INTRODUCTION:

WHAT IS A LETTER OF CREDIT?

A letter of credit is basically a document issued by a bank guaranteeing a client's ability to pay for goods or services. A bank or finance company issues a letter of credit on behalf of an importer or buyer, authorizing the exporter or seller to obtain payment within a specified timeframe once the terms and conditions outlined in the letter of credit are met. The letter of credit acts like an insurance contract for both the buyer and seller and practically eliminates the credit risk for both parties, while at the same time reducing payment delays. A letter of credit provides the exporter or seller with the greatest degree of safety when extending credit. It is useful when the importer or buyer is not well known and when exchange restrictions exist or are possible. According to Thompsons Dictionary1 a letter of credit is, a document issued by the banker authorizing the banker to whom it is addressed to honour the cheque of the person named to the extent of the amount and to charge the sums to the account of the grantor. According to Dictionary of Banking by F.E Perry2 a letter of credit means, an arrangement made by a bank for a customer proposing to stay abroad for a period who wishes always to be sure of being able to obtain money wherever he may be. The bank agrees to a total sum to the customer, debits his account in advance and writes to a correspondent bank, authorizing it to encash on demand, any cheque or draft drawn by the beneficiary, charging the sums to the debit of the issuing bank. Legally, the letter of credit is required to be in no particular form. Historically it has long been an integral part of the banking business, even though the early forms of letter of credit bear little more resemblance to the modern forms.3 Formerly the main object of such documentary credit was to enable a merchant to enter into contracts for the purchase of goods abroad and was given before he was in a position to request with reference to any particular transaction4. To understand the origin of modern documentary credit, one has to start with the traditional letter of credit, the salient features of which could be stated as, the letter of credit is a contract. The issuing party- usually a bank- promises to pay the beneficiary traditionally a seller of goods- on demand if the beneficiary presents, whatever documents, the letter may require. There are normally two parties involved in the contract. The bank, which issues a letter a credit as a principal, not as agent for as a agent for its customer, and engages its own credit. The letter of credit thus, evidences- irrevocable obligation to honour the draft presented by the beneficiary upon compliance with the terms of the credit5
1 2

Compact Edition of Thompsons Dictionary, sub,tit., letters. Dictionary of Banking by F.E Perry, sub,tit, letter of credit 3 Ward & Harfield, Bank Credits and Acceptances. Vol. II, p.213. 4 B.C.Mitra, The Law Relating to Bankers Letters of Credit and Allied Laws, (3rd edn, 1998), p.1. 5 Paul R. Verkuil, Bank Solvency and Guarantee Letters of Credit, Stan. L. Rev., Vol.25, p.719.

TYPES OF LETTER OF CREDIT

Banks may issue several types of letters of credit. It is best for importers and exporters to meet with their banking officer to determine which type of credit best suits their needs. The most common type of letters of credit are described follows: REVOCABLE A revocable letter of credit allows for amendments, modifications and cancellation of the terms outlined in the letter of credit at any time and without the consent of the exporter or beneficiary. Because this places the exporter at risk, revocable letters of credit are not generally accepted and are regarded as worthless. IRREVOCABLE An irrevocable letter of credit requires the consent of the issuing bank, the beneficiary and applicant before any amendment, modification or cancellation to the original terms can be made. This type of letter of credit is commonly used and preferred by the exporter or beneficiary because payment is always assured, provided the documents submitted comply with the terms of the letter of credit. Irrevocable letters of credit can be both confirmed and unconfirmed. Such creditors cannot be withdrawn by the issuing banker without the consent of the beneficiary even if his customer i.e. buyer requires to do so. According to the Banking dictionary of Perry6, once this type of credit has been arranged, its terms cannot be varied or changed without the concurrence of the parties to it. An exporter who is in sufficiently strong bargaining position to do so should therefore always insist on payment through irrevocable credit. The Calcutta High Court in B.S. Aujila Co. Pvt. Ltd. v. Kaluram Prasad clarified the distinction between a revocable and irrevocable letter of credit and the nature of contract between the issuing bank and the intermediary bank and the beneficiary bank 7. The court observed that revocable and irrevocable letters of credit stand on different footing. A revocable letter of credit can be revoked before negotiations. Irrevocable letters of credit may be confirmed or unconfirmed. The relationship under the contract between the issuing bank and the buyer is determined in the terms of agreement between them for opening a letter of credit. As between the seller and the banker the issue of letter of credit under intimation to the seller creates a contractual nexus and makes the banker directly liable to the seller to pay the purchase price or to accept the bill of exchange when documents are tendered. TRANSFERABLE An irrevocable letter of credit may also be transferable. With a transferable letter of credit, the exporter can transfer all or part of his rights to another party. Transferable letters of credit are often used when the exporter is the importer's agent or a middleman between supplier and importer, and not the actual supplier of merchandise. With a transferable letter of credit, the exporter uses the credit standing of the issuing bank and
6 7

ibid. AIR 1983 Cal. 106

avoids having to borrow or use his own funds to buy goods from a supplier. Hence, it is a viable pre-export financing vehicle. Before transfer can be made, the exporter must contact, in writing, the bank handling the disbursement of funds - the transferring bank. Transferable letters of credit can only be transferred based on the terms and conditions specified in the original credit, with certain exceptions. Therefore, it may be difficult to achieve flexibility and confidentiality with this finance method. The transferring bank, whether it has confirmed the letter of credit or not, is only obligated to effect the transfer to the extent and in the manner expressly specified in the letter of credit. Transferable letters of credit involve specific risks. When a bank opens a transferable letter of credit for a buyer, neither party can be certain of who will be the ultimate supplier. Both parties must rely upon the importer's assessment of the exporter's reputation and ability to perform. To reduce overall risk and prevent the shipment of substandard goods, an independent certificate of inspection can be required in the documentation. For simplicity's sake, many banks prefer single transfer and discourage multiple transfers, but will do multiple transfers if conditions are right. Partial transfers can also be made to one or several suppliers if the terms of the original letter of credit allow for partial shipments. The processing of this type of letter of credit can become complicated and tricky, requiring logistics coordination and the highest level of precision. Incomplete and/or ambiguous information on the transferable letter of credit almost always leads to problems. Furthermore, the beneficiary of the transferable letter of credit must be available throughout the entire negotiation process to assist the transferring bank. Other forms of irrevocable letters of credits, though not widely used, are unconfirmed, confirmed and back-to-back. CONFIRMED A confirmed letter of credit is when a second guarantee is added to the document by another bank. The advising bank, the branch or the correspondent through which the issuing bank routes the letter of credit, adds its undertaking and commitment to pay to the letter of credit. This confirmation means that the seller/beneficiary may also look to the credit worthiness of the confirming bank for payment assurance. UNCONFIRMED An unconfirmed letter of credit is when the document bears the guarantee of the issuing bank alone. The advising bank merely informs the exporter of the terms and conditions of the letter of credit, without adding its obligation to pay. The exporter assumes the payment risk of the issuing bank, which is typically located in a foreign country. BACK-TO-BACK LETTERS OF CREDIT Back-to-back letters of credit are two individual letters of credit that together offer an alternative to a transferable letter of credit. It is a term given in the United States of

