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Drafting Letters of Credit Basic Issues Under Article 5 of the Uniform Commercial Code, UCP 600, And ISP98

Drafting Letters of Credit Basic Issues Under Article 5 of the Uniform Commercial Code, UCP 600, And ISP98

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Published by Ray Saragih

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Published by: Ray Saragih on Apr 02, 2014
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04/02/2014

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103
D
RAFTING
 
ETTERS OF
 C
REDIT
: B
 ASIC
 I
SSUES
U
NDER 
 
RTICLE
 5
 OF THE
 U
NIFORM
C
OMMERCIAL 
 C
ODE
, UCP 600,
 AND
 ISP98
JEFFREY S. WOOD
This article compares the treatment of various letter of credit issues under  Article 5 of the New York Uniform Commercial Code (“Article 5”), the Uniform Customs and Practice for Documentary Credits 2007 Revision,International Chamber of Commerce Publication No. 600 (“UCP 600”), and the International Standby Practices (“ISP98”) published by the Institute for International Banking Law and Practice, and outlines some considerations rele-vant to those drafting letters of credit, particularly standby letters of credit and related issuance or reimbursement agreements. The discussion is intended pri-marily for those who are not experienced letter of credit practitioners, and does not extend to the kinds of issues that may arise when a letter of credit involves multiple banks — for example, when one bank issues a letter of credit, a second bank confirms the credit (thus becoming independently liable to the beneficiary)and a third bank advises the credit to the beneficiary.
L
etters of credit normally fall into one of two broad types, known as“commercial” letters of credit and “standby” letters of credit.
1
The dis-tinction is based primarily on the business purpose served and not onthe applicable legal principles or form. Commercial letters of credit, which
Jeffrey S. Wood, of counsel to Debevoise & Plimpton LLP, can be reached at jswood@debevoise.com. The author expresses special thanks to Carlos Gouveaof Debevoise & Plimpton LLP for his assistance in the preparation of this article.
Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC.
 
in concept date back hundreds of years, are used primarily to ensure paymentof the purchase price for goods moving in international trade — a buyerarranges a letter of credit in favor of a seller, who can draw on the letter of credit by delivering evidence that the goods have been shipped (such as a car-rier bill of lading, an independent inspection report covering the goods, andevidence of insurance of the shipment). By contrast, standby letters of cred-it, which have come into use in the last forty years or so, are used primarily to provide third-party credit support for specific financial obligations of per-sons (such as the obligation of a contractor to make liquidated damage pay-ments if a completed project underperforms).
2
The term “credit” is used inthis article to refer generically to any type of letter of credit, while commer-cial letters of credit are referred to as “commercial credits” or “trade credits”and standby letters of credit are referred to as “standbys” or “standby cred-its.”
3
By its terms, Article 5 of the Uniform Commercial Code is applicable toall types of letters of credit. In its present form, Article 5 dates from 1995,and has been adopted by all States and the District of Columbia. It becameeffective in New York on November 1, 2000.
4
The revision notes to Article 5indicate that the revision sought:(1) to emphasize the independence principle
5
and to conform the Article tocurrent domestic and international customs and practices,(2) to accommodate evolving technology, particularly the use of electronicmedia,(3) to maintain letters of credit as inexpensive and efficient instruments, and(4) to resolve conflicts among existing decisions.UCP 600 is a 2006 revision of the rules of practice for letters of creditprepared under the auspices of the International Chamber of Commerce (the“ICC”) that became effective on July 1, 2007. It replaced UCP 500, releasedin 1993.
6
The creation and adoption of UCP 600 seems to have been trig-gered, in large part, by a high frequency of excessively technical rejections of documents
7
presented under UCP 500 commercial credits. The ICC draft-ing committee responded to this by significantly reorganizing the text of the
BANKING LAW JOURNAL
104
Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC.
 
rules, adopting new, more comprehensive definitions and interpretations andchanging the rules for examination of documents presented. Although UCP600, like UCP 500, states that it is applicable to all forms of letter of credit,its focus is commercial credits, where payment is typically made against thepresentation of documents that may include complex bills of lading, productinspection reports, insurance documents and other documents common ininternational trade.
8
ISP98 is a product of the Institute of International Banking Law andPractice and became effective on January 1, 1999. As its full name indicates,ISP98 deals exclusively with standby credits. ISP98 is primarily the productof American bankers and lawyers operating through the U.S. Council onInternational Banking (the predecessor of the International FinancialServices Association), and its style does seem to reflect the fact that morelawyers were involved in its drafting than in the drafting of UCP 600.
9
However, because it is generally issuer-favorable, many non-US banks today prefer to issue standby credits pursuant to Article 5 (or another defined locallaw) and ISP98.
THE “INDEPENDENCE PRINCIPLE”
The most important component of modern letter of credit practice is the“independence principle” — the principle that payment under a credit willbe made solely against receipt by the issuer
10
of the documents called for inthe credit, without regard to the relationships between and the relative rightsand obligations to each other of (i) the beneficiary and the party who pro-cured the issuance of the credit (normally known as the “applicant”), or (ii)the issuer and the applicant. The independence principle is embedded in allthree sets of rules: UCC 5-103(d),
11
UCP 600 Arts 4(a) and 5,
12
and ISP98Rule 1.06(c) and 1.07.
13
In essence, the letter of credit issuer is saying “if yougive me the following pieces of paper
14
that say the following things then I will pay you the stated amount without regard to the terms of my agreements with the applicant or your agreements with the applicant.” The issuer is nei-ther expected nor entitled to look behind the pieces of paper to determine whether the statements they contain are true, or to determine whether underits agreements with the applicant, the beneficiary has the right to make
105
DRAFTING LETTERS OF CREDIT
Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC.

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