Introduction
Although letter of credit (L/C) disputes constitute a relatively niche category of litigation, letters of credit have long served as an exceptionally important instrument for payment and financing in international trade. In 2024, geopolitical conflicts, global sources of instability, and identifiable risk points have increased markedly. The heightened uncertainty in the global economy has resulted in sharp price fluctuations for certain commodities and the inclusion of various products on sanctions lists. Some importers and exporters actively seek documentary grounds to refuse payment or petition courts to enjoin payment under letters of credit based on tenuous allegations of "fraud." Concurrently, unscrupulous actors exploit the inherent features and potential vulnerabilities of letters of credit to perpetrate fraud. These combined factors have contributed to a rising incidence of L/C-related disputes. This article seeks to systematically review pertinent typical cases, distill the primary dispute types and associated risk points, and thereby provide a reference to assist enterprises and financial institutions in mitigating risks when utilizing this financial tool.
I. Concepts Related to Letters of Credit
1. Letters of credit typically operate under the International Chamber of Commerce (ICC) Uniform Customs and Practice for Documentary Credits (2007 Revision, ICC Publication No. 600, UCP600). According to UCP600, a credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.
2. Regarding classification, L/Cs can be divided into international and domestic L/Cs, sight and usance L/Cs, documentary and clean L/Cs, transferable and non-transferable L/Cs, among other classifications.
3. The issuing bank is the bank that issues a credit at the request of an applicant or on its own behalf. The beneficiary is the party in whose favour a credit is issued. Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. An advising bank is the bank that advises the credit at the request of the issuing bank.
II. Four Key Principles in L/C Operation Practice
1. Principle of Independence and Abstraction
Under the premise of good faith, a complying presentation by the beneficiary represents the fulfillment of the goods delivery obligation agreed in the underlying contract. Banks thus make payment, and the L/C operates healthily under the UCP framework. For example, UCP600 Article 4(a) states: "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."
2. Fraud Exception Principle
When fraud is encountered, it undermines the independence of the L/C and falls outside the jurisdiction of the UCP. The specific national law applies, examining the underlying sales contract to determine fraud. If fraud is constituted, before the issuing bank makes payment, the competent court, upon the applicant's application, may issue an injunction to stop payment, and the relevant bank will suspend or terminate payment under the L/C. For example, Article 10 of China's Supreme People's Court Provisions on Several Issues Concerning the Trial of Letter of Credit Dispute Cases (2020 Amendment) (hereinafter, the "L/C Judicial Interpretation") states: "Where a people's court determines the existence of letter of credit fraud, it shall rule to suspend payment or adjudge termination of payment under the letter of credit."
3. Exception to the Fraud Exception Principle
When a bona fide third party has honoured or negotiated in good faith, to protect the interests of such a third party, the court may withdraw the injunction. For example, Article 10 of China's L/C Judicial Interpretation lists exceptions to injunction for L/C fraud, including: "(1) The nominated person or authorized person of the issuing bank has made payment in good faith in accordance with the instructions of the issuing bank; (2) The issuing bank or its nominated person or authorized person has accepted the bill of exchange under the letter of credit in good faith; (3) The confirming bank has performed its payment obligation in good faith; (4) The negotiating bank has negotiated in good faith."
4. L/C Short-Circuit Principle
When payment for goods under the underlying contract cannot be realized through the L/C, the seller (beneficiary) still has the right to claim payment from the buyer (applicant) based on the underlying contract. Conversely, when incorrect payment occurs under the L/C, the buyer (applicant) still has the right to claim a refund from the seller (beneficiary) based on the underlying contract.
III. General Overview of L/C Disputes
1. Types of L/C Disputes
L/C disputes refer to disputes arising during the opening, advising, amendment, cancellation, confirmation, negotiation, reimbursement, etc., of a letter of credit. Based on a search on Wolters Kluwer's legal database as of August 21, 2024, there are 5,184 records for "letter of credit disputes," accounting for only about 0.15% of the first-level cause of action "Civil Disputes Related to Companies, Securities, Insurance, Bills, etc." (3,370,827 records), making it a relatively niche dispute type. Geographically, they are mainly distributed in coastal regions, with the top five provinces being: Zhejiang (1,954 records), Shanghai (556), Shandong (525), Jiangsu (394), and Beijing (241), collectively accounting for 70.79%.
