Informality as a Bilateral Assurance Mechanism: Comments on Ronald Mann\u27s \u27The Role of Letters of Credit in Payment Transactions\u27

Ronald Mann\u27s study of documentary defects in the presentation of commercial letters of credit is a valuable contribution to the commercial law literature in at least three respects. First, it offers a detailed and thorough empirical survey of an important though specialized aspect of commercial practice. Mann collected and coded a data sample of 500 randomly selected letter-of-credit transactions, personally evaluating each transaction to determine whether the documentary presentation by the beneficiary of the letter of credit (i.e., the seller) complied with the letter\u27s formal terms. Then, for each case in which he found one or more documentary defects, Mann went on to classify the defects and to evaluate their commercial and practical significance. He also measured how quickly and readily the issuing bank and the applicant (i.e., the buyer) responded to - and ultimately waived - the defects, in addition to collecting various other information about the transaction and the parties involved. The creation of this data set required significant time, effort, and both professional and scholarly judgment; and the result is a level and quality of information that goes substantially beyond the qualitative information gleaned from his interviews with bank officers, not to mention the anecdotal information that motivated the study in the first place. Second, Mann has not just produced a dry collection of business facts. Rather, in showing that the beneficiaries of letters of credit routinely fail to present documents that comply with the terms of the underlying letter and that the applicants and issuing banks just as routinely waive the resulting defects, he has convincingly documented an important and counterintuitive empirical regularity about commercial letters of credit - one that substantially undercuts the conventional teaching in the area that the purpose of the letter of credit is to provide the beneficiary with a guaranty of payment that is legally enforceable against the issuing bank. His findings are striking, provocative, and persuasive enough to demand explanation and, thus, to force a revision of the conventional scholarly wisdom in this area. Third, Mann has put forward a theoretical account of letters of credit, grounded in the modem economics of information and based on his prior work in other areas of commercial law, that is both more nuanced and conceptually more sophisticated than is the conventional scholarly view. His explanation is that the value of letters of credit in assuring beneficiaries of payment does not lie primarily in their legal significance, but rather in their practical significance. More specifically, the willingness of a bank to issue a letter of credit serves as a credible signal, enforced by an implicit reputational bond, of the issuer\u27s private information that the applicant is a reliable creditor; and this signal is more important to the beneficiary in practical terms than is any right to collect directly from the bank. To use Mann\u27s own terminology, the letter of credit is primarily a verification institution, not a guaranty institution.2 This explanation is creative, interesting, and as far as I know, original. It may be that Mann\u27s explanation, as he suggests at various points, will be regarded as old news by practicing commercial specialists in the letter-of-credit area. Even if this is so, however, and even if his explanation is incomplete or incorrect, he has significantly advanced the state of the scholarly literature on this topic

Informality as a Bilateral Assurance Mechanism: Comments on Ronald Mann\u27s \u27The Role of Letters of Credit in Payment Transactions\u27

Ronald Mann\u27s study of documentary defects in the presentation of commercial letters of credit is a valuable contribution to the commercial law literature in at least three respects. First, it offers a detailed and thorough empirical survey of an important though specialized aspect of commercial practice. Mann collected and coded a data sample of 500 randomly selected letter-of-credit transactions, personally evaluating each transaction to determine whether the documentary presentation by the beneficiary of the letter of credit (i.e., the seller) complied with the letter\u27s formal terms. Then, for each case in which he found one or more documentary defects, Mann went on to classify the defects and to evaluate their commercial and practical significance. He also measured how quickly and readily the issuing bank and the applicant (i.e., the buyer) responded to - and ultimately waived - the defects, in addition to collecting various other information about the transaction and the parties involved. The creation of this data set required significant time, effort, and both professional and scholarly judgment; and the result is a level and quality of information that goes substantially beyond the qualitative information gleaned from his interviews with bank officers, not to mention the anecdotal information that motivated the study in the first place. Second, Mann has not just produced a dry collection of business facts. Rather, in showing that the beneficiaries of letters of credit routinely fail to present documents that comply with the terms of the underlying letter and that the applicants and issuing banks just as routinely waive the resulting defects, he has convincingly documented an important and counterintuitive empirical regularity about commercial letters of credit - one that substantially undercuts the conventional teaching in the area that the purpose of the letter of credit is to provide the beneficiary with a guaranty of payment that is legally enforceable against the issuing bank. His findings are striking, provocative, and persuasive enough to demand explanation and, thus, to force a revision of the conventional scholarly wisdom in this area. Third, Mann has put forward a theoretical account of letters of credit, grounded in the modem economics of information and based on his prior work in other areas of commercial law, that is both more nuanced and conceptually more sophisticated than is the conventional scholarly view. His explanation is that the value of letters of credit in assuring beneficiaries of payment does not lie primarily in their legal significance, but rather in their practical significance. More specifically, the willingness of a bank to issue a letter of credit serves as a credible signal, enforced by an implicit reputational bond, of the issuer\u27s private information that the applicant is a reliable creditor; and this signal is more important to the beneficiary in practical terms than is any right to collect directly from the bank. To use Mann\u27s own terminology, the letter of credit is primarily a verification institution, not a guaranty institution.2 This explanation is creative, interesting, and as far as I know, original. It may be that Mann\u27s explanation, as he suggests at various points, will be regarded as old news by practicing commercial specialists in the letter-of-credit area. Even if this is so, however, and even if his explanation is incomplete or incorrect, he has significantly advanced the state of the scholarly literature on this topic

