Adjudicating Letter of Credit-Related Cases

Although the PRC Civil Law General Principles (中华人民共和国民法通则), PRC Contract Law (中华人民共和国合同法), PRC Security Law (中华人民共和国担保法) and PRC Civil Procedure Law (中华人民共和国民事诉讼法) provide basic laws for LC-related cases, the laws are inadequate and lacking in detail. Moreover, the People's Courts of various levels have been incoherent in ascertaining the facts, in applying the laws and separating the responsibilities of parties in LC-related matters.

In addition, numerous stop-payment orders delivered by the People's Courts to LCs issued by domestic banks have seriously tarnished the image of China's emerging banking industry. This resulted in higher People's Courts approaching the SPC to provide much needed instructions on LC-related cases. The China Banking Regulatory Commission and various commercial banks also filed complaints to the SPC on improper freezing of amounts under relevant LCs by the local People's Courts.

In order to meet the practical needs for trialling LC disputes and other related cases, the SPC promulgated the Provisions on Several Issues Concerning the Trial of Letter of Credit Disputes (Provisions) (关于审理信用証纠纷案件若干问题的规定) on November 14 2005, effective from January 1 2006, pursuant to laws including the PRC Civil Law General Principles (中华人民共和国民法通则), the PRC Contract Law (中华人民共和国合同法), the PRC Security Law (中华人民共和国担保法) and the PRC Civil Procedure Law (中华人民共和国民事诉讼法), with reference to relevant international practices, such as the UCP 500, as well as taking trial practices into account.

Legal framework of the Provisions

Applicable law

In most cases, the parties to an LC mainly agree on generally accepted international practices like the UCP 500 for LC-related disputes. Where such mutually agreed upon standards are absent, however, the People's Courts may determine the rights and obligations of the parties concerned, in accordance with the UCP 500 and other international practices. However, it should be noted that the international practices represented by the UCP 500 do not necessarily cover all legal issues related to LC cases. Depending on the nature of the legal relationship, the applicable laws for LC-related cases are described in Articles 1-4 of the Provisions.

Legal relationship

For the first time, the nature of the legal relationship between the parties to an LC is defined in the Provisions. The LC-related cases referred to in the Provisions are those involving disputes arising from such LC transactions, which include LC issuance, advice, amendment, revocation, confirmation, negotiation and reimbursement. The Provisions also apply to repayment disputes between the applicant and the opening bank arising from an LC application and issuance, any disputes over a guarantee for the application of an LC issuance and any disputes over financing under an LC.

Independence and document examination standards

Most LC cases involve the independence of the LC and standards for document examination. Independence and compliance are the key components of the LC system.

The principle of independence holds that an issuing bank's obligation to honour draws on an LC is entirely independent of the bank's account party and its underlying contract with the beneficiary. However, this is only a general principle provided in the UCP 500 and other international practices adopted by the international banking industry. Prior to the promulgation of the Provisions, a specific uniform standard espousing this principle in the trial of LC cases had not been previously made available to the People's Courts.

Pursuant to Article 5 of the Provisions, which defines the independence principle, an opening bank must hold its obligation to honour draws on an LC and if a concerned party lodges a protest based on the underlying transaction between the applicant and the beneficiary, the People's Court must not uphold such a protest. Additionally, Article 5 specifies that the independence principle will not apply where any of the LC fraudulent circumstances provided in Article 8 are identified.

Article 6 sets out the standards of compliance for the examination of documents under an LC by adopting the "appearing on their face to be in compliance" principle, in accordance with the UCP 500.

Pursuant to paragraph two of Article 6, although there is no complete consistency, on the face, between the supporting documents of the LC and the terms of the LC or between the supporting documents, but it is insufficient to give rise to ambiguity between the LC and the supporting documents or between the support documents themselves, then a ruling of inconsistency should not be deemed.

Stipulations on the rights of the opening bank to 'accept discrepant documents' in Article 7 of the Provisions complies with relevant international practices.

Fraud and suspension of payment

A definition of 'LC fraud' is not available under the UCP 500. Based on the legal principles on the constitution of civil fraud provided in the PRC Civil Law General Principles (中华人民共和国民法通则) and by reference to relevant case law in other countries, Article 8 of the Provisions states that a determination of LC fraud will be rendered in the following circumstances where:

i. the beneficiary has falsified documents or submitted documents containing false information;

ii. the beneficiary has failed to deliver the goods in bad faith or the goods delivered are deemed worthless, or

iii. the beneficiary and the applicant or a third party conspired to submit fraudulent documents and there is no genuine underlying transaction.

In the event of LC fraud, the party concerned may seek judicial remedy before a competent People's Courts by applying for an order to suspend payment under the LC from a competent People's Court, subject to the conditions set out in Article 10 of the Provisions.

Where LC fraud has been found, a ruling to suspend payment will be made unless:

i. the designated or authorized person of the opening bank has already made payment, in good faith, in accordance with the instructions of the opening bank;

ii. the opening bank or its designated or authorized person has already accepted in good faith an instrument under the LC;

iii. the confirming bank has already performed its payment obligation in good faith, or

iv. the negotiating bank has negotiated in good faith, that payment under the LC cannot be interfered with by legal means.