2. Basis for Adjudicating L/C Disputes
According to Article 2 of the L/C Judicial Interpretation: "When hearing letter of credit disputes, a people's court shall apply the relevant international practices or other stipulations agreed upon by the parties; in the absence of such agreement, the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits or other relevant international practices shall apply." Also, Article 41 of the Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China states: "The parties may choose the law applicable to the contract by agreement. If the parties have not chosen, the law of the habitual residence of the party whose performance of obligation can best reflect the characteristics of the contract or other law most closely connected with the contract shall apply." Therefore, the basis for adjudication typically includes the Uniform Customs and Practice for Documentary Credits (UCP600), the ICC International Standard Banking Practice for the Examination of Documents under UCP600 (ISBP745, effective 2013), and the Contract Section of the Civil Code. For domestic L/Cs, it also includes departmental regulations and normative documents such as the Measures for the Administration of Domestic Letter of Credit Settlement.
IV. Main Disputed Issues in L/C Disputes
According to the SPC's Regulations on Causes of Action for Civil Cases (2020 Edition), under the cause of action "Letter of Credit Disputes," there are six sub-categories: Entrustment to Open a Letter of Credit, Opening of a Letter of Credit, Negotiation of a Letter of Credit, Fraud in a Letter of Credit, Financing under a Letter of Credit, and Transfer of a Letter of Credit. Among these, the more common disputes involve L/C opening, L/C financing, L/C fraud, and L/C negotiation. They primarily revolve around two major disputed issues: L/C fraud and documentary discrepancies.
1. Whether L/C Fraud is Constituted
Letter of credit fraud is a criminal act involving the exploitation of the characteristics and vulnerabilities inherent in letters of credit through fraudulent or forged documents, papers, or other deceptive means to obtain payment or goods from banks or trading counterparties. It primarily encompasses document fraud and underlying contract performance fraud. According to Article 8 of the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Letter of Credit Dispute Cases (the "L/C Judicial Interpretation"): "Any of the following circumstances shall be deemed to constitute letter of credit fraud: (1) the beneficiary forges documents or submits documents containing false information; (2) the beneficiary maliciously fails to deliver goods or delivers goods without value; (3) the beneficiary and the applicant or a third party collude to submit false documents in the absence of a genuine underlying transaction; (4) other circumstances involving letter of credit fraud."
2. Complexity of L/C Fraud
Letter of credit fraud currently represents the most complex dimension of L/C disputes and poses a significant challenge in the practical examination of documents during operations. The primary reasons for this complexity include:
(1) Diverse and Concealed Forms
International L/C fraud mainly includes fabricating transactions and forging documents, anti-dated bills of lading, advanced bills of lading, fictitious bills of lading, using "soft clauses" to control transactions, impersonating banks, forging bank confirmations, forging L/C amendments, false inspection certificates, using obsolete L/Cs, forging confirmed L/Cs, obtaining clean bills of lading with letters of indemnity, etc.
(2) Limited Bank Authority/Means
Due to technical limitations and constraints on their authority to investigate, banks involved in document examination (such as the issuing bank, advising bank, and negotiating bank) lack adequate means and legal powers to substantively verify the authenticity of the underlying trade background during the operational process. According to the Wolters Kluwer search on August 21, 2024, there are 303 records for "letter of credit fraud disputes."
(3) Intersection with Criminal Proceedings
As letter of credit fraud constitutes a criminal act, the adjudication of L/C fraud disputes frequently involves the overlapping of civil and criminal proceedings, which tends to prolong the civil litigation process. For instance, in Case (2020) Zui Gao Fa Min Shen No. 2937 referenced in this article, the timeline extended from the initial discovery of fraud, the application for an injunction filed on August 12, 2013, and the report made to public security authorities, through to the first-instance judgment rendered on December 28, 2018, the second-instance judgment issued on November 21, 2019, and finally the retrial concluded on December 18, 2020. The entire proceeding spanned a period of 7 years.
(4) Complexity of "Good Faith" Determination
L/C fraud breaks the principle of independence, but there may be protection for bona fide third parties (exception to the fraud exception). Determining "good faith" is practically difficult. "Good faith" in the civil law sense for a bona fide third party means the negotiating bank did not know, nor should have known, about the fraud such as the absence of an underlying contract or forged documents. "Should not have known" mainly refers to whether the bank fulfilled its independent examination duty and the duty of care matching its professional level.
