Non-conforming documents

The Non-conforming documents (불합치서류/不合致書類) refer to the documentary credit which is not accompanied by documents in compliance with its terms, and accordingly lead to the refusal of payment by the issuing bank.

In this regard, a U.S. case in which a Korean bank was involved, is often cited for the following reasons:
 * The Court of Appeal held that the negotiating bank's lack of reasonable care in presenting non-conforming documents, did not prevent it from relying on preclusion principle of the Uniform Customs and Practice for Documentary Credits (UCP) under which an issuing bank has seven days from its receipt of negotiating bank's presentation in which it should communicate in specific terms its reasons for refusing payment. The Court did not mention that the knowledge of the beneficiary regarding the discrepancy affected the application of the preclusion rule.
 * On the contrary, the Court of Appeal in the Philadelphia Gear case held that the knowledge of the beneficiary regarding discrepancy did not allow the beneficiary to claim payment based on the fact that it was not advised of the discrepancy that the beneficiary already knew.

The Roman law principle, venire contra factum proprium meaning "No one may set himself in contradiction to his own previous conduct", was the principle applied in the Philadelphia Gear Court. The Philadelphia Gear Court stated the following:
 * It would be a strange rule indeed under which a party could tender drafts containing defects of which it knew and yet attain recovery on the ground that it was not advised of them.

The Court in the Hamilton Bank case did not hold that, although the beneficiary knew the discrepancy in the documents, he could still recover on the basis that he was not notified of the said discrepancy that he already knew.

Key words
letter of credit, non-conforming document, UCP,

Case brief
Hamilton Bank, N.A. v Kookmin Bank, 245 F.3d 82 (2nd Circuit 2001) is described as follows:

Facts
The issuing bank brought action against the negotiating bank for declaratory judgment regarding its responsibilities based on the documentary credit and damages for libel. Defendant counterclaimed for plaintiff’s dishonoring of letter of credit and moved for summary judgment.

Issue
Following issues were raised:
 * 1) Does any forgery or fraud in option contract and special instructions that were submitted by the negotiating bank permit the issuing bank to disclaim for fraud more than seven days after its receipt of negotiating bank’s presentation?
 * 2) Does the negotiating bank’s lack of reasonable care, in presenting non-conforming documents prevent it from relying on preclusion principle of UCP, under which the issuing bank had seven days from its receipt of negotiating bank’s presentation in which it should communicate, in specific terms, its reasons for refusing payment?
 * 3) Is the negotiating bank under obligation to mitigate its damages?
 * 4) Did the issuing bank satisfy its burden of demonstrating any express malice on the part of the negotiating bank in accusing it of fraudulent practices?

Holding and Rule

 * 1) No. The forgery and fraud in option contact and special instructions that were submitted by negotiating bank did not permit issuing bank to disclaim for fraud more than seven days after its receipt of negotiating bank’s presentation.
 * 2) No. The negotiating bank’s lack of reasonable care, in presenting non-conforming documents does not prevent it from relying on preclusion principle of UCP.
 * 3) No. Negotiating bank is under no obligation to mitigate its damages.
 * 4) No. The issuing bank failed to satisfy its burden of demonstrating any express malice on part of negotiating bank in accusing it of fraudulent practices.

Analysis
Whether such a Roman law principle can be applied to a documentary credit case has been answered in the affirmative by the Philadelphia Gear Court and the said principle was given in a more specific manner by the Court in terms of the case at hand. As to whether the Hamilton Bank Court in the Second Circuit overruled the holding of the Philadelphia Gear Court in the Fifth Circuit, the answer is it did not. Only the U.S. Supreme Court can settle the issue if the two Courts differ on the same set of facts. So far, the Supreme Court has not done so.

Furthermore there is no conflict between the two Circuits. The facts in the Second Circuit (Hamilton Bank) involve elements of fraud in the transaction while those in the Fifth Circuit (Philadelphia Gear) involve a regular transaction. And the holdings of the two Circuit Courts do not contradict each other.

In order for the Second Circuit to contradict the Fifth Circuit Court of Appeal, they would have to overrule the said Roman law principle, and that has not been done nor can it be done. Law and Equity are both sides of the legal coin and it is applied together to law in general and also to letters of credit transactions. The UCP preclusion rule is itself a rule from equity. Not only the preclusion rule in equity but there is another equitable principle.

Knowing presentation of discrepant documents and demand for recovery based on the fact that it had not been notified of the discrepancy it already knew are not clean hands. As such, the preclusion rule does not apply to such a case. The Philadelphia Gear Court has made it very clear in specific language rather than the original one, venire contra factum proprium. And the Hamilton Bank Court did not overrule the said holding of the Philadelphia Gear Court. The U.S. Supreme Court need not overrule this holding even if it very much wanted to.

There is no reasoning either in law or in equity to overrule the said holding of the Philadelphia Gear Court and the Roman law principle. Efficient operation in documentary credit rules does not mean that such clear line preclusion rule can be abused in particular cases with gusto. The law and equity undergirds all operations in life even documentary credit rules.

Has the holding of the Philadelphia Gear Court brought forth issuing bank refusing documents without specifying discrepancies? The case was decided in 1983 and we are in 2012. Almost thirty years have passed since the said decision. Sending a refusal notice without specific discrepancies is not an international banking practice that can easily be found anywhere.

Has the Philadelphia Gear decision been used by issuing banks to justify their not specifying discrepancies in their refusal notice? The answer is negative.

Lessons to be learned from the Case
General principles do not decide cases. Facts do. In a documentary credit case in the Philippines, the beneficiary and presenting bank sent the documents with a cover letter noting the discrepancy (acceptance letter issued by applicant missing). Thus it is objectively shown that the beneficiary and the presenting bank both knew that the documents they presented were discrepant.

The acceptance letter of applicant was missing and neither the beneficiary nor the presenting bank had a claim under the letter of credit which required a copy bill of lading and the said acceptance letter. They are claiming that because the issuing bank did not notify them that the acceptance letter is missing, they are entitled to payment under the preclusion rule. If they are indeed entitled to payment under such facts, the Roman law principle would have been overruled for the first time in legal history.

Banking Practices
In Korea, when negotiating bank presents shipping documents with a cover letter to the issuing bank, the cover letter is clean, i.e. there is no discrepancy noted on it.

When the beneficiary presents shipping documents, the negotiating bank examines them and if discrepancy is found, instructs the beneficiary to cure the said documents before documents are sent to issuing bank.

When shipping documents arrive from abroad in Korea, again the cover letter is usually clean for the same reasons.

When the cover letter mentions discrepancy, it is a request by the presenting bank to the issuing bank to seek waiver from the applicant so that payment can be made despite the said discrepancy. Usually the beneficiary and applicant is in prior contact to make payment for the said documents.

The presenting bank is not asking the issuing bank to immediately send the documents back to the presenting bank with a refusal notice noting the discrepancy on the cover letter.