CHAPTER 7
BANK COLLECTIONS, TRADE FINANCE, AND LETTERS OF CREDIT
CASES IN THIS CHAPTER
Maurice O’Meara Co. v. National Park Bank of New York
Courtaulds North America, Inc. v. North Carolina National Bank
Sztejn v. J. Henry Schroder Banking Corp.
Semetex Corp. v. UBAF Arab American Bank
TEACHING SUMMARY
Just as international buyers and sellers must contract to move their goods from country to
country, they must also devise methods to pay for those goods. This must take into account
different currencies, ensuring that sellers will actually be paid for their goods, and, practically,
how money will move from one country to another. The documents used in foreign sales are
also used in domestic sales but are less common. A common negotiable instrument, the draft
(also known as a bill of exchange) is a key document used in international transactions. A
documentary draft is used to expedite payment in a documentary sale. The word draft is more
frequently used in U.S. law and banking practice, while the term bill of exchange is more
frequently used outside the United States, particularly in England. Generally, the term draft is
used in this text except when referring specifically to an English bill of exchange. The draft/ bill
of exchanges serve two purposes: (1) they act as a substitute for money and (2) they act as a
financing or credit device. Where buyers and sellers are separate distance and different home
regulations or customs pertaining to financial practices, the formality of these documents helps
to assure the parties that the sale will proceed as agreed.
Additional Background: On-Line Letters of Credit. The different rules and regulations
across the globe can make financing international trade difficult. Although it is estimated that
letters of credit are used on 45% of all international trade, the form of a letter of credit is not
standardized internationally, and institutions use different methods to process them. Obviously,
this is inefficient. Consequently, intermediary companies are now providing Internet-based trade
financing products to facilitate international B2B exchanges. Such on-line financing options
permit buyers to apply for letters of credit and allow either party to initiate discrepancy requests.
Bank payment partners can then conduct all collection and transfer of data within the B2B site.
This one-stop on-line format can be accessed in real time by all relevant banking and trading
partners and g-time role as a trusted third party. For more information, see B.J. Handal, “Are
On-in Letters of Credit in Your Future?” World Trade 68 (January 2001).
1. Had the bank been aware that the newsprint shipment did not conform to the requirements
of the underlying sales contract, would it have still been required to pay under the letter of
credit?
2. If the bank pays for documents that conform to the letter of credit, but the goods
themselves turn out to be nonconforming, is the buyer legally justified in refusing to
reimburse the bank?
3. Do you think under current law and banking practice, that bankers should physically
inspect the goods when they arrive before honoring their customer’s letter of credit?
Answer: This question calls for student opinion.
Courtaulds North America, Inc. v. North Carolina National Bank
1. Why did the bank refuse to accept the draft upon presentation of the documents?
2. Had the bank known that the yarns described in the invoice as “imported acrylic yarns”
were actually 100% acrylic, as was called for in the LC, would the outcome have been affected?
3. What is the liability of a bank for paying or accepting a draft when the documents contain a
discrepancy?
1. What basic principle of letter of credit law does this decision challenge?
2. How would the result be different if the draft and documents had been sold and
negotiated to a holder in due course who took with no knowledge of the fraud, and who
then presented the documents to the issuing bank for payment?
3. Explain the misrepresentation that took place in this case. How was this “fraud in the
transaction”? Can you think of other examples of how fraud could occur in a
documentary letter of credit transaction between foreign parties?
4. What steps could a buyer and seller take to avoid falling victim to an international fraud?
How could they learn more about each other, and what sources could they consult?
1. What basic principle of letter of credit law does this decision challenge?
2. Is the court’s decision correct given the many problems with the documentation as
prepared by the freight forwarder and the additional complication of the Iraqi government
asset freeze? Why or why not?
Chapter 7: Bank Collections, Trade Finance, and Letters of Credit
3. Is the court’s definition of “outright fraudulent practice” too restrictive? What would be the
consequences for letter of credit law if the court adopted a more liberal interpretation of
fraud?
4. What could UBAF have done in the negotiation and drafting process to prevent the
ultimate outcome in this case?
