This paper will discuss letters of credit in the domestic and international settings. Both straight commercial letters of credit and standby letters of credit will be examined. The emphasis of the paper will be on the maintenance of independence between letters of credit and the underlying transactions they support.
A commercial letter of credit is a legal undertaking by a bank or other lender to pay a certain designated "beneficiary" if terms and conditions prescribed in the letter are satisfied and certain stipulated documents are tendered. The beneficiary is usually the seller of the goods in the transaction; the buyer in the transaction is referred to as the "account party." The letter of credit represents an obligation by the issuing bank to pay the designated beneficiary; underlying this obligation is a transaction between the buyer and the seller. The letter assures the seller, before he parts with his goods, that he will be paid by a bank rather than by the less creditworthy buyer. The buyer is then obligated to pay the bank. Consequently, the letter of credit is completely independent of the underlying transaction, in that compliance by either party with the terms of the transaction is not necessary for the issuing bank to be obligated to pay the seller. The bank's obligation is dependent solely upon compliance with the conditions and terms of credit; often, in the case of a documentary letter of credit, the obligation to pay is dependent only upon the presentation of drafts and documents which conform to the credit requirements. Should there be a problem in the transaction, the issuing bank will normally be obligated to pay; it may then have recourse against the buyer, or the buyer may go after the seller in an independent breach of contract action. Thus, the letter of credit is used to encourage sellers to sell their goods to buyers whom they might not know well enough to otherwise trust.
In internatio...