Montana Law and the Uniform Commercial Code: Article 5: Letters of Credi

Mason, David R.

English

University of Montana

Montana Law Review Volume 21 Issue 1 Fall 1959 Article 5 July 1959 Article 5: Letters of Credit David R. Mason Professor of Law, Montana State University School of Law Follow this and additional works at: https://scholarworks.umt.edu/mlr  Part of the Law Commons Let us know how access to this document benefits you. Recommended Citation David R. Mason, Article 5: Letters of Credit, 21 Mont. L. Rev. 47 (1959). Available at: https://scholarworks.umt.edu/mlr/vol21/iss1/5 This Article is brought to you for free and open access by ScholarWorks at University of Montana. It has been accepted for inclusion in Montana Law Review by an authorized editor of ScholarWorks at University of Montana. For more information, please contact scholarworks@mso.umt.edu. Article 5: Letters of CreditBy DAVID R. MASON*Article 5 of the Uniform Commercial Code is the first attempt atcomprehensive codification of an area of the law which has developedfor the most part in the last fifty years. Letters of credit originated as amethod of financing foreign trade and have been playing a larger rolein domestic trade, particularly in the automobile field, since WorldWar II.'In Montana there appears to be no case law on letters of credit, al-though there is some statutory law. A few provisions have remained inthe statutes since their original enactment in 1895." These provisions aredrawn on the theory that the promise of the writer of a letter of creditis that he will guarantee the repayment of the money to the person ad-vancing credit ;S but the issuer of a modern letter of credit is neither aguarantor nor a surety.' In addition the Uniform Negotiable InstrumentsLaw, enacted in Montana in 1903, contains provisions for "virtual ac-ceptances." It provides that an unconditional promise in writing to accepta bill of exchange before it is drawn is deemed an actual acceptance infavor of every person who, upon the faith thereof, receives the bill forvalue.' While this gives statutory sanction to a procedure very similar tothat involved in letters of credit, yet it would not cover a promise con-taining conditional stipulations relating to accompanying documents whichare found in letters of credit. The only other statutory provision foundin Montana is that which authorizes banks organized and existing underthe laws of this state to issue letters of credit authorizing drafts at sightor on time not exceeding one year, provided letters of credit issued atany one time to any one person shall not exceed 20 per cent of the capitaland surplus of the bank."The Code recognizes that the law of letters of credit is still developing,and it does not attempt to codify all of the law. Comment 2 to section5-102 states:Subsection (3) recognizes that in the present state of the lawand variety of practices as to letters of credit, no statute caneffectively or wisely codify all the possible law of letters of creditwithout stultifying further development of this useful financing*Professor of Law, Montana State University. Member of the Montana Bar. LL.B.1924, B.A. 1926, University of South Dakota; S.J.D. 1927, Harvard University.'See FINKELsTrEIN, LEGAL ASPECTS OF COMMERCIAL Lr'-rmS OF CREDIT (1930) ; Re-cent Extensions in the Use of Convmercial Letters of Credit, 66 YALE L.J. 902 (1957).'RsvisED CODES OF MONTANA 1947, §§ 30-601 to -609. (Hereinafter REvisED CODESOF MONTANA are cited R.C.M.)8R.C.M. 1947, § 30-601, defines a letter of credit as "a written instrument, ad-dressed by one person to another, requesting the latter to give credit to the personin whose favor it is drawn." These provisions seem to have been taken from Cali-fornia, where it was reasoned as early as 1885 that a letter of credit was a con-tract of guaranty. Lafargue v. Harrison, 70 Cal 380, 59 Am. Rep. 416, 9 Pac. 259(1885).'FINKELaTIN, supra note 1, at 32-39; Epps and Chappell, A8similation of the Letterof Credit by the Common Law, 38 VA. L. REv. 531 (1952).'R.C.M. 1947, § 55-1104. The adoption of article 3 of the Code would abolish "virtualacceptances." UNIFORM CommEncIAL CODE § 3-410(1). (Hereinafter UNIFORM COM-MERCIAL CODE is cited UCC.)4R.C.M. 1947, § 5-1001.1Mason: Article 5: Letters of CreditPublished by ScholarWorks at University of Montana, 1959MONTANA LAW REVIEWdevice. The more important areas not covered by this Article re-volve around the question of when documents in fact and in lawdo or do not comply with the terms of the credit. In addition suchminor matters as the absence of expiration dates and the effect ofextending shipment but