Clause a:
Clause:
“A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank.”
Explanation:
This clause emphasizes that a letter of credit (LC) is an independent and autonomous instrument, separate from the underlying contract of sale or any other agreement on which it might be based. The bank’s responsibility is confined to the LC terms alone and does not extend to the performance or enforcement of the underlying contract between the buyer (applicant) and the seller (beneficiary). Even if the LC references the contract, it does not bind the bank to the terms of that contract.
Example:
Suppose Company A (the buyer) in India enters into a contract to purchase goods from Company B (the seller) in Germany. Company A applies for a letter of credit from its bank to guarantee payment to Company B. If Company A later disputes the quality of the goods or any other aspect of the contract, this dispute does not affect the bank’s obligation to honor the letter of credit, provided that Company B presents compliant documents as per the LC. Company B cannot use the dispute between Company A and the issuing bank as a defense to refuse payment under the LC.
Clause b:
Clause:
“An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like.”
Explanation:
This clause advises issuing banks to discourage applicants (buyers) from including references to or copies of underlying contracts, proforma invoices, or similar documents within the letter of credit itself. This is because including such documents can create unnecessary complications and potentially obscure the clear, independent nature of the letter of credit. The focus should remain solely on the terms and conditions stipulated in the LC.
Example:
Company A requests its bank to issue an LC to Company B, and in doing so, Company A wants to include a copy of the contract between the two companies as part of the LC. The bank advises against this, explaining that including the contract might complicate the LC process and affect the independent nature of the LC. Instead, the bank focuses only on the essential documents required by the LC, such as the commercial invoice, bill of lading, and certificate of origin, ensuring the LC remains straightforward and separate from the underlying contract.