RESEARCH PAPER SUBMITTED

ON

DOCTRINE OF STRICT COMPLIANCE IN LETTER OF CREDIT

TRANSACTIONS

IN COMPLIANCE TO THE PARTAIL FULFILLMENT OF THE MARKING SCHEME

FOR TRIMESTER VII OF 2019-2020, IN THE SUBJECT OF INTERNATIONAL
TRADE LAW

SUBMITTED TO THE FACULTY

PROF. JHARNA SAHJWANI

SUBMITTED BY:

SWADHA SINGH (ROLL NO.: A052)

FOURTH Y B.A. L.L.B (hons.)

 TABLE OF CONTENT

S. NO. PARTICULARS PAGE NO.

1. INTRODUCTION 3.

2. RESEARCH PLAN 4.

3. KEY ISSUES 6.

4. CONCLUSION AND SUGGESTION 13.

5. BIBLIOGRAPHY 15.

2
INTRODUCTION

The term LETTERS OF CREDIT comes from the french word accredit if (the power
of doing something), which in turn derives from the Latin word accreditivus (trust). It
is often described as “the life blood of international commerce”. 1 LETTERS OF
CREDIT have been used since time memorial as a mechanism of financing trade; they
have been used by the Phoenicians Babylonians, Assyrians, the greek and other
merchants to help their own credit. The LETTERS OF CREDIT originated from the
bill of exchange and were a useful device for travellers who did not want to carry hard
cash while travelling for obvious security reasons they would instead give this money
in trust to their bankers in exchange for a 'LETTERS OF CREDIT’ which could later
be cashed at another bank at their destination.

LETTERS OF CREDIT were preminently used after the second world war, following
the general agreements on tariff and trade. Since then, banks have overtime assumed
the role of facilitation international transactions and communication between trades in
different countries. 2 The LETTERS OF CREDIT were later to be embodied in
provisions of the uniform customs and practice for documentary credits herein after
referred to as UCP.

One of the fundamental principles governing the LC operation is the principle of

strict compliance. The principle requires the seller to present the necessary
documents in accordance with LC requirements; in order to claim payment for the
goods sold. The principle of strict compliance is defined as the legal principle that
entitles the bank to reject documents which did not strictly comply with the
terms of LC. 3

The issue of strict compliance comes into the picture during the process of checking
documents in LC transactions. The bank is the party responsible in determining
whether or not the presentation complies with LC requirements based on the Uniform

1
R.D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd. [1978] Q.B.146
2
SITPRO, Report of the Use of Export Letters of Credit 2001/2002, SITPRO’s Letter of Credit Report,
11 April 2003
3
Hans van Houtte (2002) The Law of International Trade (second edition), London, Sweet & Maxwell,
Ch.8

3
Custom and Practice for Documentary Credit (UCP 600) and ISBP. the strict
compliance standard is not just one isolated rule, but a set of many rules that
regulate each document required by the credit and their content.

RESEARCH PLAN
The prime task of the paper is to reveal the essence of line of credit transaction and
doctrine of strict compliance associated with it. Principle of strict compliance is
significant to sustain the smooth flow of LETTERS OF CREDIT procedure.

LETTERS OF CREDIT expedites payment to a seller as well as guarantees delivery

of goods that fulfill contract description to a buyer. However, the issue of standard
of compliance causes delays in payment and vitiates the credibility of LETTERS OF
CREDIT as a method of payment in international trade. Despite the attractiveness
of the process, by choosing letters of credit, international traders often have
trouble. In particular, they find it difficult to meet the level of documentary
compliance demanded by many banks.

Once discrepancies exist in seller’s documents, the documents will be considered as

non-compliance and all undertakings are suspended. Consequently, a seller will not
receive payment and a buyer will not be able to claim the goods at port of delivery.
This paper addresses issues relating to doctrine of strict compliance in letter of
credit transactions and its requirements based on uniform custom and practice for
documentary credit (USP 600) and ISBP also how banks have applied the strict
compliance rule very rigorously to protect their own interests in case litigation
would ensue. The flipside is sellers left with the risk of not being paid and many
other.

KEYWORDS
Line of credit, Strict compliance, Bank, Cash, LETTERS OF CREDIT

RESEARCH METHODOLOGY

4
The researcher fails to conduct primary research in the form of questionnaires,
interviews, field research, etc. The research conducted shall be secondary in
nature. Materials and fact written will be taken from various books, reports,
articles and the internet. It is not done on the basis of primary data i.e. through
questionnaire, field research etc

5
KEY ISSUES

LETTER OF CREDIT
Letter of credit (LC) is a payment mechanism, used to facilitate trade in international
sales. A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a
seller will be received on time and for the correct amount. In the event that the buyer
is unable to make payment on the purchase, the bank will be required to cover the full
or remaining amount of the purchase. Due to the nature of international dealings,
including factors such as distance, differing laws in each country, and difficulty in
knowing each party personally, the use of letters of credit has become a very
important aspect of international trade. The definition of the letter of credit is in
Article 2 of the UCP 600
“Credit means any arrangement, however named or described, that is irrevocable
and thereby constitutes a definite undertaking of the issuing bank to honour a
complying presentation.”