not expiration dates are also left untouchedfor future adjudication. The rules embodied in the Article can beviewed as those expressing the fundamental theories underlyingletters of credit. For this reason the second sentence of subsection(3) makes explicit the court's power to apply a particular ruleby analogy to cases not within its terms, or to refrain from doingSO....In defining a letter of credit the Code sets forth the requirement thatthere be an engagement by a bank or other person made at the requestof a customer that the issuer will honor drafts or other demands uponcompliance with the conditions specified in the credit. The "engagement"may be by way of a promise to honor or by way of authority to honor, thusincluding in the definition papers called "authorities to purchase or pay.'"A letter of credit may be revocable or irrevocable. If irrevocable itcan be modified or revoked only with the consent of the parties. If re-vocable it may be modified or revoked without notice to or consent of theparties, but the issuer is liable to innocent third parties who have negotiatedor honored drafts drawn under the credit before receiving notice of can-cellation.'There are two forms covered by the Code, namely, the "documentary"letter of credit and the "clean" letter of credit. The "documentary" letterof credit is very likely to arise out of negotiations for a contract for thesale of goods. A typical case is where a seller is not wholly satisified withthe buyer's credit and is unwilling to ship without assurance of payment,whereas the buyer is unwilling to pay before receiving the goods or is un-able to pay without funds derived from their disposition. In such a situa-tion, the buyer asks his bank or other financier to issue a letter of credit.The "issuer" (financier) at the request of the "customer" (buyer) issuesa letter of credit engaging to honor drafts or demands of payment of the"beneficiary" (seller), provided they are accompanied by other docu-ments, such as bills of lading, invoices, insurance policies and the like.' TheCode also contemplates that an "advising bank" may give notification ofthe issuance of a letter of credit by another bank." A "confirming bank" i-:a bank which engages that it will honor a credit or that such credit willbe honored by the issuer or a third bank.' This may arise when the selleris not familiar with the issuing bank and prefers the obligation of a bankof his own choosing.The obligation of the issuer of a letter of credit is a direct and primaryobligation to the seller. The issuer is not concerned with the underlyingsales contract. Further, the issuer cannot excuse itself from honoring thedraft by the insertion of an additional general term that all documentsmust be satisfactory to it, although it may require that specified docu-7UCC § 5-103(1) (a).OUCC § 5-106.'UCC § 5-103(1) (b).'UCC § 5-103(1) (e)."UCC § 5-103(1) (f).[Vol. 21,2Montana Law Review, Vol. 21 [1959], Iss. 1, Art. 5https://scholarworks.umt.edu/mlr/vol21/iss1/5ARTICLE 5: LETTERS OF CREDITments be satisfactory to it.' It has an obligation to examine documentswith good faith and care, but it is not otherwise responsible for the genu-ineness of the documents.'Te advising bank assumes no obligation to honor drafts or demandsfor payment under the credit. Such a bank is liable if it incorrectly statesthe terms of the instrument. However, the customer bears as against theissuer all risks of transmission and reasonable translation or interpretationof any message relating to a credit. 'A "clean" letter of credit is covered by the 1957 official text of theCode as a result of criticism of the 1952 draft from which it was omitted.Such a letter of credit is one which does not require documents to bepresented as one of the conditions of honor. A so-called "traveler's" letterof credit is a "clean" letter of credit. It names the customer as beneficiaryand may be obtained to enable the customer or his agent to make purchasesin the open market. In order that article 5 apply to such a credit, it is neces-sary that the paper contain a conspicuous notation that it is a letterof credit.'Unless otherwise specified a credit may be used in portions at thediscretion of the beneficiary.' Also, a letter of credit may be transferredor assigned if it is expressly designated as transferable or assignable, andthe beneficiary may assign his rights to the proceeds even though thecredit specifically states that it is nontransferable or nonassignable.'In case the issuer improperly dishonors a draft, the person entitled tolh ocr hb.t ag:i'nst the issuer with respect to any document the rights ofa person in the position of a seller. This is also the rule applicable to therights of a beneficiary where the issuer repudiates the credit before presen-tation of the draft.