22 May 2008

Standby LC and Principle of Autonomy

The traditional LC for import and export transaction is issued to provide the exporter with a guarantee of payment when performance has occurred by submitting documents in accordance with the terms and conditions of the LC. However, the standby LC (SBLC) for import and export transaction is issued to provide the exporter with a guarantee which is only activated in the case of non-performance of another pre-arranged activity. The development of SBLC took place in the United States where the banks do not have the power to issue performance bonds and first demand guarantee.

SBLC can be issued in lieu of performance guarantee in construction contracts, as a guarantee to loan repayment or as a guarantee to a seller as a back-up to some other pre-arranged method of finance. In transactions involving the manufacturing and the sale of goods, SBLC can also be used to secure payment of the price; the payment of liquidated damages for faulty performance; and to cover a deposit repayable in the event of the non-performance of the underlying contract. Losses which could be incurred in a take-over of a company and arising from the non-payment of a promissory note, the payment of rental and the payment of an amount can be, likewise, secured by SBLC.

The beneficiary can usually draw under the SBLC on the basis of providing a certificate or statement that a specific agreement has not been complied with. Given that specified documentation is presented, the bank called upon will be required to pay, regardless as to whether or not the applicant of the LC considers he has performed. Just as in the case of commercial LCs, the payment of a SBLC is subject to the tender of a fully complying set of documents by beneficiary.

The autonomy of a SBLC leads to certain problems. As the bank’s undertaking frequently assumes the form of a promise to accept a bill of exchange accompanied by a default certificate or statement, the beneficiary, who executes the two documents, is in a position to abuse the rights conferred on him.
For example, in the case of Intraworld Industries Inc vs Girard Trust Bank, a SBLC was issued by a bank in order to cover annual rentals due under a lease of a hotel. Payment was to be effected against the beneficiaries’ sight draft, accompanied by their written statement confirming the non-payment of the rent. As the account party (the lessee) mismanaged the hotel to such an extent as to seriously damage its international reputation, the beneficiaries cancelled the lease. They made a demand under the SBLC in order to recover an amount of liquidated damages due under the terms of the lease in lieu of rent.
The account party brought an action for an injunction to restrain the bank from paying. He alleged that the beneficiaries’ demand for fraudulent because it did not involved a genuine claim for rent, as represented in the default notice, but a “stipulated penalty”. Dismissing this action, the Supreme Court of Pennsylvania observed that the circumstances which would justify the granting of an injunction were limited to situations of fraud in which the “wrongdoing” of the beneficiary had vitiated the entire transaction.

In another case, Bossier Bank & Trust Company vs Union Planters National Bank, the Circuit Court of Appeals emphasized that an injunction could be granted only if the alleged fraud related to the relationship between the issuing bank and the beneficiary and not the underlying contract between the beneficiary and the account party.

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