America to an ancillary credit, which arises where the seller uses the credit granted to him by the intermediary or issuing banker to support another credit granted by the sellers banker to his supplier8. The back-to-back letter of credit allows exporters (sellers or middlemen) who do not qualify for unsecured bank credit to use a letter of credit as security for a second letter of credit in favor of a supplier. In other words, if a foreign buyer will issue a letter of credit to an exporter, certain banks and trade finance companies will issue independent letters of credit to the exporter's suppliers so that the required goods can be purchased. Even if the initial letter of credit is not successfully completed, the second remains valid, and the issuing bank is obligated to pay under its terms. Although back-to-back letters of credit provide small and medium exporters virtually unlimited working capital to finance their sales and complete more export transactions, many banks are reluctant to take on this type of arrangement. Because back-to-back letters of credit involve two separate transactions, it is likely that several participating banks will be involved and the risk of confusion and dispute is high. To protect itself, a bank generally will require that the exporter present all relevant documents that are part of the first letter of credit before issuing the second letter of credit. The second document is worded to conform precisely to the original and dated to expire at some date prior to the first, ensuring that the seller has sufficient time to present documents within the time limits of the first. STANDBY LETTER OF CREDIT Unlike a commercial letter of credit, which is basically a payment mechanism, a standby letter of credit is a form of a bank guarantee. It may be used as necessary to cover nonpayment of a financial obligation. A standby letter of credit normally is intended to be drawn on only in the event of nonpayment. The standby letter of credit is issued by the bank and held by the seller, who in turn provides the customer open account terms. If payment is made according to the seller's terms, the letter of credit is never drawn on. However, if the customer is unable to pay, the seller presents a draft, and all other documents as required, to the bank for payment. The standby letter of credit typically expires within 12 months. CASH ADVANCE AGAINST LETTER OF CREDIT A cash advance against a letter of credit works like back-to-back letters of credit, with the exception that the bank or financing company will issue cash to the suppliers instead of another letter of credit.

Gutteridge, Law of Banking, 1962 edn., p.12

HOW TO OBTAIN A LETTER A CREDIT?

The following procedure explains how to obtain a letter of credit from any banking or financial institution. It is recommended to request a letter of credit from an institution where one has already a customer since this expedites the process and allows for faster credit checks and verifications. 1. The buyer and seller agree to the terms and conditions of the transaction, including means of transport, period of credit offered, latest date of shipment and the relevant Incoterm to be used. The buyer submits a request to the bank for a letter of credit. The bank evaluates the buyer's credit rating, and may require a cash cover and/or reduction of other lending limits. The buyer's bank issues the letter of credit and notifies the advising bank (seller's bank) by airmail, telex or SWIFT. The advising bank establishes the authenticity of the letter of credit using signature books or test codes, then informs seller (beneficiary) and confirms the letter of credit. The letter of credit becomes the legal agreement between the issuing bank and the designated beneficiary (seller). The seller confirms that the letter of credit matches the commercial agreement, and that the terms and conditions can be satisfied in the allotted time period. If there is anything that may cause a problem, an amendment should be requested. The seller ships the goods and gathers all the documents requested in the letter of credit, such as the invoice, transport document, bill of lading, insurance, etc. The documents are presented to a bank, often the advising bank. The advising bank checks the documents against the letter of credit. If the documents comply with requirements, the bank pays the seller and forwards the documents to the issuing bank. The issuing bank also checks the documents. If they are in order, the issuing bank will reimburse the seller's bank immediately. The issuing bank debits the buyer and releases the documents (including

2. 3. 4. 5.

6. 7.

8.

9. 10. 11. 12.

transport document), so that the buyer can claim the goods from the carrier.

ADVANTAGES TO THE PARTIES:

The letter of credit is the safest, most secure and most convenient settlement method for international transactions. There are a number of advantages both for the seller/exporter and the buyer/importer BENEFITS TO THE SELLER 1. Assures the security of payment from an international bank once the terms of the letter of credit are met. 2. Seller can determine when payment will be satisfied and ship the goods accordingly. 3. Bank bears the responsibility of oversight.

4. Seller does not have to open an account and grant payment terms to buyer. Credit risk is nearly eliminated. The risk of exchange control created with payment delays is greatly reduced. 5. Provides seller easier access to financing once the letter of credit has been issued. 6. Once the bank confirms the letter of credit, political and economic risk and questions regarding the buyer's ability to pay are eliminated. The confirming bank is obliged to pay, even if the buyer goes bankrupt, provided the terms of the letter of credit are met. BENEFITS TO THE BUYER 1. Facilitates financing--for example, creating banker's acceptances. 2. date. 3. 4. Buyer can confirm that the merchandise is shipped on or before the required

It is safer to deal with bank than to prepay. Buyer may get better terms and prices.

5. No cash is tied up in the process. Buyer does not have to pay cash up front to a foreign seller before receiving the documents of title to the goods purchased. This is particularly helpful when the buyer is unfamiliar with local suppliers and laws. 6. Protects the buyer since the bank only pays when the supplier complies with the specific terms and conditions and produces the documents required by the buyer. 7. The buyer can build safeguards into the letter of credit, including inspection of the goods and quality control, and set production and delivery times.

PRACTICAL DIFFICULTIES OF LETTERS OF CREDIT

Statistics show that the seller's documents will be rejected by the banks at presentation in as many as 50% of letter of credit transactions. The banks use different criteria in matching the terms and conditions of the letter of credit against the documents presented. There often is little room for judgment. The refusal to pay a letter of credit can be an extreme source of frustration to both the importer and the exporter. REJECTION FOR DISCREPANCY IN THE DESCRIPTION OF GOODS A bank may reject a letter of credit if the goods are not described EXACTLY in all documents. Suppose that a letter of credit describes goods as "fabric with a maximum synthetic content of 25%". However, the exporter presents a commercial invoice referring to the goods as "fabric with 20% synthetic content". Common sense would suggest that this consignment would be acceptable, yet some banks will reject the documents on the grounds of a discrepancy in the description of goods. SUGGESTION: Exporters must carefully review the wording of all documents before submission, using the same criteria that the issuing and advisory bank applies, and ensure that all terms used match. REJECTION FOR FAILING TO ANTICIPATE AN ASPECT OF THE TRANSACTION Each step of the transaction should be laid out in the letter of credit. Failure to do so by adding, deleting or not specifying certain steps of the process may result in a rejection. For example, a common requirement of a letter of credit is a "clean onboard bill of lading"-a document supplied by the shipping company attesting that the goods were received in apparently good condition and were loaded in the ship's hold. However, if the goods are hazardous or flammable, they will be put on the deck of the ship instead of the hold, and the bill of lading will be marked "on deck". This is not an on-board bill of lading, so the bank can reject the documents. SUGGESTION: To avoid such problems, exporters need an understanding of the different types of commercial documents (transport documents, insurance documents etc.) and

the points on each document that may come under scrutiny. FAILURE TO COMPLY WITH TIME LIMIT Letters of credit require that documents and procedures be completed within a specified time frame. Banks will not issue payment unless these deadlines are met. The three major time limitations are: the expiration date of the credit, the shipping date and the maximum time allowed between dispatch and presentation. SUGGESTION: When requesting the letter of credit, make sure that all the terms and conditions can be satisfied within the prescribed time limits. If the letter of credit calls for documents supplied by third parties, make arrangements to have them available when requested. After the goods have been dispatched, make sure that all the documents are consistent with the letter of credit.

