The role of letters of credit in payment transactions

Michigan Law Review

Volumn 98, Issue 8, 2000, Pages 2494-2534

  Mann, Ronald J ^a  

^a NONE

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EID: 0041992315     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: 10.2307/1290352     Document Type: Article

References (157)

1. Lisa Bernstein's article in this symposium also focuses on the special difficulties of cross-border sales transactions. See Lisa Bernstein, Private Commercial Law in the Cotton Industry: Value Creation Through Rules, Norms, and Institutions, 99 MICH. L. REV. (forthcoming June 2001).
2. I myself have told that story. See RONALD J. MANN, PAYMENT SYSTEMS AND OTHER FINANCIAL TRANSACTIONS 215-24 (1999). For similar accounts in the standard sources, see JOHN F. DOLAN, THE LAW OF LETTERS OF CREDIT: COMMERCIAL AND STANDBY CREDIT ¶ 1.01[3], at 1-7 (rev. ed. 1999); CLAYTON P. GILLETTE ET AL., PAYMENT SYSTEMS AND CREDIT INSTRUMENTS 560 (1996); JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE § 20-1, at 701-02 (4th ed. 1995).
3. I myself have told that story. See RONALD J. MANN, PAYMENT SYSTEMS AND OTHER FINANCIAL TRANSACTIONS 215-24 (1999). For similar accounts in the standard sources, see JOHN F. DOLAN, THE LAW OF LETTERS OF CREDIT: COMMERCIAL AND STANDBY CREDIT ¶ 1.01[3], at 1-7 (rev. ed. 1999); CLAYTON P. GILLETTE ET AL., PAYMENT SYSTEMS AND CREDIT INSTRUMENTS 560 (1996); JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE § 20-1, at 701-02 (4th ed. 1995).
4. I myself have told that story. See RONALD J. MANN, PAYMENT SYSTEMS AND OTHER FINANCIAL TRANSACTIONS 215-24 (1999). For similar accounts in the standard sources, see JOHN F. DOLAN, THE LAW OF LETTERS OF CREDIT: COMMERCIAL AND STANDBY CREDIT ¶ 1.01[3], at 1-7 (rev. ed. 1999); CLAYTON P. GILLETTE ET AL., PAYMENT SYSTEMS AND CREDIT INSTRUMENTS 560 (1996); JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE § 20-1, at 701-02 (4th ed. 1995).
5. I myself have told that story. See RONALD J. MANN, PAYMENT SYSTEMS AND OTHER FINANCIAL TRANSACTIONS 215-24 (1999). For similar accounts in the standard sources, see JOHN F. DOLAN, THE LAW OF LETTERS OF CREDIT: COMMERCIAL AND STANDBY CREDIT ¶ 1.01[3], at 1-7 (rev. ed. 1999); CLAYTON P. GILLETTE ET AL., PAYMENT SYSTEMS AND CREDIT INSTRUMENTS 560 (1996); JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE § 20-1, at 701-02 (4th ed. 1995).
6. For published references to the discrepancy problem, see Vincent M. Maulella, Payment Pitfalls for the Unwary: How to Make Your Letter of Credit Work, WORLD TRADE, Apr. 1999, at 76 ("US bankers report that 50% to 60% of all letter of credit document presentations are found discrepant on first examination."); Martin Shaw. Martin Shaw Claims There Are Better Ways to Reduce Discrepancies and That ICC Should Take Advantage of Them, DOCUMENTARY CREDITS INSIGHT, Spring 1999, at 11 (reporting the views of "informed observers" that "at least 50% - some say perhaps 60% or even 70%" of presentations do not comply). See also U.C.P. preface, at 4 ("Some surveys indicate that approximately fifty percent of the documents presented under the Documentary Credit are rejected because of discrepancies or apparent discrepancies.").
7. For published references to the discrepancy problem, see Vincent M. Maulella, Payment Pitfalls for the Unwary: How to Make Your Letter of Credit Work, WORLD TRADE, Apr. 1999, at 76 ("US bankers report that 50% to 60% of all letter of credit document presentations are found discrepant on first examination."); Martin Shaw. Martin Shaw Claims There Are Better Ways to Reduce Discrepancies and That ICC Should Take Advantage of Them, DOCUMENTARY CREDITS INSIGHT, Spring 1999, at 11 (reporting the views of "informed observers" that "at least 50% - some say perhaps 60% or even 70%" of presentations do not comply). See also U.C.P. preface, at 4 ("Some surveys indicate that approximately fifty percent of the documents presented under the Documentary Credit are rejected because of discrepancies or apparent discrepancies.").
8. For published references to the discrepancy problem, see Vincent M. Maulella, Payment Pitfalls for the Unwary: How to Make Your Letter of Credit Work, WORLD TRADE, Apr. 1999, at 76 ("US bankers report that 50% to 60% of all letter of credit document presentations are found discrepant on first examination."); Martin Shaw. Martin Shaw Claims There Are Better Ways to Reduce Discrepancies and That ICC Should Take Advantage of Them, DOCUMENTARY CREDITS INSIGHT, Spring 1999, at 11 (reporting the views of "informed observers" that "at least 50% - some say perhaps 60% or even 70%" of presentations do not comply). See also U.C.P. preface, at 4 ("Some surveys indicate that approximately fifty percent of the documents presented under the Documentary Credit are rejected because of discrepancies or apparent discrepancies.").
9. See U.C.P. art. 14(c) (authorizing issuer of letter of credit to approach applicant to seek a waiver of discrepancies in presentation).
10. For a brief description of the principal alternate methods of payment, see infra Section III.A.
11. In order to obtain access to the banks' files, I had to agree not to disclose the particular banks that I visited.
12. The transactions were selected to provide a random sample of recently completed transactions. Because the object of my study is to examine discrepancies in presentations, I excluded files in which the seller never presented a demand for payment under the letter of credit. Also, to avoid oversampling particular transactions, I only collected one profile from each file (even if the file included numerous presentations on a single letter of credit). At each bank, I continued to select files until I had a total (not counting the excluded files) of 50 import and 50 export transactions.
13. The information - about 12,500 data points - is in a Microsoft Access database. For further information about the data and its analysis, see infra the Statistical Appendix. Copies of all of the data and statistical analyses are available upon request.
14. I also collected a variety of background information: whether the letter of credit was confirmed; the countries in which the buyer and seller were located; the time when payment was due under the letter of credit, whether the letter of credit permitted multiple draws; the type of goods covered by the letter of credit; how the applicant paid the issuer for drafts on the letter of credit; whether the discrepancies suggested a contractual default; whether the discrepancies appeared to be curable, how the export-side bank responded to the documents; whether an export-side bank missed discrepancies that an import-side bank found; how waiver of discrepancies was sought; and how many days elapsed before the applicant waived the discrepancies.
15. In any event, it would not have been possible to reexamine the documents; in most cases the original documents (which often include transport documents that the buyer must use to obtain the merchandise in question) no longer were in the file.
16. Transcripts of the interviews (redacted to satisfy confidentiality requirements) are available upon request.
17. The two U.S. interviews were conducted by telephone; the Japanese interviews were conducted in person in Tokyo. The two interviews with U.S. banks were conducted on condition of anonymity. Two of the Japanese banks were Fuji and Sumitomo; the third interview was conducted on condition of anonymity.
18. Even in that one case (Profile 457), the seller did not refuse payment entirely, but authorized a discounted payment of 94% of the amount upon which the parties originally had agreed.
19. For a general discussion of verification institutions, see Ronald J. Mann, Verification Institutions in Financing Transactions, 87 GEO. L.J. 2225 (1999).
20. The reference to "commercial" letters of credit limits my study to letters of credit used to provide payment in the ordinary course of a contract for the sale of goods. I exclude the other principal type of letter of credit, the "standby" letter of credit often used to provide a secondary means of payment when an obligor defaults on some other obligation. See DOLAN, supra note 2, ¶ 1.04, at 1-20 to -24 (discussing the distinction between commercial and standby letters of credit); MANN, supra note 2, at 372-73 (same). For the sake of comparison, I did, however, collect information at two banks on discrepancies in standby letter-of-credit transactions. My data on that point, however, are much more limited (only 24 files) because it is quite rare for presentations to be made against the kind of standby letters of credit described above. (Presentations are common against so-called "direct-pay" standbys, see DOLAN, supra note 2, ¶ 1.06, at 1-45 & n.170, but I excluded those transactions from the sample that I examined.) Those data are included in the same database as the principal data.
