Standby letter of credit as a means of security in international contractual relations

2.    Sources of law for standby letters of credit

3.    The concept of Standby Letter of Credit and the legal relationships that exist with Standby Letter of Credit

According to Article 1.06 of ISP 98, a standby letter of credit is an irrevocable, independent, documentary, and binding undertaking when issued and need not to state” (Goode et al. 2007, p. 246). Three basic features of the standby letter of credit derive from this provision, namely irrevocability, independence in relation to the main business and the documentary character of this legal institute. Irrevocability means that “an issuer’s obligations under a standby cannot be amended or cancelled by the issuer except as provided in the standby or as consented to by person against whom the amendment or cancellation is asserted” (Article 1.06 b. ISP 98, Goode et al. 2007, p. 246). The independence of the standby letter of credit implies that “the enforceability of an issuer’s obligations under a standby does not depend on: i. the issuer’ right or ability to obtain reimbursement from the applicant; ii. the beneficiary’s right to obtain payment from the applicant; iii. a reference in the standby to any reimbursement agreement or underlying transaction; iv. the issuer’s knowledge of performance or breach of any reimbursement agreement or underlying transaction (Article 1.06 c. ISP 98 Goode et al. 2007, p. 246). The documentary character of the standby letter of credit implies that “an issuer’s obligations depend on presentation of documents and an examination of required documents on their face” (Article 1.06 d ISP 98, Goode et al. 2007, p. 246). We note that in this provision the term “required documentation on their face” is used for the review of documents, which could be translated as required documents by their appearance, and the same term is also used in UCP 600 in the part “Standard for Document Review” in Article 14 and where it is stated that a nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation.

“In transactions in which a standby letter of credit is used, the bank agrees to pay the financier if the debtor defaults upon his obligation to pay” (Banks 1984, p. 71).

Pavićević (1999) defines a standby letter of credit as “a letter of credit in which the bank undertakes according to its beneficiary, that on the order of his client (principal), he will pay him a certain sum of money in a certain currency if the beneficiary of the letter of credit submits to the bank, within a certain time, a statement that the debtor (principal) has not fulfilled his obligation from the basic contract when due” (p. 207). Vukadinović (1987) defines a standby letter of credit “as any agreement by which one person (issuer) obligates a third party (beneficiary) to a third party (beneficiary) on the order of another person (the principal) to pay a certain sum of money on the condition that the beneficiary submits a written statement within a certain time that the debtor (principal) did not fulfill his obligation by the due date and to submit any other required documents” (p. 449).1 A standby letter of credit could be classified as a neutral banking business, given that the bank does not appear here either as a creditor or as a debtor. A standby letter of credit could be defined as a neutral banking business and an irrevocable payment security instrument that is independent of the basic business for which it was issued, and on the basis of which the bank undertakes to the user of the letter of credit to perform remuneration, if the user submits to the bank the documents stipulated by the letter of credit, and which indicate that the principal has not fulfilled his obligation regarding maturity.

The first legal relationship that is established within this complex legal institute is the legal relationship between the principal and the bank. When we talk about the participants of this legal relationship, we notice that ISP 98 does not use the term bank as the only authorized entity for issuing standby letters of credit, but uses the term with a broader meaning “issuer”, while on the other hand UCP 600 uses the term “issuing bank” to denote the contracting party which is authorized to issue letters of credit, and therefore also to issue standby letters of credit, if the contracting parties have foreseen the application of UCP 600. Given that in international business practice the bank most often appears as the issuer of standby letters of credit, for the purposes of this paper we will talk about the legal relationship between the principal and the bank, without the label “issuing” bank due to the disputed legal nature of this legal institute. This legal relationship is based on the contract between the bank and the principal, by which the bank undertakes to issue a standby letter of credit to the beneficiary named by the principal, and the principal undertakes to pay the bank a fee for issuing the standby letter of credit and to compensate (regress) the bank for the amount paid by the bank to the user in the event of a guarantee event provided for in the letter of credit. The bank’s obligations under the standby letter of credit agreement have certain similarities with the documentary letter of credit agreement, which are reflected in the fact that the bank has certain obligations towards the principal, and certain obligations towards the beneficiary, from the moment the beneficiary is informed that the letter of credit has been issued. With a documentary letter of credit, “the bank’s obligations to the principal are: a) the obligation to open the letter of credit and b) the obligation to deliver to the principal the documents that the bank has received from the beneficiary of the letter of credit” (Đorđević, 2013, p. 109).

