Dong Heon Chae and John D Ro of Yoon & Yang review recent Supreme Court decisions on trade finance, which suggest a continuing adherence to international standards
The majority of letters of credit transactions, traditionally the most important settlement method in international trade, are governed by the Uniform Customs and Practice for Documentary Credits, International Chamber of Commerce (ICC) Publication 600 of 2007 Revision (UCP 600), established by ICC Banking Commission. Since the enforcement of the UCP 600 in 2007, no national courts have made rulings under it so far.
Under the relevant legal standards for interpreting letters of credit transactions, the Korean Supreme Court has stressed the importance of international trade practices. Employing legal interpretation standards consistent with international standards, the Korean Supreme Court has taken one step further in proposing new international standards.
In letters of credit transactions, fraud has long been a cause of numerous legal disputes. Parties to international letters of credit and bank guarantee transactions have been continuously raising fraud issues; the legal approach to such transactions focuses on the methods of resolution.
According to the provisions of article 4 of the UCP 600, the Principle of Independence is an essential standard applicable to the entire letters of credit transaction. The Supreme Court also ruled that 'based upon the Principle of Independence for letters of credit transactions, a negotiating bank may request that the issuing bank repay the letters of credit amount, regardless of whether the transaction price for the relevant products has been settled' (Supreme Court decision 2002Da2249 rendered on October 9 2003).
Similar to other national courts' decisions, the Supreme Court's decision serves as an important exception to the Principle of Independence. In a 1997 fraud case concerning Shinhan International that resulted in numerous law suits between Hong Kong multinational banks and Korean banks, the Supreme Court held that:
documentary credit transactions are inherently document-based and not product- based transactions. Therefore, a bank is responsible for examining with due care on the face, whether the shipping documents consistent with the terms of the letters are deemed to be a fraud. Since the letters of credit transaction served as a mere pretext for fraud, the bank can no longer be protected by the Principle of Independence. (Supreme Court Decision 96Da43713 rendered on August 29 1997)
Since the Supreme Court proclaimed its exception to the Principle of Independence, it has maintained such a stance in various cases including the 2000Da60296 decision rendered on October 11 2002.
The Supreme Court has maintained its stance in the 2008Da88337 on January 13 2011 and the 2009Da93817 on January 27, 2012. However, in the 2008Da88337 case, the Supreme Court held that 'in a documentary credit transaction, unless the negotiating bank is aware that the relevant documents have been forged or have sufficient reasons to suspect such forgery, the issuing bank cannot be exempted from reimbursement'. Unlike its precedents, this court decision seems to enhance the status of nominated banks or negotiating banks to promote the stability of letters of credit transactions.
Following this precedent, Supreme Court decisions have demonstrated that, for the purpose of ensuring the stability of letters of credit transactions, the Court takes a very stringent position on the extent to which nominated and negotiating banks are not protected from fraudulent transactions based on the Principle of Independence. In 2008Da88337 and 2009Da93817, the Supreme Court held that 'based solely on the evidence presented by and the circumstances argued by the defendant, it cannot be argued that the plaintiff (nominated bank or negotiating bank) was aware of or had sufficient reasons to suspect the fraud between the applicant and the beneficiary'. In this regard, the Supreme Court dismissed the fraud allegations by the issuing bank or the applicant. This trend in Supreme Court decisions has been followed by the lower courts.
The Supreme Court's basic stance towards fraud that shares similar principles is revealed in its decisions on bank guarantees or demand guarantees. Particularly in the 2013Da23700 decision rendered on August 26 2014, the Supreme Court maintained its prior position regarding the significance and characteristics of the first demand bank guarantee.