Article 11 sets out the conditions for the People's Courts to accept an application by a concerned party for suspension of payment of the amount under an LC. These conditions are intended to provide the People's Courts with clear guidelines as to what LC cases are acceptable and not acceptable, so as to prevent any improper interference by the People's Courts of various levels in the development of the LC system in China. Articles 12 and 13 set out the procedures of the People's Court in rendering an order to suspend payment under the LC.

It should be noted that the stipulations on the conditions and procedures of the People's Court to render an order to suspend the payment under an LC are, by taking the uniqueness of LC cases into account, generally formulated on the relevant provisions relating to 'preservation of property' found in the PRC Civil Procedure Law (中华人民共和国民事诉讼法). Firstly, the People's Court may list a third party to the proceeding such as the opening bank, negotiating bank or any other stakeholder(s) in the LC transaction that is concerned with the dispute. Secondly, a party objecting to an order to suspend payment under an LC may apply for review by the People's Court 'one level up', and the reviewing court must render its 'order' to the review application.

Adjudication

Article 14 of the Provisions sets forth the procedures for adjudication of LC cases involving LC fraud by the People's Court, which includes trial of the LC dispute and any dispute over the underlying transaction in the same proceeding and listing or a third party. According to Article 15, upon determination through substantive trial that LC fraud is established, judgment must be made to terminate payment under the LC.

Assumption of liability for guarantee

There are many cases of dispute over the guarantee under LCs and most of them arise from the guarantee for the application of LC issuance. However, the Provisions only set out two grounds for the guarantor's submission that its guarantee obligation is discharged.

Firstly, Article 16 provides that the People's Court will not uphold that a guarantee obligation has been discharged when the opening bank or applicant accepted a discrepancy without seeking its consent. Secondly, based on Article 30 of the Interpretations on Several Issues Concerning the Application of the (关于适用《中华人民共和国担保法》若干问题的解释), Article 17 stipulates that "the guarantor shall bear its guarantee obligation only for the time and to the extent specified in the original guarantee contract or in law". The two Articles, although simple, will serve to provide adequate and fair protection for both the guarantor and the bank.

Impact on judicial circles and the banking sector

Since the legislative procedure in China is generally complicated and time-consuming, the Provisions offer a timely legal basis for LC cases in the form of a judicial interpretation.

Firstly, the Provisions provide a solid legal basis to protect the legal rights and interests of Chinese banks and enterprises, while leaving necessary room for adjustment in accordance with the new development of China's LC system in the future. These Provisions may be deemed to be an innovation in China's judicial practice, in that they not only pay adequate attention to relevant international practices but also contain provisions for issues not covered by international practices.

Secondly, the Provisions are highly practical in that they provide not only substantive rules but also procedural rules for the trial of LC-related dispute cases. Article 4 of the Provisions detailing the application of relevant PRC laws in particular situations, is an example of the substantive rules provided by the Provisions. An example of procedural rules is found in Article 15, which provides that, "if the people's court, through the actual trial, determines that letter of credit fraud is constituted and that none of the circumstances specified in Article 10 exists, it shall render a judgment halting the payment of the amount under the letter of credit".

The Provisions have also provided new challenges for LC-related transactions by domestic enterprises and banks.

Article 4 of the Provisions expressly states that, "the relevant laws of the People's Republic of China" will govern LC disputes. This means that domestic enterprises and banks, while observing relevant international practices, will have to pay special attention to the particular requirements under existing PRC law regarding the applicant, opening bank and conditions for LC establishment. Therefore, domestic enterprises and banks in establishing an LC should ensure that all of their operations and documents comply with both relevant international practices and the Provisions.

New systems and principles set out in the Provisions also pose new challenges to the common practices of domestic banks and enterprises in LC transactions. In most cases, the opening banks in China generally pay insufficient attention to the examination of documents received and make arrangements for payment solely on the instruction of importers. However, according to Article 7 of the Provisions, the opening bank has the right and obligation to examine documents by itself and may determine in its sole judgment whether the documents are, on their face, in compliance with the terms and conditions of the LC and consistent with one another, and decide in its own judgment whether or not to accept discrepant documents.

The opening bank may, upon determining that the documents are discrepant, in its own judgment decide whether or not to seek a waiver of the discrepancies from the applicant, and is not bound by the applicant's decision in this regard, unless otherwise agreed between opening bank and applicant. Therefore, the right of the opening bank to examine the documents is independent; the opening bank may not be relieved from the responsibilities and obligations of examination of documents, on the grounds that the applicant has examined these documents. This poses a challenge to the level and efficiency of domestic banks to examine the documents under an LC.

Knowledge and understanding is key

The Provisions pose a significant challenge to domestic banks, trading companies and judicial circles. In order to standardize activities in LC transactions, all parties to the transactions should have a profound knowledge of LC international practices and a good understanding of these Provisions.