3. Whether a Documentary Discrepancy Exists
(1) Meaning of Complying Presentation
According to UCP practice, a complying presentation means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of the UCP, and international standard banking practice. UCP600 Article 14 contains 12 standards for document examination, the core being "complying presentation," i.e., "documents consistent with each other and documents consistent with the credit." "Credit" refers to the original/copy of the L/C. "Documents" include commercial invoices, transport documents, bills of lading, etc. Other documents often include certificates of origin, inspection certificates, packing lists, fumigation certificates, etc.
Each document has specific content requirements and examination standards. For example, a bill of lading must show the name of the carrier and be signed by the carrier, master, or named agents; indicate that the goods have been shipped on board a named vessel at the port of loading stated in the credit; indicate shipment from the port of loading to the port of discharge stated in the credit; be the sole original bill of lading or, if issued in more than one original, the full set as indicated; contain terms and conditions of carriage or refer to another source containing them; and not indicate that it is subject to a charter party.
(2) The "Strict Compliance" Standard
The "Strict Compliance" standard does not require a word-for-word or character-by-character comparison between the documents and the credit terms, as if applying a "mirror image" test. For example, UCP600 Article 14(f) provides: "If a credit requires presentation of a document other than a transport document, insurance document or commercial invoice, without stipulating by whom the document is to be issued or its data content, banks will accept the document as presented if its content appears to fulfil the function of the required document and otherwise complies with sub-article 14 (d)." UCP600 Article 14(d) further clarifies: "Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit."
(3) Professional Judgment in Practice
In practice, determining strict compliance relies on the professional judgment of the bank. This professional judgment inherently involves a degree of subjective assessment by individual banks and their document examiners. Consequently, once a dispute arises, the core issue often centers on whether the presentation constituted a complying presentation.
V. Typical Cases and Key Adjudication Points
1. Determination of the "Strict Compliance" Standard in L/C Document Examination
【Guiding Case】 DBS Bank Ltd. (Singapore) v. Wuxi Humei Thermal Power Engineering Co., Ltd. Letter of Credit Dispute
Supreme People's Court | (2017) Zui Gao Fa Min Zhong No. 327 | Adjudicated on July 26, 2017
【Key Points】 In disputes between beneficiaries and issuing banks concerning letters of credit, it is a common defense for the issuing bank to dishonor payment based on alleged discrepancies in the documents submitted by the beneficiary. In this instance, the issuing bank (DBS) dishonored the presentation on the grounds that the FOB price listed in column 9 of the Certificate of Origin submitted by the beneficiary (Humei) matched the CIF price indicated on the invoice, thereby constituting a discrepancy.
The court held that the "strict compliance" standard for document examination, as established under the UCP and the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Letter of Credit Dispute Cases (the "L/C Judicial Interpretation"), must be correctly understood and applied. When the entry on the Certificate of Origin concerning the "origin criterion" was sufficient to fulfill the function of the document, when the relevant data on the certificate were mutually corroborative and also consistent with the goods price stated in the credit and the commercial invoice required by the credit, and when no contradiction existed among the documents, the alleged discrepancy raised by the issuing bank was to be deemed invalid. Accordingly, the court found that the beneficiary's presentation constituted a complying presentation, and the issuing bank was obligated to make payment.
2. Negotiating Bank's Independent Examination Duty and Determination of Negotiation in Good Faith
【Selected Case】 Company P v. Bank A Asia, et al. Letter of Credit Fraud Dispute
Supreme People's Court | (2020) Zui Gao Fa Min Shen No. 2937 | Adjudicated on December 18, 2020
【Key Points】 Article 10(4) of the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Letter of Credit Dispute Cases (the "L/C Judicial Interpretation"), which stipulates "the negotiating bank has negotiated in good faith," establishes one of the exceptions to the fraud exception principle. In this case, the relevant bills of lading were required to be "to order, blank endorsed and marked 'freight prepaid'." ISBP745 (2013), paragraph E13a, mandates that an order bill of lading must be endorsed by the shipper. Verifying whether an order bill of lading is effectively endorsed by the shipper constitutes a critical step in the bank's document examination process under documentary credits and represents a long-standing industry practice. Here, the presented bills of lading lacked effective endorsement by the shipper.