After the bank informs the user that a standby letter of credit has been issued in his favour, the bank enters into a legal relationship with the user and undertakes the obligation to pay the letter of credit sum in the event that the user submits to the bank the required documents proving that the principal, i.e. the debtor has not fulfilled his obligation from the basic contract. With a documentary letter of credit, “the bank’s obligation towards the beneficiary of the letter of credit are: a) the bank’s obligation to review the documents it receives from the beneficiary, b) the bank’s obligation to settle the debt based on the letter of credit (the obligation to honour and the obligation to negotiate) (Đorđević, 2013, p. 109). However, unlike a documentary letter of credit, with a standby letter of credit, the bank has the obligation to review the documents submitted by the user and the obligation to pay the contracted amount only in the event that the principal has not fulfilled the obligation from the basic transaction. As for the documents that the user is obliged to submit to the bank if he wants to exercise the right to the payment of the letter of credit sum, it is important to note that it can only be a written statement that the principal has not fulfilled his obligation, and there can also be documents proving that the principal has not fulfilled his obligations that he assumed in the basic contract or that he did not fulfil them within the agreed period.

4.    The role of standby letters of credit in international contractual relations and the relationship with other banking operations 4.1.    General notes

When we talk about the role of standby letters of credit in international contractual relations, it is necessary to mention that this legal institute represents one of the instruments of international goods and payment transactions. International goods and payment instruments aim “to meet the practical needs of business people in payment transactions and to unify their way of issuing, using and interpreting” (Dukić-Mijatović, 2010, p. 485). The basic role of a standby letter of credit in contracts in the field of international commercial law is to provide assurance by the bank to one contracting party that the other contracting party will fulfill its obligations, that is, that it will fulfill its obligations on maturity. A standby letter of credit can refer to guaranteeing the fulfillment of monetary obligations, such as in the case of sales contracts, and it can also refer to guaranteeing the fulfillment of non-monetary obligations, such as in the case of construction contracts or contracts for the performance of investment works. The question arises as to what is the bank’s interest in providing security to its client’s creditor that he will fulfill his obligations. The main interest is in the payment of the fee for the issuance of the standby letter of credit by the client – the principal. However, by assuming the obligation to issue a standby letter of credit, the bank assumes a significantly higher risk than the income it will generate by charging the issuing fee. Therefore, in practice, the bank most often asks the principal to provide it with certain payment security instruments, such as a mortgage, a pledge on movable property, a deposit, etc. In earlier presentations, we stated that the standby letter of credit belongs to the group of neutral banking transactions, however, the documentary letter of credit and bank guarantee also belong to this group, so it is necessary to delineate the role of the standby letter of credit as a neutral banking transaction in relation to the role of the documentary letter of credit and bank guarantee. However, before entering into the discussion of this issue, it is important to note that there is also a similarity between a documentary letter of credit and a bank guarantee, which is reflected in the fact that “both a documentary letter of credit and a bank guarantee are instruments for securing the fulfillment of obligations from the basic business” (Dukić-Mijatović, 2010, p. 487). “However, while in bank guarantee it is the basic and only function, the documentary letter of credit primarily represents a means of payment and only in parallel with it a means of securing payment” (Dukić-Mijatović, 2010, p. 488).

• 4.2.    Relationship between standby letter of credit and documentary letter of credit

  With standby letters of credit, we can distinguish between those in which the bank ensures the performance of payment obligations (financial standby), which occur in sales contracts and those in which the bank guarantees that the contractor will fulfill its obligations, which occur in construction contracts with a foreign element. In American legal theory, the name “performance standby” is used for the second type of standby letter of credit, which could be translated as standby for good work performance. Kozolchyk (1995) points out that performance standbys “assure the seriousness of a supplier’s, contractor’s or subcontractor’s bid or the successful completion of the contract awarded to them” (p. 406). In the case of the financial standby “its issuer must pay the beneficiary if the tendered documents conform with terms and conditions that solely reflect the maturity of the applicant’s underlying financial obligations or the applicant default” (Kozolchyk, 1995, p. 406). It is obvious that the performance standby has very few points of contact with the documentary letter of credit, while the financial standby letter of credit has many more similarities.

