El tiempo libre y la recreación.

A similar dilemma would arise between the bank and its customer (the applicant for the credit or the account party) when the latter becomes a debtor in bankruptcy. Then the question is: does the bank honour the beneficiary's draft and provide payment under the credit, placed in the same position as other creditors of an insolvent account party? In other words, does the bank's security under the letter of credit (right of reimbursement) put the bank in a better position than other creditors who do not have such a security.®®

In case of commercial letters of credit the insolvency of the applicant for the credit causes less harm for the bank since in that type of credits banks usually take documents as a security measure; so, in case of insolvency of the applicant they use the documents and resell the goods to recover their money paid under the credit.®^ In case of standby letters of credit (SLCs) banks may face difficulties if they

Davis, supra (f.n. 20), pp. 93-94; the same writer suggested that there is a possibility that the beneficiary may benefit from such a fund and that is where the bank and its customer both become insolvent. In such sitution it is said that the Rule in Ex parte W aring (1815), 19 Ves. 345 applies. The Rule can be briefly stated as follows: "Where the customer has remitted bills or given other securities to his banker to meet acceptances and both become insolvent, the securities held by the banker are available to the holders o f the acceptances which the securities have been remitted to meet." [for further details about the Rule see pp. 94- 95 and p. 205 o f the same reference.]

Rodenberg, James A., "Letters o f credit in bankruptcy: Can the independence doctrine survive preference attacks?". Commercial Law Journal, Vol. 96, No. 4, Winter 1991, pp. 431-56, at p. 439 said: "A survey o f the bankruptcy case law addressing letter o f credit situations in which the account party is the debtor reveals a progression from vety basic and general principles to, recently, very technical and specific issues. [...] The first issue confronted by the courts when the account party to a letter o f credit was the debtor was whether a letter o f credit was property o f the debtor,"; see also Colon, Edgardo E., "Letters o f credit in times of business and bank failu re s", Banking Law Journal, Vol. 107, Iss. 1, January/February 1990, pp. 6- 37 that in the abstract o f the article said: "How to deal with a letter of credit when the bank customer has gone bankrupt has proven to be a difficult issue for bankruptcy courts. The heart o f the problem seems to be how to maintain intact the properties and characteristics o f letters o f credit but, at the same time, respect the equity and fairness principles embodied in the Bankruptcy Code. The question o f whether a bankruptcy court should estimate letters o f credit as a contingent claim , even though they are contingent on a future event, can be answered only through cases and treaties that have dealt with similar issues. The establishment o f an escrow account in the insolvency or reorganisation plan should persuade a bankruptcy court to obstain from estimating letters o f credit." [Emphasis added.]

For more details see discussion relevant to the bank's security in Chapter V III.

do not arrange for proper security since in such a case, contrary to the use of commercial letters of credit, banks do not have control over valuable documents. Under SLCs the bank's customer (applicant for the SLCs) has usually defaulted not by failing to pay for the amount of the credit when the goods have arrived, but by failing to conduct the promise made under the transaction, e.g., building a factory. In such a situation, if banks provide no security for their services, they may find themselves as unsecured creditors beside other creditors of the insolvent customer.

As to the insolvency of the applicant for the credit and its impact upon the beneficiary's right of payment under the credit, it is worth pointing out that the letter's benefits under LCs are not affected as a result of the former's bankruptcy, since the beneficiary's payment under the credit is not made out of the property of the applicant, but out of the bank's own funds. Therefore, if there is any dispute In that respect it is between the applicant and his bank.®®

In respect of the time of insolvency of the applicant and its impact upon his contractual relationship with the issuing bank, several points of time should be differentiated, as follows.