21. The reference to "commercial" letters of credit limits my study to letters of credit used to provide payment in the ordinary course of a contract for the sale of goods. I exclude the other principal type of letter of credit, the "standby" letter of credit often used to provide a secondary means of payment when an obligor defaults on some other obligation. See DOLAN, supra note 2, ¶ 1.04, at 1-20 to -24 (discussing the distinction between commercial and standby letters of credit); MANN, supra note 2, at 372-73 (same). For the sake of comparison, I did, however, collect information at two banks on discrepancies in standby letter-of-credit transactions. My data on that point, however, are much more limited (only 24 files) because it is quite rare for presentations to be made against the kind of standby letters of credit described above. (Presentations are common against so-called "direct-pay" standbys, see DOLAN, supra note 2, ¶ 1.06, at 1-45 & n.170, but I excluded those transactions from the sample that I examined.) Those data are included in the same database as the principal data.
22. See U.C.C. § 5-102(a)(10) (defining a letter of credit as an undertaking to pay in response to a documentary presentation); see also U.C.C. § 5-108(g) (authorizing the issuer to "disregard" any nondocumentary conditions in a letter of credit); U.C.P. art. 13(c) (same).
23. See U.C.C. § 5-102(a)(10) (defining a letter of credit as an undertaking to pay in response to a documentary presentation); see also U.C.C. § 5-108(g) (authorizing the issuer to "disregard" any nondocumentary conditions in a letter of credit); U.C.P. art. 13(c) (same).
24. See U.C.C. § 5-102(a)(10) (defining a letter of credit as an undertaking to pay in response to a documentary presentation); see also U.C.C. § 5-108(g) (authorizing the issuer to "disregard" any nondocumentary conditions in a letter of credit); U.C.P. art. 13(c) (same).
25. See U.C.C. § 5-102(a)(2) (defining "applicant" for purposes of letter-of-credit law); U.C.C, § 5-102(a)(9) (defining "issuer" for purposes of letter-of-credit law); U.C.P. art. 2 (defining "Applicant" and "Issuing Bank" for purposes of the U.C.P.).
26. See U.C.C. § 5-102(a)(2) (defining "applicant" for purposes of letter-of-credit law); U.C.C, § 5-102(a)(9) (defining "issuer" for purposes of letter-of-credit law); U.C.P. art. 2 (defining "Applicant" and "Issuing Bank" for purposes of the U.C.P.).
27. See U.C.C. § 5-102(a)(2) (defining "applicant" for purposes of letter-of-credit law); U.C.C, § 5-102(a)(9) (defining "issuer" for purposes of letter-of-credit law); U.C.P. art. 2 (defining "Applicant" and "Issuing Bank" for purposes of the U.C.P.).
28. See MANN, supra note 2, at 217.
29. In the U.C.C.'s language: Rights and obligations of an issuer to a beneficiary . . . under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary. U.C.C. § 5-103(d); see U.C.P. art. 3(a) ("Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the Credit.").
30. In the U.C.C.'s language: Rights and obligations of an issuer to a beneficiary . . . under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary. U.C.C. § 5-103(d); see U.C.P. art. 3(a) ("Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the Credit.").
31. See U.C.P. art. 4 ("In Credit operations all parties concerned deal with documents, and not with goods, services and/ or other performances to which the documents may relate."). Neither the U.C.C. nor the U.C.P. requires any particular documents to be presented; each letter of credit describes the documents to be presented. It is quite difficult to generalize, but a typical list would include, among other things, an invoice, packing list, insurance certificate, some transport document (such as a bill of lading), and often some form of inspection certificate.
32. Roy Goode, Abstract Payment Undertakings, in ESSAYS FOR PATRICK ATIYAH 209, 209-13 (Peter Cane & Jane Stapleton eds., 1991). For a more readily available explanation of the point, see Roy Goode, Abstract Payment Undertakings and the Rules of the International Chamber of Commerce, 39 ST. LOUIS U. L.J. 725, 731-35 (1995).
33. Roy Goode, Abstract Payment Undertakings, in ESSAYS FOR PATRICK ATIYAH 209, 209-13 (Peter Cane & Jane Stapleton eds., 1991). For a more readily available explanation of the point, see Roy Goode, Abstract Payment Undertakings and the Rules of the International Chamber of Commerce, 39 ST. LOUIS U. L.J. 725, 731-35 (1995).
34. U.C.C. § 5-102(a)(3) (defining "beneficiary" for purposes of letter-of-credit law); U.C.P. art. 2(i) (defining "Beneficiary" for purposes of the U.C.P.).
35. U.C.C. § 5-102(a)(3) (defining "beneficiary" for purposes of letter-of-credit law); U.C.P. art. 2(i) (defining "Beneficiary" for purposes of the U.C.P.).
36. The goods were shipped from one country to another in all but 51 (10.2%) of the files. Even that figure may be distorted by an unusually high rate of same-country files at the bank to which I refer as the Major Northeast Bank (33 of the 51 same-country shipments). Excluding the Major Northeast Bank, the rate of same-country shipments was only 4.5%.
37. The beneficiary presented documents directly to the issuer, without retaining its own intermediary financial institution, in only 15 (3%) of my files. Again, that rate may be distorted by an unusually high rate of direct presentation files at the Major Northeast Bank (9 of the 15 direct presentations). Excluding the Major Northeast Bank, the rate of direct presentations was only 1.5%.
38. The beneficiary's bank is described in the statute as a "nominated person," that is, a person that the issuer permits to process documents from the beneficiary and obtain payment from the issuer. U.C.C. § 5-102(a)(11).
39. See U.C.C. § 5-107(c); U.C.P. art. 7(a).
40. See U.C.C. § 5-107(c); U.C.P. art. 7(a).
41. See U.C.C. § 5-107(a); U.C.P. art. 9(b). In the 247 export-side files that I examined, the beneficiary's bank confirmed the letter of credit in 55 (22%) of the files.
42. See U.C.C. § 5-107(a); U.C.P. art. 9(b). In the 247 export-side files that I examined, the beneficiary's bank confirmed the letter of credit in 55 (22%) of the files.
43. The U.C.C. grants that right of reimbursement indirectly. U.C.C. section 5-108(i)(1) grants the issuer a right of reimbursement against the applicant; U.C.C. section 5-107(a) states that the confirmer has the same rights against the issuer as the issuer has against the applicant. See MANN, supra note 2, at 230-31.
44. That point is underscored by the significant explanatory power of the identity of the bank among the banks from which I collected files. See infra Statistical Appendix.
45. The conformity rates were 26% at the Midwest Bank, 17% at the Mid-Sized Northeast Bank, 29% at the West-Coast Bank, 27% at the Foreign Bank, and 36% at the Major Northeast Bank.
46. See, e.g., Boris Kozolchyk, The UNIDROIT Principles as a Model for the Unification of the Best Contractual Practices in the Americas, 46 AM. J. COMP. L. 151, 160-61 (1998) (arguing that "arbitrary" judicial evaluations of discrepancies "had encouraged bad faith practices by bankers and their customers whereby meaningless defects in the documents tendered by beneficiaries were used to justify nonpayment of letters of credit").
