CHAPTER 7
Bank Collections, Trade Finance,
and Letters of Credit
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a part of South-Western Cengage Learning.
The Bill of Exchange
• A Bill of Exchange (English) is a negotiable
instrument that contains:
– Unconditional order in writing.
– From one person to another.
– Signed by the person giving it.
– To pay on demand or at a certain time.
– Fixed sum of money.
– To the ORDER or BEARER.
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Negotiation and Transfer of
Negotiable Instruments
• Negotiation is the transfer of an instrument
from one party to another (the holder) who
takes legal rights in the instrument.
• Indorsement.
• Delivery.
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Documentary Draft and the
Bank Collection Process
• Act as a substitute for money.
• Act as a financing or credit device.
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Documentary Draft and the
Bank Collection Process
• Drafts can be accepted by buyer creating a trade
acceptance.
• Buyer agrees to pay unconditionally at the time stated
on the draft.
• Banker’s acceptance= bank agrees to pay= negotiable
instrument.
• Documentary collections is similar to a C.O.D.
transaction.
• The SWIFT System  (The Bolero Project).
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Documentary Drafts Used
in Trade Finance
• Time Draft.
• Banker’s Acceptances and Acceptance
Financing.
• Credit Risk in Trade Finance Programs.
• Credit Risk in Acceptance Financing: Rights of
Holder in Due Course 
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Holder in Due Course
• Have a negotiable instrument (draft or
acceptance).
• Taken for value.
• In good faith.
• Without notice of dishonor or overdue.
• Without notice of alteration or unauthorized
signature.
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Credit Risks in Factoring Accounts
Receivable: Rights of the Assignee
• Seller assigns rights to collect to assignee or
factor.
• Does Assignee have the same rights as a holder
in due course?
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Letter of Credit
• Documentary Letter of Credit.
• Issuing Bank (Buyer’s bank), account party
(Buyer), beneficiary (seller).
• Bank promises to pay the beneficiary’s draft
upon presentation of the specified documents.
• Bank’s promise to pay is better than buyer’s.
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The Documentary Sale with a Letter of Credit
SHIP / VESSEL
D
Importer
Account Party
(Buyer)
F
B
A
Sales Contract
CIF Port of Destination
CAD Irrevocable LOC
Exporter/
Beneficiary
(seller)
C
E
E
F
C
E
Issuing Bank
A.
B.
C.
D.
E.
F
Advising,
Confirming,
or
Negotiating Banks
Sales contract calls for LOC
Application for LOC
LOC forwarded to beneficiary through advising bank
Documents prepared according to LOC -- goods shipped
Documents negotiated for payment against sight draft through negotiating or
confirming bank
F. © 2009
Payment
after
documents
Copyright
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Legal Studies
in Business, checked for discrepencies
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Law Applicable to Letters of Credit
• Art. 5 UCC.
• Uniform Customs & Practice (UCP)
incorporated into LOC.
• NY law states UCP not UCC is applicable.
• Presumed Irrevocable.
• The LOC is independent of the sales contract
between the buyer and seller 
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Independence: Maurice O’Meara v.
National Park Bank of New York
• NPB issued letter of credit to Ronconi
(beneficiary) at request of Sun Herald to cover a
delivery of newsprint. Ronconi presents invoice
and draft to bank, but bank refused because it
could not test strength of paper. During this time
the price of newsprint dropped over $20,000.
Ronconi transferred their right to collect to
O’Meara.
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Independence: Maurice O’Meara v.
National Park Bank of New York
• Issue: Was was bank correct under the law to
refuse to pay on the letter of credit despite
presentation of the proper documents because it
wanted to assure itself that the paper was the
proper weight?
• Holding: No, the bank wan not correct. The bank’s
obligation is to pay when presented with the
documents called for in the letter of credit.
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Independence: Maurice O’Meara v.
National Park Bank of New York
• The contract between the buyer and seller is
separate from the obligation of the bank on
the letter of credit. The buyer still has a
separate right of action against the seller for
breach of contract.
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Following a Letter of
Credit Transaction
• Buyer’s Application and Contract with the Issuing
Bank.
– It is up to the buyer to apply for a letter of credit from a
bank.
– LOC contains instructions, terms, and condition to
release the money.
– Buyer’s application for credit is a contract between the
buyer and the bank.
• Complies with UCP.
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Following a Letter of
Credit Transaction
• Seller’s Compliance with the Letter of Credit.
– Seller must read the terms and conditions of the LOC
very carefully before shipment or manufacturing of
product.
– Is the LOC accurate? Does it reflect the terms and
conditions of the sales contract?
