Comparative Study of Unconscionability Exception to the Principle of Autonomy in Law of Letter of Credits

AuthorHamed Alavi
PositionGuest Lecturer, Tallinn University of Technology, Estonia
Pages94-121
ACTA UNIVERSITATIS DANUBIUS Vol. 12, no. 2/2016
94
Comparative Study of Unconscionability
Exception to the Principle of Autonomy
in Law of Letter of Credits
Hamed ALAVI
1
Abstract: This paper touches upon the legal nature and scope of unconscionability as an exception to
autonomy principle of documentary letters of credit (LC) and bank guarantees. Complicated process of
international trade is known as the main reason behind development of new exceptions to globally
appreciated p rinciple of autonomy in process of LC transaction. Apart from fraud which has been
recognized in international business society and various jurisdictions, other exceptions including
unconscionability, nullity, illegality and recklessness have received different treatments in different
national laws. Unconscionability is applied to situations where beneficiary’s demand to draw under the
LC is not fraudulent but affected with bad faith in a way that court prevents bank from honouring the
credit. While UCP leaves the problem of fraud and other exceptions to autonomy principle to be solved
by national laws, among common law countries, unconscionability defence has been recognized in
Australia and Singapore but others do not show welcoming attitude towards it. Current paper tries to
find reasons behind different attitudes of common law jurisdictions to unconscionability d efence in
letter of credit process by answering following questions: What is the nature of unconscionability? How
different common law jurisdictions have received it as an exception to principle of autonomy in
documentary letters of credit and bank guarantees? And last but not the least, what are arguments in
favour and against its universal recognition as a defence for payment under letter of credit and bank
guarantee system?
Keywords: Documentary Letters of Credit; International Trade; Exceptions to Principle of Autonomy;
Unconscionability; Common Law System
1. Introduction
In the process of international business, documentary letters of credit are used
historically for the purpose of shifting risk of payment from applicant as a natural
person to the bank as a more reputable entity with legal personality. By using
1
Guest Lecturer, Tallinn University of Technology, Estonia, Address: Ehitajate tee 5, 19086
Tallinn, Estonia, Tel.: +372 620 2002, Corresponding author: hamed.alavi@ttu.ee.
AUDJ, vol. 12, no. 2/2016, pp. 94-121
JURIDICA
95
documentary credits, seller would be sure that his payment is ready upon
presentation of complying documents to bank and regardless to any dispute on the
underlying contract.On the other hand, buyer is sure that in case of noncompliance
of documents with terms and conditions of credit or committing fraud and forgery
by seller bank would not make payment and his interests are protected. (Alavi, 2016,
pp. 106-121) Mechanism of international LC transaction just like bank guarantee is
subjected to two main principles of autonomy and strict compliance
1
. Accordingly,
principle of autonomy separates the credit from its underlying contract while
principle of strict compliance imposes condition of strict compliance of presentation
with terms and conditions of credit for letting bank to effectuate the payment. Before
case of Sztejn v Henry Schroder banking Corporation
2
absolute application of the
principle of autonomy deemed uncontested. However, recognition of fraud as the
first exception to the principle of autonomy in documentary letters of credit raised
fear of moving “down the slippery slope toward a more pervasive impairment of the
utility of letters of credit” (Johns & Blodgett, 2010, p. 297) among commentators.
Such concerns seem to be true as trade practices started to develop further disruptions
including unconscionability, illegality, recklessness and nullity as new exceptions to
the principle of autonomy in international LC transaction (Alavi, 2016, p. 70).
Unconscionability, as the focus point of current research, refers to condition in which
claim of beneficiary to draw under the credit or bank guarantee is so affected with
bad faith that court decides to prevent bank from payment in absence of fraud or
forgery. (Ellinger & Neo, 2010, p. 169) The unclear nature of unconscionability has
resulted in divergent approaches to above mentioned circumstances in different
jurisdictions. Many legal practitioners and academicians endeavoured to articulate it
and occasions under which unconscionability can be used as a defence.
3
However,
majority of efforts have been failed due to difficulties in providing a precise
definition and circumstances for application of unconscionability as an exception to
autonomy principle of documentary letters of credit (Amaefule, 2012). At the same
time, its supporters claim that unconscionability will provide court with more
flexibility
4
and possibility to “police agreement directly”
5
and reject contractual
1
UCP 600, Article 4, 5 and 6.
2
Sztejn v Henry Schroder banking Corporation 31 NYS 2d 631 (1941).
3
(Rickett, 2006). In John Lowry Commercial Law: Perspective and Practice, Lexis Nexis, p. 175.
4
Epstein. R, (1975). Unconscionability: A Critical Reappraisal. 18 J LEcon. 293, 304.
5
Hilman. R, (1981). Debunking some Myth about Unconscionability: A New Framework for UCC
Section 2-302. 67 Cornell L Rev 1, 15.

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