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

• Author: Hamed Alavi
• Position: Guest Lecturer, Tallinn University of Technology, Estonia
• Pages: 94-121

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”

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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.