1, Prior to the time of acceptance of the applicant’s application for issuing a credit

The applicant submits an application for the issue of a credit, but before his application is accepted by the issuing bank the applicant, unknown to the bank, files an assignment for a receiving order or is declared bankrupt. If subsequent to the effective date of bankruptcy a letter of credit is issued and accepted by the beneficiary, would the trustee (appointed to control the applicant's assets) and the issuing bank contest the validity of the credit? it is hard to support the idea that in

One o f the first cases in the USA that considered the effect o f the applicant's bankruptcy on LCs is fn re M arine Distributors. Inc.. 522 F, 2d. 791 (9th Circuit 1975). In that case the banks' customer (the applicant for the credit) became insolvent and the timstee in bankruptcy tried to obtain an injunction against the bank restraining the issuer from honouring the letters o f credit. The court held for the bank and the beneficiary o f the credit on the ground based upon the "doctrine o f autonomy" namely that the applicant for the credit is not a party to a letter o f credit Ixansaction between the bank and the beneficiary; therefore, the bank has an independent obligation namely to pay the beneficiary.

such a situation the beneficiary should be prevented from receiving his payment under the credit if he is carrying out his obligations under the credit transaction. The main reason in favour of such argument is the doctrine of autonomy.

2. Prior to the Issue of the credit

Prior to the issue of the credit the applicant files an assignment in bankruptcy, and before any documents are presented by the beneficiary the issuing bank receives a notice from the applicant's trustee advising the bank that any assets which belongs to the applicant now form part of the bankrupt estate. As a result of such a notice is the issuing bank entitled to stop payment under the credit transaction if the beneficiary presented required documents? An author has rightly pointed out that the bankruptcy of the applicant has no effect on the right of the beneficiary under the letter of credit since, firstly, on the date of contract the applicant had full capacity to enter into the contract; and secondly, the letter of credit is independent from the underlying contract.®®

3. Following the issue of the credit

There should be no problem in such a situation because the credit transaction between the issuing bank and the beneficiary is an independent contract.^®®

Sarna, Lazar, "Letters of credit: Bankruptcy, fraud and identity o f parties". The Canadian Bar Review, Vol. 65, 1986, pp. 303-27, at p. 312 [hereinafter it is referred to as Sarna].

It is a common case and there are many decided cases related to issue under consideration. For instance in a Canadian decision Re M eridian Developments Inc. and Toronto-Dominian Bank. (1984) 11 D.L.R. (4th) 576 (Alta. Q.B.) held in favour o f the view that banks's undertaking is independent. On the other hand in an American case In Re Tw ist Cap. Inc. v. Southeast Bank. 1 Banker, 284 (Banker D. Fla. 1979), the court enjoined the issuing bank from making payment under the letter o f credit following the bankruptcy o f the applicant under a standby letter o f credit on the ground that the contract was executory, and under section 365(a) o f the Bankruptcy Code in the USA which provides that the trustee may assume or reject any executory contiact or unexpired lease o f the debtor. That decision was severely creticised. [For more details about that decision see Baird, Doglas G., "Standby letters of credit in b an kru ptcy". University o f Chicago Review, Vol. 49, Part 1, Winter 1982, pp. 130-54]]; and for other relevant matterials see Verkuil, Paul R., "B ank solvency and standby letters o f credit: Lessons from the USNB fa ilu re ". Tulane Law Review, Vol. 53, 1979, pp.314-28, Mclaughline, Gerald T., "The impact o f Federal C rim inal and Bankruptcy Laws on letters o f c re d it". Commercial Lending Review, Vol. 4, No. 1, Winter 1988-89, pp. 28-38, at p. 31 said: "Recently, however, courts have had to grapple with whether or not standby letters o f credit can be used to effect eve-of-bankruptcy preferential transfers to credittors. Since monies paid under a letter o f credit are the property o f the issuing bank, not the property o f the bankrupt debtor, the letter o f credit mechanism may

2.2.5.3. Beneficiary's insolvency

Under letters of credit the insolvency of the bank or its customer (the applicant for the credit) is a cause for disputes between interested parties but the beneficiary's insolvency has received less attention since it has less impact upon the banks' undertaking under the credit, namely, payment against documents which comply with terms and conditions of the creditT^ However, there are several possibilities: 1) a letter of credit is issued for the beneficiary and before the performance under the credit the beneficiary goes into bankruptcy; 2) the beneficiary becomes insolvent after the performance under the credit and before presenting any document(s) to the bank; 3) the beneficiary becomes bankrupt after presenting the documents required under the credit and before their acceptance by the bank; and 4) the beneficiary's insolvency comes after his documents are accepted by the bank and before payment. In all of the above situations the question may arise whether the trustee In bankruptcy can draw on the letter of credit.