47. Clay Gillette suggests in his comment on this Article that bankers have an incentive to classify documents as discrepant to protect themselves against claims by their customers of wrongful honor. See Clayton P. Gillette, Letters of Credit as Signals: Comments on Ronald Mann's 'The Role of Letters of Credit in Payment Transactions,' 98 MICH. L. REV. 2537, 2538-39 (2000). One difficulty with that view is that it ignores the likelihood - which I consider quite strong - that bankers want to avoid an appearance of unduly strict document examination because undue strictness undermines their apparent willingness to stand behind the letters of credit that they issue. Moreover, if he is correct, bankers should support relatively vague standards for document examination. Cf., e.g., Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908, 1927-40 (1998) (presenting an analogous argument that the interests of Delaware corporate lawyers are advanced by indeterminacy of legal rules). In fact, although the examination practice might seem hypertechnical to the outsider, U.S. banks have expended considerable effort to enhance the objectivity of document examination. The bankers might be suffering from false consciousness, but they certainly believe that objectivity in examination standards furthers their interests, primarily by making it easier to identify bad actors (so that reputational sanctions can root them out). The most recent effort is illustrative, the promulgation of a detailed document (used at all of the banks that I visited) describing the items that banks should check on the most commonly presented types of documents. See U.S. COUNCIL ON INTERNATIONAL BANKING, INC., STANDARD BANKING PRACTICE FOR THE EXAMINATION OF LETTER OF CREDIT DOCUMENTS (1996); see also Boris Kozolchyk, The "Best Practices" Approach to the Uniformity of International Commercial Law: The UCP 500 and the NAFTA Implementation Experience, 13 ARIZ. J. INT'L & COMP. L. 443, 446-48 (1996) (discussing development of the USCIB standards). As doubts about the standards for document examination overseas suggest (see, e.g., infra notes 47 & 50), it is not at all clear that those efforts have made significant progress overseas.
48. Clay Gillette suggests in his comment on this Article that bankers have an incentive to classify documents as discrepant to protect themselves against claims by their customers of wrongful honor. See Clayton P. Gillette, Letters of Credit as Signals: Comments on Ronald Mann's 'The Role of Letters of Credit in Payment Transactions,' 98 MICH. L. REV. 2537, 2538-39 (2000). One difficulty with that view is that it ignores the likelihood - which I consider quite strong - that bankers want to avoid an appearance of unduly strict document examination because undue strictness undermines their apparent willingness to stand behind the letters of credit that they issue. Moreover, if he is correct, bankers should support relatively vague standards for document examination. Cf., e.g., Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908, 1927-40 (1998) (presenting an analogous argument that the interests of Delaware corporate lawyers are advanced by indeterminacy of legal rules). In fact, although the examination practice might seem hypertechnical to the outsider, U.S. banks have expended considerable effort to enhance the objectivity of document examination. The bankers might be suffering from false consciousness, but they certainly believe that objectivity in examination standards furthers their interests, primarily by making it easier to identify bad actors (so that reputational sanctions can root them out). The most recent effort is illustrative, the promulgation of a detailed document (used at all of the banks that I visited) describing the items that banks should check on the most commonly presented types of documents. See U.S. COUNCIL ON INTERNATIONAL BANKING, INC., STANDARD BANKING PRACTICE FOR THE EXAMINATION OF LETTER OF CREDIT DOCUMENTS (1996); see also Boris Kozolchyk, The "Best Practices" Approach to the Uniformity of International Commercial Law: The UCP 500 and the NAFTA Implementation Experience, 13 ARIZ. J. INT'L & COMP. L. 443, 446-48 (1996) (discussing development of the USCIB standards). As doubts about the standards for document examination overseas suggest (see, e.g., infra notes 47 & 50), it is not at all clear that those efforts have made significant progress overseas.
49. Clay Gillette suggests in his comment on this Article that bankers have an incentive to classify documents as discrepant to protect themselves against claims by their customers of wrongful honor. See Clayton P. Gillette, Letters of Credit as Signals: Comments on Ronald Mann's 'The Role of Letters of Credit in Payment Transactions,' 98 MICH. L. REV. 2537, 2538-39 (2000). One difficulty with that view is that it ignores the likelihood - which I consider quite strong - that bankers want to avoid an appearance of unduly strict document examination because undue strictness undermines their apparent willingness to stand behind the letters of credit that they issue. Moreover, if he is correct, bankers should support relatively vague standards for document examination. Cf., e.g., Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908, 1927-40 (1998) (presenting an analogous argument that the interests of Delaware corporate lawyers are advanced by indeterminacy of legal rules). In fact, although the examination practice might seem hypertechnical to the outsider, U.S. banks have expended considerable effort to enhance the objectivity of document examination. The bankers might be suffering from false consciousness, but they certainly believe that objectivity in examination standards furthers their interests, primarily by making it easier to identify bad actors (so that reputational sanctions can root them out). The most recent effort is illustrative, the promulgation of a detailed document (used at all of the banks that I visited) describing the items that banks should check on the most commonly presented types of documents. See U.S. COUNCIL ON INTERNATIONAL BANKING, INC., STANDARD BANKING PRACTICE FOR THE EXAMINATION OF LETTER OF CREDIT DOCUMENTS (1996); see also Boris Kozolchyk, The "Best Practices" Approach to the Uniformity of International Commercial Law: The UCP 500 and the NAFTA Implementation Experience, 13 ARIZ. J. INT'L & COMP. L. 443, 446-48 (1996) (discussing development of the USCIB standards). As doubts about the standards for document examination overseas suggest (see, e.g., infra notes 47 & 50), it is not at all clear that those efforts have made significant progress overseas.
50. Clay Gillette suggests in his comment on this Article that bankers have an incentive to classify documents as discrepant to protect themselves against claims by their customers of wrongful honor. See Clayton P. Gillette, Letters of Credit as Signals: Comments on Ronald Mann's 'The Role of Letters of Credit in Payment Transactions,' 98 MICH. L. REV. 2537, 2538-39 (2000). One difficulty with that view is that it ignores the likelihood - which I consider quite strong - that bankers want to avoid an appearance of unduly strict document examination because undue strictness undermines their apparent willingness to stand behind the letters of credit that they issue. Moreover, if he is correct, bankers should support relatively vague standards for document examination. Cf., e.g., Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908, 1927-40 (1998) (presenting an analogous argument that the interests of Delaware corporate lawyers are advanced by indeterminacy of legal rules). In fact, although the examination practice might seem hypertechnical to the outsider, U.S. banks have expended considerable effort to enhance the objectivity of document examination. The bankers might be suffering from false consciousness, but they certainly believe that objectivity in examination standards furthers their interests, primarily by making it easier to identify bad actors (so that reputational sanctions can root them out). The most recent effort is illustrative, the promulgation of a detailed document (used at all of the banks that I visited) describing the items that banks should check on the most commonly presented types of documents. See U.S. COUNCIL ON INTERNATIONAL BANKING, INC., STANDARD BANKING PRACTICE FOR THE EXAMINATION OF LETTER OF CREDIT DOCUMENTS (1996); see also Boris Kozolchyk, The "Best Practices" Approach to the Uniformity of International Commercial Law: The UCP 500 and the NAFTA Implementation Experience, 13 ARIZ. J. INT'L & COMP. L. 443, 446-48 (1996) (discussing development of the USCIB standards). As doubts about the standards for document examination overseas suggest (see, e.g., infra notes 47 & 50), it is not at all clear that those efforts have made significant progress overseas.
51. Although 365 files failed to comply, 22 of those files were not even examined: in those cases the applicant approved payment without the need for examination of the documents. Thus, the information that I report about the types of defaults states percentages as a share of the 343 examined files found to be discrepant.
52. As mentioned in the introduction, I relied entirely on the banks' assessment to determine what discrepancies existed. See supra text accompanying note 10. I had to judge for myself, however, whether the discrepancies suggested a contractual default, something that was not always clear. I made a judgment call at the time I examined the file as to whether I thought the discrepancies collectively raised a serious doubt about the performance by the seller. Because I was interested in the frequency with which technical defects that do not go to the seller's performance appear as discrepancies, I tried to err on the side of assuming that there might be a default.
53. Defects in documents collectively constituted the largest category of discrepancy, appearing in 293 (85.4%) of the files. It is particularly difficult to determine whether defective documents suggest a contractual default, because it is rarely possible to tell from the file whether the defect reflects inadequate performance or inadequate documentation of adequate performance.
54. Unless the letter of credit stipulates otherwise, documents must be presented no later than 21 days after the date of shipment. See U.C.P. art. 43(a). It was not common for the parties to alter that 21-day period in the letters of credit that I examined.
55. In addition to the implied deadline for presentation mentioned in the previous note, each letter of credit includes an express date on which the credit expires. Any later presentation is defective. See U.C.P. art. 42(b); see also U.C.P. art. 44(a) (implied extension of expiration date to next business day).
56. In addition to the implied deadline for presentation mentioned in the previous note, each letter of credit includes an express date on which the credit expires. Any later presentation is defective. See U.C.P. art. 42(b); see also U.C.P. art. 44(a) (implied extension of expiration date to next business day).