Position Under English Law

Midland Bank Ltd. v. Seymour9 In this case Devlin J held that, in the absence of a clear requirement that the bill of lading should contain all the particulars of the shipment, it was sufficient that the documents taken together should do so. In his judgment he said: . . . .no principle is better established than that when a banker or anyone else is given
9

(1955) 2 Lloyd's Rep. 147.

instructions or a mandate of this sort, they must be given to him with reasonable clearness. The banker is obliged to act upon them precisely. He may act at his peril if he disobeys them or does not conform to them. In those circumstances there is a corresponding duty cast on the giver of instructions to see that he puts them in a clear form. Perhaps it is putting it too high for this purpose to say that it is a duty cast upon him. The true view of the matter, I think, is that when an agent acts upon ambiguous instructions he is not in default if he can show that he adopted what was a reasonable meaning. W J Alan & Co. Ltd. v. El Nasr Export & Import Co.10 This case deals with the nature of payment by Letter of Credit. The facts of the case were that the plaintiffs, coffee producers in Kenya, in 1967 entered into two contracts for the supply of coffee to the defendants, an Egyptian State Trading Corporation, at a price expressed in Kenya shillings, which at the time of the contract, in particular being expressed in sterling, but the plaintiffs accepted it, and drew upon it, being paid in sterling on the date in November on which sterling was devalued. The plaintiffs now claimed additional payment to cover their Kenya shilling loss on the devaluation. The defendants contended that nothing further was owned, on the grounds either (1) that the credit, once accepted amounted to payment of the price, or (2) that the money of account had been varied by agreement or that the sellers had waived payment in Kenya currency and accepted sterling instead. Upon judgment being given for the plaintiffs, the defendants appealed. It was held by the Court of Appeal that the plaintiffs had by their conduct waived payment in Kenya currency. Although in view of this finding the defendants first argument was not necessary to the decision. Lord Denning observed the following: In my opinion a letter of credit is not to be regarded as absolute payment, unless the seller stipulates, expressly or impliedly, that it should be so. He may do it impliedly if he stipulates for the credit to be issued be a particular banker in such circumstances that it is to be inferred that the seller looks to that particular banker to the exclusion of the buyer. . . . . . . .I am of the opinion that in the ordinary way, when the contract of sale stipulates for payment to be made by confirmed irrevocable letter of credit, then, when the letter of credit is issued and accepted by the seller, it operates as conditional payment of the price. It does not operate as absolute payment. It is analogous to the case where under a contract of sale, the buyer gives a bill of exchange or a cheque for the price. It is presumed to be
10

(1972) 2 Q.B. 189.

given, not as absolute payment nor as collateral security, but as conditional payment. If the bank honours the letter of credit when the documents are presented to it, the debt is discharged. If it is not honoured, the debt is not discharged, and the seller has a remedy in damages against both banker and buyer. JH Rayner & Co. Ltd. and others v. Hambros Bank Ltd11 The credit called for documents covering a shipment of Coromandel groundnuts; the invoice tendered was for Coromandel groundnuts, but the bill of lading evidenced a shipment of machineshelled groundnut kernels; country of origin was stated to be British India, and Hambros Bank refused to pay on the ground that the letter of credit called for an invoice and bill of lading both covering a shipment of Coromandel groundnuts whereas the bill of lading did not describe the goods in those terms, their attitude was upheld-by the Court of Appeal. Mackinnon, LJ., laying down that a person who ships in reliance on a letter of credit must do so in exact compliance with its terms, observed: The defendant bank was told by their Danish principals to issue a letter of credit under which they were to accept document and invoice and bills of lading covering Coromandel groundnuts in bags. They were offered bills of lading covering machine shelled groundnut kernels. The country of origin was stated to be British Indian. The words in that bill of lading clearly are not the same as those required by the letter of credit. The whole case of the plaintiffs is that they are almost the same, or they will do just as sell. The bank if they had accepted that proposition, would have done so at their own risk, I think on pure principle that the bank were entitled to refuse to accept this sight draft on the ground that the documents tendered, the bill of lading in particular, did not comply precisely with the terms of the letter of credit which they had issued. Moreover Goddard LJ observed the following: The bank, if they accept the mandate to open the credit must do exactly what their customer requires them to do, and if the customer says: I require a bill of lading for Coromandel groundnuts, the bank are not justified, in my judgment, in paying against a bill of lading for anything except Coromandel groundnuts. It is no answer to say: you know perfectly well that machines shelled groundnut kernels are the same as Coromandel groundnuts. For the entire bank knows, their customers may have a particular reason for wanting Coromandel groundnuts in the bill of lading. At any rate, that is the instruction which the customers here have given to the bank, and if the bank want to be reimbursed by the customers, they must show that they have performed their mandate. British Imex Industries Ltd. v. Midland Bank Ltd. 12 The facts were that the defendant bank had confirmed an irrevocable credit for 23.000 in favour of the plaintiffs covering a shipment of steel bars to Jordan. Shipment took place from Antwerp under bills of lading which included amount the printed clauses on the back a clause providing that
11

12

1942 T.L.R. 2l (1958) 1 Q.B. 542.

the vessel would not be responsible for correct delivery in the absence of certain specified marking of the pieces and the bundles. When sight drafts were presented under the credit the bank refused to pay them on the grounds that there was no acknowledgement on the face of the bills of lading that this clause had been complied with. The plaintiffs brought the present action of the drafts. It was held that a credit calling for bills of lading without further qualification required clean bill of lading i.e. bills containing no indication that the goods or packing were defective; that the bills in the present case were in fact clean bill, and that there was nothing in the letter of credit that called for an express acknowledgment that the clause in question had been complied with. The bank therefore had no right to insist on such an acknowledgment. Cape Asbestos Co. Ltd. v. Lloyds Bank Ltd13 In this case Bailhacne, J held that bank owed to duty to advise the beneficiaries of the cancellation; and further that the irregularity in the bill of lading and in the invoice would have justified that banks refusal to pay. In the course of his judgment he said: It is to be observed that the notice that was given by the bank on the opening of the credit is of the opening of a revocable credit and not of a confirmed credit. That tells the person in whose favour the credit is opened that he may find that the credit is revoked at any time. That being the representation which is made by the bank to the person in whose favour the credit is opened, the seller in this case, are the bank under any legal obligation to him to inform him when that a credit is revoked . . . .I have come to the conclusion that, however wise and however prudent, and however much in the interest of business, such a notice may be, there is no legal basis upon which I can find an obligation on the bank to give such a notice under such circumstances. Urquhart Lindsay & Co. v. Eastern Bank Ltd.14 In this case Rowlatt J held that the position of the banker under an irrevocable credit is in law the same as that of a person, who has contracted to buy a shipping document representing the goods shipped, or to be shipped, under the contract between the beneficiary and the person at whose instance the credit has been issued. The credit in this case was opened in pursuance of a contract between Urquhart, Lindsay & Co. and Benjamin Jute Mills, by which the former were to manufacture certain machinery and deliver it f.o.b. Glasgow, for shipment to Calcutta. Two installments of the machinery were manufactured and shipped and duly paid for the bank. A third installment was also manufactured and shipped, but the bank in this case refused to take up the shipping documents and honour the draft on the
13 14