In this case, the Supreme Court held that:
in a case where a bank provides a guarantee, upon presenting the demand consistent with the terms of payment and documents, which are expressly requested by a guarantee, and the bank promises that it would promptly provide the amount to the beneficiary without restrictions, the said guarantee is not a general guarantee attached to the main debt but a so-called first demand bank guarantee. Regardless of the contract or the tender of performance in which the said guarantee is based upon, the first demand bank guarantee means that the bank cannot refuse the beneficiary's claim by claiming the causal relationship between the guarantee applicant (main debtor) and the beneficiary (creditor) and automatically assumes a payment liability upon the beneficiary's claim. The guarantor of the first demand bank guarantee should provide the amount stated in the guarantee, regardless of the applicant's failure to perform its obligation in its relationship with the beneficiary. In this regard, the first demand bank guarantee is subject to the so-called no causation principle, which recognises a lack of causation between a beneficiary and an applicant.
In its decision, the Supreme Court established conditions to determine a beneficiary's claim for the first demand bank guarantee as an abuse of right. The Supreme Court ruled that:
even in the case of the first demand bank guarantee, the principles of good faith or no abuse of rights are not excluded to the fullest extent. If it is clearly evident that the beneficiary, who actually lacks rights towards the applicant, abuses the no causation principle for the purpose of filing a claim for guarantee with the guarantor, such claim constitutes an abuse of right and should be disallowed. In such a case, the bank, as a guarantor, can refuse the payment of the amount upon the beneficiary's claim. However, considering the inherent characteristics of the no causation of the first demand bank guarantee, the abuse of right should not be easily acknowledged, unless it is clearly evident that the beneficiary lacks rights vis-a-vis the applicant when making the amount and that the beneficiary is undoubtedly abusing its formal legal status.
In this regard, the Supreme Court takes a similar approach as with the letters of credit fraud cases. The Supreme Court promotes the stability of demand guarantee transactions, unless it can be clearly ascertained that a beneficiary's claim to an issuing bank is unjust. This position seems to comply with recent global trade trends.
In the amendment process of the UCP 600, substantive discussions have revolved around the idea of removing the concept of negotiation itself from letters of credit transactions. However, it was concluded that instead of removal, negotiation should be defined in a more sophisticated manner to ensure more stable transactions.
In the Supreme Court decision 96Da43713 rendered on August 29 1997 regarding the UCP 500, the Court held that:
a bank authorised to negotiate documents can negotiate such documents by paying the actual price to the beneficiary by cash or through wire transfer, etc, or by assuming the liability for the payment. Here, negotiation by the latter method means that the negotiating bank unconditionally and fully assumes the liability of payment to the beneficiary on a certain date instead of prompt payment of the actual price.
This very independent and specific interpretation proposed by the Supreme Court has been maintained in recent court judgments regarding the UCP 600 negotiations.
With regards to the definition of negotiation in article 2 of the UCP 600, the Supreme Court recently ruled the same as above. In light of the negotiation provision in article 2 of the UCP 600:
a bank authorised to negotiate documents can negotiate such documents by paying the actual price to the beneficiary by cash or through wire transfer, etc. or by assuming the liability for the payment. Here, the negotiation by the latter method means that the negotiating bank unconditionally and fully assumes the liability of payment to the beneficiary on a certain date instead of prompt payment of the actual price. (2009Da93817 decision rendered on January 27 2012)
In this case, Company B presented the required documents to Bank A and requested the negotiation. Bank A then deposited the fund for negotiating such letters of credit in a special account for Company B. After this amount was paid to Bank A, they agreed to offset from the fund deposited in this special account the amount of another two letters of credit, (including one previously refused) and then to allow Company B to withdraw and use its balance.
The Supreme Court ruled in this case that:
Bank A's deposit of the fund at the special account for Company B seems to represent an actual return for having negotiated the immediate payment of the amount. This agreement does not nullify the effectiveness of Bank A's immediate payment of an actual return to Company B, since it is merely a separate agreement for taking the fund in the special account as security to offset Company B's reimbursement obligations to Bank A for other letters of credit.
This Supreme Court interpretation, premised on the idea that fact-finding requires clear evidence, declares that a return on the condition of an evident transfer of rights must be paid in the negotiation of the letters of credit.
