Byrne over the period
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