(1921) 3 LDB 314 (1921) 1 KB 315

ground that items for extra cost of labour were included in the invoice price of the goods and that the bank had been instructed by Benjamin Jute Mills to refuse payment in those circumstances. The court held that in such a case, the banker must accept and pay for the documents irrespective of any defense, which there may be to a claim under the contract of sale, and that such defense is solely a matter to be fought out between the buyer and the seller. The Kings Bench held that the refusal of the defendants bank to take and pay for the particular bills on presentation of the proper documents constituted, a repudiation of the contract as a whole and that the plaintiffs were entitled to damages arising from such a breach. It may be noted that in that case the buyer objected to the price quoted in the invoices and he had notified his objection to the bank, but under the terms of the letter of credit the bank was required to make payments on the basis of the invoices tendered by the seller. The court held that if the buyers had an enforceable claim that adjustment must be made by way of refund by the seller and not by the way of retention by the buyer. Pavia & Co. S.P.A. v. Thurmann Neilsen15. The facts were in a contract for the sale c.i.f. of Shelled Brazilian groundnuts payment was to be by confirmed irrevocable credit, the contract providing that the shipping periods should be from February 1 to May 31. Despite repeated requests by the sellers for the credit to be opened it was not in fact made available until April 22. Only a small portion of the quantity of groundnuts covered by the contract was, shipped, and the sellers claimed damage for breach of contract by delay in opening the credit. The Court of Appeal held that the credit should have been established on February 1. In his judgment Denning LJ said: In the absence of express stipulation, I think the credit must be made available to the seller at the beginning of the shipment period. The reason is because the seller is entitled, before he ships the goods; to be assured that, on shipment, he will get paid. The seller is not bound to tell the buyer the precise date when he is going to ship; and whenever he does ship the goods, he must be able to draw on the credit. He may ship on the very first day of the shipment period. If therefore, the buyer is to fulfill his obligations he must make the credit available to the seller at the very first date when the goods may be lawfully shipped incompliance with the contract. The court here referred to Stein v. Hambros Bank of Northern Commerce16 wherein there was a contract for the sale of hides by an English seller to a buyer from Venice, to be shipped from India, was financed by an irrevocable letter of credit. The buyer, contending that a condition had not been met, instructed that bank to cancel the credit and to refuse acceptance, which was accordingly done. In an action by the seller against the issuing bank, it was held that there had
15 16

(1952) 2 KB 84 (1921) 9 L1 LR 433 rev

been a breach of the letter of credit contract and that the seller could recover the amount of the bill of exchange for which acceptance was refused. The case was concerned chiefly with the question of the measure of damages. The right of the seller to maintain the action, if the conditions had been met; seems, to have been assumed without discussion. The theory underlying, this, result is that the issuing bank is not concerned with the sales contract at all. With respect to this the court observed the following: The obligation of the bank is absolute and is meant to be absolute that when the documents are presented they have to accept the bill. That is the commercial meaning of it. Therefore, the fulfillment of the terms of the sales contract is a matter for the seller and the buyer alone.

POSITION IN INDIA
Coming to the Indian scene, we have already discussed that letters of credit these days play an important role in the international trade and in fact they have been termed as the specie of Bank Guarantee and further that they constitute what may be termed as the life-blood of international trade. The Uniform Customs and Practice, as we have seen, govern such letters of credit, for Documentary Credits, which has been evolved by the International Chamber of Commerce in collaboration with the United Nations and the Foreign Trade Banks. Certain principles have been followed and have come to be known as to constitute the law relating to the letters of credit and the bank shall not be complete in case a reference to these cases is not made. The subject shall become all the more important when we consider that so far as the banks are concerned, they regard their words as Bond. Lord Wright had once stated, bankers regard their word as their bond, and honour their signature even though they might have an answer in law. Question very often arises when the bankers are in trouble and sometimes such situations arise when they have to seek injunctions from a court of law. The following cases are important from the point of view of letters of credit: United Bank of India Ltd v. Nederlandsche Standard Bank 17 In the present case, the main question related to the constructions, terms and effect of the letter of credit dated the 24th November 1947. The judgment discusses the significance of the term in the letter of credit that it would be valid till January 5,1948. It was held that this applied to the delivery or presentation of the documents under the credit. This judgment stresses the need for care on the part of an advising bank while advising the beneficiary of a letter of credit issued by another bank. The advice should make it clear that the credit is that of the issuing bank and that the advising bank is merely advising or transmitting it to the beneficiary.
17

(1963) 33 Comp. Cas. 1.

Judgment was given in favour of Nederlandsche Standard Bank, and the Court thus held that the documents should have been presented to that bank on or before the specified expiry date. In the opinion of the Court, NTS was not acting as an advising bank but as the issuing bank. NSB had requested it: Please open irrevocable credit in favour of HJC and in compliance with this request NTS issued its letter in question to HJC. The printed clause at the bottom of the letter did not alter the position of NTS as an issuing bank since the clause, not having been, specially signed or initiated did not form part of the body of the letter and, even if it was, it was not applicable since it was inconsistent with the text of the letter and the text prevailed. It was held in this case that a person who seeks to rely on a letter of credit must do so in exact compliance with its terms and a bank is not bound or indeed entitled to honour drafts presented to it under a letter of credit unless those drafts with the accompanying documents are in strict accordance with the credit as opened. A letter of credit is not a negotiable instrument at all. Where a letter of credit is opened with a specific bank creating a specific credit to a named beneficiary, no other bank can take a transfer or assignment of the letter of credit or act on it. This case is also important from the point of view of the applicability of law where there is a conflict between the actual text of the letter and the printed clause. If there is a conflict between the text of a letter and a printed clause, then certainly the text of the letter must prevail over the ordinary printed clause as being the special variation where the printed clause would be inapplicable. This principle is well recognized in Canada and Dominion Sugar Co. Ltd. v. Canadian National (West Indies) Steamships Ltd18 where Lord Wright, delivering the judgment of the Privy Council, observed: If there is any discrepancy between this printed clause and the stamped clause in the margin, the latter, on ordinary principles of construction, will prevail. M/s. Tarapore and Co. v. M/s Via Tractor export, Moscow & another19 In this case, the Supreme Court had refused to grant an injunction, which was sought by the buyer restraining the issuing Bank from making payment under its letter of credit on the ground, that the letter of credit was independent of an unqualified by the contract of sale or the underlying transaction. The court cited observations of Jenkins, LJ . . . .it seems to be plain enough that the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon the banker an absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to a contract or not. This decision is also in accordance with the principles embodied in the uniform customs and practice for documentary credits. So far as the present case is concerned, the facts that an Indian firm had entered into a contract with a Russian firm for the purchase of certain machinery and in
18 19

