Letters of credit are commonly used in international trade.

They are usually issued by larger banks and contain a

promise to pay a seller upon receipt of goods by a buyer if certain conditions outlined in the letter have been met.
There are three general principles which govern the use of letters of credit: 1) The banks' responsibility to deal in
documents only; 2) the rule of strict construction, which dictates that the terms and conditions of the letter of credit
are to strictly adhered to; and 3) the rule of independence, which mandates that the letter of credit is to be
considered independent from the sales contract or any other agreement between the parties.
There may be different legal implications, however, in international trade depending upon applicable or stipulated
local laws or accepted trade terms.
The rule of independence, the third governing principle of letters of credit, means that the parties to a letter of credit
are obligated to pay as outlined in the letter of credit regardless of any developments which may have occurred
during the performance of their contract.
According to the rule of independence, the letter of credit is separate and distinct from the oral or written contract
between the buyer and seller. A buyer's bank must, therefore, honor a letter of credit even though the buyer does
not receive the goods for which it contracted.
This situation can be averted by including the model of the product in the letter. And, although the buyer might still
have a breach of contract claim, the seller would already have its payment.
When courts apply the rule of independence in trials resulting from disputes between buyers and sellers, they will
only consider the documents required by the letter of credit.
In general, the issuer of the letter of credit is not required to and is even prohibited from looking beyond the letter of
credit (and any documents it requires) to see if any problems have occurred in the underlying transaction.
It is possible, however, for the parties to enter into an agreement that the issuing bank may look beyond the
documents required by the letter of credit in order to verify that the parties have performed their contract. In
practice, a letter of credit obtained from a bank will usually state that the transaction is governed by both sets of
rules. Both the uniform commercial code (UCC) and uniform customs and practice for documentary credits (UCP)
have codified the rule of independence. Some differences do exist in interpretation under the UCC and UCP rules, for
instance regarding "nondocumentary" conditions appearing in letters of credits.
"Nondocumentary" conditions appearing in letters of credit could pertain to a specific date by which a shipment must
be made or whether a partial shipment would be acceptable.
Under the UCC, an issuer can be justified for refusing to honor a demand for payment if such nondocumentary
conditions are not met. However, under the UCP, a letter of credit can be dishonored only when documentary
conditions are breached.
If, however, a letter of credit states that it is governed by both the UCC and UCP, which is usually the case, a
nondocumentary breach such as a late shipment can be used to justify the issuing bank's refusal to honor a demand
for payment.
Under the UCC, an exception to the rule of independence is a situation where fraud is involved. According to the
UCC, there are two types of fraud exceptions: 1) forged or fraudulent documents, and 2) fraud in the transaction.
The UCP does not address fraudulent transactions.
However, U.S. courts have generally held that UCC provisions regarding fraud apply when a letter of credit is
expressly made subject to the UCP.
It is not an easy thing, though, to determine how the fraud exception is to be applied in these cases. For example, a
buyer and seller enter into a transaction in which the letter of credit authorizes the seller to collect on the letter of
credit upon shipment of the goods.
The seller presents credible shipping documents to the issuing bank, but no goods have actually been shipped. If the
buyer discovers the fraud before the bank has honored the letter of credit and attempts to stop payment, the bank is
still obligated to go ahead and honor the letter of credit.
If the documents appear to conform at face value with those required by the letter of credit, then the issuer is bound
to make payment.
Noel Allen, a partner with Raleigh law firm Allen and Pinnix PA, was the founding chairman of the International Law
and Practice Section of the North Carolina Bar Association.

Read more: Letter of credit common tool in international trade | Triangle Business Journal