A letter of credit legally explained
S J Tubrazy
A letter of credit, according to Halsbury’s Laws of England, Volume 3, Fourth Edition, is an undertaking by a banker to meet drafts drawn under the credit by the beneficiary of the credit in accordance with the conditions laid therein. Where the credit is designed to facilitate trade a letter of credit may be addressed to another specified banker (called the intermediary banker) or to the beneficiary. Where the credit is addressed to the intermediary banker, it may contain an instruction to that banker either merely to advise the beneficiary of the credit without any commitment or to add his confirmatory undertaking to it, in which case the beneficiary has the promise of both bankers.
A letter of credit comes into being as the result of a formal written application by the applicant, usually the buyer of goods, who pursuant to his sales contract, instructs his banker to open a credit and undertakes to put the bankers in funds, providing the documents against which the banker pays are what the buyer calls for. The application is at the same time, a request, a mandate and an indemnity. The banker is bound to apply the funds to the purpose to which they are appropriated. Normally, and in the absence of any express arrangement to the contrary, the banker on paying under the credit debits the buyer’s account. The banker must comply rigidly with his instructions and where he does, he is entitled to the indemnity of an agent. Denning, L. J observed in Pavia do Co., S. P. A. v. Thurmann‑Neilsen ((1952) 1 All. E R 492), “the sale of good across the world is now usually arranged by means of confirmed credits. The buyer requests his banker to open a credit in favour of the seller and in pursuance of that request, the banker or his foreign agent, issues a confirmed credit in favour of the seller. This credit is a promise by the banker to pay money to the seller in return for the shipping documents. Then the seller, when he presents the documents, gets paid the contract price. The conditions of the credit must be strictly fulfilled, otherwise the seller would not be entitled to draw on it”. According to Paget’s Law of Banking (Eighth Edition) the usual form of import credit consists of an undertaking by the buyer’s banker addressed to his foreign correspondent (the advising, paying, or negotiating banker), or to the beneficiary by which the buyer’s banker issues or opens his (irrevocable) credit in favour of the beneficiary, promising that payment will be made against tender of documents (including usually full set bills of lading, invoice and marine insurance policy) within a given period of time. The credit usually states further that it is available by sight (or time) drafts, drawn on the issuing banker or the buyer and may ask the intermediary banker to add his confirmation or merely to advise.