Potential risk of letter of credit payment under the aspect of case law No. 13

Mr. Dang Phuc Nguyen (Associate)

Mr. Le Dang Khoa (Paralegal)

The letter of credit (“L/C”) is an international payment vehicle used worldwide and the most commonly used one. However, by using L/C worldwide, the parties participating in a transaction usually give not enough concerns on the terms and conditions of the L/C opened under the contract. In fact, the L/C vehicle contains many risks as mentioned under Case Law No. 13/2017/AL issued by the Judges’ Council of the Supreme Court (“Judges’ Council”) dated 14 December 2017 (“Case Law 13”)

Effectiveness of L/C when a sale contract as the basic formation of L/C is cancelled

Plenty of people believe that L/C is an integral part of the sale contract (“Sale Contract”); as a result, when the contract is cancelled, the parties are free from their agreed obligations, including obligations regarding the L/C. Nevertheless, Case Law 13 has recognized L/C as a separate contract due to the reason that the L/C stipulated under regulations of Uniform Customs and Practice for Documentary Credits (“UCP600”) issued by International Commercial Chamber (ICC); therefore, the L/C will be considered as “a separate transaction with the Sale Contract”.

From this aspect, in the light of the L/C considered as a separate transaction, regardless of the Sale Contract being cancelled in Case Law 13, the L/C is valid and binding on both parties. The recognition of Case Law 13 will lead to a result that in case the terms and conditions of L/C are not strictly stipulated, the buyer/importer (“Buyer”) has a risk of suffering some consequences. In particular, per Case Law 13, despite cancellation of the Sale Contract, if the seller/exporter (“Seller”) properly submits the documents as required by the L/C, the issuing Bank must make payment for the Seller.

Essence of L/C in connection with UCP600

By nature, the L/C is regarded as an international payment vehicle basically created by agreement between the Buyer and the Seller via their banks. The L/C aims at creating the guarantee of the Buyer to the Seller on payment of the value of goods under the Sale Contract by using an escrow deposit as security for the performance of a civil obligation at the bank[1].

Legally speaking, current laws have no relevant provisions to govern when the deposit is terminated. However, considering the aspect of a civil obligation used as security for another civil obligation and taking into account such other guarantee vehicles as pledge and mortgage[2], the validity and the term of the deposit vehicle will depend on the validity and the term of the guaranteed transaction. It is supposed that, when the Sale Contract is cancelled which results in the Buyer’s obligations no longer existing, the respective guarantee vehicle being the deposit is automatically terminated due to the guarantee obligations no longer existing.

Practically, this interpretation is appropriate with Vietnam’s rules of law. However, the noteworthy point is L/C in the Case Law 13 chooses UCP600 as an applicable law to govern the terms and conditions of the L/C. Hence, beyond the terms and conditions of the Sale Contract considered and solved under the applicable law chosen as agreed by the parties, when the dispute happens, the dispute resolution authorities must use UCP600 to solve matters regarding the L/C.

As judgments of Case Law 13, the Judges’ Council uses Article 2, Article 4, Article 5 and Article 7 of UCP600[3] (“Articles”) to argue that the L/C exists independently and separately, no matter how distinguishing the content or the formation is, in comparison with the Sale Contract from the beginning. The base for these judgments is the application of one (01) of the two (02) most basic principles of the rinciple of Independence As expressed under the Articles

Solution for mitigating risks when using L/C

Practically, not all buyers always suffer risks when using the L/C for payment. Under Article 34 of UCP600 on liability exemption with the validity of required documents, the Banks have no obligation or responsibility for formation, sufficiency, accuracy, clarity, forgery or legal effectiveness of any required documents. However, in case the Buyer has clear evidences to prove that the required documents submitted is forged and not in conformity with the agreements of the parties on the required documents, the Banks have the right to consider the transaction and refuse payment to the beneficiary.

Moreover, for ensuring no damage incurred during participating in international commercial relationship and avoiding potential consequences, it is important that the Buyer should consult advice from lawyers to formulate the strict and clear terms and conditions of the L/C when opening an L/C at the bank, especially those regarding the required documents on quantity, quality, packaging standards, and the applicable law. If the parties agree to use UCP600, they should bear in mind that this uniform code allows the parties to reserve/remove one or more articles, provided that the L/C clearly expresses the application such articles. Then, to be on the safety side, the parties should reserve articles considering L/C as a separate transaction to avoid potential risks from happening as in Case Law 13.

[1] Article 330, 2015 Civil Code

[2] Article 315 and Article 327, 2015 Civil Code

[3] Article 4, UCP600: “A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary”.