-The Code gives priority to the owner or beneficiary of the letter ofcredit against the assets of the issuer who becomes insolvent before thetransaction is completed." A comment explains that this does no wrongto the bank's depositors and other general creditors:The typical letter of credit transaction facilitates the movement ofgoods.... [The issuer] expects to be put in funds by its customerbefore it makes disbursements, or to be reimbursed immediatelyafterwards. And everybody understands that the documents re-ceived upon honor of complying drafts are to be turned overto the customer at once when he makes reimbursement or signstrust receipts. Only the bank's commission, if the transaction iscompleted, will enter the bank's general assets and join the otherbacking of its deposit liabilities.'The above indicates the prinicpal features of article 5 of the Code.This article is largely a codification of existing case law and practices,"UCC 5 5-114(1)."UCC § 5-109.-UCC § 5-107.'UCC § 5-102(1) (c).i"UCC § 5-110(1)."UCC § 5-116."UCO 9 5-115."1UCC § 5-117."UCC § 5-117, comment.195913Mason: Article 5: Letters of CreditPublished by ScholarWorks at University of Montana, 1959MONTANA LAW REVIEWand sets an independent theoretical frame for the further developmentof letters of credit.' If adopted in Montana it would replace the existinginadequate statutory provisions framed on an erroneous theory that aletter of credit is a mere guarantee of money to one advancing credit,' andwould afford a sound legal basis for the use of this growing financingdevice.2 UCc § 5-101, comment.'It would appear that the adoption of article 5 would not repeal by implication thepresent prohibitions upon Montana banks authorizing drafts on time exceeding oneyear, and issuing letters of credit at any one time to any one person for more than20% of capital and surplus, See note 6 supra,[Vol. 21,4Montana Law Review, Vol. 21 [1959], Iss. 1, Art. 5https://scholarworks.umt.edu/mlr/vol21/iss1/5

Article 5: Letters of Credit

University of Montana School of Law

Montana Law Review
Volume 21
Issue 1 Fall 1959 Article 5
July 1959
Article 5: Letters of Credit
David R. Mason
Professor of Law, Montana State University School of Law
Follow this and additional works at: https://scholarship.law.umt.edu/mlr
Part of the Law Commons
This Article is brought to you for free and open access by The Scholarly Forum @ Montana Law. It has been accepted for inclusion in Montana Law
Review by an authorized editor of The Scholarly Forum @ Montana Law.
Recommended Citation
David R. Mason, Article 5: Letters of Credit, 21 Mont. L. Rev. 47 (1959).
Available at: https://scholarship.law.umt.edu/mlr/vol21/iss1/5
Article 5: Letters of Credit
By DAVID R. MASON*
Article 5 of the Uniform Commercial Code is the first attempt at
comprehensive codification of an area of the law which has developed
for the most part in the last fifty years. Letters of credit originated as a
method of financing foreign trade and have been playing a larger role
in domestic trade, particularly in the automobile field, since World
War II.'
In Montana there appears to be no case law on letters of credit, al-
though there is some statutory law. A few provisions have remained in
the statutes since their original enactment in 1895." These provisions are
drawn on the theory that the promise of the writer of a letter of credit
is that he will guarantee the repayment of the money to the person ad-
vancing credit ;S but the issuer of a modern letter of credit is neither a
guarantor nor a surety.' In addition the Uniform Negotiable Instruments
Law, enacted in Montana in 1903, contains provisions for "virtual ac-
ceptances." It provides that an unconditional promise in writing to accept
a bill of exchange before it is drawn is deemed an actual acceptance in
favor of every person who, upon the faith thereof, receives the bill for
value.' While this gives statutory sanction to a procedure very similar to
that involved in letters of credit, yet it would not cover a promise con-
taining conditional stipulations relating to accompanying documents which
are found in letters of credit. The only other statutory provision found
in Montana is that which authorizes banks organized and existing under
the laws of this state to issue letters of credit authorizing drafts at sight
or on time not exceeding one year, provided letters of credit issued at
any one time to any one person shall not exceed 20 per cent of the capital
and surplus of the bank."