57. In assessing those numbers, it is important to remember that many presentations contained multiple defects. Thus, the figures in the text count most of the files multiple times (because discrepant files often contained multiple defects, 554 defects in 343 examined files with discrepancies).
58. As mentioned above, I treated ambiguous cases as suggesting a default. See supra note 34. Thus, that 59% figure is, if anything, understated.
59. Late presentation (which I did not treat as a contractual default) must be distinguished from late shipment, which I did treat as a contractual default.
60. I leave to one side the question whether the performance that the system seeks is performance up to standards set by unenforceable industry norms or performance up to the standards of judicially enforceable contractual provisions. For discussion of the distinction between those two different types of standards, see Bernstein, supra note 1.
61. See Shaw, supra note 3, at 11-12. Bob Rasmussen has pointed out to me that the poor fit is less relevant if you accept the idea (proposed in Part III of this Article) that letters of credit operate primarily as a device for verifying the reliability of the applicant rather than as a device for assuring payment. In any event, analysis of that problem is far beyond the scope of this Article.
62. Because I do not have access to the files of the export-side bank that handled the import-side files that I examined, I do not know what the rate of discrepancy was when the documents originally were presented by the customers in those transactions; I know only the rate of discrepancy that persisted after processing by the export-side bank, as evidenced by the documents reviewed by the import-side bank. The rate of discrepancy identified in the text does not change significantly even if I exclude the fifteen direct presentations (as to which the "cleansing" hypothesis is not relevant). All of the direct presentations (obviously) were import transactions (because the beneficiary-seller came straight to the issuer without using an intermediary export-side bank). Excluding those transactions (five of which involved conforming documents), the import discrepancy rate would have been 78% (186 out of 238).
63. A detailed description of the multivariate analysis appears in the Statistical Appendix.
64. Indeed, more than one banker suggested that in Asia banks offer a standard product in which the seller agrees up front that its bank will not examine the documents, but instead will forward them immediately to the issuer without determining whether they comply. See Notes from Site Visit to Foreign Bank 1 (Aug. 26, 1999 - Aug. 27, 1999) [hereinafter Foreign Bank Site Visit Notes] (copy on file with author); Notes from Site Visit to Midwest Bank 4 (July 28, 1999-July 29, 1999) [hereinafter Midwest Bank Site Visit Notes] (copy on file with author). It is not likely that the pattern that I discern is permanent. More than one banker suggested that a reverse pattern - more compliant documents coming into the United States than going out - was characteristic in earlier years. See Telephone Interview with Manager, Trade Service Issues, Second Major Northeast Bank 5-6 (Sept. 21, 1999) [hereinafter Second Major Northeast Bank Telephone Interview] (transcript on file with author); Telephone Interview with Vice President and Operations Manager, West-Coast Bank 4 (Aug. 12, 1999) [hereinafter West-Coast Bank Interview] (transcript on file with author); see also Interview with Yutaka Abe, Senior Manager, Overseas Business Division, The Fuji Bank, Limited, Tokyo 3 (June 15, 1999) [hereinafter Fuji Bank Interview] (transcript on file with author) (suggesting that discrepancies formerly were much higher in Japanese import transactions than they are now).
65. That rate is simply the flip side of the 78% discrepancy rate in import-side transactions. I also should emphasize that the rate differs considerably from bank to bank. In my data, it varied from 72% to 82%. One other U.S. banker with a large portfolio told me that the discrepancy rate in his import portfolio was only 60%. Second Major Northeast Bank Telephone Interview, supra note 45, at 2. Furthermore, the identity of the bank was a significant predictor variable in my multivariate analysis both for the likelihood of conformance and for the likelihood that defects would be cured. Because I did not collect information about the customers, I do not have data about variation in discrepancy rates among customers, but anecdotal evidence suggests that the rate varies significantly from customer to customer. For example, one banker explained that although some of his customers submitted documents that complied 99.9% of the time, others submit documents that are discrepant 90% of the time. Second Major Northeast Bank Telephone Interview, supra note 45, at 15; see also Maulella, supra note 3 ("[S]ome exporters report that over 95% of the document presentations are in order; other exporters report a 95% frustration rate.").
66. Again, because I do not have access to the files of the export-side banks in my import-side transactions, there always is the possibility that those banks had a systematically different view of the rate of discrepancy in the documents that I transmitted. See infra note 51 (discussing anecdotal evidence related to document-examination practices in Japan). To make any sense of the practice, however, I have to use some baseline for compliance, and given data collected only from U.S. banks, it makes sense to use U.S. document-examination practices as a baseline. Responding to that concern, I hope to collect similar data in Japan later this year.
67. See West-Coast Bank Interview, supra note 45, at 7 ("Our whole setup is based on not sending documents out of here which a bank overseas can find discrepancies with . . . because we know that in some areas of the world it's a tendency to find discrepancies for the sole purpose of coming up with a discount."). Interestingly, one banker suggested that banks follow country-by-country conditions so closely that they step up the vigilance of their document checking in countries (such as Asian countries in recent years) that appear to be undergoing particular crises. See Telephone Interview with Vice President, Bank Number One 12-13 (Aug. 6, 1999) [hereinafter Midwest Bank Interview] (transcript on file with author). As he explained, although the banks in the country under stress might honor discrepant documents 99% of the time under normal conditions, "in hard times they might reject half of them." Id. at 13.
68. See infra Section III.C.2.
69. See infra Section III.C.1. I thank Bob Rasmussen for pushing me to see that point.
70. Some loose evidence of the less stringent document-review practices overseas seems to be apparent from the perception of Japanese banks that there is a very low rate of discrepancy in the documents they receive from their clients in export transactions. See Interview with Deputy General Manager (Special Assignments), Deputy General Manager, and Senior Manager, Anonymous Japanese Bank, Tokyo (June 17, 1999) [hereinafter Anonymous Japanese Bank Interview] (transcript on file with author) (reporting a discrepancy rate on export transactions of only 35%); Interview with Hiroshi Higuma, Assistant Manager, Corporate Planning Dep't, The Sumitomo Bank, Ltd., Tokyo 3 (June 21, 1999) [hereinafter Sumitomo Interview] (transcript on file with author) (reporting a discrepancy rate on export transactions of only 15% (albeit after cure efforts at the branch-bank level)). Those rates suggest to me that a considerably different standard for document examination prevails in Japan than the one that prevails in U.S. banks reviewing documents received from Japan. As it happens, my information on documents coming into this country from Japan (4 of the 13 Japan-based import transactions (31%) included complying presentations) is too limited to support any inferences about those practices. Moreover, even if I examined Japanese transactions at a Japanese bank, it would not provide direct evidence of the relative rigor of their document examination practices. The most obvious test would require using U.S.-trained examiners to study a set of documents also submitted to Japanese examiners; that type of test is not practical with the logistical resources available for my research.
71. See supra note 45 and accompanying text (mentioning references to that practice).
72. Clay Gillette suggests in his comment on this Article that the high rate of uncured defects is unsurprising, reasoning that buyers easily could cure the defects in the rare case in which a seller is intransigent. See Gillette, supra note 32, at 2539. In most cases, however, that would be impractical. For one thing, no amount of effort could cure a presentation that involves a late shipment, late presentation, or expired letter of credit. At least one of those defects appeared in 98 of the 343 discrepant files that I examined. Furthermore, because documents ordinarily must be presented no more than 21 days after the shipment, see U.C.P. art. 43(a), supra note 36, and because documents ordinarily are presented quite close to the presentation deadline in the first instance, it seems most unlikely that a buyer in any significant group of cases could (a) present discrepant documents; (b) await rejection by the seller; (c) cure the discrepancy; and (d) still represent compliant documents before expiration of the 21-day time frame.
