Letters of credit disputes: Legal risks and practical guidance

Letters of credit (LCs) are often called the “cornerstone of international trade finance”, offering a mechanism by which sellers can secure payment and buyers can ensure goods are shipped before funds are released. Despite their widespread use and the standardisation offered by the ICC’s Uniform Customs and Practice for Documentary Credits (UCP 600), disputes still arise often with significant commercial consequences.

Below explores the nature of LC, the legal and practical issues that commonly emerge when demands are refused, and how parties can protect themselves.

What is a letter of credit? 

LCs are financial instruments issued by banks (the issuer) at the request of a buyer (the applicant), undertaking to pay a seller (the beneficiary) upon presentation of specified documents evidencing shipment or performance. It's independent of the underlying sales contract and governed by its own terms, often incorporating UCP 600.

Key features include:

• Autonomy and independence: The LC is separate from the underlying sale contract and the obligation to pay under an LC is independent of any agreement between the buyer and seller.
• Irrevocability: Under UCP 600, all credits are irrevocable unless stated otherwise.
• Documentary nature: Issuers deal in documents, not goods or services.
• Strict compliance: Documents must conform precisely to the terms of the LC.

Common disputes and legal issues

Despite the clarity of UCP 600 where parties have incorporated UCP 600 to their LC, disputes frequently arise when an issuer refuses to honour a demand. These disputes typically fall into the following categories:

1. Allegations of fraud

The autonomy principle is subject to a narrow fraud exception. If the beneficiary knowingly presents false documents, the issuer may refuse payment.

In United City Merchants v Royal Bank of Canada [1982] 2 Lloyd’s Rep 1, the House of Lords held that an issuer could refuse payment where the beneficiary knowingly presented a bill of lading with a false shipment date. However, if the beneficiary is innocent, the fraud exception does not apply.

More recently, in Petrosaudi Oil Services v Novo Banco [2017] EWCA Civ 9, the Court of Appeal considered whether a demand under a standby LC (SBLC) was fraudulent due to a misrepresentation of payment obligations. The court held that the fraud exception did not apply where the beneficiary genuinely believed the demand was valid even if that belief was mistaken.

Issuers must have clear evidence of fraud at the time of presentation. Innocent errors or disputes over interpretation will not suffice.

2. Documentary discrepancies

LCs typically contain strict requirements for the presentation of documents especially where UCP 600 has been incorporated. Issuers are entitled to reject documents that do not strictly comply with the LC terms. Even minor discrepancies can be fatal.

For example, in Bulgrains & Co v Shinhan Bank [2013] EWHC 2498 (QB), the issuer rejected documents because the beneficiary’s name included an ampersand (“&”) not present in the LC. The court upheld the rejection, confirming that even typographical differences can justify refusal. It’s been argued that it wasn’t possible to insert an ampersand into SWIFT; even if that was the case the court determined the beneficiary should have used the word “and” to clearly identify the entity.

That said, issuers must act promptly in notifying parties of document discrepancies. UCP 600 requires an issuer to notify any discrepancies within five days. In Fortis Bank v Indian Overseas Bank [2011] EWCA Civ 58, the issuer failed to return discrepant documents promptly after giving notice of rejection. The Court of Appeal held that this failure precluded the issuer from relying on the discrepancies under UCP 600 Article 16(f).

Beneficiaries must ensure absolute conformity with LC terms. Issuers must comply with any requirements under the LCs (including UCP 600 procedures) when rejecting documents.

3. Illegality

Problems often occur where an issuer refuses to make payment in circumstances where payment would be illegal in the jurisdiction where performance of that payment obligation is due (what is known as the rule in Ralli Bros).  

In Litasco v Banque El Amana [2025] EWHC 312 (Comm), the High Court considered whether a Mauritanian bank could rely on the rule in Ralli Bros to avoid payment under a standby LC (SBLC) governed by English law. The issuer refused payment citing that a Mauritanian court had made an order prohibiting payment and that to make payment would therefore be unlawful in Mauritania.

The court rejected this, holding that the rule only extends to legislative or regulatory requirements in the jurisdiction in question; it does not extend to foreign court orders unless recognised under the English regime for enforcement of foreign judgments. 

The court also determined that the place of performance was Switzerland, where payment was to be received, not Mauritania where preparatory steps would occur. No illegality would therefore arise by making payment in Switzerland. It clarified that illegality in jurisdictions other than the place of performance does not engage the rule in Ralli Bros. 

It’s therefore important for parties to carefully consider the jurisdictions in which performance under LCs will occur to ensure that no difficulties arise whereby an issuer may seek to raise an argument that it’s unlawful to make payment under an LC.  

4. Sanctions and political risk

Sanctions regimes can complicate payment obligations under LCs, particularly where counterparties are based in or are connected with entities and/or jurisdictions subject of sanctions.

In Celestial Aviation Services v UniCredit Bank [2024] EWCA Civ 628, the LC prescribed that payment would be in USD. The issuer originally refused payment under LCs confirmed in favour of Irish companies leasing aircraft to Russian entities on the basis of UK and US sanctions. Whilst the issuer obtained a UK licence to pay the monies to the Irish lessors, a dispute arose about whether the issuer should account for interest and costs accrued as a result of late payment.

