INDEPENDENCE PRINCIPLE UNDER LETTER OF CREDIT AND THE FRAUD EXCEPTION

Paper Number :WP42/2024
Publication Date :April 17, 2024

In international trade finance, the Letter of credit (LC) has a key role to play in risk mitigation. However, the Letter of credit is a complex instrument, and guidelines from the International Chamber of Commerce (ICC) in the form of Uniform Customs and Practice for Documentary Credits (UCP-600) as well as the ICC dispute resolution process form the basis of the letter of credit transactions. The letter of credit as an instrument of payment is independent of the underlying contract between the buyer and the seller as well as independent of the contractual relationships between banks or between the importer and the importer’s bank. Moreover, in determining a complying presentation, banks are expected to examine the documents only on the face of it and not with the actual physical goods to which the documents relate. These two criteria form the basis of the independence principle for the Letter of Credit. While the banks have to adhere to the ‘Independence principle’ to ensure the effective functioning of the Letter of credit, the same principle can be exploited by fraudsters to defraud the banks involved by submitting fake documents. In this context, the paper examines the fraud exception to the ‘independence principle’ using a textual analysis of the select legal judgments on the fraud exception in the letter of credit.