(1947) AC 46.57. A1R 1970 Supreme Court 891

pursuance of the contract got a confirmed and irrevocable letter of credit. This credit was also subject to the uniform customs and practice for documentary credits. The complaint of the Indian firm was that the performance of the machinery was not as efficient as was promised and the Indian firm wanted an injunction restraining the Russian firm from realizing any amount under the letter of credit. The suit was subsequently withdrawn on the condition that the seller should instruct the Russian Bank not to demand any further payment under the letter of credit for a period of six months. During this period, the Indian Rupee had been devalued and in terms of a gold clause in the contract, the contract price went up. The Russian firm wanted an additional letter of credit to be opened which the Indian firm objected to. When the matter came before the Supreme Court, the Indian firm did not succeed. The Supreme Court held that except under very exceptional circumstances, the court should not interfere with the mechanism of international trade as any interference with the mechanism is going to have serious repercussions. The court was of the view that autonomy of irrevocable letter of credit is entitled to protection and the courts refrained from interfering with that autonomy. If however, there is a plea of fraud, the matter is otherwise. In the present case there was no such plea that the Russian firm was guilty of, fraud. The scope of an irrevocable letter of credit is explained thus in Halsburys Laws of England20: It is often made a condition of a mercantile contract that the buyer shall pay for the goods by means of a confirmed credit, and it is then the duty of the buyer to procure his bank, known as the issuing or originating bank, to issue an irrevocable credit in favour of the seller by which the bank undertakes to the seller, either directly or through another bank in the sellers country known as the correspondent or negotiating bank, to accept drafts drawn upon it for the price of the goods, against tender by the seller of the shipping documents. The contractual relationship between the issuing bank and the buyer is defined by the terms of the agreement between them under which the letter -opening the credit is issued; and as between the seller and the, bank, the issue of the credit duly notified to the seller create a new contractual nexus and renders the bank directly liable to the seller to pay the purchase price or to accept the bill of exchange upon tender of the documents. The contract thus created between the seller and the bank is separate from, although ancillary to, the original contract between the buyer and the seller, by reason of the banks undertaking to the seller, which is absolute. Thus the bank is not entitled to rely upon terms of the contract between the buyer and the seller which might permit the buyer to reject the goods and to refuse payment therefore; and, conversely, the buyer is not entitled to an injunction restraining the seller from dealing with the letter of credit if the goods are defective. Chalmers on Bills of Exchange explains the legal position in these words: The modern commercial credit serves to interpose between a buyer and seller a third person of un-questioned solvency, almost invariably a banker of international repute: the banker on the instructions of the buyer issues the letter of credit and thereby undertakes to act as paymaster upon the seller performing the conditions set out in it. A letter of credit may be in anyone of a number of specialized forms and contains the undertaking of the
20

Halsbury's Laws of England (Vol. 34, Paragraph 319 at page 185)

banker to honour all bills of exchange drawn there under. It can hardly be overemphasized that the banker is not bound or entitled to honour such bills of exchange unless they, and such accompanying documents as may be required there under, are in exact compliance with the terms of the credit. Such documents must be scrutinized with meticulous care; the maxim de minimis non curat lex cannot be invoked where payment is made by the letter of credit. If the seller has complied with the terms of the letter of credit, however, there is an absolute obligation upon the banker to pay irrespective of any disputes there may be between the buyer and the seller as to whether the goods are up to contract or not. This judgment, therefore, makes it clear that so far as the rights and obligations of the parties to a letter of credit are concerned, the court cannot interfere them with. It should be noted that there may well be cases where the court would exercise jurisdiction, as in a case where there is a fraudulent transaction, However, in the present case as have already been stated the Supreme Court held that the facts placed did not amount to a plea of fraud by any stretch of imagination. Roshan Lal Anand v. Mercantile Bank Ltd. 21 In the present case, the Delhi High Court held that according to appellants, the bill of lading and other papers presented to the bank by the beneficiary were not in conformity with the import license and, therefore, the bank was not entitled to make the letter of credit available for negotiation of the bills issued by the beneficiary. It was contended by the appellants that wrong goods had been supplied and the bank was negligent in permitting negotiation against the letter of credit although the invoices did not tally with the import license. It is also one of the conditions of the import license that where an irrevocable letter of credit is opened by the holder of the license to finance the import of any goods covered thereby, then the bank opening the credit being an authorized dealer for foreign exchange shall be deemed to be a joint holder of this license to the extent of the goods covered by the credit. It may also be stated here that, even according to the shipping documents, components of zigzag industrial embroidery machines were not shipped at all but there were two sets of shipping documents in respect of components of industrial sewing machine in respect of which two bills of exchange for 731-10-0 equivalent to Rs. 9,787.31 each were negotiated. Therefore, the shipping documents in respect of components of industrial sewing machines were of a total value of Rs. 19,574.62 against the value of Rs. 13,500 as permitted by the import license. The trial court held that to the extent of Rs. 6,074.62 the negotiation of the bills was not in accordance with the import license for which the bank must suffer. The trial court further held that it was no concern of the bank that the goods had been seized by customs and the bank was entitled to claim from the appellants to the extent of the amount, which was permitted by the import license. It was further stated that the entire conduct of the appellants as indicated by the aforementioned correspondence shows that at no time, until the filing of the suit, did the appellants
21

(1975) 45 Comp Cas. 519.

take any objection to the negotiation of the two bills under the letter of credit even though they must have known that at least one of the bills of exchange was not authorized by the limits imposed by the import license. In fact, far front there being any repudiation of liability, the appellants accepted their liability under the two bills of exchange and were only keen to have the goods cleared from customs and dispatched. If the appellants had at any time repudiated their liability in respect of one of the bills of exchange, it would have been open to the bank not to put in any bill of entry for customs examination of the goods and they could have re-shipped the goods back to Tokyo at the risk and account of the shippers. In these circumstances, the appellants cannot be heard to say that the negotiation of both the bills of exchange, which had been accepted by them, was unauthorized. Dismissing the appellants appeal and allowing the respondents cross-objections, it was held by the Court that: (i) That in order to be entitled to recover from the person who had opened the letter of credit, the amount payable to the banker or the shipper, the banker must show that it had carried out, in all their strictness, its instructions as notified to it by the buyer. It was not a question of negligence or of a breach of employment to use reasonable care and skill but the case rested entirely on performance of the conditions precedent to the right of indemnity which were specified in the contract between the buyer and the banker resulting in the issue or the credit. That the import license was an integral part of the contract leading to the opening of the letter of credit. It was the duty of the banker to see that the documents were in respect of goods and to the extent authorized by the import license. If the apparent tenor of the shipping documents clearly showed either that the goods were not goods the importation of which was authorized by the import license or even if they were, the value thereof was in excess of the value as authorized by the import license, the banker could not claim indemnification. That since the shipping documents, invoices, etc., contained the description of the goods, viz., Parts for industrial sewing machines, the import limit whereof was fixed by the license at Rs. 13,500, the bank was justified in negotiating one of the bills of exchange because the amount would be under that limit. That, though the bank was not justified in negotiating the second bill of exchange, the entire conduct of the appellants indicating that at no time did they take objection to the two bills under the letter of credit even though they must have known that at least one of them was not authorized by the limit imposed by the import license but accepted their liability under both the bills and were only keen to have the goods cleared and dispatched. If the appellants had at any time repudiated their liability in respect of one of the bills of exchange. it would have been open to the bank not to put in any bill of entry 01 customs examination of the goods and the bank could have reshipped the goods back to Tokyo at the risk and account of the shippers. In these circumstances, the appellants could not be heard to say that the negotiation of both the bills of exchange,