73. Clay Gillette suggests in his comment on this Article that the high rate of uncured defects is unsurprising, reasoning that buyers easily could cure the defects in the rare case in which a seller is intransigent. See Gillette, supra note 32, at 2539. In most cases, however, that would be impractical. For one thing, no amount of effort could cure a presentation that involves a late shipment, late presentation, or expired letter of credit. At least one of those defects appeared in 98 of the 343 discrepant files that I examined. Furthermore, because documents ordinarily must be presented no more than 21 days after the shipment, see U.C.P. art. 43(a), supra note 36, and because documents ordinarily are presented quite close to the presentation deadline in the first instance, it seems most unlikely that a buyer in any significant group of cases could (a) present discrepant documents; (b) await rejection by the seller; (c) cure the discrepancy; and (d) still represent compliant documents before expiration of the 21-day time frame.
74. See infra Statistical Appendix. As with all of the statistical results, the predictive force of that variable is relatively small.
75. See infra Statistical Appendix. That finding also is somewhat confounded by the contrary results for the issuer region variable (which suggest that a Western issuer is least likely to be associated with a cure). That seems to me most likely to be caused by the circumstance that most of the Western issuer/Western applicant transactions are same-country U.S. transactions, as to which the analysis in the text related to export transactions is inapplicable. Thus, I discount significantly the issuer region data, pending efforts to collect data from banks located in a country outside the industrialized West (Japan).
76. Specifically, those findings show that a willingness to submit curable documents (sloppiness) is associated (incoherently, to my mind) with Asian issuers and nonindustrialized applicants and inversely correlated with Western issuers and Asian applicants. See infra Statistical Appendix. That finding is particularly problematic because that equation is the most successful in explaining variation, producing an adjusted explained variance of 8%.
77. See Second Major Northeast Bank Telephone Interview, supra note 45, at 6.
78. See infra Statistical Appendix; see also infra notes 112-113 (discussing unique characteristics of garment transactions).
79. As suggested above, see supra text accompanying notes 49-50, that thesis gains some support from the analysis in Section III.C.2, which outlines several country-specific reasons why export transactions from the United States might use letters of credit in continuing relationships, even though there is good reason to think that exporters generally use letters of credit less often in continuing relationships, see infra p. 2518 (discussing the possible inverse connection between letters of credit and the strength of the buyer-seller relationship).
80. See Midwest Bank Interview, supra note 48, at 11-12; see also Interview with Vice President and Manager, International Operations, Bank Number Two 12 (Aug. 5, 1999) [hereinafter Mid-Sized Northeast Bank Interview] (location not disclosed to protect anonymity) (transcript on file with author) (explaining that relational considerations are the prime motivation for buyers to waive discrepancies in documents presented for payment on letters of credit).
81. My expectation was supported by the views of the drafters of the U.C.P., who report that "[s]ome surveys indicate that approximately fifty percent of the documents presented under the Documentary Credit are rejected because of discrepancies or apparent discrepancies." U.C.P. preface, at 4. In hindsight, I can make that statement correct by interpreting the reference to "reject[ion]" to mean only a determination of discrepancy, but before I did this study, I interpreted it to mean rejection in the sense of refusal to accept.
82. Profile 457. That transaction included some defects that did not demonstrably indicate contractual defaults: expiration, late presentation, a missing document (one counterpart of a purchase order), and a defective document (technically inaccurate shipping terms). It also included, however, a late shipment, which normally would reflect a default on the underlying contract.
83. In all of my files, the banks immediately paid upon receipt of the waiver. It is, however, the view of the industry that the bank is not bound by the waiver issued by its customer the applicant. See International Chamber of Commerce (ICC), MORE QUERIES AND RESPONSES ON UCP 500, 1997: Opinions of the ICC Banking Commission, at 14 (Gary Collyer ed., 1997) (Response 254) ("In the event that discrepancies are observed in a presentation of documents and the issuing bank [gives adequate notice of the discrepancies], the issuing bank is under no obligation to take up the documents, even if a proper waiver of the discrepancies is received from the applicant."); id. at 28 (Response 267) ("The receipt of a waiver from the applicant, either direct or via the beneficiary, does not bind the issuing bank to accept the documents. The decision of whether or not to comply with the waiver is one for the issuing bank to decide in its sole judgment."). It appears that the only substantial reason that a bank would decline to accept such a waiver would be doubts about its ability to obtain reimbursement from the applicant. See Second Major Northeast Bank Telephone Interview, supra note 45, at 6-7.
84. See Foreign Bank Site Visit Notes, supra note 45, at 1 (estimating three refusals each year out of 10,000 presentations, for a rate of .03%); Telephone Interview with Executive from Bank Number Five 10 (Oct. 8, 1999) [hereinafter Major Northeast Bank Interview] (transcript on file with author) ("I would have said it was a small fraction of one percent."); Telephone Interview with Vice President, Technical Consultant for Global Trade Services, Major Midwest Bank 7 (July 19, 1999) (interview conducted on condition of anonymity) [hereinafter Major Midwest Bank Telephone Interview] (transcript on file with author) ("I would say ninety-nine percent of the documents [that are discrepant are paid]."); Second Major Northeast Bank Telephone Interview, supra note 45, at 5 ("[A]t the end of the day ninety-nine point nine percent of the documents they present, whether they carry discrepancies or not, are paid."); Second Major Northeast Bank Telephone Interview, supra note 45, at 17 (banker who does 100,000 transactions a year suggesting that "I would be very comfortable in just guessing [that the number of rejected documents per year is] less than a hundred. It may be less than ten."); West-Coast Bank Interview, supra note 45, at 7 (agreeing with my expectation of finding only one or two refused presentations in my 500-file study). The pattern appears to be similar in Japan. See Anonymous Japanese Bank Interview, supra note 51, at 7 (suggesting rejection of about ten documents out of a monthly volume of 17,000 transactions); Fuji Bank Interview, supra note 45, at 9 (reporting rejection of documents or reduction of amount to be paid in about ten out of every 18,000 transactions); Sumitomo Bank Interview, supra note 51, at 4 (suggesting rejection of ten documents out of a monthly volume of one thousand noncomplying transactions).
85. One week (five business days) serves as a rough guide of a timely response, because the issuer generally needs to respond to the bank that presented the documents within seven business days after it receives the documents. See U.C.P. art. 13(b) (calling for a response within "a reasonable time, not to exceed seven banking days"). If the issuer takes two business days to examine the documents, that would leave five business days for the applicant to decide whether it wishes to waive any discrepancies without preventing the issuer from transmitting a timely acceptance of the documents. Of course, if the issuer does not receive a waiver by the seventh business day, it still can pay later, by sending a notice rejecting the documents on the seventh business day, followed by a later notice accepting the documents with discrepancies. For a thorough discussion of typical practice, see International Fin. Serv. Ass'n, Statement of Practice: Reasonable Time for Examination & Notice of Dishonor, in THE 1999 ANNUAL SURVEY OF LETTER OF CREDIT LAW & PRACTICE 311 (James E. Byrne ed., Institute of Int'l Banking Law & Practice 1999).
86. One week (five business days) serves as a rough guide of a timely response, because the issuer generally needs to respond to the bank that presented the documents within seven business days after it receives the documents. See U.C.P. art. 13(b) (calling for a response within "a reasonable time, not to exceed seven banking days"). If the issuer takes two business days to examine the documents, that would leave five business days for the applicant to decide whether it wishes to waive any discrepancies without preventing the issuer from transmitting a timely acceptance of the documents. Of course, if the issuer does not receive a waiver by the seventh business day, it still can pay later, by sending a notice rejecting the documents on the seventh business day, followed by a later notice accepting the documents with discrepancies. For a thorough discussion of typical practice, see International Fin. Serv. Ass'n, Statement of Practice: Reasonable Time for Examination & Notice of Dishonor, in THE 1999 ANNUAL SURVEY OF LETTER OF CREDIT LAW & PRACTICE 311 (James E. Byrne ed., Institute of Int'l Banking Law & Practice 1999).
87. See infra p. 2518 (discussing reasons why parties select letters of credit instead of other payment mechanisms).
88. See MANN, supra note 2, at 217. Because all methods of payment in cross-border transactions involve some out-of-pocket transaction costs, the excess cost of the letter of credit is a bit less than that $2,500 figure.
89. For comments to that effect in this context, see Fuji Bank Interview, supra note 45, at 13-14 (discussing the lack of sophistication by smaller companies doing international trade and explaining that "there's a perception for the Japanese company that the LC is very credible, reliable. And once they receive an LC they feel like they have completed the transaction."); Second Major Northeast Bank Telephone Interview, supra note 45, at 15, 17 (suggesting that customers focus on the fact that their letter-of-credit transactions get paid rather than the risk of nonpayment).
