The seller cannot avail itself of the defense that a separate contract existed between the seller and the bank to defend itself against the buyer’s suit, because the theory of independence is not applicable once the payment by the bank has been made. If the bank does honor the letter of credit and pays the seller, the buyer may now sue the seller to recover all or part of the letter of credit proceeds from the seller. What is more likely to happen is that the buyer would retain counsel, make an application to court, and have the court issue an injunction directing the bank not to make payment under its obligation to the seller. The buyer must produce convincing evidence that the entire transaction was a total fraud, e.g., the shipment consists of empty cartons with no furniture in the cartons. If the buyer can produce a clear evidence of fraud in the underlying contract that was entered into between the buyer and seller, the bank may have a right to refuse to honor the letter of credit in a fraudulent situation. On the other hand, situations arise where a bank may choose to dishonor a letter of credit even on presentation of proper documents or titles. After the bank pays the seller, the buyer may institute suit for a breach of contract or a breach of warranty (or whatever other remedies are available against the seller) for the seller’s failure to deliver the merchandise as it was ordered. The failure of the bank to honor the said letter of credit will expose the bank to a lawsuit directly by the seller.
Because of the separateness of the contracts, the bank is under a direct obligation to fulfill the letter of credit if the seller presents the proper documents of title to the bank. Where a seller delivers defective goods to a buyer, the buyer attempts to persuade the bank not to pay the letter of credit. Each contract is independent and can be enforced by the parties to the contract regardless of the other two contracts. The concept that each contract is separate and distinct from the other contract is most important to understand in the letter of credit transaction.
One of the results of the above contractual relationships is that in a bankruptcy proceeding of the account party, the selling party is still entitled to enforce the letter of credit because the account party is not involved in nor has any connection with the agreement between the beneficiary and the issuing bank. (3) the contract between the beneficiary (the selling party) and the account party (the purchasing party) who arranges for the issuance of the letter of credit. (2) a contract between the issuing bank and the account party (the purchasing party) who is obligated to advance or to reimburse the bank for any monies paid out by the bank and (1) a contract between the issuing bank and the beneficiary (the selling party) of the credit This agreement between the issuing bank and the account party is totally separate and distinct from the actual letter of credit, which is a separate agreement between the issuing bank and the beneficiary (seller).ĭistinct and apart from the above two contracts, a separate contract exists between the beneficiary (seller) and the account party (buyer), which is the contract for the sale of the goods and the terms and conditions of payment for the goods by a letter of credit. The account party has a separate agreement with the bank, and under the terms of this agreement must pay the bank in advance or reimburse the bank for any monies paid under the letter of credit, i.e., for any monies that the bank pays to the beneficiary. The account party (purchasing party) is a debtor and owes the bank money in the event that a letter of credit is exercised. Second, a separate agreement lies between the account party (buyer) and the issuing bank. Basically, the beneficiary of the credit is the party who is to receive payment and the bank is the party who is to issue payment to the beneficiary (seller). We will attempt to furnish a basic explanation.įirst, the letter of credit is a direct agreement between the issuing bank and the beneficiary (selling party) of the credit. When a person first encounters the transaction of a letter of credit, or arranges for the issuance of the letter of credit, or is the recipient of the letter of credit, the transaction surrounding the letter of credit may seem somewhat complex.
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