Determining whether the negotiating bank negotiated in good faith requires an assessment of whether it participated in or was aware of the fraud prior to negotiation, and whether it fulfilled its duty to examine the documents. First, it must be established whether the negotiating bank had an independent duty to examine the documents. This duty is not exempted by the issuing bank's waiver of discrepancies or its agreement to honour the presentation, nor is it negated by any guarantees furnished by the beneficiary or a third party. Second, it is necessary to ascertain whether the bills of lading indeed contained discrepancies. Finally, an evaluation must be made as to whether the negotiating bank discharged its document examination duty. To be deemed to have negotiated in good faith, the negotiating bank must have meticulously examined the documents in compliance with the International Standard Banking Practice for the Examination of Documents under Documentary Credits (ISBP), other applicable practices, and the instructions of the credit.
【Official Classic Case】 Zhongji Ningbo Group Co., Ltd., Australia and New Zealand Banking Group (China) Co., Ltd. Shanghai Branch v. Hong Kong Lianchuang Resources Co., Ltd., Ningbo Bonded Zone Shengtong International Trade Co., Ltd. Letter of Credit Fraud Dispute
Zhejiang High People's Court | (2011) Zhe Shang Wai Zhong No. 39 | Adjudicated on January 17, 2012
【Key Points】 The relevant L/C were opened not as a means of payment for international trade but to achieve financing purposes, lacking a genuine transaction basis. Shi et al. constituted L/C fraud. ANZ Shanghai, as the negotiating bank, should have known that Shi et al. applied for the L/Cs for financing purposes and fabricated the underlying transactions. It failed to exercise reasonable care; its negotiation was not in good faith and thus could not be exempted from liability. Accordingly, the court adjudicated to terminate payment under the L/Cs.
3. Issuing Bank's Right to dishonor When Not Induced into a Fraudulent State
【Selected Case】 Ningbo Company A v. Bank B Letter of Credit Dispute
Zhejiang High People's Court | (2021) Zhe Min Zhong No. 115 | Adjudicated on December 10, 2021
【Key Points】 According to the principle of independence, the issuing bank need not examine whether goods were delivered through documents not submitted to the bank. If the documents submitted by the beneficiary to the bank are false and there were no genuine goods, L/C fraud can be determined. However, if evidence proves that there existed an L/C transaction model between the applicant, issuing bank, and beneficiary where the issuing bank first received and controlled the goods under the L/C and later settled through false documents, and the goods were delivered to the consignee with the issuing bank's consent, then the issuing bank was not induced into a fraudulent state. It can not dishonor under the L/C on grounds of fraud.
4. Standard for Determining Whether Advising Bank Fulfilled Reasonable Duty of Care When Receiving Messages via SWIFT Authentication
【Selected Case】 Heavy Industry Company C v. Dalian Bank D, Ningbo Bank E Letter of Credit Dispute
Dalian Economic and Technological Development Zone People's Court, Liaoning | (2023) Liao 0291 Min Chu No. 2382 | Adjudicated on April 25, 2023
【Key Points】 If an advising bank is at fault in performing its notification duty and causes loss to the beneficiary, it shall bear corresponding tort liability. An advising bank receives messages via SWIFT authentication. In the absence of evidence to the contrary, it can be deemed to have fulfilled its reasonable duty of care to verify the apparent authenticity of the credit. If an advising bank is at fault in performing its notification duty and causes loss to the beneficiary, it shall bear corresponding tort liability. An advising bank receives messages via SWIFT authentication. In the absence of evidence to the contrary, it can be deemed to have fulfilled its reasonable duty of care to verify the apparent authenticity of the credit.