The Code recognizes that the law of letters of credit is still developing,
and it does not attempt to codify all of the law. Comment 2 to section
5-102 states:
Subsection (3) recognizes that in the present state of the law
and variety of practices as to letters of credit, no statute can
effectively or wisely codify all the possible law of letters of credit
without stultifying further development of this useful financing
*Professor of Law, Montana State University. Member of the Montana Bar. LL.B.
1924, B.A. 1926, University of South Dakota; S.J.D. 1927, Harvard University.
'See FINKELsTrEIN, LEGAL ASPECTS OF COMMERCIAL Lr'-rmS OF CREDIT (1930) ; Re-
cent Extensions in the Use of Convmercial Letters of Credit, 66 YALE L.J. 902 (1957).
'RsvisED CODES OF MONTANA 1947, §§ 30-601 to -609. (Hereinafter REvisED CODES
OF MONTANA are cited R.C.M.)8R.C.M. 1947, § 30-601, defines a letter of credit as "a written instrument, ad-
dressed by one person to another, requesting the latter to give credit to the person
in whose favor it is drawn." These provisions seem to have been taken from Cali-
fornia, where it was reasoned as early as 1885 that a letter of credit was a con-
tract of guaranty. Lafargue v. Harrison, 70 Cal 380, 59 Am. Rep. 416, 9 Pac. 259
(1885).
'FINKELaTIN, supra note 1, at 32-39; Epps and Chappell, A8similation of the Letter
of Credit by the Common Law, 38 VA. L. REv. 531 (1952).
'R.C.M. 1947, § 55-1104. The adoption of article 3 of the Code would abolish "virtual
acceptances." UNIFORM CommEncIAL CODE § 3-410(1). (Hereinafter UNIFORM COM-
MERCIAL CODE is cited UCC.)
4R.C.M. 1947, § 5-1001.
1
Mason: Article 5: Letters of Credit
Published by The Scholarly Forum @ Montana Law, 1959
MONTANA LAW REVIEW
device. The more important areas not covered by this Article re-
volve around the question of when documents in fact and in law
do or do not comply with the terms of the credit. In addition such
minor matters as the absence of expiration dates and the effect of
extending shipment but not expiration dates are also left untouched
for future adjudication. The rules embodied in the Article can be
viewed as those expressing the fundamental theories underlying
letters of credit. For this reason the second sentence of subsection
(3) makes explicit the court's power to apply a particular rule
by analogy to cases not within its terms, or to refrain from doing
SO....
In defining a letter of credit the Code sets forth the requirement that
there be an engagement by a bank or other person made at the request
of a customer that the issuer will honor drafts or other demands upon
compliance with the conditions specified in the credit. The "engagement"
may be by way of a promise to honor or by way of authority to honor, thus
including in the definition papers called "authorities to purchase or pay.'"
A letter of credit may be revocable or irrevocable. If irrevocable it
can be modified or revoked only with the consent of the parties. If re-
vocable it may be modified or revoked without notice to or consent of the
parties, but the issuer is liable to innocent third parties who have negotiated
or honored drafts drawn under the credit before receiving notice of can-
cellation.'
There are two forms covered by the Code, namely, the "documentary"
letter of credit and the "clean" letter of credit. The "documentary" letter
of credit is very likely to arise out of negotiations for a contract for the
sale of goods. A typical case is where a seller is not wholly satisified with
the buyer's credit and is unwilling to ship without assurance of payment,
whereas the buyer is unwilling to pay before receiving the goods or is un-
able to pay without funds derived from their disposition. In such a situa-
tion, the buyer asks his bank or other financier to issue a letter of credit.
The "issuer" (financier) at the request of the "customer" (buyer) issues
a letter of credit engaging to honor drafts or demands of payment of the
"beneficiary" (seller), provided they are accompanied by other docu-
ments, such as bills of lading, invoices, insurance policies and the like.' The
Code also contemplates that an "advising bank" may give notification of
the issuance of a letter of credit by another bank." A "confirming bank" i-:
a bank which engages that it will honor a credit or that such credit will
be honored by the issuer or a third bank.' This may arise when the seller
is not familiar with the issuing bank and prefers the obligation of a bank
of his own choosing.
