The Buyer has not opened the letter of credit, what can we do? This is a question which we have been asked on a number of occasions recently. This client alert is intended to provide some guidance to sellers when dealing with buyers that fail to open a letter of credit on time or at all; steps to be taken both when agreeing the contract terms and when the time for opening the letter of credit has expired. We set out general considerations and principles but clearly much will depend on the exact terms of your sale contract.
There are four general principles of an English law sale contract to bear in mind:
- Letters of credit are separate agreements, independent from the underlying sale contract. The sale contract is an agreement between the seller and buyer. The L/C is a direct contract between the issuing bank and the beneficiary/seller.
- Notwithstanding the independence of the L/C and the sale contract, the terms of the sale contract could effectively be amended by accepting inconsistent terms in L/C.
- The time for the opening of the L/C will usually be of “the essence”. This means that the provision of the L/C and on time are generally conditions of the sale contract.
- Conditions are the most important terms of the sale contract. Breach of a condition gives the innocent party the option to treat the contract as terminated and claim damages.
- Ultimately, the seller’s rights will depend upon the wording of the sale contract and whether, for example, there is an event of default clause.
- Generally, the opening of the L/C will be a pre-condition to the seller’s obligation to ship the goods. One exception is where the contract expressly provides for the L/C to be opened at some later date.
Practical considerations: pre-contract
Do you have sufficient security?
Before entering into a contract, trading houses generally carry out some form of credit risk assessment, whether globally (for these types of trades) or specific (for the counterparty). If, having carried such an assessment, the seller seeks a secured payment mechanism such as an L/C, thought should also be given to whether additional security is required.
- An L/C will provide comfort for payment of the price if opened. If not opened, you may well suffer losses as a result if prices have fallen. These losses would not be secured.
- Accordingly, in addition to the L/C requirement, sellers may wish to consider requiring a performance bond, standby letter of credit or guarantee to cover this potential risk (particularly in the case of term contracts involving multiple deliveries and multiple L/Cs).
Is the contract worded appropriately?
The first point is perhaps an obvious one: the sale contract must provide expressly for payment by means of L/C. Any requirements the seller may have for the L/C must be set out in the sale contract. The key points on which to focus are:
- Form and value of L/C – consider attaching a copy of the draft L/C and specifying that the L/C must be opened in the format attached to the sale contract
- Identity of issuing bank
- Advising and/or confirming bank
- Payment by sight or on deferred terms
- Documents to be presented
- Any special conditions (eg stale documents, charterparty B/Ls acceptable, banking charges)
- Timing of L/C opening
Deadlines for opening the L/C
The timing of the L/C opening is crucial. We recommend that the sale contract clearly state when the L/C must be received by the seller.
- Specifying a deadline will generally mean that the time for the opening of the L/C is of the essence. This will, in turn, usually mean that the provision is a condition of the sale contract entitling the seller to terminate the contract if the buyer fails to comply.
- This position can, if commercially acceptable, be strengthened by inserting additional provisions in the L/C clause giving the seller the express right to suspend performance, refuse to ship and terminate if the L/C is not opened on time.
What is an appropriate deadline?
What deadline is appropriate will depend upon a variety of factors. The most imperative consideration for a seller is to establish a time frame which will ensure that the secure payment mechanism offered by the L/C is in place before: (i) he relinquishes physical and/or legal control of the goods; and (ii) he starts incurring costs in the performance of his obligations.
- FOB sellers should ensure that the L/C is in place prior to loading. If the deadline is later, the goods will already be on board the buyer’s vessel, defeating the purpose of the secured payment mechanism.
- CIF/CFR/DES sellers should ensure that the deadline for opening the L/C is, if possible, prior to the date for nomination of the vessel. If the deadline is later, the seller may incur significant costs in presenting the vessel for loading/sailing to the agreed discharge port.
Practical considerations: during performance
What do I do if my buyer has not opened the L/C on time?
The answer to this question will always depend upon a number of considerations.
- What, commercially, do you want to do?
- What are the relevant terms of the sale contract?
- What has been said to the buyer already or in the past?
- Where are the goods?
- What are my chances of recovering damages in practice from the Buyer.
Can I terminate?
One option for the seller may be to terminate the sale contract when the deadline specified in the sale contract has expired and no L/C has been opened.
