The erosion of autonomy of commercial letters of credit

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3 December 2010

Commercial letters of credit are a useful tool in facilitating international trade. Their usefulness lies in the autonomy and the certainty which they provide to parties to international sale of goods contracts. However, in Australia, the autonomy and certainty of letters of credit has been eroded by the application of sections 51AA and 51AC of the Trade Practices Act 1974 (Cth) (TPA).

Letters of credit – independent payment mechanism

There is inherent risk involved in the international sale of goods because the buyer and the seller are in different countries and subject to different legal systems and use different currencies. Letters of credit have been used to alleviate these risks by providing a promise by the importer’s bank to pay the exporter for goods that have been shipped. This promise is traditionally independent of the contract of sale and any dispute arising under that contract.

Without the assurance that the exporter gets from a letter of credit the exporter may consider an international sale of goods contract to be too risky due to the potential for non-payment by the importer and the risks and expenses of attempting to enforce in a foreign jurisdiction.

Court decisions erode autonomy of letters of credit

Traditionally, the courts have only interfered with the autonomy of letters of credit in the case of fraud. However, over the past twelve years Australian courts have also applied sections 51AA and 51AC of the TPA. For example:

  • the Supreme Court of New South Wales found that “the principle of autonomy, applicable to a standby letter of credit, cannot override the statute (TPA)”;
  • the Supreme Court of Victoria found the TPA has made “a substantial inroad into the well established common law autonomy of letters of credit and performance bonds and other guarantees”; and
  • the Federal Court has held that unconscionable conduct could found an order restraining payment under a Letter of Credit.

Some commentators suggest that s 51AA of the TPA should not apply to letters of credit because the section was not intended to be so broadly applied. They argue that the intention of legislators was to prevent the type of unconscionable conduct set out in the Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 which was limited to a specific set of conduct during the bargaining process.

However, even if letters of credit fall outside the operation of s51AA of the TPA, they are certainly caught by the more recently introduced section 51AC. The introduction of section 51AC enlarges the notion of unconscionable conduct by including a list of factors to which the court is entitled to have regard when determining if conduct is unconscionable. The courts have held that those factors go beyond what would constitute unconscionability in equity to ground a new form of “statutory unconscionability”.

Conclusion

The application of sections 51AA and 51AC of the TPA to letters of credit weakens their autonomy. The provisions allow the court to interfere with the certainty of payment to the exporter. While the provisions of the TPA are often viewed as desirable for commerce because they prevent inequity, there is an active debate as to whether parliament should consider altering the TPA to prevent it applying to letters of credit, thereby preserving certainty of payment to the exporter.

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