90. The size of such a relationship was particularly evident at two of the banks (Banks One and Four), whose file-numbering systems included a separate filing system - with separate numbers and file locations - for the transactions of two prominent retailers that are their largest letter-of-credit customers. Each of those customers provided, on a conservative estimate, more than 20% of the bank's letter-of-credit work.
91. See Mid-Sized Northeast Bank Interview, supra note 60, at 6-7.
92. See Mid-Sized Northeast Bank Interview, supra note 60, at 6.
93. For a more detailed summary, see MANN, supra note 2, at 457-66. For descriptions by a banker, see Mid-Sized Northeast Bank Interview, supra note 60, at 6-7. Because two of the banks that I visited maintained records on documentary-draft transactions at the same sites as they maintained letter-of-credit records, I collected information on documentary-draft transactions at those sites (50 records at each bank for a total of 100). Those records are in the same database as the other data.
94. See Mid-Sized Northeast Bank Interview, supra note 60, at 7 ("If the documents are titled properly then no pay, no documents for merchandise."). Two common variations use nonnegotiable documents of title. In one, the goods are consigned to the collecting bank; that has substantially the same effect as a negotiable shipment, because the buyer usually must pay to acquire the goods. See id. at 8-9. The other common variation, particularly in shipments by air, uses nonnegotiable documents and ships directly to the buyer. In that transaction the buyer can obtain the goods without paying the bank for them. See id. at 8. Thus, that transaction provides the seller little more protection than the open-account transaction discussed above. The transactions proceeded in that less protective fashion in 33 out of the 96 (34%) collection transactions for which I could examine the relevant documents.
95. See Midwest Bank Interview, supra note 48, at 8 ("[A] collection raises the obligation of absolutely nobody to do anything that they don't want to do."); West-Coast Bank Interview, supra note 45, at 13 ("[Y]ou're completely putting yourself at the mercy of that party [i.e., the overseas buyer].").
96. See Mid-Sized Northeast Bank Interview, supra note 60, at 7. Buyers declined to pay the banks in 12 out of the 100 collection transactions. That 12% nonpayment rate is striking compared to the nonpayment rate in the letter-of-credit transactions of less than one-tenth of one percent. The higher nonpayment rate would not surprise the bankers to whom I spoke about collection transactions. See, e.g., id. at 12 (discussing difficulties of obtaining payment in collection transactions); West-Coast Bank Interview, supra note 45, at 13-17 (same).
97. See Mid-Sized Northeast Bank Interview, supra note 60, at 15-16 (discussing the different types of charges in letter-of-credit transactions and collection transactions); West-Coast Bank Interview, supra note 45, at 12 ("[O]bviously the cost of a letter of credit is very much higher than a collection. Our collection fees are low - very low in comparison. [Collections a]re not a big money maker and they're looked at more as a service to a customer instead of an actual money-making product."); see also supra note 67 (discussing fees for letters of credit). My estimate of the fees for collection transactions is based on my review of the files in my database.
98. Midwest Bank Interview, supra note 48, at 8; see Mid-Sized Northeast Bank Interview, supra note 60, at 19-20 (discussing reasons why parties choose collection transactions instead of letters of credit); West-Coast Bank Interview, supra note 45, at 12 ("[T]he only reason [collection transactions] exist is because there's a great deal of . . . trust between the parties concerned or in some cases people just would rather take the risk than pay the initial letter-of-credit fees, which can get pretty expensive."). For a similar view from a knowledgeable academic, see John F. Dolan, Letters of Credit: A Comparison of UCP 500 and the New U.S. Article 5, 1999 J. BUS. L. 521. 528 ("Thus the commercial letter of credit arises most often between parties that know little of each other or are in distant markets and, when at least one party is located in a developing economy.").
99. One banker reported to me two sources of data in his possession. The data that he considered more reliable suggested that 13% of such transactions were done by letters of credit, 72% by open account, 4% by documentary collections, and 2% by cash in advance. Another source (that he considered less accurate) reported 29% letters of credit, 52% open account, 12% cash in advance, and 7% documentary collections. See Interview with Group Vice President and Head of Trade Services Product Management, International Trade & Advisory Group, Bank Number Four 13 (Sept. 2, 1999) [hereinafter Foreign Bank Interview] (location not disclosed to protect anonymity of bank) (transcript on file with author). Whichever figures are closer to reality, however, both figures suggest that letters of credit are not used routinely without regard to cost.
100. See supra pp. 2508-10.
101. The size of the transaction was significant in the univariate analysis, but the correlation was not monotonic (that is, the rate of conformance and efforts to cure did not increase with the size of the transaction). Moreover, although we included the size of the transaction in our multivariate analysis, it was not a useful predictor for any of the three dependent variables. See infra Statistical Appendix.
102. I offer in Section III.C.2 a reason for letter of credit usage independent from those relation-based concerns.
103. See supra note 45 (discussing that product as available to businesses shipping goods from Asia to the United States); infra note 131 (same).
104. At the banks that I visited, discrepant presentations universally were assessed a fee, which ranged from a low of $25 to a high of $75.
105. I organize my observations here using the framework I previously have developed to discuss third-party "verification institutions." See Mann, supra note 14, at 2265-71.
106. The classic explanation of reputational intermediation appears in Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 618-21 (1984) (discussing reputational intermediation in the issuance of securities); see also Mann, supra note 14, at 2269-71 (generalizing that idea).
107. The classic explanation of reputational intermediation appears in Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 618-21 (1984) (discussing reputational intermediation in the issuance of securities); see also Mann, supra note 14, at 2269-71 (generalizing that idea).
108. The best anecdote I heard about the significance of bank reputation in the letter-of-credit context involved Chinese banks that were barred by the Chinese government from using hard currency to honor previously issued letters of credit. Notwithstanding the plenary control of the government over bank activities in mainland China, the officers at those banks still used a variety of arrangements - offsets against overseas funds and the like - to do the best they could to provide timely payment on the letters of credit that they had issued. See Foreign Bank Interview, supra note 78, at 3-4.
109. For a theoretical discussion of reasons why it is difficult for many countries to develop effective systems for disseminating credible information about their businesses, see Bernard S. Black, The Legal and Institutional Preconditions for Strong Stock Markets: The Nontriviality of Securities Law (Sept. 1999) (unpublished manuscript) (copy on file with author).
110. See Foreign Bank Interview, supra note 78, at 4 ("If you're selling to somebody outside the United States it's very difficult to get good credit information so you try to go to [Dun & Bradstreet] or whatever you can. But, you get very sketchy information."); Major Northeast Bank Interview, supra note 64, at 7.
111. Midwest Bank Interview, supra note 48, at 5.
112. See Foreign Bank Interview, supra note 78, at 5 (pointing out that Dun & Bradstreet collects information on foreign companies, but suggesting that "companies in another country are not so concerned [as U.S. companies] about [the validity of the information that they provide Dun & Bradstreet]").
113. See Second Major Northeast Bank Telephone Interview, supra note 45, at 14 ("When we're asked to confirm a credit - we're making that decision for the most part based on the bank. . . . We understand the bank and we know the bank and we have a relationship with the bank and we may not have a relationship or know the importer.").
114. See Foreign Bank Interview, supra note 78, at 5 ("[T]here's an awful lot publicized. There's a lot you can read in The Economist or other periodicals, magazines, things about the creditworthiness of various banks and the countries that they're in.").
115. See Foreign Bank Interview, supra note 78, at 5-6: Banks are much more standardized in the way that they do their accounting. . . . [T]hey're also going to be doing a lot of international activities so there's going to be a lot of pressure on them from correspondent banks they are doing business with to state their numbers according to generally accepted accounting principles.