(ii)

(iii)

(iv)

which had been accepted them, was unauthorized. The bank was, therefore, entitled to claim the full amount of the two bills of exchange. So far as the present decision is concerned, it reaffirms the principles that in documentary credit operations all parties deal in documents and not in goods. It is also clear that the banks dealing with such credits are not responsible for the descriptions, quality or existence of goods represented by the documents handled by them. In the present case, the goods were not what they were described to be in documents negotiated under the credit but the bank could not be held liable on that ground. Indian Overseas Bank Ltd. v. S,K.Ramalingam Chettiar and another22 The facts of the case were that the Plaintiff at Kumbakonam, entered into a c.i.f contract with a firm in Calcutta for the purchase of brass scraps. To facilitate the purchase, the Indian Overseas Bank opened a letter of credit on account of the plaintiff in favour of the seller. The letter of credit called for, inter alia, complete set of clean on board railway receipt to order of the Indian Overseas Bank and marked freight paid and Transit insurance policy or certificate of insurance including war risk for 10% over, c.i.f invoice value, claims payable at Madras or Kumbakonam. The letter of credit also required: Insurance should cover risks of war, marine theft, pilferage nondelivery, civil commotion, strikes, riots, warehouse-to-warehouse c1ause and transshipment. The buyer and seller later agreed to the dispatch of the goods by ship and the letter of credit would seem to have been amended accordingly. The shipment was made and the, bank the seller was paid accepted the relative documents. When the shipment arrived at Madras, six of the forty-eight drums containing the goods were found to be damaged and there was a shortage of goods, which was attributed by a survey report to pilferage on account of the damage to the drums. The relative bill of lading had contained a special note: Drums old and second hand steamer not responsible for shortage or damage. The insurance policy accepted by the bank did not cover the risks of theft or pilferage. The plaintiff claimed damages from the bank pleading negligence on its part in accepting a foul bill of lading and not scrutinizing the insurance policy. In this case, the bill of lading was held to be not a clean one because of the special note therein regarding the condition of packing of the goods. The, letter of credit called for a clean bill of lading and hence the issuing bank was held liable to its customer. The insurance policy was also defective since it did not cover the risks of theft and pilferage: The court pointed out that these risks are not automatically covered by a policy which covers perils against pirates, rovers and thieves. The court stated in its judgment that there is reference in the records to the first defendant-bank accepting the documents taking a guarantee from the sellers bank, and the evidence of the agent of the first defendant-bank belt that the, documents, bill of lading and the insurance policy, were not in terms of the letter of credit. . . . The consciousness of the first defendant bank and the seller can be taken as the true interpretation of the buyers requirement as the documents. It follows from the foregoing discussion that if the first defendant had been prudent and alert as in duty bound to
22

1970 MLJ Vol. II, p. 288.

the customer, it would have rejected the documents. The Court also referred to Gutterridges Law of Bankers Commercial Credits23, where the bankers duty is defined thus; It is broadly speaking, the duty of the banker to scrutinize the documents tendered to him by the beneficiary under the credit or by the intermediary banker, and to check them carefully with the instructions which he had received from his customer, and which, presumably, he had faithfully embodied in his credit or his credit instructions to his correspondent bank. Any default in this respect will debar him from claiming reimbursement by the customer of any amount which may be paid against the documents and will also cause him to forfeit his right to remuneration. Premier Tyres Ltd. v. State Trading Corp. of India Ltd.24 In this case also, the matter related to the letters of credit and the facts of the case may be briefly submitted as under: The appellant was a manufacturer of tyres. The natural rubber which is used in the manufacturing process is canalized through the respondent Corporation. For their requirements, the appellant entered into an agreement with the respondent for the supply of 360 MT of natural rubber by the respondent and furnished bank guarantee from the Bank of India for Rs. 3.6 lakhs as required. The appellant agreed as per conditions of allotment to make payment of the goods within the time prescribed by the State Trading Corporation, and it had further agreed that in the case of default, in either case, the State Trading Corporation shall be free to forfeit the earnest money or invoke the bank guarantee or could take any other action as the State Trading Corporation may deem fit without reference to the appellant. After some part performance of the contract, both parties alleged violation of the terms of the original contract against each other. The respondent thereupon wrote to the Bank of India stating that the appellant had failed to observe the terms and conditions of the allocation order and invoked the bank guarantee to the extent of Rs. 1,16,000 and requested the bank to remit the said amount within a week of the said letter. The appellant on being informed by the bank had protested at this action of the respondent and filed a suit seeking a permanent injunction restraining the defendant from the relating any amount in pursuance of the guarantee. The appellant, pending disposal of the suit, sought an ad interim injunction which was refused by a single judge and against which order he filed an appeal to a Division Bench of two judges. Division Bench of the Delhi High Court stated as under: If a bank guarantee given in the widest terms as in the present case was not to be treated as an irrevocable letter of credit and the beneficiary was still to be embroiled in a litigation simply because a dispute was raised by the buyer, much of the stream of trade will dry up thus causing great economic loss to the society and the nation. In this matter at keeping the
23

24

Gutterridge, Law of Bankers Commercial Credits, 3rd Ed. at p. 68 (1981) ST, Comp Cas. 316.

stream of trade unhindered and unpolluted we can see no reason to draw a distinction between the international trade and the internal trade. As a matter of fact the courts have consistently held that a payment under a bank guarantee in favour of a buyer cannot be stopped in international trade even though the buyer may have defaulted in his part of the contract. In such a case, a seller has obviously a great disadvantage in recovering the said amount from the buyer because of different laws and jurisdiction as was recognized in the appeal court case. But that situation does not arise when the parties both belong inside the country. All that may happen is that if an irrevocable bank guarantee like the present is allowed to be encashed it may at the mast give immediate advantage to the seller but the buyer is under no such great constraints or complications in seeking to recover the amount if he ultimately succeeds in the litigation. From that point of view there is less justification to interfere in this settled commercial practice that has grown up around irrevocable bank guarantees in the matter of internal trade rather than international trade. In the case of the latter, the laws of the foreign country may same times be discriminatory and harsh towards foreigners that the denial to issue an injunction may probably cause serious harm, and yet a braider consideration of international trade dependence of world economy compels the court from refraining to issue an injunction. We feel that the same kind of self-restraint and avoidance to trespass on this delicate field of trade, even internal, must govern the consideration of the courts, unless in the exceptional case of a probable case of fraud. No such exceptional case is made out to take a different line. This case is also important insofar as the question of the comparison of the bank guarantee with the letter of credit is to be made and their implications are to be studied. United Commercial Bank v. Bank of India & others25 The facts of this case were that M/s Godrej Soaps Ltd., the plaintiffs, agreed under a contract to supply to the Bihar State Food & Civil Supplies Corporation Ltd., (Bihar Corporation) one thousand metric tones of Sizola Brand Pure Mustard Oil valued Rs. 86 lakhs. The can tract provided inter alia that the Bihar Inter Corporation were to pen a letter of credit with the United Commercial Bank, the appellant, for the said amount, which the Bihar Corporation duly did. The plaintiff from time to time dispatched the goods in lots. When the relative documents with respect to the first lot were presented by the plaintiffs for payment, the appellant bank refused to make payment except under reserve. The main discrepancy was that the goods were described in the Railway receipt as Sizola Brand Pure Mustard Oil Unrefined. The plaintiff accordingly instructed their bankers, the Bank of India, the negotiating bank (respondent), to accept payment under reserve which they did. The amount was credited to the plaintiffs account by the Bank of India also under reserve with a specific notation that it was paid under reserve on account of discrepancies. Subsequently the appellant addressed a letter to the Bank of India making a demand for the refund of the amount paid under reserve as the bills were not acceptable to the
25