PARTIES INVOLVED

 The applicant – the party on whose request the credit is issued (usually the
buyer or importer)
 The issuing bank – the bank that issues a credit at the request of an applicant
or on its own behalf
 The beneficiary – the party in whose favour a credit is issued (usually the
seller or exporter).4

BREAKING DOWN LETTER OF CREDIT letter of credit is typically

a negotiable instrument, the issuing bank pays the beneficiary or any bank nominated
by the beneficiary. If a letter of credit is transferable, the beneficiary may assign
another entity, such as a corporate parent or a third party, the right to draw. Banks
typically require a pledge of securities or cash as collateral for issuing a letter of
credit. Banks also collect a fee for service, typically a percentage of the size of the
letter of credit.

4
Art 2. Of UCP 600.

6
THE INTERNATIONAL CHAMBER OF COMMERCE UNIFORM
CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS
This body oversees letters of credit used in international transactions.
EXAMPLE
Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe,
Asia and the Middle East who may have difficulty obtaining international credit on
their own. Citibank’s letters of credit help exporters minimize the importer’s country
risk and the issuing bank’s commercial credit risk. Letters of credit are typically
provided within two business days, guaranteeing payment by the confirming Citibank
branch. This benefit is especially valuable when a client is located in a potentially
unstable economic environment.

TYPES
 Direct payment mode: commercial letter of credit
 Secondary payment mode: standby letter of credit.

Commercial letter of credit is where the issuing bank makes the payments to the
beneficiary. involves a bank other than the issuing bank guaranteeing the letter of
credit. Standby letter of credit is where the bank pays the beneficiary only when the
holder cannot.

LEGAL PRINCIPLE- DOCTRINE OF STRICT COMPLIANCE

The law relating to letters of credit is founded on–the doctrine of strict compliance
(governed by 14(a) of the UCP 600).

This legal principle entitles the bank to reject documents which did not strictly
comply with the terms of LC. One of the fundamental principles governing the LC
operation is the principle of strict compliance. The principle requires the seller to
present the necessary documents in accordance with LC requirements; in order to
claim payment for the goods sold.

SCOPE The doctrine ensures the buyer that the bank will only make the payment if
the documents received comply strictly with the terms and conditions of the credit as

7
stipulated by the buyer, and the seller knows that payment will be received even if the
buyer would not pay voluntarily for some reason, provided the terms and conditions
of the credit are strictly complied with.

Buyer’s Perspective The principle of strict compliance aims to protect the buyer who
has neither the opportunity to examine the physical goods nor to supervise the process
of loading the goods in the seller’s country due to geographical distance. Therefore,
the documents are the only security for the buyer. The documents prove that the
goods have been properly delivered in accordance with the description in the sale
contract.

Seller’s Perspective the principle of strict compliance also benefits the seller by
providing fast payment. The seller does not have to wait until the goods shipped
safely reach the buyer before claiming payment. The seller can claim payment for the
goods sold by presenting to the bank the documents required by the buyer once the
goods have been shipped to the buyer.

Bank’s Perspective Apart from the buyer and seller, the bank also benefits from the
application of the principle of strict compliance in LC. The bank will be protected
against any legal repercussion as long as the payment to the seller was made upon
strict compliance of seller’s documents. This is irrespective of the condition of the
goods received by the buyer. Since banks usually have limited expertise in goods or
industries, they are not expected to know every aspect of commercial terminology in
trade In most cases, the bank does not even know what kinds of goods are transacted
between the seller and the buyer.

Hence, even if there is any problem with the goods delivered, the bank will not be
held responsible for releasing the payment to the seller as long as the documents are
in order.

STANDARD OF COMPLIANCE Since there were no standard parameters set by

the previous revisions of the UCP, the task of determining the standard of compliance
required in documents was left to the courts to decide.
Evidently, this loophole has contributed towards conflicts of judgment in case laws as
well as uncertainty in banking practices. Over the years, judges and LC experts

8
struggled to come up with a formula to determine the standard of compliance in LC,
resulting in diverse opinions and views being formulated.