Letters of credit terms and conditions
According to the Supreme Court Decisions 2011Da16431, 2011Da16448 and 2011Da16455 rendered on October 31 2013:
a transaction by a letter of credit must strictly comply to the terms and conditions of the credit, because such transaction is performed with documents and not with products. However, if an issuing bank states terms and conditions inconsistent with those under the UCP or ISBP in a credit, the issuing bank must clearly specify such terms and conditions, so that the beneficiary or the negotiating bank may understand the objective meaning or intent. When the beneficiary or the negotiating bank presents documents required by the letter of credit, the issuing bank is disallowed from refusing to pay that letter of credit in the following situation: if such meaning or intent is unclear or ambiguous, and as a result the relevant letter of credit is construed as demanding the terms and conditions that do not differ much from those under UCP or ISBP, the issuing bank cannot refuse on the grounds of inconsistency between the relevant terms and conditions in the credit and the issuing bank's intentions.
Supreme Court Decision 2008Da88337 rendered on January 13 2011, elucidates the consequences of a bank issuing an irrevocable letter of credit, which substantially changes the beneficiary's rights or the requirements for exercising such rights by the instruction form, given to the nominated bank without the beneficiary's consent. The Court interpreted the meaning of article 9(d) of the UCP 500 regarding the effectiveness of that instruction:
This provision states that 'except as otherwise provided by article 48, an irrevocable credit can neither be amended nor canceled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary'. Therefore, any changes in the terms and conditions of a credit that may affect the beneficiary's rights or the requirements for exercising the beneficiary's rights set out in a credit are invalid, unless the beneficiary agrees thereto. This limitation on the amendment of the terms and conditions applies when an issuing bank substantially changes the beneficiary's rights or the requirements for exercising the beneficiary's rights, even by the form of instruction to the nominated bank, eg negotiating bank. Unless the beneficiary agrees to the instruction, the instruction is ineffective. If such instruction by the issuing bank is ineffective only with regard to the beneficiary, but still effective regarding the negotiating bank, the negotiating bank must comply with the issuing bank's instructions. Moreover, the beneficiary cannot actually exercise its own rights, while the issuing bank may arbitrarily amend the terms and conditions of the credit by providing instructions to the negotiating bank without the beneficiary's consent. Therefore, in such a case, the issuing bank cannot argue the validity of such instruction, not only against the beneficiary but also the negotiating bank.
Similarly, when the issuing bank notifies the negotiating bank that it will delete additional terms and conditions, and the beneficiary does not accept the deletion request, the Supreme Court ruled that the issuing bank's instruction is invalid. This is because the beneficiary rejected the deletion request, which constitutes a change of terms and conditions under a letter of credit.
This ruling is deemed to adhere closely to the fundamental principles of letters of credit transactions that ensure the stability of cross-border price settlements.
Examination of documents
Recent Supreme Court decisions, such as 2008Da88337 rendered on January 13 2011, regarding the strict compliance rule and its exceptions, deal with document contents and evaluation of document compliance under the terms and conditions of credit. In 2008Da8837, the Supreme Court held that:
the strict compliance of the accompanying document(s) with the terms and conditions of a credit does not necessarily mean that each wording of the document should correspond exactly to the terms and conditions of a credit. Indeed, the notion of strict compliance exists to the extent that it is facially evident that a slight difference in the wording does not necessarily alter the meaning, or that it merely supplements and specifies the product description set forth in the credit, without damaging the terms and conditions of a credit. In these specific circumstances, strict compliance exists depending on whether such difference is an acceptable one in international standard banking practice.
The Supreme Court maintains the pre-existing strict compliance rule.
In this case, whereas the particulars of the cargo of each credit states 'KL', the commercial invoice states 'KLS'. As KL or KLS corresponds to Arabic numerals and the preposition 'of' indicates the volume of kerosene or gasoil, it is evident that both represent a metric unit for product weight excluded from the product description. Also, considering that the relevant cargo is crude oil, KL or KLS is certainly construed to be a unit of a kilolitre. The Supreme Court further held that
its original decision stating that the terms and conditions under the credit and the commercial invoice is lawfully consistent because it was evident that the inconsistency in the units resulted from the mere mingling of two different expressions for the same unit and did not damage the terms and conditions of the credit.