AIR 1981 S.C. 1926.

Bihar Corporation due to discrepancies. The plaintiff being apprehensive that their bankers, the Bank of India, would be bounded to refund the amount pursuant to the notice of demand served by the appellant, inasmuch as the payment was made under reserve, filed a suit in the original side of the Bombay High Court along with an application for the grant of a temporary injunction to restrain the appellant from recalling the amount. The learned single judge had granted temporary injunction which was subsequently made absolute till the disposal of the suit on the view that the appellant was not entitled under the terms of the letter of credit to unilaterally impose the condition of payment under reserve or refuse to pay against the documents tendered by the plaintiffs merely because of the alleged discrepancies. The appellant-bank being aggrieved by the order unsuccessfully filed an appeal to the Division Bench of the High Court and thereafter pursued the matter further by filing appeal to the Supreme Court. The main point of controversy before the Supreme Court was whether the court should in a transaction between a banker and a banker grant an injunction, at the instance of the beneficiary of an irrevocable letter of credit restraining the issuing bank from recalling the amount paid under reserve from the negotiating bank. In this case, perhaps, the entire case law on the subject has been summarized by the Supreme Court of India and certain principles of law have been established which cannot be challenged in any manner and which go to the very root of the question relating to the letter of credit and the bank guarantees and which also studies the question if the courts can interfere with the working of the letters of credit. In this case the Supreme Court held that in dealing with commercial letters of credit, the documents tendered by the seller must comply with the terms of letters of credit and that banker owes a duty to the buyer to ensure that the buyers instructions relative to the documents against which the letter of credit is to be honoured are combined with. A bank issuing or confirming a letter of credit is not concerned with the underlying contract between the buyer and seller. Duties of a bank under a letter of credit are created by the document itself, but in any case it has the power and is subject to the limitations which are given or imposed by it in the absence of the appropriate provisions in the letter of credit. In view of the bankers obligation under an irrevocable letter of credit to pay, his buyer-customer cannot instruct him 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. The same considerations apply to a bank guarantee. A letter of credit sometimes resembles and is analogous to a contract of guarantee. A bank which gives a performance guarantee must honour that guarantee according to its terms The opening of a confirmed letter of credit constitutes a bargain between the bankers and the seller of the goods which imposes on the banker an absolute obligation to pay. However the banker is not bound or entitled to honour the bills of exchange drawn by the seller unless they, and such accompanying documents as may be required thereunder, are in exact compliance with the terms of the credit. Such documents must be scrutinized with meticulous care. Held, in the circumstances that the plaintiff was not entitled to injunction restraining the issuing bank from recalling the payments made under reserve. The High Court could not grant injunction on assumption that the issuing bank was wrong in imposing the condition of payment under

reserve as such assumption would amount to prejudging the issue. Though as a matter of rule the Supreme Court does not interfere with interlocutory orders under Art. 136, in. view of the exceptional circumstances of the instant case, it set aside the order of injunction granted by the High Court. The courts usually refrain from granting injunction to restrain the performance of the contractual obligations arising out of letter of credit or a bank guarantee between one bank and another. If such temporary injunctions were to be granted in a transaction between a banker and a banker, restraining a bank from reca1ling the amount due when payment is made under reserve to another bank or in terms of the letter of guarantee or credit executed by it, the whole banking system in the country would fail. It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. They are the life-blood of international commerce. The machinery and commitments of banks are on a different level They must be allowed to be honoured, free from interference by the courts. Otherwise, trust in international commerce could be irreparably damaged A payment under reserve is understood in banking transactions to mean that the recipient of money may not deem it as his own but must be prepared to return it on demand. The balance of convenience clearly lies in allowing the normal banking transactions to go forward. Furthermore, the plaintiffs have failed to establish that they would be put to an irreparable loss unless an interim injunction was granted. Therefore, there is no scope of injunction in the present case and that by granting an injunction, the High Court appeared to be wholly unwarranted. M/s Banerjee & Banerjee v. Hindustan Steel Works Construction Ltd.26 The bank guarantees and the Letters of Credit (L/C) are given by the bankers at the instance of one of the parties to the main contract and pursuant to the express terms of the main contract. Therefore, the contractor, at whose request the bank guarantee is given or the LIC is opened has nexus therein. He cannot be said to be a total stranger to the contract of guarantee or L/C. A wrongful or fraudulent enforcement of the bank guarantee will vitally affect the contractor. Hence if the guarantee is enforced by fraud, misrepresentation, deliberate suppression of material facts, or the like, that will give rise to a special equity in favour of the contractor who will then have the right to stop its enforcement by obtaining an order from court. But for obtaining an order from court, a very strong prima facie arguable case in support of the contention that there is a fraud or special equity, must be made out. The courts will not interfere with the enforcement of unconditional or conditional bank guarantees or Letters of Credit on the mere allegation of fraud or special equity. If the guarantee is a conditional one, it becomes enforceable upon fulfillment of the conditions stipulated and the beneficiary must have alleged in the demand letter that the conditions have been fulfilled. Otherwise the Bank will not be liable to pay. As a matter of fact, if the conditions are not fulfilled, it is the duty of the bank to refuse payment. In the instant case the bank guarantees were given pursuant to the express terms of the contract entered into between the petitioner, a Principal debtor and the respondent 1, a beneficiary, a
26

AIR 1986 Cal. 374.

