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Chapter 3

Operation of the Independence Principle and the
Doctrine of Documentary Compliance

3.1 Introduction
The basic rules by which the letters of credit transactions operate are widely recognised. Underlying these rules is the principle that letters of credit are transactions autonomous or independent of the underlying contracts on which they are based. Under this principle, the issuer is not concerned with or bound by underlying contracts. It deals exclusively in documents and not in goods or services to which the documents may relate.
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Arguably there are questions as to the extent to which this principle should be applied. Focus on this principle under certain circumstances may bring injustice to applicant-buyers, and as mentioned in Chapter 1, entail the assumption of collusion risk by banks despite the operative protections of the UCP. Against the background of the respective apportionment of risks discussed in Chapter 1, this chapter will assess the position of banks and applicant-buyers under the letter of credit under the independence principle and the compliance principle derived from the independence principle. It will be demonstrated that the UCP does not incorporate
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See UCP, Articles 3 and 4.

adequate or clear enough duties to be exercised on the part of issuers toward applicants, and severely restricts the applicant’s right to sue if the issuer has wrongfully honoured. The treatment of buyers is underlined by the 1995 amendments to Article 5 of the
UCC. The 1962 version which was superseded by these amendments set forth a relatively balanced set of rights and duties that were, in certain key areas, adjusted in the 1995 amendments in ways that were not favourable to applicants, for the sake of uniformity with the UCP. The 1962 version will therefore be referred to where it provides a useful illustration of provisions that are relatively balanced in their approach.
3.2 The
Independence
Principle
The general understanding of the law of letter of credit is that it is essentially a contract between the issuer and the beneficiary and it is independent of the underlying contract between the applicant and the beneficiary. The rule in relation to the independence principle is embodied in Article 3 and Article 4 of the UCP. Article 3 stipulates Credits, by their nature, are separated transactions from the sales or other contracts, even if any reference whatsoever to such contracts) is included in the Credit Article 4 further stipulates

In credit operations all parties concerned deal with documents and not with goods, services and/or other performances to which the documents may relate.”
In the United States the independence principle is recognised in similar provisions within the UCC(’95), particularly at d, which states that rights and obligations of an issuer to a beneficiary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contractor arrangement out 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.
Since its inception, the independence principle has governed letter of credit transactions. It declares that credits are by their nature transactions separate from their underlying transactions and that payment by the issuer is to be based solely on a determination of the conformity of the documents presented with the terms and conditions of the credit without reference to the beneficiary’s performance of the underlying contract. Under the independence principle, usually the bank is under a duty to accept the tender of conforming documents and should not get involved in controversy between the buyer and seller. The bank is moreover not concerned about any debts or claims between the seller and the buyer, so the bank’s undertaking to the seller is separated from the

undertaking between the seller and the buyer. This separation of documents and goods has been considered essential to the continued utility of the letter of credit and is the basis upon which the banks enter into these transactions Most banks and many commentators have accepted the view that the continued utility and even the viability of the letter of credit as a payment mechanism depends upon the strictest observance of this principle. Therefore, this chapter will focus on how banks deal with documents and their relationship with other parties in the document transaction. As Lord Justice Jenkins stated in Malas (Hamzeh) & Sons v British