TYPES OF STANDARD OF COMPLAAINCE

Literal Compliance Standards: The literal compliant standard demands a high

standard of compliance. The documents must be in strict compliance with the LC
requirements. In other words, it must be the ‘mirror image’ of the LC. This standard
suggests that minor mistakes such as typographical errors can be considered as a
discrepancy which allows the bank to reject the documents. It also protects the banks
from customers’ complaints.
Substantial Compliance Standards: it suggests that the presentation of documents
which are substantially in compliance with the credit can be accepted as a good
presentation. Accordingly, any trivial or non- significant discrepancies can be waived.
The rationale behind the substantial compliance standard is to promote equity to the
beneficiary. It also protects the relationship between bankers and their high valued-
customer from being affected by minor discrepancies; which results in documentary
non-compliance. As compared to the literal compliant standard; the substantial
compliance standard is not easily practiced. The latter requires skills and in-depth
knowledge in order to determine whether to accept or reject the documents tendered.
Thus, to certain extent, substantial compliance standard demands the involvement of
the bank’s senior or experienced officers to make decisions.

STEPS BY BANK CONCERNING THE STRICT COMPLIANCE RULE

Document examination when in a letter of credit transaction documents are

presented to the bank it must examine the presentation to determine, on the basis of
the documents alone. it must be done in a maximum of five banking days following
the day of presentation
Honour If the credit instructions are clear enough and the beneficiary has tendered a
complying presentation, the bank must honour. However, if the tendered documents
do not comply strictly with the terms of the letter of credit, the bank needs to decide
what to do
Discussion During the allowed five days the bank has to take many decisions. Firstly,
the bank needs to decide whether the presentation is strictly complying. In this
process banks are expected to adhere strictly to the instructions given by the applicant

9
because they normally have no expert knowledge of the particular trade they are
financing.

UCP 600 UNIFORM CUSTOMS & PRACTICE FOR DOCUMENTARY

CREDITS

It is the official publication which are issued by the International Chamber of

Commerce (ICC). A set of 39 articles on issuing and using Letters of Credit, which
applies to 175 countries around the world, constituting some $1tn USD of trade per
year.
The current UCP 600 is the result of the ICC Committee’s effort to solve problems
relating to strict compliance and documentary discrepancies which arise from the
application of the UCP 500. Having realized the high rate of discrepancies found in
the seller’s documents, the ICC working groups came up with the new UCP 600. The
new version aims to reduce the strict requirements imposed by the UCP 500 on
documents. Various views and comments on the current rules in the UCP 600 portray
it as more customer-friendly and an easier reference compared to the earlier UCP
version. It also introduces new articles including those which provide definitions of
presentation and complying presentation.
Doctrine Of Strict Compliance: The doctrine of strict compliance has been relaxed
by the provisions introduced by the UCP 6005 means eliminates the narrow provision
of Article 13(a) of the UCP 500, which stated that documents which are “inconsistent
with one another,” will be treated as non-compliant. The introduction of the new
provision by the UCP 600 reduces the complexity presented by the strict compliance
principle. It signifies that as long as the contents of the documents are not contrary to
the LC, the bank will accept documents as in compliance. the seller’s documents
“need not be identical to, but must not conflict” eliminates conflicts between different
documents, which is the most frequent ground for the dishonor of documents
presented under commercial LCs. This provision however does not objectively state
the criteria of compliance. While it undoubtedly implies a wider compliance
approach, it however opens up room for potential new disputes; for example, to what
extent the data is not in conflict with each other

5
Alan M. Christenfield & W. Melzer Shepard, New Rules for Letters of Credit, New York Law Journal,
Thursday, February 1, 2007.

10
Commercial Invoice It does not promise absolute leniency for the seller. The
requirement of strict compliance still remains in Article 18(c) relating to the
description of the goods in a commercial invoice. Generally the leniency offered to
other LC documents 6 are not extended to commercial invoice because since the
phrase “must correspond” with the requirement of LC in Article 37(c) of the previous
UCP 500 is still maintained.

Bank’s Duty Failure by the bank to state clearly in the notice its refusal and rejection
of the presentation of documents may preclude the bank from exercising its right of
rejection. The UCP 600 provides disclaimers for the banks to protect them from any
difficulties arising out of the documents and performance of LC transactions 7

ISBP, 20138

SCOPE Another important reference that guides the banks in determining the
international standard to be used in checking documents is the ISBP which aims to
reduce the number of documents rejected by banks, has already played a significant
role in reducing international discrepancies.

It contains a list of general principles relating to the standard practices for determining
documentary compliance. The ISBP is referred to in cases whereby the rules of the
UCP need clarification9 explained how the UCP rules were to be applied.

The ISBP allows the transaction to continue in a normal way without hindering it.
This has definitely contributed a lot in reducing discrepancies since the ISBP requires
substantial compliance instead of strict literal compliance. If the UCP and the ISBP
cannot provide a sufficient answer as to how strictly exactly the document at
issue should comply with the credit, banks can rely on the standards of strictness
of international standard banking practice.