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Following a Letter of
Credit Transaction
• Complying Presentation: delivery of seller’s
documents and draft to the nominated bank or
directly to the issuing bank. Contains:
– All the required documents,
– Within the time frame allowed and prior to expiry of the
credit,
– With no discrepancies, and
– Which complies with all other terms of the LOC.
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Following a Letter of
Credit Transaction
• Examination of Documents and Discrepancies.
– UCP allows up to five banking days to inspect.
• Commercial Invoice: required by buyers, banks,
and customs authorities.
• Bill of Lading: must be “on board.”
• Insurance Policy (plus 10%).
• Certificates of Analysis or Inspection.
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Strict Compliance: Courtalds N.A. v.
North Carolina National Bank
• Bank opened letter of credit for buyer Adastra
with Courtald’s, seller, as beneficiary. The LOC
covered “100% acrylic yarn.” Seller presented
documents with invoice “imported acrylic yarn”
as well as a packing list “100% acrylic.”
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Strict Compliance: Courtalds N.A. v.
North Carolina National Bank
• Bank refused to pay. In the meantime the buyer
went into bankruptcy. Lower court holds for seller
and the bank appealed.
• Issue: Did the bank violate the UCP and the
state law in insisting on strict compliance with
the letter of credit and refusing to pay the seller
upon presentation of the documents.
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Strict Compliance: Courtalds N.A. v.
North Carolina National Bank
• No, the bank was correct in refusing to pay
when the documents did not match the
letter of credit. “There is no room for
documents which are almost the same or
which will do just as well.”
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The UCP 600 Rule
• Changes to UCP in 2007 indicate move to
modified strict compliance rule.
• Functional standard of compliance (used by
courts in United States and some European
countries).
• What about ethical issues in LOC?
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Procedures for Dishonor of LOC
• Bank must follow procedure or face “issuer
preclusion” and will be prevented from asserting
the documents are discrepant.
• Ask purchaser if wants to waive discrepancies?
• Bank must give notice no later 7 banking days
after receipt of the documents.
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Enjoining Banks from Purchasing
LOC in Cases of Fraud
• Sztejn v. J. Henry Schroder Banking
Corp.
• Plaintiff contracts to buy hog bristles. Bank
opens letter of credit with seller as
beneficiary. Seller fills boxes with cow hair
and rubbish and presents bank with
documents for payment. Buyer brings this
action to block bank from payment.
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Enjoining Banks from Purchasing
LOC in Cases of Fraud
• Issue: When the there is active fraud, may a
court enjoin a bank from payment on an
irrevocable letter of credit?
• Yes, although the contract between buyer
and seller is separate, where there is
credible evidence of active fraud on the
seller’s part before the bank has paid on the
LOC, the court may enjoin payment.
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BUT..
• Confirming banks are not permitted to refuse a
demand for payment when the documents
comply with the LOC.
• United City Merchants v. Royal Bank of
Canada.
– Under English view, fraud by a third party does not
constitute fraud in the transaction. There was no
evidence here of fraud by the beneficiary or knowledge
of fraud.
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Confirmed Letters of Credit
• Why needed?
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Standby Letters of Credit: Middle East
• Why? Performance guaranty.
• American Bell International, Inc. v. Islamic
Republic of Iran.
– Issue: Will the court enjoin the bank from paying 30
million on the standby letter of credit to Iran which
was callable “at any time and for any reason”.
– Holding: No. Bell negotiated this standby letter of
credit under those terms with its eyes open
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Standby Letters of Credit: Middle East
• “One who reaps the rewards of commercial
arrangements must also accept its burdens.”
• The court also noted that the bank had other
remedies available.
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Other Specialized Uses for LOC
•
•
•
•
Transferable Credits.
Red Clauses in Credits.
Revolving and Evergreen Credits.
Back-to-Back Letter of Credit Financing.
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eUCP
• 2002 International Chamber of Commerce
extends UCP to electronic documents
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LOC in Trade Finance Programs
• AID Financing.
• Eximbank Financing: largest U.S. export
financing agency. Can provide guarantees on
loans made by commercial banks, and insurance
on credit to foreign customers.
• Commodity Credit Corporation.
• Foreign Credit Insurance Association.
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Conclusion: Review
• Identify goals.
• Set terms, negotiate conscious of responsibilities
and price accordingly.
• Delineate contract to manage risk.
• Use of samples .
• Make sure language reflects your agreement.
• Inspect LOC for problems (60-80% have errors)
• Remember rule of strict compliance.
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Schaffer International Business Law 7th Ed. 2009