Letters of Credit and the Insolvent Applicant: A Recipe for Bad Faith Dishonor

44 Pages Posted: 15 Sep 2008

See all articles by Margaret L. Moses

Margaret L. Moses

Loyola University Chicago School of Law

Abstract

This Article will focus on the letter of credit's failure to protect against buyer insolvency, and it will show how the letter of credit system provides an issuing bank with substantial discretion to deny payment under a letter of credit when it believes its customer, the buyer, is unable to reimburse it. The Article will also consider whether the bank's obligation to act in good faith should limit its discretion to deny payment to the seller under a letter of credit when the buyer is insolvent. This Article will focus on those cases where the bank dishonors the letter of credit when the buyer/applicant insolvent. Part II of this Article will focus on the causes and consequences of letter of credit failure. Part III will consider certain conduct of the issuing bank which could be considered opportunistic, the incentives for such conduct, and the impact it has on the letter of credit process. Part IV will discuss the obligation of good faith imposed on issuing banks; the impact on this obligation of two important aspects of letter of credit law, strict compliance and the independence principle; and the different approaches to the good faith obligation taken in the Untied States and in civil law countries. Finally, Part V will consider the application of the good faith standard when a bank denies payment under a letter of credit because the applicant is insolvent. The Article concludes that in cases of applicant insolvency, when a bank is likely to dishonor a letter of credit because it fears non-reimbursement, the bank's claim that it is dishonoring for other reasons should be carefully scrutinized. Holding a bank to a good faith standard of conduct in cases of applicant insolvency would strengthen the letter of credit process and provide an incentive to all banks to follow standard practices when dealing with letters of credit.

Keywords: letters of credit, buyer insolvency, good faith, credit failure

JEL Classification: E50, G21

Suggested Citation

Moses, Margaret L., Letters of Credit and the Insolvent Applicant: A Recipe for Bad Faith Dishonor. Alabama Law Review, Vol. 57, pg. 31, 2005, Available at SSRN: https://ssrn.com/abstract=1098287

Margaret L. Moses (Contact Author)

Loyola University Chicago School of Law ( email )

25 E. Pearson
Chicago, IL 60611
United States
312-915-6430 (Phone)
847-475-8984 (Fax)

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