in Paris where he finds himself in need of funds. He refers to the list of foreign correspondents and selects one located in Paris. He goes to this banker, exhibits his letter of credit and requests the payment of say $200. The banker then fills out a draft for this amount on the American bank which has opened the credit, and has the beneficiary sign it. His signature is compared with the letter of indication, and if satisfied as to the authenticity of the writing, the foreign banker buys the draft. The banker thus receives dollar exchange and gives the beneficiary the equivalent in francs. This conversion is made by the banker on the basis of his buying rate on that day for dollar sight drafts on New York. The negotiating banker endorses the necessary details on the reverse side of the letter and returns it to the traveler. The draft is then sent to a New York correspondent which in turn presents it to the drawee bank for payment. Frequently the negotiating bank sends the draft directly to the issuer of the letter, especially when the two institutions stand in relation of branch to home office.

A somewhat different procedure is followed in the operation of a sterling credit. In issuing this form of credit, the American bank specifies in the traveler's letter of credit the name of its London correspondent on whom drafts are to be drawn. The American bank, on issuing a sterling credit, sends its British correspondent specimens of the beneficiary's signature. The negotiator of the draft remits them to the London bank which compares the signature on the draft with that on the specimen card. If the writing appears genuine, the London bank pays the draft and charges the amount against the account of the American bank which has issued the letter of credit.

The letter thus enables the traveler to obtain funds from any of the numerous correspondents of the issuing bank. Also the letter serves as a means of introduction and in a way is the issuing bank's expression of the credit standing of the holder. For performing these services the various banks involved in the transaction naturally receive a compensation in one form or another. The interior bank, which has no foreign connection of its own but is selling the letter merely as an agent, receives a commission of usually 1/4 of one per cent of the amount of the credit. The bank which issues the credit also receives a similar commission but at times may exact no charge at all. This insti

tution is able to charge little or even nothing for the letter, since it has use of the funds until the credit is exhausted by the beneficiary. Besides, the bank derives a publicity advantage in having its letters of credit carried all over the world. The foreign correspondent, in negotiating the drafts, buys them at its own quotation on sight bills and thus obtains a profit on the purchase of exchange on New York or London.

CHAPTER VI

THE LETTER OF CREDIT IN AMERICAN LAW

-PRINCIPLES

I. Definitions and Classifications of the Letter of Credit . in American Law.-Before analyzing the American cases dealing with the letter of credit, it may be well first to consider some of the definitions of this instrument as found in the laws of the states, decisions of the courts and commentaries of jurists. The codes of the states of California, Montana and the Dakotas all describe a letter of credit as a "written instrument addressed by one person to another requiring the latter to give credit to the person in whose favor it is drawn." The same thought is expressed in the recent case of American Steel Co. vs Irving National Bank (266 Federal Reporter 41), which regards a letter of credit as a "letter requesting one person to make advances to a third person on the credit of the writer." Judge Joseph Story in his work on "Bills of Exchange," p. 459, defines a letter of credit as a "letter of request, whereby one person (usually a merchant or banker) requests some other person or persons to advance moneys, or give credit to a third person, named therein, for a certain amount, and promises that he will repay the same to the person advancing the same or accept bills drawn upon himself for the like amount.'

Considering next the classification of letters of credit as presented in the above sources, we find that the court, in American Steel Co. vs Irving National Bank, groups these instruments as either general or special. "They are general," says the court, "if directed to the writer's correspondents generally; they are special if they are addressed to some particular person." In a similar tone, Judge Story observes that the instrument in question is called "a general letter of credit when it is addressed to all merchants, or other persons in general, requesting such advance to a third person; and is called a special letter of credit when it is addressed to a particular person by name, requesting him to make such advance to a third person." The definition and

classification of the letter of credit presented above has been accepted in American law from the early decisions of John Marshall to current articles in legal reviews.

An examination of these statements indicates, however, that they apply not to the commercial but rather to the traveler's letter of credit described in the previous chapter. It was there noted that the traveler's letter of credit was a communication sent by a banker to one or more of his correspondents who are requested to give credit to a beneficiary by cashing his drafts. On the other hand, the commercial letter of credit is rather an authorization to a beneficiary to draw his drafts. The distinction between these two instruments is well drawn in a British case (Union Bank of Canada vs Cole, 41 Law Journal, Queen's Bench, 100) which regards commercial letters of credit as "giving credit but not requesting any third party to give credit." In addition to this essential difference in the nature of the two documents, other dissimilarities were noted in the preceding chapter. These distinctions have not been generally appreciated by judges in their decisions or by writers in their comments and as a result considerable confusion today surrounds the legal aspects of letters of credit.

II. Historical and Legal Evolution of the Letter of Credit. The cause of this confusion in American law can be found in the historical evolution of the letter of credit. It came into extensive use by American exporters about the opening of the nineteenth century when the Napoleonic Wars drew thousands of men from the farms of Europe and caused a well-nigh insatiable demand for wheat and other foodstuffs produced in the United States. Along with this, the Industrial Revolution in England expanded the manufacture of textiles and created an almost unlimited market for American cotton while its production at the same time was stimulated by the invention of Whitney's gin. Although these exports were often financed by the letter of credit, it was in a form akin to the present day traveler's rather than to the commercial letter. The instrument thus evolved, in time became the subject of litigation and was the basis of numerous decisions by Chief Justices Marshall and Story. After the first quarter of the nineteenth century, fewer cases on letters of credit arose, due partly to the fact that foreign commerce declined relatively in proportion to domestic

trade which increased rapidly with the development of the West.

During the first half of the nineteenth century, Great Britain also underwent rapid economic changes. As a result of the Napoleonic Wars, the center of finance shifted definitely from Amsterdam to London. The increase in the production of manufactured goods compelled England to seek markets abroad and an ever-expanding foreign trade was developed by British merchants. Some of them applied their capital to founding institutions to finance overseas trade, and in doing so developed the letter of credit from its old form which resembled the traveler's letter into the modern or commercial type. This evolution is clearly evidenced in the cases which are reported from time to time in the records of the British courts. About the middle of the nineteenth century with the growing use of the sterling bill as the currency of international finance, cases on letters of credit. became more frequent and by the close of the century the nature of the instrument and the liabilities of parties to it were well defined in the British law.

In the United States the letter of credit declined relatively in use due largely to the fact that after the Civil War the bill of exchange yielded to the promissory note as a means of settling business transactions. In the meantime, the new or commercial form of letter of credit, as developed in England and on the Continent, was gradually introduced in the United States and a few cases involving this instrument came before the American courts. Most of these credits were drawn in sterling and did not present some of the innovations which have arisen since 1914 when dollar credits were first issued on an extensive scale. Although the letter of credit was used to finance exports worth hundreds of millions of dollars from 1914 until 1919, only a negligible amount of litigation arose either in American or British courts. The absence of legal controversy may be explained by reference to the abnormal war demand which absorbed goods regardless of prices. The rejection of a shipment or the cancellation of an order rarely occurred.

The change in the price level after May, 1920, was followed by serious consequences all over the world. The collapse of the Japanese silk market, the debacle in the Javanese and Cuban sugar industry, the fall of quotations on South American coffee,