• 4.3.    The relationship between standby letters of credit and bank guarantees

  When we talk about the role of the standby letter of credit in international commercial law contracts, it is obvious that it has more similarities with a bank guarantee than with a documentary letter of credit. The economic function of the standby letter of credit is to ensure the fulfillment of the principal’s obligations, i.e. debtor from the basic business. A bank guarantee has the same economic function. In particular, we notice the similarities between the standby letter of credit and the type of bank guarantee with a “no objection” or “on first call” clause, and it is a type of bank guarantee that “deprives the bank of the right to raise objections against the beneficiary of the bank guarantee, which could be raised by the bank’s client, such as the debtor towards his creditor, who in this particular case is the beneficiary of the bank guarantee (Carić, Vitez, Dukić-Mijatović & Veselinović, 2016, p. 303). “Such bank guarantees appear in foreign trade exchange in order to protect the interests of creditors, which can be seriously threatened by the initiation of court and arbitration disputes” (Carić et al., 2016, p. 303).

5.    Conclusion

When we compare a standby letter of credit with a documentary letter of credit, the first question that arises is whether a standby letter of credit is a type of letter of credit at all or is about another contract of international commercial law. The common feature of these two legal institutes is that they were created as a need to ensure the mutual obligations of the contractual parties from the basic business and to achieve a certain balance when taking risks by participants in international business relations. Banks played a key role in the creation of both legal institutes as a necessary link in international trade relations. “Standby letters of credit and traditional letters of credit are both mechanisms for allocating risks among the parties in commercial transaction” (Stern, 1985, p. 222). “The traditional commercial letter of credit is used as a payment service and is expected to be drawn upon, whereas the standby letter of credit acts as a means of securing payment if the bank’s customer defaults on the underlying obligation” (Banks, 1984, p. 74).

Similarities also exist in the sources of law by which these legal institutes are regulated, given that UCP 600 contains rules for both standby and documentary letters of credit. There is also a similarity in the economic function of these two legal institutes because both aim to ensure the seller that the buyer will pay the purchase price when the seller submits certain documents to the bank. The difference is reflected in the fact that the documentary letter of credit primarily has the role of an instrument for payment of the purchase price from the contract for the sale of goods, while the standby letter of credit has the role of a payment security instrument and is “activated”, i.e. realized only in the event that the buyer does not pay the purchase price within the stipulated period. Vukmir (2007) states that “a documentary letter of credit is a normal way of payment for the performance of an obligation, most often related to the delivery of goods or services, while a standby letter of credit is insurance in case of non-performance of an obligation” (p. 266). With a documentary letter of credit, “the specificity of the legal relationship between the letter of credit and confirming bank on the one hand and the user of the letter of credit on the other is reflected in the fact that only one party has obligations (the letter of credit and the confirming bank), and the other party (the user of the letter of credit) has the right to request payment letter of credit amount, but in order to realize his right, he must fulfill certain conditions” (Đorđević, 2013, p. 155). The same is the case with the standby letter of credit, considering that the issuing bank undertakes obligations towards the beneficiary regarding the payment of the letter of credit sum, and the beneficiary does not undertake obligations towards the bank, except that in the case of submitting a request for payment, he should attach the documents provided for in the announcement on the issuance of the letter of credit. The difference between these two legal institutes can also be seen in terms of the documents that the user is obliged to submit. With a documentary letter of credit, one or more documents proving the delivery of the goods can be provided, namely: commercial invoice, transport document covering at least two different types of transport, bill of lading (bill of lading), non-transferable maritime bill of lading, charter party bill of lading, air transport document, documents on transport by road, rail or inland waterways, courier receipt, postal receipt, or confirmation of shipment by post, insurance document. “With standby, all the documents required for payment usually come from the standby user himself and are not collected from various sources, as is the case with a commercial letter of credit. These documents usually consist of evidence that some obligation has not been fulfilled” (Vukmir, 2007, p. 266). Schutze and Fontane (2001) point out that there is a difference between these two legal institutes in terms of the type of document that needs to be presented, “for payment under a standby letter of credit the beneficiary needs to provide payment demand stating that the applicant has not meet his obligations under the secured transaction and possibly some supporting documents to substantiate the claim” (p. 17). Documents that prove that the principal or the debtor from the basic business did not fulfill their obligation can be “an arbitral award, a statement by an expert, a reservation in a certificate of delivery or a written refusal to grant such a certificate” (Houtte, 2022, p. 282).

A standby letter of credit is a complex legal institution that is unknown to our obligation law and can only appear in foreign trade between our and foreign businessmen. We find the reasons for its existence in the need to protect the contractual party that first fulfils its contractual obligation (e.g. the seller who delivers the goods in the case where advance payment is not provided for) so that the third party – the bank will guarantee that the other contractual party that according to the contract will later to fulfill an obligation (e.g. a customer who pays the price after receiving the goods), to fulfill that obligation within the maturity date. A standby letter of credit can refer to both financial obligations and performance obligations. In the sales contract, the bank undertakes the seller to pay the letter of credit amount in case the buyer fails to do so after receiving the goods. In the case of construction contracts, the user of the standby letter of credit can be both the client of the works and the contractor.