6
Article 14(e), UCP 600
7
Articles 34, 35, 36 and 37, UCP 600.
8
ICC (2003) International Standard Banking Practice for the examination of documents under
documentary credits, ICC Publication No. 645
9
For instance, the issues of what constitute discrepancy or non-compliance can be guided by the
provisions of Rule 23, definition of invoice by Rules C1-C2 and description of goods by Rules C3-
C14, ISBP.

11
Criticism It should be noted that the requirement that a presentation must be in
accordance to the ISBP is not mandatory. Banks may only adopt the ISBP for
clarification. They cannot rely only on the ISBP in deciding whether to reject or
accept the presentation as it must be solely based on the UCP alone.

12
CONCLUSION AND SUGGESTIONS

Each of the offered adjustments to the UCP and ISBP, as far it concerns the required
documentary compliance, are made with the aim to ensure the necessary protection
for banks. Maybe some of the recommended adjustments have put an additional
burden on the beneficiary to be more careful and precise in the document preparation
process, but this is the price to pay for a fast and prompt payment for international
trade.

The application of the principle of strict compliance may put the buyer in difficulty if
the seller’s documents are rejected for non-compliance. The buyer in such a case
needs to wait for the seller to rectify the rejected documents. This delay may affect
the buyer’s business schedule and causes him to lose his business profit. Even though
the buyer has the right to waive the discrepancies, in practice, the final say in most
cases is still with the bank.

The hindrance caused by the discrepancies of documents produces negative impact on

the LC as a means of payment. Such discrepancies trigger unnecessary hiccups. In
most cases, non- compliance disputes will open a leeway to court proceedings. The
delays may definitely be prolonged as the litigation continues. In worse situations,
delay of payment may end up causing possible loss of future trade.

Moreover There are however some LC experts who do not favor the literal and
substantial compliance standard classification. The phrase is merely a fiction invented
by lawyers drawn from contract law. Moreover, they also alleged that “strict”
compliance is not a principle of sound banking.

UCP 600 The existence of the latest UCP 600 is claimed to provide leniency and a
higher degree of compromise to the strict compliance principle. Wider strict
compliance as suggested by the UCP 600 does not mean that the data content in any
documents could go ‘unmatched’. It widens the scope of compliance where data in
any document may differ expressly with one another but should not contradict each
other. This new approach of compliance is seen to ensure smoother payment under
the LC rather than looking for discrepancies and rejecting such discrepant documents
during the process of document examination.

13
The current UCP 600 limits the depth of examination of documents by banks
Generally, as far as ‘compliance’ is concerned, the UCP 600 can be said to encourage
fair and equitable trade. Nevertheless, it is alleged that the adoption does not totally
eradicate issues of compliance of documents in LC since the examination process of
documents involves human intervention. Therefore, discrepancies cannot be avoided
completely no matter how well the UCP is written.

SUGGESTIONS In dealing with letters of credit beneficiaries must know the rules of
the game in order to succeed. The document examination standard, it is left to courts
to develop a new body of case law over the new rules and shape the document
examination standard further toward solving the strict compliance problem. The idea
signifies that compliance should be determined based on the documents as a whole
with reference to their roles in LC transactions. Regardless of the standard applied,
the examination of documents which involves humans checking should not be carried
out based on scientific method but it must be realistic. In addition, the question of
standard of compliance is subjective and it depends on each individual approach.

14
BIBLIOGRAPHY

WEBSITES
 https://www.academia.edu/11352999/Doctrines_of_strict_compliance_and_au
tonomy_as_used_in_Letters_of_credit
 https://www.hg.org/legal-articles/letters-of-credit-bills-of-lading-and-
international-trade-finance-documentation-issues-important-in-litigation-
18850
 https://umexpert.um.edu.my/file/publication/00008256_97294.pdf
 https://www.investopedia.com/terms/l/letterofcredit.asp
 http://pure.au.dk/portal/files/2543/Krazovska_MasterThesis.pdf
 https://www.academia.edu/22867185/IMPACT_OF_THE_DOCTRINE_OF_
STRICT_COMPLIANCE_ON_A_LETTER_OF_CREDIT_TRANSACTION

BOOKS

 Hans van Houtte (2002) The Law of International Trade (second edition),
London, Sweet & Maxwell

ARTICLES
 Principle Of Strict Compliance In Letter Of Credit (Lc): Towards A Proper
Standard Of Compliance By Dr Rosmawani Che Hashim, Legal Network
Series (2013)
 Impact Of The Doctrine Of Strict Compliance On A Letter Of Credit
Transaction By Danute Krazovska

15