The exporter wants to ensure that he is paid for his merchandise before the possession and title to the merchandise pass to the importer. This is sought to be achieved through the intermediary of the bank which opens a letter of credit on behalf of the importer, naming the exporter as the beneficiary.
A letter of credit represents a contractual relationship between the opening bank and the beneficiary viz., the exporter. The bank in fact makes a commitment under the L/C that it would make payment of the agreed sum, as indicated the L/C subject to the conditions that all documents as asked for are submitted to the bank and, on scrutiny found to be in order. Opening and negotiation of the letters of credit are governed by the International Chamber of Commerce Brochure No 500 entitled Uniform Customs & Practice for Documentary Credits, commonly known as UCP.
Even though an L/C represents a contract, which is based on a sales/purchase contract, the credit transaction is supposed to be independent of the physical transaction of the goods. UCP General provision and Definitions Article 3 provides.
Credits by their nature are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound contracts.
Parties of the Letter of credit:
A number of parties are involved in the international trade transactions involving the use of letters of credit:
1. There is first a contractual relationship between the importer and the exporter, evidenced by the sales contract.
2. There is a banker customer relationship between the applicant of credit viz., the importer and the opening Bank. An identical relationship exists between the beneficiary viz., the exporter and the negotiating/ advising bank
3. The third relationship is between the two banks, where the negotiating bank is performing as a special agent of the opening bank.
4. The fourth relationship is between the beneficiary and the opening bank which is that of a credit contract.
Doctrine of Strict Compliance:
Since the banks have to make payments only on the basis of documents presented to them, this doctrine has come to be developed under this doctrine, the bank has the right to reject any document which is not in strict conformity with what is asked for in the letter of credit. There is no minor or major discrepancy in documents. Any discrepancy makes the documents liable for non-acceptance.
In Equitable Trust Co of New York vs Dawson partners Ltd., the defendants bought Vanilla beans from Jakarta. They had asked the bank to open a confirmed letter of credit in favor of the seller and to make payment on the presentation of certain documents including a certificate of quality signed by experts. The seller submitted a certificate signed by an expert. The Bank made the payment was not entitled to reimbursement. It was held that:
It is both common ground and common sense in such a transaction that the accepting bank can only claim indemnity if the conditions on which it is authorized acceptance in the matter of the accompanying documents are strictly observed. There is no room for documents which are almost the same or which will do just as well.
The same principle has recently been reconfirmed by the Supreme Court of India in United Commercial Bank vs Bank of India and Others.