The primary function of a standby letter of credit is to ensure that the principal will fulfill contractual obligations to the beneficiary. A standby letter of credit is a means or an instrument for ensuring the fulfillment of obligations. If the principal does not fulfill its obligations, the issuing bank will be obliged to pay the letter of credit amount to the beneficiary, and then it becomes a means or instrument of payment, which means that its secondary function in economic relations is the payment of the agreed price.

In order to determine its legal nature, we compared this legal institute with a documentary letter of credit and with a bank guarantee and concluded that it has more similarities with a guarantee than with a letter of credit. However, despite significant similarities with the guarantee, we could not equate it with a bank guarantee because there are differences in terms of the source of law, the form in which it is issued and the documents that are presented. When it comes to the legal nature of the standby letter of credit, we are of the opinion that this is a special contract of international banking law that contains to a lesser extent the elements of a documentary letter of credit, and to a greater extent contains the essential elements of a bank guarantee. This means that the role of standby letters of credit is the same as guarantees, to provide assurance to one contracting party that the other party will fulfill its obligations, but regulations related to guarantees cannot be applied to standby letters of credit – Uniform rules for guarantees at first call, but only the International Standby Practices (International Standby Practices ISP 98) or the Uniform Rules and

Practices for Documentary Credits of 2007 (UCP 600) depending on which rules are provided for in the standby letter of credit agreement.

Dukić Mijatović Marijana

Fakultet tehničkih nauka Univerziteta u Novom Sadu, Srbija

Đorđević Dragan

Advokat u Novom Sadu, Srbija

STANDBY AKREDITIV KAO SREDSTVO OBEZBEĐENJA U MEĐUNARODNIMUGOVORNIM ODNOSIMA

REZIME: Tema ovog rada je vrsta akreditiva koju ne srećemo u praksi domaćih banaka, i koja nije posebno regulisana domaćim zakonodavstvom, ali se može pretpostaviti da će imati sve veći značaj u međunarodnim poslovnim odnosima naših privrednika sa kompanijama drugih zemalja gde je upotreba ovog instrumenta obezbeđenja plaćanja uobičajena u bankarskom poslovanju. Reč je o vrsti akreditiva kod koje je u teoriji sporna pravna priroda, odnosno sporno je da li se ovde uopšte radi o vrsti akreditiva, ili je reč o vrsti garancije, ili je ovde u pitanju poseban pravni institut. Tema istraživanja je standby akreditiv kao sredstvo obezbeđenja u međunarodnim ugovornim odnosima. Kada govorimo o međunarodnim ugovornim odnosima kod kojih se javlja potreba uspostavljanja sredstva obezbeđenja ispunjenja međusobnih obaveza ugovornih strana u obliku standby akreditiva, pre svega mislimo na: ugovor o prodaji i ugovor o građenju. Standby akreditiv kod ugovora o prodaji obezbeđuje interese prodavca, dok kod ugovora o građenju može obezbeđivati interese i naručioca i izvođača, u zavisnosti od činjenice u čiju je korist izdat. U radu ćemo pokušati da definišemo standby akreditiv, da objasnimo njegovu ulogu u zaštiti prava i interesa ugovornih strana iz osnovnog posla a koji predstavljaju i razlog njegovog postojanja, da pokušamo da odredimo pravnu prirodu standby akreditiva istovremeno upoređujući ovaj pravni institut sa „klasičnim” dokumentarnim akreditivom i bankarskom garancijom. U našoj pravnoj teoriji, a još u većem obimu u američkoj i engleskoj pravnoj teoriji postoje brojni radovi koji obrađuju tematiku standby akreditiva, međutim, tokom vremena pravna regulativa koja se odnosi na bankarsko poslovanje se menjala, a pored toga cilj ovog rada je da upoznamo naša privredna društva i banke koji posluju sa stranim kompanijama i stranim bankama kod kojih je uobičajeno izdavanje ove vrste akreditiva sa ulogom standby akreditiva kao instrumenta obezbeđenja ispunjenja ugovornih obaveza, kao i sa pravnim odnosima koji se uspostavljaju kod ove vrste akreditiva.

Ključne reči: standby akreditiv, dokumentarni akreditiv, bankarska garancija, međunarodni ugovorni odnosi .