CHAPTER VII

THE LETTER OF CREDIT IN AMERICAN LAW

-DECISIONS

The letter of credit has been the subject of many decisions by American courts, but only a few apply to the commercial letter of credit. Some of these cases are rather unsatisfactory since the judges have at times failed to understand the true nature of the letter of credit and consequently made statements which depart from the actual facts of the cases involved. However, the group of decisions taken as a whole may be regarded as having established a firm and, on the whole, satisfactory legal foundation for American credits and dollar exchange.

Litigation over letters of credit naturally arises from the refusal of a party to fulfill his engagement, as when the issuer cancels the credit, or the opener refuses reimbursement to the negotiator. Cases involving these issues will be considered by presenting the principle involved, the facts of the case, the decision of the court and general comments. A diagram will be used to show the relation of the parties to one another and the sequence of their successive acts and, wherever court records permit, the documents such as letters of credit, applications and contracts will be reproduced in full.

I. A Bank May Not Cancel Its Clean Irrevocable Letter of Credit Before Its Expiration Date.

Johanessen vs Munroe, 158 New York 641.

1. A ship broker engaged in business in New York City paid a sum of money to Munroe & Co., bankers, to open a letter of credit with their Paris office in favor of Johanessen, captain of a Norwegian steamship.

2. Accordingly Munroe & Co. sent to their Paris office the following communication:

MESSRS. MUNROE & Co.,

GENTLEMEN:

Paris.

"Office of John Munroe & Co., Bankers,

New York, Feb. 26, 1892.

We hereby open a credit with you in favor of Captain J. A. Johanessen, S.S. Raylton Dixon, for frs. 15,000, available in bills at 90 days' date; on acceptance of any bill or bills drawn under this credit you are to draw on Carsten Boe, New York, at 75 days' date; payable at the current rate of exchange for first-class bankers' bills on Paris on day of maturity. Commission is arranged. Bills under this credit to be drawn at any time prior to May 1, 1892.

JOHN MUNROE & Co."

The bill may be availed of in sterling, if desired; say £600 sterling. 3. The Paris office in turn informed Johanessen of the opening of the credit.

4. The business transaction between Boe and Johanessen was not completed, and the latter incurred a financial loss of $3,700 which the former offered to settle by giving $500 in cash and £600 in the form of the above letter of credit. Johanessen gave Boe a receipt for this amount in full settlement of all claims, but Munroe & Co. informed Johanessen that they were about to instruct their Paris office to cancel the letter of credit. Counsel for Johanessen replied that the drafts would be drawn on the Paris office and if the credit were dishonored, the issuing bank would be held responsible.

Decision.

"The entire transaction presented all the elements of an estoppel which precluded the defendants from setting up a defense based upon the alleged invalidity of the letter of credit for any cause."

Comment.-The case does not involve the usual letter of credit addressed by the issuing bank to the beneficiary, but is based

on a communication between the issuing bank and the notifier which, in this instance, is a branch office. The document is a clean letter of credit, since payment is not conditioned upon the presentation of any documents by the beneficiary. Furthermore, the credit is irrevocable, since drafts are available until May first, and no mention is made of the right of cancellation by the issuing bank. As the letter of credit was clean and irrevocable, the bank was unconditionally obligated to honor the drafts if drawn by Johanessen before the date of expiration. The court in deciding for the beneficiary was upholding the inviolability of an irrevocable letter of credit as the unqualified promise of the issuer to honor the drafts of the beneficiary. The court in its decision expressed the fundamental function of banking, the substitution of better known for less known credit as follows: "The plaintiff would naturally have greater confidence in the credit of a well-known banking house than in the financial ability of Boe who had just defaulted in his charter contract.' II. An Irrevocable Letter of Credit May Be Canceled After Its Expiration Date.

1. Gossler & Co. entered into a contract to sell to a party named Finlay a quantity of sugar from St. Vincent, to be a "May-June shipment," and to be financed by a letter of credit expiring on June 30.