QUESTIONS AND CASE PROBLEMS
1. Answer: Wade’s documents were non-conforming. Conforming documents must be
2. Answer: Smith/Smitth or McDonald/MacDonald, the same remains the same and can
3. Answer: J.H Rayner and Company, Ltd. v. Hambro‘s Bank, Ltd is a classic English case.
4. Answer: This circumstance differs from the facts in Sztejn as the sellers were unaware
security.
6. Answer: With regard to the issuing bank, Barclay’s cannot receive payment on the
Chapter 7: Bank Collections, Trade Finance, and Letters of Credit
This appears to be a “scam” in which buyer and seller conspire to set up a revolving letter of
credit and pretend to send pharmaceuticals from Germany to South Africa. The carrier does not
MANAGERIAL IMPLICATIONS
1. Answer: These different regions reflect different risks to U.S. exporters. Generally, the
credit risk (as assessed using international credit reporting agencies, such as Dun and
2. Answer:
(a) There is a discrepancy; the trucker’s document is no substitute for the ocean bill of
lading as called for in the credit.
Chapter 7: Bank Collections, Trade Finance, and Letters of Credit
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ETHICAL CONSIDERATIONS _______________________________________________
1. ANSWER: The buyer’s primary contention was that it was fraudulently induced into entering
into this transaction. This fraud was so extensive as to vitiate the entire transaction and thus
By contrast, the seller contended that injunctive relief was not appropriate as the commission of
fraud, if any, occurred in the underlying sales transaction. Injunctive relief was only proper if
The buyer’s behavior throughout this transaction demonstrated a certain degree of naïveté with
respect to international commerce. This is practically evident in the failure to ascertain the
The Ohio Supreme Court reversed the court of appeals and ordered the enjoining of
enforcement of the letter of credit on the basis that it was used by the seller as a “vehicle for
Given the Ohio Supreme Court’s finding with respect to the fraud that infected the totality of this
transaction, it appears that the vast majority of losses arising from this transaction should fall
upon the seller.
2. ANSWER: In addressing the ethical issues here, let us make the following assumptions: (a)
Chapter 7: Bank Collections, Trade Finance, and Letters of Credit
and is in a position to profit far more than he ever thought of profiting; (b) that the buyer knows
perfectly well that the goods are conforming. If so, several ethical theories might be advanced to
prescribe behavior for the parties to the contract. Kantian deontology would use the categorical
Contracts Theory, Academy of Management Review, April 1994). Here, if the seller realizes a
windfall, prevailing norms and customs in the silk sales community might well point to a
satisfactory ethical path. Thus, if all participants in the silk trade understand the risks of
commodities fluctuations, participants can perhaps plan for the kind of market flooding that has
drastically lowered the price. But if the events are unprecedented, historic community norms
may be a miserable guide. Instead, a buyer or seller might consider value or virtue ethics,
identifying central or core values that are a matter of general consensus, values like honesty,
promise-keeping, integrity, respect, fairness, caring, and responsibility.
On a long-term basis of dealing, both buyer and seller would benefit if there were
sufficient trust, honesty, respect, and fairness that the seller were willing to renegotiate a fair
INTERNET EXERCISE: UCP AND LETTERS OF CREDIT
Chapter 7: Bank Collections, Trade Finance, and Letters of Credit
Ask students to draft a letter of credit compliant with the standards of the UCP. Students can
look at the information on: www.lexmercatoria.org or http://www.iccwbo.org/
TEACHING SUGGESTION / COOPERATIVE LEARNING ACTIVITY: CREDIT
As an extension of the contract negotiation exercise, instructors may also require students to
finance the transaction. Several student groups can be assigned the roles of sellers/buyers and
banks (buyer’s and seller’s), etc., and required to draft the appropriate documents for a
transaction (this may be limited to financing aspects or include the bill of lading/air waybill,
insurance policies, letter of credit). For example, students may be required to draft a letter of
credit (perhaps pursuant with a student bank’s requirements) for presentation. A student bank
that improperly honors the draft will lose points in the exercise.