Standard of Documentary Compliance in letter of Credit Cases

The parties were involved in two letter of credit disputes. In the second dispute, the signature specimen provided by the Applicant to the Issuing Bank to evidence receipt of goods contained the signature of Wu Bin and Yi Feng, with the official seal of Hualong Co. attached to each. When the receipt of goods presented by the Beneficiary only bore Yi Feng's official signature with the seal of Hualong Co. attached, the Issuing Bank refused to honour the letter of credit. The Beneficiary then sued the Issuing Bank for dishonouring the second letter of credit.

Judgment

The UCP allows an issuing bank to refuse to accept any document where the issuing bank finds any discrepancy on the face of the document. In this case, the SPC rejected the Beneficiary's argument that the two official seals and signatures on the signature specimen should be treated as two independent or alternative specimens, holding instead that the receipt of goods must strictly comply with the deposited specimen, which had two signatures.

Soft Clauses

The key issue in this case involved a typical "soft clause" in letter of credit transactions, the receipt of goods clause. Under such clauses, it is not the beneficiary but the applicant who can control whether the documents are in strict compliance with the letter of credit. The SPC's decision demonstrated its commitment to respect the terms of the letter of credit as agreed by the parties, even when such terms may be disadvantageous to the beneficiary.

This case shows the dangers of "soft clauses" to beneficiaries. Parties who continue to include such clauses in letters of credit, despite repeated disputes and claims of fraud involving soft clauses in letters of credit, and despite repeated warnings by legal counsel, do so at their peril.

The Standard of Documentary Examination

The UCP only stipulates that in general, documents should be in strict compliance with the letter of credit and other documents. How to interpret "strict compliance" is a contentious issue that divides courts and remains frequently debated among legal scholars. In this case, the SPC interpreted the principle of strict compliance in a rather stringent way. Although the SPC's decision in this case did not specify how to apply the principle of strict compliance, its opinion is still a useful indicator of how the Court will decide future letter of credit cases. The decision suggests that the SPC will require that the documents and letter of credit be virtually identical, to the point where the one is a copy of the other or must match the other "word by word".

It bears noting that the banking world in China had mixed reactions to this decision, with some banks fearing that the SPC's decision sets a standard that is too high and commercially impractical, and may be unfair to beneficiaries. Banks tend to look at letters of credit as a method of payment. Setting such a high standard prevents them from making payment in certain cases.

On the other hand, the decision will provide banks an incentive to scrutinize documents more carefully. At present, many banks are too ax in their examination of documents. By more carefully scrutinizing documents, banks will reduce the risk of the applicant refusing to reimburse them after it has made payment to the beneficiary.

Similarly, PRC courts, which have tended to take a lax approach, will now be required to examine documents more strictly. The courts' lax approach to document compliance was threatening to undermine the entire letter of credit mechanism.

By Jin Saibo,
Yi Wen Firm,
Beijing