2. Finlay applied for a letter of credit, coinciding exactly with the contract of sale, to Welsh, a New York banker.

3. Welsh telegraphed to Gossler's representatives in St. Vincent a credit as dictated by Gossler. This credit failed to contain the prohibition against its use after June 30.

4. The representatives of Gossler did not ship the sugar until

in July and then drew drafts under the credit. Finlay refused to accept the sugar because it had not been shipped before June 30 in compliance with the contract. As the bills of lading had been made out to Welsh, the banker, he had legal possession of the sugar. Welsh agreed to surrender the sugar to Gossler provided the latter would pay the advances made in paying the drafts drawn by the exporters in St. Vincent. Gossler refused and Welsh sold the sugar. The proceeds of this sale did not cover the full amount of the money paid out on the drafts, so Welsh sued Gossler for the balance.

Decision.

"Finlay might accept the sugars notwithstanding the delay. He might waive the provision of the contract which required June shipment. If he did, the appointees [representatives in St. Vincent] were rightfully in possession of the money as paid upon the latter's contract of sale. But if he did not, if he refused to accept, and stood upon the terms of the contract, then Gossler & Company were in the position of appropriating plaintiff's money as a loan or advance upon the faith of the sugar shipped to the plaintiffs to sell on commission. Finlay was not bound to accept sugar shipped in July; neither defendants nor their representatives in St. Vincent acquired a right to use the credit after June 30, although the form of the telegraphed credit enabled them to do so."

...

Comment.-Johanessen vs Munroe and also the above case are both concerned with the expiration date of a letter of credit. In the former case, the court held that an irrevocable letter of credit could not be rescinded before the expiration date. In Welsh vs Gossler, the beneficiary, through his representatives, availed himself of the credit after June 30, the day when the credit was to terminate. Had Gossler observed all the terms of the credit by making shipment during June and drawing drafts before June 30, Finlay, the purchaser, would have had no other choice but to make payment. As Gossler failed to observe the condition as to time, Finlay was in a position to accept or reject the shipment. He chose the latter course and in so doing was fully within his rights. The case of Welsh vs Gossler was cited in Higgins vs Steinhardter (106 Miscellaneous New York 168), in which the court granted an injunction restraining the payment of drafts drawn under a letter of credit after its expiration date.

III. A Letter of Credit May Be Cancelled by the Issuer Upon Notice to the Beneficiary, But Not After He Has Drawn His Drafts.

Quentell
(opener)

Rodewald
(beneficiary)

Gelpcke
(issuer)

5

FIG. 3

1. Quentell, a merchant and banker of Bremen, was importing merchandise from the firm of Rodewald & Co., of New Orleans, and in their favor opened a letter of credit with Gelpcke, a banker of New York. The communication sent by Quentell to Gelpeke read as follows:

"Bremen, Dec. 24, 1859.

"I take the liberty to open a credit with your house for my account in favor of Messrs. Henry Rodewald & Co. in New Orleans for the amount of $50,000 to be used by 60 days' sight drafts. This credit is intended for advances on consignments of merchandise to my address, and you will please to keep the same in force for the coming year, 1860. It is, however, not required that bills of lading accompany the advice of the drafts. Requesting you, by a few lines, to advise Messrs. Rodewald & Co. of the opening of the credit, and assuring you that your draft for reimbursement to a point to be drawn on me at maturity of your acceptances will be promptly honored."

2. On January 17 Gelpcke thereupon sent Rodewald & Co. the following communication:

"We hereby have the pleasure to inform you that our mutual friend, Wm. Ed. Quentell of Bremen, has opened a credit with us, in your favor, for the sum of $50,000-say fifty thousand dollars-to be used by your drafts 60 days' sight against shipments of consignment to the address of said friend. In confirming this credit, we hope you may soon have occasion to make use of it. Your drafts will meet with prompt protection."

3. On February 1, 4 and 7 Rodewald & Co. drew their drafts