116. See Foreign Bank Interview, supra note 78, at 5: [I]t's also quite true that countries are very sensitive - or at least traditionally very sensitive - to keeping all of their banks running. So, as long as the country itself is in good condition it's very unlikely that a bank will go bankrupt. . . . [Y]ou can't depend on that completely but it's a much better risk than a corporate risk. That observation does not apply, of course, to the United States and other countries sufficiently confident in their financial systems to allow bank failures to provide market discipline. For discussion of some of the
117. See Foreign Bank Interview, supra note 78, at 5: [I]t's also quite true that countries are very sensitive - or at least traditionally very sensitive - to keeping all of their banks running. So, as long as the country itself is in good condition it's very unlikely that a bank will go bankrupt. . . . [Y]ou can't depend on that completely but it's a much better risk than a corporate risk. That observation does not apply, of course, to the United States and other countries sufficiently confident in their financial systems to allow bank failures to provide market discipline. For discussion of some of the difficulties that regulators face in permitting bank failures, see Curtis J. Milhaupt, Japan's Experience with Deposit Insurance and Failing Banks: Implications for Financial Regulatory Design?, 77 WASH. U. L.Q. 399 (1999); Geoffrey P. Miller, Is Deposit Insurance Inevitable? Lessons from Argentina, 16 INT'L REV. L. & ECON. 211 (1996).
118. See Foreign Bank Interview, supra note 78, at 6 (discussing such a publication); Midwest Bank Interview, supra note 48, at 6 (discussing ratings agencies that rate foreign banks).
119. See Foreign Bank Interview, supra note 78, at 6 (discussing the availability of such updates).
120. See Foreign Bank Interview, supra note 78, at 6 (discussing the bank's willingness to provide that information); Mid-Sized Northeast Bank Interview, supra note 60, at 18 (describing requests for such information). The importance of reliable information is underscored by the common practice of a U.S. bank seeking confirmation from another U.S. bank of a letter of credit issued by an overseas bank with which the first U.S. bank is not adequately familiar. See Mid-Sized Northeast Bank Interview, supra note 60, at 18-19; Midwest Bank Interview, supra note 48, at 6; see also Major Northeast Bank Interview, supra note 64. at 4 (discussing the value to a Hong Kong bank of having a letter of credit issued by its North American correspondent).
121. See Mid-Sized Northeast Bank Interview, supra note 60, at 16-17 (discussing unwillingness to continue processing letters of credit issued by banks whose customers fail to waive discrepancies in a timely manner); Second Major Northeast Bank Telephone Interview, supra note 45, at 13 (discussing calls from other bankers about the interview subject's willingness to confirm letters of credit issued by lesser-known foreign banks); West-Coast Bank Interview, supra note 45, at 9-10 (explaining that confirmation by a U.S. bank of a letter of credit issued by a foreign bank with which he is not familiar would assuage concerns about the reliability of the foreign bank and its customer).
122. For that reason, I am puzzled by Clay Gillette's argument in his comment on this Article that a system, that can impose reputational sanctions on banks, should be able to impose reputational sanctions on buyers as well. See Gillette, supra note 32, at 2545-46. As I understand the dynamic, there are relatively few banks in the industry in each country and the banks serve as intermediaries on both sides of the transaction - collecting information about the buyers for whom they issue letters of credit and about the banks whose letters of credit they process. I see no reason why the export-side bank should be lax in that process simply because it is an adviser rather than a confirmer - the exporting customer expects to get paid either way, and will be unhappy if the overseas bank and its customer reject documents after the goods have been shipped.
123. See Foreign Bank Interview, supra note 78, at 5 (suggesting that issuance of a letter of credit provides a "credit reference" and agreeing that the reference extends not only to financial strength but also to general probity); Midwest Bank Interview, supra note 48, at 6 ("If you have an issuing bank that is of a certain reputation and class and standing it's not a difficult leap of faith to say that the customers that they're issuing letters of credits on behalf of - that . . . the customer is worthy of that extension of credit."); West-Coast Bank Interview, supra note 45, at 10 ("[T]hat a bank in India will issue a credit for this importer . . . says they must think highly of them.").
124. Foreign Bank Interview, supra note 78, at 7: We're very uncomfortable whenever we do refuse a set of documents. So even though I guess we're pretty willing to find discrepancies and call a customer up and say, "These are all the discrepancies," . . . [w]e want them to waive all those discrepancies. If they are going to refuse . . . we want it to be based on good grounds for refusal.
125. Mid-Sized Northeast Bank Interview, supra note 60, at 17.
126. See Anonymous Japanese Bank Interview, supra note 51, at 5 ("[W]e do not force them, but we ask them very persuasively to pay immediately."); Fuji Bank Interview, supra note 45, at 10 ("To suspend the payment sometimes sends a negative message for the bank."); Fuji Bank Interview, supra note 45, at 11 (discussing efforts to persuade customers to waive defects); Sumitomo Interview, supra note 51, at 8 ("[I]f there is some slight discrepancy then of course we try to persuade them to pay for the draft."). I do not mean to suggest a peculiar Japanese attitude, only that the Japanese attitude differs from the U.S. attitude. My only possible source of direct information on the attitudes of bankers from countries other than the United States and Japan would be my work at foreign-owned banks in the United States. My impression - which might be worth little - is that the foreign-owned banks that I visited were not substantially influenced in the "culture" of their letter-of-credit departments by their foreign ownership. It is true, however, that the only U.S. banker willing to admit to a similar practice was at a U.S. office of a foreign bank. He explained: "We'd tell them that they're playing games and we've actually told customers to take their business elsewhere if they're going to do that. . . . So, we try to put as much pressure on them as possible and say, 'You've got to pay.'" Foreign Bank Interview, supra note 78, at 9.
127. See Major Midwest Bank Telephone Interview, supra note 64, at 8 ("We don't urge our clients to pay. That's the client's decision."); Mid-Sized Northeast Bank Interview, supra note 60, at 14; West-Coast Bank Interview, supra note 45, at 3.
128. See Foreign Bank Interview, supra note 78, at 4 (describing the significance of "[t]he fact that a bank is willing to issue a letter of credit for somebody"); West-Coast Bank Interview, supra note 45, at 9 ("[T]he fact that a bank will issue a letter of credit tells me something about the credit standing of that customer which gives me a good feeling."). One banker agreed that many bankers make such a "quantum leap of faith," but that it is "unwarranted." Second Major Northeast Bank Telephone Interview, supra note 45, at 13-14. He explained that point by identifying several reasons why one bank might be willing to issue a letter of credit for a weak applicant, which would not justify a second bank in relying on the applicant. See id. 106. See, e.g., Midwest Bank Interview, supra note 48, at 7 ("[S]imply because somebody comes in and asks you to issue a letter of credit you're not going to do it.").
129. See Major Northeast Bank Interview, supra note 64, at 4-5 ("U.S. banks in general will not deal with clients who are disreputable, who are dishonest, whose management is not known to them, who are in and out of bankruptcy, who are acting in an unethical and dishonest manner."); see also ERIC N. COMPTON, PRINCIPLES OF BANKING 284 (1991) (discussing "the five Cs of credit," the first of which is "character of the borrower").
130. Midwest Bank Interview, supra note 48, at 7.
131. See West-Coast Bank Interview, supra note 45, at 11 ("In particular - I know that our people are very stringent on who they grant credit to because I've seen a lot of their customers leave or be asked to leave."); Foreign Bank Interview, supra note 78, at 10: [W]e don't like doing business with people like that. We sometimes get ourselves into big arguments with the relationship managers because they want to do the business. . . . [T]hey say "Oh, it's a great credit relationship." And we say, "Well, tell them to take their letters of credit somewhere else then because we just don't want to be associated with people like this."
132. See Second Major Northeast Bank Telephone Interview, supra note 45, at 7 (explaining that the letter-of-credit department would bring to the attention of a client's relationship manager any pattern of delays in waiving discrepancies on letters of credit). For a similar sentiment from Japan, see Anonymous Japanese Bank Interview, supra note 51, at 11 (suggesting that his bank does not experience substantial problems with failure to waive discrepancies because of the quality of companies with which his bank deals).
133. As more than one banker emphasized, some industries (most notably the garment industry, see infra note 112) are characterized by lengthy delays in waiver of discrepancies on letters of credit. But that does not mean that bankers are reluctant to issue letters of credit in that industry; rather, it means that they are more tolerant of delays than they would be in other industries. Even there, however, issuers would cease to do business with an otherwise profitable customer if it began imposing pre-waiver delays that were longer than customary. See Major Northeast Bank Interview, supra note 64, at 5-6 ("If I saw a transaction that broke an industry pattern it would raise eyebrows, it would raise a red flag for me and I hope whatever bank that was involved that was handling it."); Second Major Northeast Bank Telephone Interview, supra note 45, at 18-19 ("If we had an importer who was doing this [i.e., refusing to waive discrepancies in a timely manner] on a regular basis and it was outside the norm then I guess that would be it.").