The recent Supreme Court decision 2012Da113438 rendered on May 29 2014 ruled that:
if a letter of credit demands the presentation of a clean on board ocean bill of lading as one of the shipping documents, though 'clean' is not explicitly stated in the presented bill of lading, the bill of lading may still meet the 'clean on board' requirement when the presented bill of lading lacks provisions or supplementary notes that expressly declare the status of defect(s) in goods or packaging and indicates that the goods are placed on board. However, if a letter of credit does not demand or permit the presentation of a charter party bills of lading, the presentation of the charter party bills of lading represents a direct violation of article 20(a)(vi) of the UCP 600. When the issuing bank states in its refusal of payment to the presenter, 'a charter party bill of lading was presented' without supplementary notes, this statement constitutes a refusal according to article 16(c) of the UCP 600.
Supreme Court decision 2011Da16431, 2011Da16448 and 2011Da16455 rendered on October 31 2013 regarding article 14 (a) and (d) of the UCP 600 held that:
if the terms and conditions of a credit require the bill of lading signed by the carrier as one of the shipping documents, the issuing bank must only accept the documents that fulfill the requirements under article 20(a)(i) of the UCP 600 and article 94 of the ISBP as those in compliance with such terms and conditions of a credit. Additionally, whether the bill of lading satisfies the requirements above, the issuing bank must refer not to the details of other credit-related documents, but to the relevant text of the bill of lading itself, with formal strict complying presentation standards (see Supreme Court Decisions 2001Da49302 dated November 28 2003; 2005Da57691 dated May 10 2007).
Further, in the aforementioned decision, the Court held that:
it is rather difficult for the issuing bank to conclude that a principal occupies a shipper's position, if the bill of lading is presented as one of the required documents under the terms and conditions of a credit and states the name of the shipper or the principal, and the representative signs the bill of lading on behalf of the principal, but does not expressly state that the principal is in the shipper's position. This is because the issuing bank does not refer to the description set forth in other credit-related documents and renders decisions in a strictly formal manner based on the text of the relevant bill of lading. Therefore, a bill of lading lacking such information is deemed to hardly comply in a strictly formal manner with the signature requirements of article 20(a)(i) of the UCP 600 and article 94 of the ISBP.
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Dong Heon Chae
Yoon & Yang
About the author
Dong Heon Chae is a partner, the head of the trade finance practice group, and part of the corporate and banking litigation, international arbitration and litigation team of Yoon & Yang. Prior to joining the firm, Chae served for nearly 20 years as a judge at all levels of the courts.
Chae is a member of the International Chamber of Commerce (ICC) Banking Commission and an expert on the DOCDEX (documentary credit dispute resolution expertise) panel. He was engaged in the working group for the UCP 600. He is also a member of the ICC Commission on Arbitration and ADR, and is the vice chairman of the international finance committee of ICC Korea and an international arbitrator of the KCAB [Korean Commercial Arbitration Board].
Chae advises clients on the Companies Act and on civil and criminal aspects of general corporate management. He is a well known commentator on commercial matters related to the Companies Act and the capital markets.
John D Ro
Yoon & Yang
About the author
John D Ro is a senior foreign attorney at Yoon & Yang, and his practice concentrates on M&A and cross-border transactions, corporate and general, finance and banking. He has been the lead attorney in various negotiations, documentation and consummation of complex M&A, formation of joint ventures, cross-border investments and financial transactions, as well as in licensing intellectual property rights. In addition, he has advised many multinational corporations in cross-border transactions, formation of subsidiaries and agencies, trade mark infringement and trade secret misappropriation, real-estate leases and transactions, financing, litigation, and criminal proceedings.
Before joining Yoon & Yang, Ro worked as a foreign legal consultant at an intellectual property law firm in Korea. He is a certified public accountant in Maryland, and he is admitted to the bars in New York and California.