company for construction works in the Super Power Thermal Project. Out of the seven bank guarantees, two were in lieu of security deposit and five were for securing mobilization advance made by the respondent 1 to the petitioner. Under the terms of the guarantees, for enforcement of the guarantees the respondent 1 had to make a written demand stating that the petitioner has committed breach of any terms of the contract and the extent or the quantum of loss or damage suffered or to be suffered by the respondent 1 as a result thereof. The decision of the respondent 1 regarding the quantum of damage was not to be questioned or challenged by the banks. On fulfillment of these two conditions, the bank was bound to release the guaranteed amount. However, the respondent 1 while seeking the enforcement of the bank guarantees failed to discharge its duty as the sole Judge to quantify the damages and to mention the extent of recoveries made by it although it was within its special knowledge. Although a large amount was recovered by respondent 1 there was no whisper about the same in the demand letters. Held, that by suppressing the material fact from the banks, the respondent 1 attempted to recover the entire sum under the seven guarantees and the suppression of such material fact in the demand letters had given rise to a special equity in favour of the petitioner to stop payment by the bank on the basis of these demand letters. Although in the petition, there was no allegation of fraud, the said willful false representation by the beneficiary that the entire guaranteed amount has become due and payable by suppressing the facts of recoveries already made, was a factor, which must be treated on the same footing as fraud giving rise to special equity and must be treated as an exception to the general rule that the court should not interfere in these matters. By enunciating the general principle of non-interference by courts in respect of guarantee and L/C the courts only intended that the international trade and commerce should function smoothly without interference from court. At the same time, the courts expected that the merchants and traders in international trade and commerce will honour their respective commitments and the business honesty would be maintained. By the theory of noninterference in cases of L/Cs and guarantees, certainly the courts did not intend that international trade and commerce should flourish and thrive by adopting dishonest unscrupulous practice. These trade practices and t4e commitments by the banks are treated on a different level by the courts and are allowed to function without interference from court only with the view that the trust in international commerce is not damaged in any way and not for encouraging mala fide activities of unscrupulous traders. If so, fraud or the special equity arising out of the peculiar situation of the case could not have been made exceptions to the general principles of non-interference by courts. Therefore, the guarantees and L/Cs must be enforced in accordance with the terms of the documents only which ipso facto excludes the possibility of enforcement of these documents contrary to their terms. The plea of the respondent that the guarantees should be allowed to be invoked to the extent of outstanding dues there under would not be sustainable. M/s. Centax (India) Ltd. v. Vinmar Impex Inc. and other27 The facts of the case were that the appellant (Indian buyer) covenanted to purchase from
27

1987 Com. Cas. Vol. 61 p. 697.

respondent 1 (foreign sellers) certain high-density polythene powder on an irrevocable letter of credit being opened by the appellant in favour of respondent 1. One of the terms of the con tract as per the letter of intent signed by both the parties pertained to the shipping mark and was to the effect: Bills of lading should mention shipping mark 5202. Pursuant thereto, at the request of the appellant the bank opened a letter of credit in favour of respondent 1. Respondent 1 despatched the goods which arrived at an Indian port. Respondent 1 failed to forward, through bank, the original bills of lading, marine insurance policy, etc., to enable the appellant to take delivery of the goods. Since the shipping company was refusing to release the cargo for want of the original bills of lading and other documents, respondent 1 instructed them to release the cargo upon the appellant furnishing a bank guarantee for release of the goods in lieu of the original bills of lading. The bank executed the letters of indemnity, the shipping company. On the strength of the letters of indemnity, the shipping company delivered the goods to the appellant without production of the original bills of lading. After taking delivery of the goods, the appellant sold them for a certain sum of money. The shipping company having made a demand upon the bank to honour the letters of indemnity and the bank having called upon the appellant to pay the amount due, the appellant filed a suit for recovery of damages from respondent 1 on the ground that the goods despatched by the seller were of inferior quality and not the goods contracted for and that the seller had failed to forward the original shipping documents. The appellant also filed an application for .grant of a temporary injunction restraining the bank from making any payment to the shipping company in terms of the letters of indemnity and also restraining respondent 1 from recovering the amount due thereunder. A single judge held that the mark 5202 pertained not to the quality of the goods or the grade but to the shipping mark, that despite knowledge of the goods being of a different mark or grade, the appellant took delivery of the goods and sold them, for a huge sum with a clear margin of over Rs. 8 lakhs, even assuming that the appellant had suffered damages, that the appellant did not pay anything to respondent 1, out of the sale proceeds, that, therefore, the balance of convenience did not require the grant of an injunction and that its refusal would not put the appellant to any irreparable loss. A Division Bench of the High Court affirmed the order of the single judge and held that the obligation of the bank under the letters of indemnity, countersigned by the appellant, was absolute and upon a demand being made by the shipping company, the bank was liable to honour the same regardless of any controversy between the parties as to whether the contract of sale had been performed. An appeal was filed to the Supreme Court of India where the judges confirmed the judgment of the High Court and held that the injunction could not be granted. It was held that the case was really an extension of the principles laid down by this court in United Commercial Bank case28. The question in that case also related to the fact whether the court should in a transaction between a banker and a banker grant an injunction at the instance of the beneficiary of a irrevocable letter of credit restraining the issuing bank from recalling the amount paid under reserve from the negotiating bank acting on behalf of the beneficiary against a document of guarantee/ indemnity at the instance of the beneficiary. In dealing with the nature of a bankers obligation under an irrevocable letter of credit, the court observed that a letter of credit sometimes resembles and is analogous to a contract of guarantee. In Elian v. Matsas 29,Lord Denning M.R, while refusing to grant an injunction stated:
28

(1981) 3 SCR 300: (1982) 52 Com. Cas. 186 (SC).

. . . .a bank guarantee is very much like a letter of credit. The courts will do their utmost to enforce it according to its terms. They will not, in the ordinary course of things, interfere by way of injunction to prevent its due implementation. . . . The court said that that commitments of banks must be allowed to be honoured free from interference by the courts. Otherwise, trust, in international commerce would be irreparably damaged. The court added that except possibly in clear cases of fraud of which the banks have noticed, the courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or as stipulated in the contracts. Hence it observed that: We do not see why the same principles should not apply to a bankers letter of indemnity. Accordingly, the appeal must fail and is dismissed with costs. CONCLUSION The letter of credit along with the bank guarantee forms the lifeblood of the trade commerce across the world. It is considered to be one of the most important documents in commercial transactions and is considered sine qua non for smooth and quick flow of money in the business. Therefore, the letter of credit agreement is considered to be independent from the main contract between the seller and the buyer, and thus autonomy is granted to it. The credit is separate from an independent of the underlying contract of sale or other transaction and bank, which operates the credit, is only concerned in ascertaining whether the documents tendered by the seller correspond to those specified in the instructions under the letter of credit. It is due to this autonomy, that doctrine of strict performance is invoked on the part of the bank and it cannot refuse to honour the draft or cheque presented by the seller along with the necessary documents. The principle of autonomy of credit is set out in Article 3 and 4 of Uniform Customs and Practice for Documentary Credits and the principle is well accepted in United Commercial Bank v. Bank of India30. The only exceptions to this rule of autonomy are fraud, of which the bank had knowledge, and an irreparable harm to any of the parties, if the letter of credit is invoked and honoured. Apart from these exceptions, the bank cannot refuse to honour the letter of credit and it would exercise utmost possible restraint from granting an injunction restraining the bank from honouring the documentary credit. This has been established as a rule in trade and commerce across the world and has been accepted both by the Common law courts and the Indian courts.

29 30

1966) 2 ULR 495 supra n.17