As pointed out above, payment under the credit is conditional, namely, against documents in compliance with the credit's conditions; therefore, in the above situations 1 and 2 no documents are presented, so the paying bank is under no duty to provide payment under the credit. Even if the trustee in bankruptcy chooses to carrying out the beneficiary's obligations and presents required documents under the credit, he may face the banks's objection on the ground that documents are not issued (e.g. commercial invoice) and presented (e.g. bills of lading, insurance policy etc.) by the beneficiary himself as required under the credit transaction.^®^

arguably be able to execute preferential transfers. It s e e m s clear, however, that the law should not allow a debtor to do indirectly what it cannot do directly."

See Articles 2, 4, and 13 o f UCP 500.

The whole structure o f the documentary credits system is based on the faith o f the bank upon the beneficiary as far as documents are concerened. So, even if documents like bills o f lading, insurance issued by person other than the beneficiary they should be presented by the beneficiary o f the credit and no body else and this issue is also confirmed under Article 48(h) o f the UCP 500 namely "the Credit can be transferred only on the teims and condition es specified in the original Credit [...]"; and as to the situation that the documents must be issued by the beneficiai-y himself see Article 37 (a)(1) which provides that a 1 2 6

Is such an argument acceptable? To challenge that argument it is possible to suggest that the position of a trustee in bankruptcy is different from the position of a second beneficiary (in case of transferable credit) requiring the bank's prior agreement, since, he is appointed by the law relevant to the bankruptcy in particular circumstances and it is obvious that the law overrules any agreement made by parties to a private contract in case of conflict between the terms of that contract and the law/®® So, in general, the bank’s argument may be rejected by courts on the ground explained above; however, it is sounder for the trustee to reach some sort of agreement with the bank before starting any performance under the credit.

In respect of situation 3 above (namely, the beneficiary becoming insolvent after presenting the required documents and before his documents are accepted by the banks) the trustee's position is different from that stated under situation 2. In those circumstances if tendered documents are in compliance with the credits' conditions, then the bank is obliged to arrange payment under the credit and the beneficiary is entitled to assign its right to proceed to the trustee (under Article 49 of the UCP 500).^®'^ By contrast, if presented documents are rejected by the bank for commercial invoice "must appear on their face to be issued by the Beneficiary made in the Credit (except as provided in Article 48)."

Sarna, supra (f.n. 99), at p. 309 stated: "Even if the trustee in bankruptcy find himself in such a position, he may find it is unable to enforce the rights o f the bankrupt beneficiary because o f the strict compliance rule, [...] in case Sw ift A ir Lines v. Crocker National Bank. US Bankruptcy Appl. (1983), 30 B.R. 490, reported in (1984), 2 I.B.L. 143 the issuer refused to make payment upon being presented a document signed by the trustee in bankruptcy o f the corporate bankrupt. Under law the trustee has a full power under the Ic the beneficiaiy must sign documents peresenting for the payment [...] following the bankruptcy the beneficiary is not permitted to act on its own behalf [...] therefore the trustee was prevented from asserting the beneficiary's right under the credit."

Here other points may arise namely whether a bankrupt beneficiary is able to apply his right o f proceeds under the credit even after he becomes insolvent. It is obvious that after bankruptcy the beneficiary has no right to act in his own name; therefore, do the trustee assign the right o f the proceeds to another person (the assignee) instead o f the insolvent beneficiaiy? There are nothing relating to those issues under Article 49 o f UCP 500 and Section 5-116 o f the UCC; Sarna, supra (f.n. 99), at p. 308 said; "In the event of bankruptcy o f the beneficiary under the letter o f credit one might readily assume that the beneficiary's rights vest in the trustee, permitting the trustee to act in stead o f the beneficiary for all purpose, including presentation o f documents, execution o f drafts and demand for payment. There are, however, objections to this assumption. Those objections relate to certain letters o f credit which on their face are said not to be assignable, or are not assignable as a result o f the governing code o f rules. The other basis o f attack is the literal wording o f the letter o f credit, which requires the personal intervention o f the beneficiary at the most crucial stages o f the letter o f credit transaction, namely, presentation o f documents and demand for payment."; as to the issue o f

any reason, then the trustee's position should be considered under situation 2 (discussed above). A conclusion similar to what is discussed with respect to situation 3 (namely, the beneficiary going into bankruptcy after presenting documents stipulated under the credit and before acceptance but accepted later by the bank) would be acceptable for situation 4, namely, where the beneficiary becomes bankrupt after his documents are accepted by the bank(s) and before payment.

