Letter of credit

Letter of credit (L/C, 신용장/信用狀) refers to a document issued by a bank at the request of a buyer to a seller of goods, which provides that the issuer will pay the seller for goods the seller delivers to the buyer. The issuer then seeks reimbursement from the buyer or the buyer's bank. The document serves essentially as a guarantee to the seller that it will be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to pay.

In this way, the risk that the buyer will fail to pay is transferred from the seller to the L/C issuer. So letters of credit are used primarily in international trade for large transactions between two parties with unknown credit background. In such cases, as requested by L/C-involved banks, transactions of documentary credit are generally governed by the Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 ("UCP 600").

The above mechanisms may apply to such case as the issuing bank is ready to pay the amount for the written "Non-performance statement of the beneficiary. In such case, it is called a "standby letter of credit".

Key words
documentary credit, UCP 600, negotiation, principle of independence and abstraction, injunction

Legal principles governing documentary credits
One of the primary peculiarities of the documentary credit is that the payment obligation is abstract and independent from the underlying contract of sale or any other contract in the transaction. Thus the issuing bank’s obligation is defined by the terms of the credit alone, and the sale contract is irrelevant. The defensive of the buyer arising out of the sale contract do not concern the bank and in no way affect its liability.

Article 4(a) UCP states this principle clearly. Article 5 UCP further states that banks deal with documents only, they are not concerned with the goods (facts). Accordingly, if the documents tendered by the beneficiary, or his or her agent, appear to be in order ("within the four corners" of the document), then in general the bank is obliged to pay without further qualifications.

Principle of independence and abstraction
Policies behind adopting the abstraction principle are purely commercial, and reflect a party’s expectations:

First, if the responsibility for the validity of documents was thrown onto banks, they would be burdened with investigating the underlying facts of each transaction, and would thus be less inclined to issue documentary credits as the transaction would involve great risk and inconvenience.

Second, documents required under the credit could in certain circumstances be different from those required under the sale transaction. This would place banks in a dilemma in deciding which terms to follow if required to look behind the credit agreement.

Third, the fact that the basic function of the credit is to provide a seller with the certainty of payment for documentary duties suggests that banks should honor their obligation notwithstanding allegations of misfeasance by the buyer.

Finally, courts have emphasize that buyers always have a remedy for an action upon the contract of sale, and that it would be a calamity for the business world if, for every breach of contract between the seller and buyer, a bank were required to investigate said breach.

Strict compliance v. substantial compliance
The “principle of strict compliance” also aims to make the bank’s duty of effecting payment against documents easy, efficient and quick. Hence, if the documents tendered under the credit deviate from the language of the credit the bank is entitled to withhold payment even if the deviation is purely terminological. The general legal maxim de minimis non curat lex has no place in the field of documentary credits.

Practical issues
In dealing with a documentay credit, the following issues are frequently raised by the parties concerned:
 * What does it mean to negotiate (매입/買入) a letter of credit?
 * In a transaction of documentary credit, at any case, isn't it true for a bank to be protected by the independence and abstraction principle (독립추상성의 원칙/獨立抽象性原則) of the credit?
 * If not, when does the bank get out of such principle?
 * In such case, what's the remedy which the other party may resort to?

Case law on the documentary credit principle
In 2012, the Supreme Court confirmed its position again on the transactions of documentary credit.

In light of Article 2 of UCP 600 and Article and 9 a. of UCP the advising bank's credit advice merely advises the beneficiary about the issuing bank's credit and its contents and presentation or delivery of the original letter of credit is not required.

What's the negotiation?
Further, since negotiation merely means that the nominated bank purchases "draft and/or documents" itself, presentation or delivery of the original letter of credit is not necessary in negotiation. Thus, even if the original letter of credit is not delivered when the advising bank advises the credit to the beneficiary, or not presented when the negotiating bank negotiates the credit documents from the beneficiary, the credit advice or negotiation is lawful and valid.

According to the "Negotiation" of Article 2 of UCP 600, negotiation of documents can be done by the negotiation-authorized nominated bank's sight payment including cash payment or deposit into account, etc, or by incurring an unconditional or absolute obligation to pay definitely at a specific date to the beneficiary, which is equivalent to a sight payment.

Setting-off the negotiation amount?
As long as K Bank deposited credit negotiation amount to B Co.'s special account, it paid negotiation amount at sight, since the separate agreement to pay other credit negotiation amount from the special account deposit is merely to set off B Co.'s previous obligation by setting up collateral for obligation and it does not deny the effect that K Bank paid at sight, in case where K Bank deposited negotiation amount into B Co.'s special account upon B Co.'s credit negotiation request after being presented with the credit and documents, and they agreed to set off two previously rejected credit negotiation payment when the credit amount is paid to K Bank and B Co. will withdraw its remainder.

Duty of care of fraudulent L/C transactions
A transaction by a documentary credit in essence is the transaction not by goods but by documents. The bank needs to confirm with considerable care whether shipping documents comply with conditions of the credit. It is not obligated to examine shipping documents actually.

In case where the shipping documents are forged (including change or false description), if the bank is the party to forgery or knew documents forgery beforehand or there are sufficient grounds for suspicion, it constitutes merely a fraudulent transaction under the pretext of credit transaction, and the bank can not be protected by the independence and abstraction principle of the credit.

In this regard, see the U.S. case law on Non-conforming documents.