Letters of credit: kinds, UCP 600 and the autonomy principle

1. Why a letter of credit

In an international sale the seller does not want to ship until he is sure of payment, and the buyer does not want to pay until he is sure the goods have been shipped. Neither knows the other well, and suing abroad is costly. A documentary credit resolves this: a bank, on the buyer's instructions, undertakes to pay the seller if the seller presents specified documents showing shipment. The seller relies on the bank's promise instead of the buyer's; the buyer knows that the bank will pay only against documents evidencing shipment of the goods described.

2. Parties and steps

• Applicant: the buyer, who asks his bank to open the credit.
• Issuing bank: the buyer's bank, which issues the credit and is bound to honour a complying presentation (UCP 600, Article 7).
• Advising bank: a bank in the seller's country that advises the credit and checks its apparent authenticity (Article 9).
• Confirming bank: a bank that adds its own undertaking to honour or negotiate (Article 8).
• Beneficiary: the seller.
• Nominated bank: the bank with which the credit is available.

The sequence: the sale contract requires payment by credit; the buyer applies; the issuing bank issues the credit; it is advised to the seller; the seller ships and obtains the bill of lading, invoice, insurance document and other required documents; he presents them to the nominated or confirming bank within the time allowed; the bank examines them and, if they comply, pays, accepts a draft or negotiates; it is reimbursed by the issuing bank, which collects from the buyer and releases the documents to him so that he can take the goods from the carrier.

3. The UCP 600

Credits are governed by the Uniform Customs and Practice for Documentary Credits, published by the International Chamber of Commerce, the current revision being UCP 600 (2007, in effect from 1 July 2007). It applies when the credit expressly incorporates it (Article 1), which almost all do, and is applied by Indian banks and courts as the usage of the trade. It is supplemented by the eUCP for electronic presentation and by the International Standard Banking Practice (ISBP) for examination of documents. Key rules:

• A credit is irrevocable even if there is no indication to that effect (Article 3).
• A credit is separate from the sale contract (Article 4) and banks deal with documents, not goods (Article 5).
• A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation, and must state an expiry date (Article 6).
• A credit cannot be amended or cancelled without the agreement of the issuing bank, any confirming bank and the beneficiary (Article 10).
• Banks have a maximum of five banking days after presentation to determine whether it complies (Article 14(b)); transport documents must be presented not later than 21 calendar days after shipment and within the expiry date (Article 14(c)).
• A bank refusing must give a single notice stating all discrepancies (Article 16); failure precludes it from claiming non-compliance.
• Detailed rules on the commercial invoice (Article 18), bills of lading (Article 20), and insurance documents (Article 28).

4. Kinds of letters of credit

• Revocable and irrevocable. A revocable credit could be amended or cancelled by the issuing bank without notice, and gave little security; UCP 600 no longer provides for it, and credits are irrevocable unless expressly stated otherwise.
• Confirmed and unconfirmed. A confirmed credit carries the undertaking of a second bank, usually in the seller's country, protecting the seller against the issuing bank's failure or exchange controls in the buyer's country.
• Sight credit: payment on presentation of complying documents.
• Deferred payment credit: payment at a fixed future date, without a draft.
• Acceptance credit: the bank accepts a time draft (bill of exchange) drawn on it and pays at maturity; the seller may discount the accepted bill.
• Negotiation credit: a nominated bank purchases drafts or documents, advancing funds to the beneficiary. It may be restricted to one bank or freely negotiable.
• Transferable credit (Article 38): the beneficiary (often a middleman) may request that the credit be made available in whole or part to a second beneficiary (the actual supplier). It can be transferred only once and only if expressly designated “transferable”.
• Back-to-back credit: a middleman uses a credit in his favour as security to have a second, separate credit issued in favour of his supplier, on similar terms. Unlike a transferable credit, the two are independent.
• Red clause credit: allows an advance to the beneficiary before shipment, to buy or process the goods (so called because the clause was printed in red). Green clause credits extend this to storage of the goods.
• Revolving credit: renewed automatically, in amount or time, for a series of shipments without fresh issue each time.
• Standby credit: a guarantee in the form of a credit, payable on a statement of the applicant's default; governed by the ISP98 rules or the UCP.
• With or without recourse, documentary or clean (a clean credit requires only a draft, no shipping documents), and import and export credits from the point of view of each party.

5. Autonomy and strict compliance

Autonomy. The credit is independent of the sale. The bank's duty to pay is not affected by disputes between buyer and seller about the quality of the goods. Courts will not ordinarily restrain payment under a credit, because the commercial value of credits depends on certainty of payment (Hamzeh Malas & Sons v. British Imex Industries, Court of Appeal, 1958). The Supreme Court adopted this principle in United Commercial Bank v. Bank of India, 1981 INSC 78, (1981) 2 SCC 766, holding that courts should not grant interim injunctions restraining payment under an irrevocable letter of credit, except in exceptional cases such as established fraud, since a bank must honour its obligations according to their terms.

Strict compliance. The documents must comply with the credit. “There is no room for documents which are almost the same, or which will do just as well” (Viscount Sumner in Equitable Trust Co. of New York v. Dawson Partners Ltd., House of Lords, 1927). UCP 600 tempers this: data in a document need not be identical to, but must not conflict with, data in other documents or the credit (Article 14(d)), and the description of goods in documents other than the invoice may be general (Article 14(e)).

The fraud exception. A bank may refuse, and a court may restrain payment, where the beneficiary has presented documents he knows to be forged or false: Sztejn v. J. Henry Schroder Banking Corp. (New York, 1941). The fraud must be clear and known to the bank; it must be the beneficiary's own fraud (United City Merchants (Investments) Ltd. v. Royal Bank of Canada, House of Lords, 1983, where a loading broker's false date on the bill of lading did not defeat an innocent seller). The Indian courts apply the same narrow exception, together with irretrievable injury.

How this is examined

For the June 2025 essay: purpose, parties and steps, UCP 600, then the kinds of credit in a list with a short explanation each (irrevocable, confirmed, sight, deferred, acceptance, negotiation, transferable, back-to-back, red clause, revolving, standby), and close with autonomy, strict compliance and fraud with United Commercial Bank.