2.2.5.4. Section 5-117 of the UCC

The Uniform Commercial Code (UCC) addresses, under Section 5-117, bank insolvency by requiring that any funds held as collateral by the issuing bank for a documentary credit must be used to pay drafts presented under the credit. Any excess must be returned to the importer. By contrast, the UCP 500 contains no provisions relating to the insolvency of the issuing bank.^®®

As to sub-section 1 of Section 5-117 a question may arise; does UCC cover only those credits which are issued under paragraphs (a) or (b) of section 5-102(1) of the UCC? In other words, what is the solution where an issued credit is not within those mentioned in the above paragraphs but falls under paragraph (c) of section 5-102(1): "but conspicuously stated that letter of a credit or is conspicuously so entitled." It has been said that the reason for accepting such a policy is to prevent abusing the provision in case of ambiguity.^®® It seems there is a distinction between Section 5-117 and Section 5-102(1). if a credit falls into the last category of assignment the same writer pointed out: "Accordingly, if a credit is silent as to the matter, it is presumed to be non-transferable; on the other hand, the silence o f the credit does not prevent the beneficiary from assigning its rights to proceeds. It is evident that an assginee would have no right to proceeds unless the demand mechanism is appropriately triggered by the beneficiary itself presenting the documentation and making the appropriate demand for payment." [Sarna, supra (f.n. 99), p. 308]; for more details about the right o f assignment o f the proceeds under the credit see relevant discussion under the present section.

Ellinger, JBL 1994, supra (f.n. 27), p. 28; in the Proposal Final Draft (PFD) for revision o f Article 5 o f the UCC the omission o f Section 5-117 was suggested; see table 2.1 (below).

In Official Comment to Section 5-117 said: "The section is limited to transactions under Section 5-102(1) (a) and (b) to prevent abuse in situations where the commercial purpose o f facilitating the movement o f goods, securities or the like may be lacking."

section 5-102(1), i.e. paragraph(c), and is supported by law, there should be no objection that such a credit be confirmed and covered by Section 5-117 too,

2.2.5.5. Concluding remarks

A letter of credit assures payment from one party to another by making arrangements for a bank to lend its full faith and credit to the transaction. The process assumes that the issuing bank is at least as creditworthy as its customers, but this is not always true. The best way that the other parties to a credit transaction (applicant for a credit and the beneficiary) can reduce the risk of bank insolvency is to consider carefully the financial strength of banks from which they obtain their LCs

107 services.

One important issue generated as a result of the bankruptcy of the issuing bank is whether the law of bankruptcy has any impact on the "doctrine of autonomy" accepted under the documentary credit systems. In other words, whether the beneficiary's special right of payment under the credit would be affected in such a situation. There are two views regarding this question, but the preferred opinion is that the bank's trustee is not entitled to put the beneficiary of a credit in the position of other creditors of the bank and treat him similarly. On the other hand, it becomes clear that the bank's insolvency does not automatically put an end to the credit transaction and if the beneficiary likes to pursue his rights under the credit, he must carry out his side of the contract, namely, by presenting documents required by the credit contract and compliant with its terms and conditions.

As to the banks's insolvency and its impact upon the applicant for a credit, who under the reimbursement contract must reimburse the amount of the credit one day before the maturity of the credit, or deposit funds for the purpose of meeting the beneficiary's draft(s) drawn under the letter of credit, it Is accepted by courts in the

Locher, Gabriel, "Hedge your bets in L/C transactions". Business Credit, Vol. 94, Iss. 6, June 1992, pp. 28-29 stated: "When reviewing any bank's financial statements, the following points should be considered: 1. Is the bank adequately capitalized?; 2. Does the bank's capital position meet or exceed regulatoi-y requirements? 3. Is the allowance for loan losses inadequate, given the bank's level o f non­ performing or past due loans?; 4. What is the ratio o f non-performing loans to total loans? Crucial to the health o f a financial institution is the state o f its loan portfolio."