The Relative Costs of Incorporating Trade Usage into Domestic versus International Sales Contracts: Comments on Clayton Gillette, Institutional Design and International Usages Under the CISG

Clayton Gillette\u27s paper on the use of trade usage in reported disputes arising under the United Nations Convention on Contracts for the International Sale of Goods ( CISG ) presents a challenge to recent scholarly critiques of modern contractual interpretation. As Gillette explains, much recent writing by economically influenced US scholars in contracts and commercial law has argued in favor of more formalistic methods of interpretation, and against the overwhelming trend of the last half of the twentieth century: a trend toward a more contextual interpretative approach that takes into account a variety of evidence, including the business purpose of the transaction, the customs and practices of the market in which the parties transact, the history of the parties\u27 dealings, and even the parties\u27 pre- and post-contractual communications. These critiques have extended even to the interpretative use of trade usage, which has long been regarded as an especially reliable source of information about the parties\u27 intentions and which enjoys a privileged status in US domestic sales cases decided under the Uniform Commercial Code ( UCC ). Gillette argues, based on a survey of international case law, that Article 9(2) of the CISG, which directs tribunals to incorporate international trade usage into private contracts governed by the Convention unless the parties agree otherwise, works well in practice and has not led to the adverse consequences of which formalist critics have warned. This Comment expands upon Gillette\u27s argument to provide a more robust account of when substantive interpretative doctrines such as trade usage might be desirable, and why such doctrines appear to be especially useful in the transnational setting of the CISG. In my view, Gillette\u27s account is incomplete because it does not provide an explanation of why international tribunals have not fallen prey to the temptations of more substantive interpretation in the way that US domestic courts have, and because it focuses primarily on the costs of interpretative uncertainty to the exclusion of a fuller list of costs and benefits relevant to the choice of interpretative regime. Taking this list of considerations into account renders more comprehensible the widespread use of trade usage and similar contextual standards in the transnational setting, and reinforces Gillette\u27s conclusions regarding trade usage\u27s commercial functionality

An Economic Analysis of the Guaranty Contract

Guaranty arrangements, in which one person stands as surety for a second person\u27s obligation to a third, are ubiquitous in commercial transactions and in commercial law. In recent years, however, scholarly attention to the topic has been scant; and no one has systematically analyzed this body of law and practice from an economic policy perspective. Accordingly, this Article attempts to outline the basic economic logic underlying the guaranty relationship, and applies the results to a variety of specific issues in government policy and private planning. It poses and answers three main questions: First, why would a creditor prefer to make a guaranteed loan rather than an unguaranteed one? The answer is not as obvious as might first appear, given that market competition over credit terms tends to adjust the interest rate paid by an individual borrower to reflect the specific default risk that he presents. Second, given that they bear the residual risk of debtor default, why would guarantors prefer to guarantee loans rather than make loans directly, thus forgoing the opportunity to earn interest payments that could help to compensate for the risk they bear? Third, even if it is efficient for one creditor to provide funds and another to provide insurance against default, why would the parties prefer to implement this arrangement through the triangular form of a guaranty, instead of simply having the former creditor lend to the latter and the latter lend to the ultimate borrower