Letters of credit are a common payment mechanism in international trade that normally allow a buyer to substitute the financial integrity of a stable credit source such as a bank for his own. For the seller of goods, a letter of credit functions as a bank’s irrevocable promise to pay when certain documents are presented that conform with the terms of the letter of credit.
Because the letter of credit is based on documents, it is independent of the underlying contract. So long as the documents comply with the terms of the credit, the bank must pay, regardless of whether the buyer complains that the goods at issue are nonconforming or that there is some other breach of the underlying contract. This provides the parties with simplicity and certainty as the payment.
Because of this simplicity, however, there is a rule of strict compliance for the documents. If the documents presented do not conform in any way to the terms of the credit, then the bank does not need to honor the letter of credit. The bank will frequently seek a waiver from the buyer for any minor discrepancies, but the bank itself has no duty to pay if the documents do not conform exactly to the terms.
These provisions governing letters of credit are part of the Uniform Customs and Practices for Documentary Credits (the UCP, the most recent version of which is the UCP600), an international set of rules established by the International Chamber of Commerce, and specifically incorporated into most international letters of credit.
If you have any questions about honoring or dishonoring international letters of credit, feel free to reach out to the attorneys at FITCH Law Partners to discuss.