5. Whether Holding a Bill of Lading Confers Ownership Rights to the Goods Under It
【Guiding Case】 China Construction Bank Guangzhou Liwan Sub-branch v. Guangdong Lanyue Energy Development Co., Ltd., Huilai Yuedong Electric Power Fuel Co., Ltd., et al. Letter of Credit Opening Dispute
Supreme People's Court | (2015) Min Ti No. 126 | Adjudicated on October 19, 2015
【Key Points】 A bill of lading possesses the dual attributes of being both a document of title and a document evidencing a right to payment. Whether the holder acquires property rights, and what type of property rights, upon delivery of the bill of lading depends on the contractual agreement between the relevant parties. In the present case, the issuing bank held the bills of lading pursuant to its contract with the applicant. Considering the parties' true intent and the inherent characteristics of letter of credit transactions, it should be determined that the issuing bank held a pledge right over the bills of lading (as part of the documents under the L/C) and over the goods represented thereby. The issuing bank exercises its pledge right over the bills of lading in the same manner as exercising a pledge over the movable property they represent; that is, it holds a priority right to compensation from the proceeds realized after the appraisal, sale, or auction of the goods. The holder of the bill of lading may apply to the court overseeing enforcement proceedings to participate in the distribution of proceeds based on an effective judgment. Should its pledge right over the bill of lading come into conflict with rights such as liens or possessory pledges that other creditors may hold over the goods, such conflicts may be resolved according to law within the enforcement distribution procedure.
6. Determination of Intermediary Bank's Liability for Fault
【Official Typical Case】 Qixia Lüyuan Fruits & Vegetables Co., Ltd. v. Bank of China Beijing Branch Letter of Credit Transfer Dispute
Supreme People's Court | (2013) Min Shen No. 1296 | Adjudicated on August 30, 2013
【Key Points】 Firstly, when neither Chinese law nor international practices like UCP clearly规定 the scope of liability for an intermediary bank's erroneous advice, and there is no contractual relationship between the intermediary bank and the beneficiary, the principle of tort liability for damages should apply to determine that the intermediary bank has a duty to accurately advise information and bears corresponding liability for damages upon breach. Secondly, parties in an L/C relationship deal with documents, not with goods, services, or other performances to which the documents may relate. Therefore, the sole legal basis for determining loss caused by the intermediary bank's fault must be the L/C itself, not the underlying contract, clearly revealing the connotation of the principle of independence. Thirdly, applying the principle of foreseeability to determine the scope of compensatory damages not exceeding the unpaid amount under the L/C plus interest ensures the predictability of the liability scope.
7. Determination of Advising Bank's Duty of Surface Examination under UCP600
【Official Classic Case】 Maizhi Holding Group Co., Ltd. v. Bank of Communications Co., Ltd. Letter of Credit Negotiation Dispute
Shanghai High People's Court | (2017) Hu Min Zhong No. 408 | Adjudicated on December 3, 2018
【Key Points】 Under UCP600, an advising bank still has the duty to check the apparent authenticity of the credit, and its confirmation of apparent authenticity should be based on reasonable grounds. Using authenticated SWIFT messages to query the issuing bank is a reasonable and effective examination method. When SWIFT message content is ambiguous, whether the advising bank's understanding is reasonable should be judged based on the background and purpose of the message. The understanding of the same message content by the presenting bank/negotiating bank can be used for comparative comparison to assess the reasonableness of the advising bank's understanding.
【Case】 Guochu Energy Trading (Shanghai) Co., Ltd. v. Bank of Shanghai Co., Ltd., Postal Savings Bank of China Letter of Credit Fraud Dispute
Shanghai Financial Court | (2018) Hu 74 Min Chu No. 1217 | Adjudicated on April 30, 2021
【Key Points】
Firstly, the direct cause of Guochu's inability to realize its rights under the relevant L/C was the refusal by the issuing party, CREDIT SUISSE BANCORP, to pay on the grounds that the beneficiary and applicant under the L/C had agreed to resolve payment outside the L/C. This act was unrelated to the transmission/advising acts of Postal Savings Bank and Bank of Shanghai. Secondly, Guochu did not provide evidence prove that the content transmitted/advised by Postal Savings Bank and Bank of Shanghai differed from the actual information. Thirdly, according to UCP600, the advising bank's examination duty is limited to apparent authenticity and does not include substantive examination of the issuer's creditworthiness, L/C risks, etc. Moreover, Bank of Shanghai's advice to Guochu stated: "We advise the credit without any engagement on our part." In international L/C business, banks may use their professional knowledge to warn clients of risks, reducing trade risks. However, such warning does not yet constitute a specific duty of an advising bank under laws, regulations, and international commercial practices, nor was there relevant agreement between the parties. Therefore, Guochu's claim lacked basis and could not be supported.