Research on the Letter of Credit Suspension System:
The essence of a letter of credit is to replace commercial credit with bank credit. In modern international trade, letters of credit are the most common method of settlement. They not only solve the problem of mutual distrust caused by difficulties in ascertaining each other's creditworthiness in international trade, which hinders its development, but also provide financing convenience for both trade parties.
Therefore, since its emergence in the 19th century, the letter of credit payment method has developed rapidly and been widely adopted, hailed as the "blood" of international trade and the "lifeline" of international commerce. According to ICC statistics, trade settled via letters of credit accounts for over 70% of daily world trade. In recent years, although new trade settlement methods such as collection have developed, the letter of credit method will remain the most common settlement method in international trade for a considerable period.
However, the letter of credit system is not flawless. Its unique operational mechanism, while facilitating trade, also leaves room for unscrupulous individuals. Letter of credit fraud has become an international issue. Since fraudsters always target developing countries with lower levels of international trade and banking expertise and incomplete judicial relief systems, China has long been, and remains, a primary victim of letter of credit fraud. This phenomenon may become more severe after joining the WTO. How to solve this problem to ensure the smooth progress of China's reform and opening up is a crucial topic requiring urgent research. Improving the judicial relief system in this area is an important measure to curb fraud, perfect the letter of credit mechanism, and maintain a good international trade order. It is a significant part of legal preparation for China's accession to the WTO.
I. Origin and Legal Basis of the Letter of Credit Suspension System
Letter of credit suspension originates from the unique operational mechanism under the principle of independence of the letter of credit. It is a product of improving and restricting its own defects.
The principle of independence and abstraction of letters of credit has two basic meanings: First, the letter of credit is independent of the contractual relationship that generated it. In international trade, if the buyer and seller agree to pay by letter of credit, this should be specified in the sales contract. After the contract is established, the buyer applies to the bank for issuance of a letter of credit. Once issued, the letter of credit is independent of the sales contract and the contract for issuing the letter of credit between the buyer and the bank, forming a completely independent transaction—the letter of credit transaction. The letter of credit constitutes an independent and binding contract between the issuing bank and the beneficiary.
Second, a letter of credit transaction is a document transaction. The bank, according to the requirements of the letter of credit, examines relevant documents and should unconditionally pay the beneficiary if the documents appear on their face to comply.
Practice has proven that the principle of independence and abstraction of letters of credit has unique value functions: First, it establishes the obligation of the issuing bank to pay, providing strong assurance that the beneficiary can reliably and even promptly receive payment after fulfilling obligations, thus realizing the basic function of the letter of credit. Second, it establishes the bank's neutral and detached position in international sales relations, isolating it from the underlying contract with its potential commercial risks. By carefully handling documents, banks can obtain stable and reliable income, encouraging active participation in issuing, advising, confirming, negotiating, and paying letters of credit, thus promoting the smooth operation of the mechanism. Third, it establishes the rule that banks only judge payment based on documents, protecting holders in due course from defenses based on underlying contract breaches. This makes drafts under letters of credit highly negotiable, serving as a convenient and fast financing tool, fully reflecting the economic value of letters of credit and effectively promoting international trade. Fourth, it establishes the method for banks to examine documents based on the terms of the letter of credit itself, supervising the beneficiary in fulfilling obligations under the underlying contract. This relieves the applicant's concern about paying without receiving goods and, to some extent, solves the seller's credit risk issue.
However, because the letter of credit only guarantees that the seller can obtain payment when documents comply, not that the buyer will receive real, conforming goods, the bank is only responsible for documents appearing "on their face" to comply with the letter of credit terms. It does not inspect the goods or ensure the seller actually fulfills the underlying contract obligation. This allows unscrupulous individuals to find opportunities for fraud. With modern technology, few documents are difficult to forge. When forged documents are presented to a bank, the bank, under the "apparent compliance" rule, usually does not question the authenticity of the documents. The ratio of the low cost of forged documents to the potential proceeds under the letter of credit is enough to tempt some to take risks.
To address defects in the letter of credit operational mechanism, countries have sought measures to curb letter of credit fraud. The fraud exception principle has gradually been established. The letter of credit suspension, as the means to realize the fraud exception principle, emerged as required. The landmark case establishing the precedent for courts to order banks to stop payment to beneficiaries under letters of credit due to fraud, linking the letter of credit to the underlying contract to some extent, was the Bristle case heard by the New York Supreme Court in 1941. The plaintiff (buyer) contracted with an Indian merchant to purchase a batch of bristles. The buyer requested a U.S. bank (defendant) to issue an irrevocable letter of credit in favor of the seller. Documents were submitted through an intermediate bank in India acting as collecting agent. Invoices and bills of lading indicated bristles, but the buyer discovered the seller had shipped not bristles but cow hair and other waste. The buyer sued, requesting the letter of credit be declared invalid and an injunction stopping the bank from paying. The court ultimately ruled for the plaintiff, prohibiting the defendant issuing bank from fulfilling its payment obligation under the letter of credit. This case is considered a landmark. The fraud exception principle it established was widely accepted in common law countries like Australia, Canada, and Singapore. Civil law countries like Italy, Germany, France, and Switzerland, based on their civil law principles such as bad faith should not be protected, prohibition of abuse of rights, and good faith, uniformly acknowledged that the independence principle should not be used to protect letter of credit fraud.
Furthermore, courts in various countries use injunctions to stop payment of letters of credit, preventing fraud and achieving the legal effect of the fraud exception principle. From the emergence of the letter of credit suspension system described above, it can be concluded that the independence principle is the cornerstone of the letter of credit system, the fraud exception principle addresses its inherent defects, and the suspension system is a crucial anti-fraud measure. Its implementation does not harm the independence principle but maintains normal order within the letter of credit mechanism under it, promoting international trade development.
II. China's Exploration and Practice of the Letter of Credit Suspension
China currently lacks specific laws on letter of credit transactions and related fraud. The People's Bank of China issued "Domestic Letter of Credit Settlement Procedures", which does not apply to international letters of credit and contains no specific provisions on fraud. Chinese courts currently apply the letter of credit suspension based on property preservation rules in the Civil Procedure Law, the Supreme People's Court's 1989 "Summary of National Symposium on Foreign-Related and Hong Kong-Macao-Taiwan-Related Economic Trials in Coastal Areas" or the 1995 Supreme People's Court's original Communication Division's "Summary of National Maritime Trial Work (Ningbo) Seminar". The two minutes emphasize adhering to the independence principle, stating: "Generally, freezing payments under letters of credit issued by Chinese banks due to disputes over foreign-related sales contracts should be avoided, as it might affect their credit standing." However, they also recognize the internationally accepted fraud exception principle. The minutes stipulate that in cases of "seller fraud through signing contracts," or "causing shipment before letter of credit issuance, ante-dating, and forgery of bills of lading," the applicant may apply to freeze payments." The two minutes established fundamental principles for China's letter of credit suspension. While freezing payments via courts has saved some Chinese companies from losses or reduced them, issues are plentiful. Some courts freeze letters of credit arbitrarily, excessively interfering—a phenomenon noted by the international business community with negative legal consequences for China.
Without swift improvements: first, Chinese banks' credit reputation may significantly suffer, making foreign banks reluctant to confirm Chinese letters of credit, hindering China's foreign trade; secondly China's judicial authority maybe undermined. Amid pending proximity of the WTO. . Furthermore - As trade integration occurs and environments simultaneously become more complex without sufficient Telecom channel ...
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