134. It seems to be common in the garment industry for importers to delay their acceptance of discrepant documents by lengthy periods of time on the order of a month. See Major Northeast Bank Interview, supra note 64, at 1-3; Second Major Northeast Bank Telephone Interview, supra note 45, at 18 ("We have customers here who have money who I think will jerk beneficiaries around given the opportunity because it's the nature of the trade they're in. It's the nature of the rag business."); Notes from Site Visit to Bank Number Two 1 (August 4, 1999 - Aug. 5, 1999) (copy on file with author); West-Coast Bank Interview, supra note 45, at 3. Indeed, many bankers believe that garment-industry letters of credit are designed by the U.S. importers to be especially complex for the purpose of enhancing the likelihood of discrepancies. See West-Coast Bank Interview, supra note 45, at 8 ("Garment-type credits are . . . notorious for discrepancies because of the text of the credits going out. They're so detailed with regard to merchandise description. It just gives an opportunity for greater mistakes to be made"). To be sure, the limited willingness to accept discrepant documents is attributed in part to the greater likelihood that even slight delays in shipment or slight nonconformities of the product will have an effect on the underlying commercial transaction. For example, a fall line of clothes that arrives two months late in December is more likely to have a diminished value than a part needed to repair a broken machine that arrives after a similar delay. See Mid-Sized Northeast Bank Interview, supra note 60, at 1-2. The delays that those importers impose on discrepant documents usually are followed by waiver of the discrepancies and full payment on the letter of credit, but there also seems to be an expectation of negotiation outside the letter-of-credit process that might result in other concessions not apparent from the bank's files. See West-Coast Bank Interview, supra note 45, at 3. Moreover, the delays that are typical for the industry appear to be taken into account in the pricing of the transactions in the first instance. See Major Northeast Bank Interview, supra note 64, at 6: It is not up to me to determine what kind of a deal the buyer and the seller strike and when I started in this business 28 years ago, I was horrified to learn of some of these things until I discovered that, well yes, but in the rag trade coming from this part of the world that the vendors figure it's a forty-three day delay when they are dealing with Company A. They know that and they build it into their prices.
135. Foreign Bank Interview, supra note 78, at 9.
136. Major Northeast Bank Interview, supra note 64, at 4.
137. See supra pp. 2516-19 (discussing the choice businesses make between letter-of-credit transactions and documentary-collection transactions).
138. See supra note 75 (reporting data on that point).
139. See supra notes 110-111 and accompanying text (discussing evidence suggesting that banks would stop dealing with customers that refuse to follow industry norms in waiving discrepancies in presentations on letters of credit).
140. The ready willingness to impose nonlegal sanctions on a trading partner for insisting upon something that is entirely lawful reminds me of the sanctions that Lisa Bernstein discusses for "laying down on a contract" in her discussion of the cotton industry. See Bernstein, supra note 1. I have no firm answer for the deeper question: Why does the bank sanction the buyer that refuses payment in a transaction supported by a letter of credit but not in a transaction supported only by documentary-collection arrangements? The most likely answer seems to be a general understanding of the issuer that its reputation is on the line for presentations against its letters of credit to be honored, where its reputation is completely disengaged from the results of a documentary-collection transaction. See supra note 74 (reporting the relatively lackadaisical attitude of banks to nonpayment in documentary-collection transactions).
141. See Mann, supra note 14, at 2261-62 (suggesting that the same analysis is a common justification for guaranties and standby letters of credit).
142. Clay Gillette makes that point well in his comment on this Article. See Gillette. supra note 32, at 2544.
143. One banker, commenting on a draft of this Article, emphasized the narrow range of the phenomenon - transactions that are themselves illegal. Banks do not undertake, for example, to investigate or verify a manufacturer's compliance with child- or prison-labor regulations.
144. See Midwest Bank Interview, supra note 48, at 1.
145. See Midwest Bank Interview, supra note 48, at 3-4 (offering that example); see also Foreign Bank Interview, supra note 78, at 2 (offering a similar example); Major Northeast Bank Interview, supra note 64, at 8-9 (suggesting that the parties don't even bother to ship goods in those transactions). One banker suggested that a similar transaction could be used in reverse on large sales of goods going into a currency-restricted country. The Asian seller could issue an invoice reciting an inappropriately low price; the out-country buyer could pay the invoice directly and transfer the remainder of the actual (non-invoiced) price in hard currency to an account for the benefit of the seller in a secure location. See Foreign Bank Interview, supra note 78, at 2-3 (discussing that transaction as well-known in sales of goods to mainland China).
146. See Midwest Bank Interview, supra note 48, at 1.
147. It seems clear that bank involvement - however it might be brought about - is effective in discovering fraudulent transactions. Although it is difficult to get data, one banker did tell me that his office detects three to five such transactions each week. See Major Northeast Bank Interview, supra note 64, at 7, 9.
148. See Midwest Bank Interview, supra note 48, at 1-2 (discussing such requirements in Japan after World War II and their gradual disappearance over the intervening years; citing Malawi and unspecified countries in Latin America as still requiring letters of credit for transactions in certain commodities).
149. See Foreign Bank Interview, supra note 78, at 1 (offering that scenario). Alternatively, the government might accept lower deposits for license applications when the transaction has a letter of credit. See Midwest Bank Interview, supra note 48, at 3-4.
150. See Foreign Bank Interview, supra note 78, at 1-2 (offering that explanation); Mid-Sized Northeast Bank Interview, supra note 60, at 4-5 (same); see also Foreign Bank Interview, supra note 78, at 3-4 (describing recent series of transactions in which the Chinese government refused to allow Chinese banks to use hard currency to honor letters of credit that they previously had issued, even in transactions for which the banks had obtained the approvals appropriate at the time of the transaction).
151. See Midwest Bank Interview, supra note 48, at 3-4 (suggesting that India imposes such a requirement for any transaction over the equivalent of $5,000).
152. See Midwest Bank Interview, supra note 48, at 3-4.
153. See Foreign Bank Interview, supra note 78, at 1-2 (offering that scenario). One banker explained that in those transactions the parties waive document examination at both ends of the transaction and that he never has seen rejection of a presentation against such a credit. See Midwest Bank Site Visit Notes, supra note 45, at 3.
154. See Major Northeast Bank Interview, supra note 64, at 3-4; Midwest Bank Interview, supra note 48, at 9-10; Second Major Northeast Bank Telephone Interview, supra note 45, at 3; see also Fuji Bank Interview, supra note 45, at 12 (describing that transaction as a "switch" transaction).
155. See Midwest Bank Interview, supra note 48, at 9-10; Second Major Northeast Bank Telephone Interview, supra note 45, at 3-4.
156. See Midwest Bank Interview, supra note 48, at 10-11; Second Major Northeast Bank Telephone Interview, supra note 45, at 3-4. As one banker explained, in countries that offer interest subsidies for export transactions, the use of a letter of credit can enhance the amount of the subsidy by extending the term of the loan. See Second Major Northeast Bank Telephone Interview, supra note 45, at 4-5. Because the bank in a packing-credit transaction loans the money to the borrower/trading company at the time that the ultimate importer provides its letter of credit, the interest subsidy can begin accruing at that time. See id. In a transaction without a letter of credit, the bank normally would not loan the money until the trading company actually had shipped the goods to the ultimate importer. See id. Effectively, that use of the letter of credit transforms a very-short-term transit-financing transaction into a much more useful working-capital financing transaction. See id. 135. See, e.g., Ronald J. Mann, Explaining the Pattern of Secured Credit, 110 HARV. L. REV. 625, 682 (1997) (arguing that no single cause can explain the pattern of secured credit and suggesting a group of positive and negative factors that collectively can explain that pattern).
157. The explanation of multiple classification analysis that follows draws on FRANK M. ANDREWS ET AL., MULTIPLE CLASSIFICATION ANALYSIS (Univ. of Michigan Inst. for Social Research 3d ed. 1976).