The Letter of Credit, its resilience and viability in securing international commercial transactions

Author:Norman Mugarura
Position:Global Action Research and Development Initiative Limited, London, UK
Pages:246-264
SUMMARY

Purpose - This paper aims to address issues of law and policy, the potential pitfalls such as fraud, conflict of law and documents discrepancies that are often encountered by the parties in usage and practice of the Letter of Credit (LC). The article has gleaned other forms of payment mechanisms in international commercial trade to demonstrate that despite the upsurge in international payment instruments, the LC has remained a viable commercial product. This article aims to provide an in-depth analysis of the law governing the LC and why it has remained resilient and a viable commercial product for many years. Design/methodology/approach - The author has utilized the current version of UCP 600 (2007) ... (see full summary)

 
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The Letter of Credit, its
resilience and viability in
securing international
commercial transactions
Norman Mugarura
Global Action Research and Development Initiative Limited, London, UK
Abstract
Purpose – This paper aims to address issues of law and policy, the potential pitfalls such as fraud,
conict of law and documents discrepancies that are often encountered by the parties in usage and
practice of the Letter of Credit (LC). The article has gleaned other forms of payment mechanisms in
international commercial trade to demonstrate that despite the upsurge in international payment
instruments, the LC has remained a viable commercial product. This article aims to provide an in-depth
analysis of the law governing the LC and why it has remained resilient and a viable commercial product
for many years.
Design/methodology/approach – The author has utilized the current version of UCP 600 (2007) and
the legislation such as Brussels Convention (2000) in Europe, litigated cases and secondary data sources
in writing the paper. The data generated were then evaluated taking into account the most recent legal
and policy changes regarding the usage and practice of the LC in international commercial transactions.
The paper straddles many issues but evaluated in a distinctive way to underscore the purpose for
writing it.
Findings The ndings of the paper have demonstrated that despite a myriad of payment
mechanisms as a result of innovation in international trade, the LC is still a viable commercial product.
Parties will need to be knowledgeable and skilled enough to keep abreast of dynamic changes on law
and policy relating to usage and practice of LCs. Short of that parties could be vulnerable to risk
exigencies inherent in international trade they sought to eliminate by subscribing to the LC.
Research limitations/implications The limitations lie in realm that the paper was largely
library-based and the author did not carry out extensive corroborative research studies on issues it was
written on. Thus, any future work on the LC will try to corroborate issues of policy and practice and how
they are internalized in commercial practice.
Practical implications – The paper has articulated the governing law of the LC and the context in
which it is harnessed in commercial practice. It has articulated potential risk areas that the parties ought
to watch out for before and during the process of harnessing the LC as a payment mechanism. The paper
has demonstrated that risks inherent in international trade are now higher than in past decades because
of globalization and its attendant uid environment. The paper is relevant to banks, regulators,
governments and also students because it internalizes most recent changes in the usage and practice of
the LCs in international trade.
Social implications – International trade affects local businesses, banks, ordinary people, national
governments and it has far reaching implications for societies as whole. The LC is utilized to mitigate,
if not eliminate, potential risks in international trade transactions, and it has far reaching social
implications for economies to be overlooked.
Originality/value – The article has gleaned other forms of payment mechanisms in international
commercial trade to tease out that despite the upsurge in international payment mechanisms, the LC has
remained a viable commercial product. This article is a MUST read because it internalizes recent
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1477-0024.htm
JITLP
13,3
246
Received 14 January 2014
Revised 16 April 2014
Accepted 13 July 2014
Journal of International Trade Law
and Policy
Vol. 13 No. 3, 2014
pp. 246-264
© Emerald Group Publishing Limited
1477-0024
DOI 10.1108/JITLP-01-2014-0001
changes in the usage and practice of documentary credit which have not been addressed in its context.
Even though the article has been undertaken by analysis of secondary and primary data sources, the
author has done so in a distinctive way to underscore the most recent changes to the usage and practice
of the LC and the purpose it was written.
Keywords Potential pitfalls to watch out, Its commercial viability, Letter of Credit,
Why its resilience
Paper type Research paper
1. Introduction
This article aims to provide an in-depth analysis of the law governing the Letter of
Credit (hereinafter LC) to demonstrate its resilience and commercial viability for many
years. The LC is a commercial specialty used to guarantee payment of goods by banks
(on behalf of the buyer) to the seller and it has performed this fundamental function for
more than 150 years (Ellinger, 2007). The applicable version of UCP depends on the one
in force at any particular time (Debattista, 2007)[1]. The interposition of banks between
the parties is designed to provide enhanced security by minimizing information
asymmetries between the parties. More often, the parties to the LC would be based in
different foreign countries (jurisdictions), with little knowledge of each other and also
the potential of a language barrier. Therefore banks are interposed to bridge the
information gap between the buyer and the seller. However, it needs to be noted that
while banks are not concerned with[2] underlying sales contracts, the LC is undertaken
pursuant to sales contracts between the buyer and seller. Parties would have nominated
a clause into the sale contract to the effect that payment will be made by the LC. Banks
are also interposed into the LC process to provide security to the parties with regard to
rigorous examination of[3] tendered documents. Thus, this article addresses recent
changes introduced by UCP 600 and a shift in policy on documentary credit practice in
international commercial transactions. The article addresses issues of law and policy,
the potential pitfalls that are often encountered by the parties and usage in practice of
the LC. The article has explored other forms of payment mechanisms in international
commercial trade to tease out that despite the upsurge in international payment
mechanisms, the LC has remained a viable commercial product. This article is a MUST
read because it internalizes recent changes in the usage and practice of documentary
credit which have not been addressed in its context. Even though the article has been
undertaken by analysis of secondary and primary data sources, the author has done so
in a distinctive way to underscore the most recent changes to the usage and practice of
the LC and the purpose it was written. The article is structured in three parts, where part
one addresses the process within which the LC is executed, part two addresses the role
of banks and part three deals with issues of law and policy on documentary credit
practice.
2. The mechanics of the LC
The main feature of the LC is that it is separate and separable from underlying sales
contract for which they are generated (Bridge, 1999). As a commercial product, the
purpose of LC is to perform two principal functions: rst, it is a source of nance to the
buyer to effect commercial transactions and thus boosts the buyer’s capacity to engage
in international trade with ease. Second, it provides security to the seller, ensuring
(through a reliable paymaster-the bank-of payment) that he will get paid. However, it
247
The Letter of
Credit

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