The obligation of the issuer of a letter of credit is a direct and primary
obligation to the seller. The issuer is not concerned with the underlying
sales contract. Further, the issuer cannot excuse itself from honoring the
draft by the insertion of an additional general term that all documents
must be satisfactory to it, although it may require that specified docu-
7UCC § 5-103(1) (a).
OUCC § 5-106.
'UCC § 5-103(1) (b).
'UCC § 5-103(1) (e).
"UCC § 5-103(1) (f).
[Vol. 21,
2
Montana Law Review, Vol. 21 [1959], Iss. 1, Art. 5
https://scholarship.law.umt.edu/mlr/vol21/iss1/5
ARTICLE 5: LETTERS OF CREDIT
ments be satisfactory to it.' It has an obligation to examine documents
with good faith and care, but it is not otherwise responsible for the genu-
ineness of the documents.'
Te advising bank assumes no obligation to honor drafts or demands
for payment under the credit. Such a bank is liable if it incorrectly states
the terms of the instrument. However, the customer bears as against the
issuer all risks of transmission and reasonable translation or interpretation
of any message relating to a credit. '
A "clean" letter of credit is covered by the 1957 official text of the
Code as a result of criticism of the 1952 draft from which it was omitted.
Such a letter of credit is one which does not require documents to be
presented as one of the conditions of honor. A so-called "traveler's" letter
of credit is a "clean" letter of credit. It names the customer as beneficiary
and may be obtained to enable the customer or his agent to make purchases
in the open market. In order that article 5 apply to such a credit, it is neces-
sary that the paper contain a conspicuous notation that it is a letter
of credit.'
Unless otherwise specified a credit may be used in portions at the
discretion of the beneficiary.' Also, a letter of credit may be transferred
or assigned if it is expressly designated as transferable or assignable, and
the beneficiary may assign his rights to the proceeds even though the
credit specifically states that it is nontransferable or nonassignable.'
In case the issuer improperly dishonors a draft, the person entitled to
lh ocr hb.t ag:i'nst the issuer with respect to any document the rights of
a person in the position of a seller. This is also the rule applicable to the
rights of a beneficiary where the issuer repudiates the credit before presen-
tation of the draft.-
The Code gives priority to the owner or beneficiary of the letter of
credit against the assets of the issuer who becomes insolvent before the
transaction is completed." A comment explains that this does no wrong
to the bank's depositors and other general creditors:
The typical letter of credit transaction facilitates the movement of
goods.... [The issuer] expects to be put in funds by its customer
before it makes disbursements, or to be reimbursed immediately
afterwards. And everybody understands that the documents re-
ceived upon honor of complying drafts are to be turned over
to the customer at once when he makes reimbursement or signs
trust receipts. Only the bank's commission, if the transaction is
completed, will enter the bank's general assets and join the other
backing of its deposit liabilities.'
The above indicates the prinicpal features of article 5 of the Code.
This article is largely a codification of existing case law and practices,
"UCC 5 5-114(1).
"UCC § 5-109.
-UCC § 5-107.
'UCC § 5-102(1) (c).
i"UCC § 5-110(1).
"UCC § 5-116.
"UCO 9 5-115.
"1UCC § 5-117.
"UCC § 5-117, comment.
19591
3
Mason: Article 5: Letters of Credit
Published by The Scholarly Forum @ Montana Law, 1959
MONTANA LAW REVIEW
and sets an independent theoretical frame for the further development
of letters of credit.' If adopted in Montana it would replace the existing
inadequate statutory provisions framed on an erroneous theory that a
letter of credit is a mere guarantee of money to one advancing credit,' and
would afford a sound legal basis for the use of this growing financing
device.
2 UCc § 5-101, comment.
'It would appear that the adoption of article 5 would not repeal by implication the
present prohibitions upon Montana banks authorizing drafts on time exceeding one
year, and issuing letters of credit at any one time to any one person for more than
20% of capital and surplus, See note 6 supra,
[Vol. 21,
4
Montana Law Review, Vol. 21 [1959], Iss. 1, Art. 5
https://scholarship.law.umt.edu/mlr/vol21/iss1/5


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