An Introduction to Letters of Credit for Banking Lawyers
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The document provides an overview of letters of credit (LCs) including their definition, commercial uses, and the roles of Canadian banks in LC transactions. It explains the parties involved in these transactions, their legal relationships, and applicable international rules. Additionally, it addresses the complexities that may arise in international projects and the legal frameworks that govern these financial instruments.
An Introduction to Letters of Credit for Banking Lawyers
- 1. AN INTRODUCTION TO LETTERS OF CREDIT FOR BANKING LAWYERS Presented by Marc Lemieux +1 514 878 8806 Marc.lemieux@fmc-law.com November 19, 2012
- 2. OVERVIEW • What are letters of credit (LCs)? • For what commercial purposes are LCs used? • What roles do Canadian banks play in LC transactions? • Who are the parties to a LC transaction and what are the applicable legal rules? 2
- 4. DEFINITION OF LCs • LCs are: – Irrevocable undertakings issued by banks and other financial institutions (referred to as Issuing Banks for convenience) – At the request and for the account of Applicants – To pay a stipulated amount to Beneficiaries (at sight or on a stipulated future date) – Upon the presentation of documents appearing to comply with the stipulated requirements 4
- 5. FOR WHAT COMMERCIAL PURPOSES ARE LCs USED?
- 6. COMMERCIAL PURPOSES • LCs are used as: – A form of payment • To pay the price for the (usually but not restricted to international) sale of goods or services (they are then referred to as “Commercial LCs”) • Advantages of Commercial LCs over other forms of payment in sale agreements – A form of security • To guarantee the payment of other (domestic or international) obligations (they are then referred to as “Standby LCs”) – Bid, performance, payment and other guarantees in international projects – Obligations to pay judgment awards – Commercial leases, etc. • References to Standby LCs in this presentation include instruments known as “Letters of guarantee” or “Demand Guarantees” • Advantages of Standby LCs over other forms of security 6
- 7. WHAT ROLES DO CANADIAN BANKS PLAY IN LC TRANSACTIONS?
- 8. ROLE OF CANADIAN BANKS • Commercial LCs – Issue Commercial LCs (referred to as “Import LCs”) for the account of their clients who are buyers (or importers) of goods sold by a (typically foreign) seller (exporter) – Advise, confirm or negotiate Commercial LCs (referred to as “ Export LCs ”) issued by (typically foreign) banks for the account of foreign buyers of goods sold by the banks’ clients who are sellers (exporters) • Standby LCs – Issue Standby LCs for the account of their clients who are debtors of (foreign or domestic) creditors under a contract or by operation of law – Advise or confirm Standby LCs issued by other (domestic or foreign) banks for the account of (foreign or domestic) debtors in favour of their clients who are creditors 8
- 9. WHO ARE THE PARTIES TO A LC TRANSACTION AND WHAT ARE THE APPLICABLE LEGAL RULES?
- 10. THE PARTIES AND THEIR RELATIONSHIPS • The Applicant and the Beneficiary • The Applicant and the Issuing Bank • The Issuing Bank and the Beneficiary • The rights and obligations of the Advising Bank • The rights and obligations of the Confirming Bank • The rights and obligations of the Negotiating Bank • Guarantees and Counter-Guarantees 10
- 11. THE CORE PARTIES Applicant Beneficiary Issuing Bank 11
- 12. THE APPLICANT AND THE BENEFICIARY • The legal relationship between the Applicant and the Beneficiary is based – In Commercial LCs, on an underlying (and usually international) contract of sale (where the Applicant is the buyer and the Beneficiary is the seller) – In Standby LCs, on a (domestic or international) underlying contract or by operation of (domestic or international) law • Banks are strangers to the Applicant-Beneficiary relationship 12
- 13. THE APPLICANT AND THE ISSUING BANK • The legal relationship between the Applicant and the Issuing Bank is based on an agreement respecting the issuance of a letter of credit • Form 1003 at RBC and as the case may be a credit agreement between the parties: – Request the Issuing Bank to issue a LC – Grant the Issuing Bank the authority to pay the LC upon the presentation of conforming documents – Provide for the reimbursement to the Issuing Bank of all amounts paid under the LC, commissions for the issuance of the LC, expenses incurred (including legal expenses) and interest – As the case may be provide security for the amounts to be owed by the Applicant to the Issuing Bank 13
- 14. THE ISSUING BANK AND THE BENEFICIARY • The terms of the LC – Documents to be presented – Expiry date (and renewal thereof) • Rules of the International Chamber of Commerce (ICC) – Commercial LCs: Uniform Customs and Practices (UCP) 600 – Standby LCs: International Standby Practices (ISP) 98, Uniform Rules for Demand Guarantees (URDG) 758 or UCP 600 – Avoid higher risk LCs which do not explicitly refer to ICC rules • Residual applicable law – The Canadian example of Angelica Whitewear (discussed below) – Local law in the beneficiary’s country may also apply 14
- 15. (CONTINUED) • Documents – Commercial LCs: • Draft demand for payment • Purchase order • Commercial invoice • Bill of lading or other transport document • Packing list, certificate of origin, certificate of inspection or quality • Insurance policy – Standby LCs: • Draft/demand for payment • As the case may be, a certificate of default confirming with or without detail that an amount has become due and payable 15
- 16. (CONTINUED) • ICC Rules – The autonomy principle • LCs are independent from the underlying contracts and other legal obligations • Banks deal in documents and are not concerned with disputes between the Applicants and the Beneficiaries – The examination of documents • Documents must “appear to comply” • Discrepancies of no material impact • Waiver of discrepancies by the Applicant • Loss of right to raise discrepancies (if none raised within the applicable and short examination period) 16
- 17. THE ADVISING BANK Applicant Beneficiary Issuing Bank Advising Bank • LCs are rarely sent directly to Beneficiaries • Advising Banks simply check the authenticity of LCs and inform the Beneficiaries of the issuance of LCs in their favour; they incur no liability to pay under the advised LCs 17
- 18. THE CONFIRMING BANK Applicant Beneficiary Issuing Bank Confirming Bank • The Confirming Bank (which can also be the Advising Bank) adds its own undertaking to pay the LC upon the presentation of complying documents to the Issuing Bank’s undertaking (and has a reimbursement claim against the Issuing Bank) 18
- 19. THE NEGOTIATING BANK Applicant Beneficiary Issuing Bank Negotiating Bank • Commercial LCs available by negotiation enable third parties (referred to for convenience as Negotiating Banks) to purchase from the Beneficiaries for a discounted value the documents to be presented to Issuing Banks under LCs 19
- 20. COUNTER-GUARANTEES • In international projects, counter-guarantees by Canadian banks in favour of foreign banks can facilitate the issuance of local guarantees which Canadian exporters of services are required to deliver to Beneficiaries in foreign countries • In Canadian projects, guarantees issued by Canadian banks in favour of Canadian project proponents can be supported by counter-guarantees issued by banks in the country of the suppliers of services to the Canadian proponent • Such cross-border structures can raise challenges for Canadian banks due to exposure to foreign laws or the orders of foreign courts 20
- 21. The preceding presentation contains examples of the kinds of issues companies looking at Alternative Dispute Resolution could face. If you are faced with one of these issues, please retain professional assistance as each situation is unique.
- 22. Thank you! Marc.lemieux@fmc-law.com +1 514 878 8806 LinkedIn