At first instance, the High Court determined that payment under the LCs did not prohibit the issuer from paying out under the LC because in respect of: (1) UK sanctions, the payment would be separate from the underlying leases and those leases predated the sanctions regime; and (2) in respect of US sanctions, payment by the issuer would not be illegal as payment could be made in a different manner to avoid it being paid via a correspondent account in the US.  

On appeal, the Court of Appeal determined the LCs were separate from the underlying leases (underlying the autonomy principle), they were issued in connection with the leases and were therefore caught by the respective sanctions regime. In respect of: 

1. UK sanctions, the issuer had argued that it had a defence under the Sanctions and Anti-Money Laundering Act 2018 (SAMLA) on the basis it had a reasonable belief that to pay out under the LC would have amounted to a breach of UK sanctions. Whilst the Court of Appeal determined the issuer had acted reasonably, ultimately the provision of SAMLA could not protect the issuer from paying interest and costs under the LCs.
2. US sanctions law, the Issuer argued that it was not obligated to make payment where to do so would be illegal in the jurisdiction where performance of the obligation occurs (citing the rule in Ralli Bros). Whilst determining the first instance decision that the issuer could have made payment in a different method than prescribed under the LC was wrong, the Court of Appeal found that on the facts of this case, the issuer hadn’t used reasonable efforts to try and obtain a requisite licence from US authorities to make the payment.  

Parties involved in LCs should assess at the time of contracting and during the life of LCs the risk of sanctions and whether that may impact any payment obligations.

5. Modifications

Arguments arise where modifications have been made in the LC in particular in relation to UCP 600 terms where UCP 600 has been incorporated.  

However, such modifications have to be clear. In Heytex v Unity Trade Capital [2022] EWHC 2488, an issuer argued it had no payment obligation under an LC because: (1) the LC provided at field 78 of the MT700 that it was “subject to the terms and other conditions governing the issuance of this credit, credit norms of the issuing institution and UCP 600”; and (2) certain actions between the buyer and the seller contravened its credit norms.

The court found that these provisions, if effective, would represent a “fundamental and somewhat startling departure” from the UCP 600 regime. However, it held that the “credit norms” were not incorporated into the LC. That was because they weren’t made available to the beneficiary, were referenced only vaguely and weren’t expressed to govern the relationship between the issuer and beneficiary. Even if incorporated, the court found that the “credit norms” governed the issuer’s relationship with the applicant (Seller), not the issuer’s relationship with the beneficiary. 

In rejecting the argument, the court noted that such terms needed to be clearly articulated to the beneficiary: “In particular, if the purported terms are onerous or commercially unusual (which turns on the context in each case) they may need, as was said by Denning LJ in J Spurling Ltd v Bradshaw [1956] 1 WLR 461 (CA) 466, to be "printed in red ink on the face of the document with a red hand pointing to it".

Parties should therefore check the terms of LCs carefully and in particular whether any modifications have sought to be made to UCP 600 where it’s invoked. If there are modifications, parties should ensure that the modifications are clear and understood by the parties.

6. Governing law and jurisdiction

By their very nature, LCs often involve multiple jurisdictions where the issuer, beneficiary and applicant are from different jurisdictions. Determining the governing law and what the appropriate forum is to resolve the dispute can be complex, especially where no express choice is made.

When issues concerning what law applies to the agreement, the English courts will principally look at where the obligations under the LC are performed. For example, in PT Pan Indonesia Bank v Marconi Communications International [2005] EWCA Civ 422, the Court of Appeal upheld a first instance judgment determining English law applied. It determined that had the LC operated according to its terms, the beneficiary would have received payment and dealt with its advising and negotiating bank in London. Accordingly, it found the English court was the most appropriate court to resolve the dispute.

To prevent any uncertainties, parties should specify governing law and jurisdiction in the LC and related contracts to avoid uncertainty.

Practical steps to avoid disputes

Given the pitfalls that do arise with LCs, parties to LCs should consider the following when entering into them:

• Ensure the LC terms match the underlying contract
• Ensure that the terms are clear and whether applicable rules such as UCP 600 are incorporated
• Specify the documents which are required to be presented are precisely detailed and that the documents prepared to be presented under the LC meet the LC’s requirements
• Make sure the governing law and dispute resolution clause is provided for in the LC
• Choose reputable issuers with experience in trade finance and consider confirmations from local banks
• Monitor sanctions and political risk affecting the parties
• Seek legal advice if discrepancies or delays arise

When making a demand under an LC:

• Ensure the demand is in the prescribed format
• Present documents within the time limits
• Anticipate potential objections and address them proactively

In the case of applicants (buyers), they may consider seeking an injunction to restrain payment by issuers to beneficiaries (especially where there are grounds the LC was prescribed by fraud) although such injunctions are seldomly granted by the English courts in circumstances where the LC represents an “irrevocable undertaking” to make payment.

If payment is refused (or in respect of an applicant, payment is made), legal advice should be sought to consider what options you have.

Conclusion

Letters of credit offer security and efficiency in trade finance, but they aren’t immune from dispute. Understanding the legal framework, particularly under UCP 600, and taking proactive steps can help parties avoid costly litigation.

If you’re involved in a dispute concerning LCs, or wish to ensure your arrangements are robust, please contact the authors of this article.