Take care to ensure that you are entitled to terminate. Termination must always be treated seriously. Terminate too early and you will yourself be in breach of contract, giving the buyer the right to claim damages against you. It is easy to lose the right to terminate – see ‘waiver’ below. We would recommend that legal advice is sought before steps to terminate are taken.
- If you can terminate:
(i) any procedure for termination specified in the sale contract (eg in a default clause) must be followed.
(ii) absent an express default clause, the seller must notify the buyer promptly that he is treating the buyer’s breach as terminating the contract.
- Keep all relevant departments informed and have one point of contact with the buyer. There are two reasons for this:
(i) reducing the risk of inadvertently losing the right to terminate by waiving your rights. Waivers can easily occur, for example, where traders or operations are seeking to terminate whilst trade finance continues to ask the buyer for the L/C.
(ii) the termination of the sale contract may well have important consequences for other agreements (eg cross-default provisions in finance agreements).
The key issue is waiver of rights. The rights set out in the sale contract can be, and are frequently, amended or completely negated by the conduct of the party seeking to rely on them. Typically, this will happen by way of a waiver or a “course of dealings”.
A waiver of rights is when you act inconsistently with your rights under the sale contract and/or let the time for performance of an obligation pass without comment. In doing so, you are leading the buyer to believe that you will not exercise those rights, thus you will be prevented relying upon the strict letter of the contract.
A course of dealing will arise if, for example, you have allowed the buyer additional time for the opening of the L/C on one or more previous occasions. This will mean that you would not be entitled to rely on your strict contractual rights because you did not do so in your prior dealings with the buyer.
We explore below how to avoid the pitfalls of waivers and course of dealing.
Allow the buyer more time?
Most of our clients do not wish to terminate the sale contract upon a late opening of an L/C. From a commercial perspective, immediate termination of a sale contract the moment that a “technical” failure to comply with its terms has occurred may not be attractive. This is understandable. However, it is important always to preserve, and not to waive, your rights.
If, therefore, you wish to allow your buyer more time to open the L/C:
In your correspondence with the buyer, reserve all of your rights.
Impose a clear new deadline for the opening of the L/C (see our guidance below) and make clear the consequence of non-compliance.
Consider what effect the late L/C will have on your ability to ship within the contract shipment period: if late shipment is likely, you must spell this out in messages.
During this time, you may be entitled to suspend performance of your obligations. Before doing so, you should ensure that the contract has been checked to verify that you have this right.
If you have already allowed your buyer more time in which to open the L/C:
- You need to inform the buyer that you will terminate the contract unless the L/C is opened by a specific time. This serves to put the buyer on notice that you are treating the opening of the L/C seriously, so that time again becomes of the essence.
- The deadline needs to be “reasonable”, which will depend entirely on the sale contract and the circumstances. However, “reasonable” will not necessarily mean that the buyer must be given sufficient time to comply.
How does my previous conduct affect my rights?
Many trading companies fall foul of its previous conduct, whether during of the same contract or other sale contracts with the same counterparty over a period of time.
If you have previously allowed the buyer additional time for the opening of the L/C on one or more occasions, the buyer may be entitled to rely on a “course of dealings” argument to the effect that you are not entitled on this occasion to act differently.
There are four ways to reduce the risk of this happening:
- Insert a “waiver” provision in your contracts. Such a provision will specify that a single waiver of rights on one occasion will not count as a waiver of all rights in the future if the same breach is committed again.
- Each time you allow more time to your buyer, tell the buyer that you are doing so on this occasion only and reserve your rights to rely on strict performance of the contract in the future.
- At the start of the next contract/delivery, tell the buyer that you expect performance of the contract in accordance with its terms on this occasion.
- Finally, if the buyer fails to open the L/C, follow the course of action identified above and ensure you impose a clear new deadline for the L/C to be opened.
In summary, sellers can take several steps to improve their position both before and after the contract is concluded:
1. the outset
- Consider additional security
- Draft the sale contract appropriately and set an express deadline for the issuance of the L/C
2. the buyer has not opened the L/C on time
- Check the sale contract carefully before taking action
- If you can and wish to terminate, follow the correct procedure
- Take care not to waive your rights
- If you have or wish to grant more time to the buyer, make time of the essence – set a new deadline
Finally, please note that this client alert is intended for guidance only. The facts and wording of the sale contract in any particular case will be of paramount importance, affecting the general legal position.