The fraud rule under letter of credit law in the people’s republic of China and implications for Vietnam

Use your smartphone to scan this QR code and download this article ABSTRACT In international trade where the buyer and the seller do not have information about each other, letter of credit is used to assure the other parties' fears in the sale contract. For instance, the sellers are afraid of not being paid after sending the goods bought by the purchasers, meanwhile, the buyers have no reasonable grounds to believe the sellers will send the conforming goods under the requirements of the sale contracts. The letter of credit is a settlement between parties to reduce the risks and inserts security into the international sale of goods. However, there are fraudsters who tries to defraud the process of the letter of credit and fraud rule is expected to prevent this issue. There are countries tried to develop specific regulations for the letter of credit and fraud rule, one of those countries is the People's Republic of China (P.R.C). The practices of letter of credit in China had been an aiming point of critiques through years by letter of credit experts. In such wise, the Supreme People's Court of P.R.C has issued the Rules of the Supreme People's Court Concerning Several Issues in Hearing Letter of Credit Case (``the 2005 Rules'') in an effort to partly solve the problems. This paper will give a brief introduction about the letter of credit's operation, the law regulating the letter of credit in international trade as well as illustrate the specify law for the fraud rule in letter of credit law in P.R.C by emphasizing the history and summarizing the structure of the fraud rule. Thenceforward, the author will evaluate the case study in Vietnam to show the situation of Vietnam in these days and giving recommendations.


INTRODUCTION
The documentary credit is now adopted universally 2 in the global trade. The rationale of the letter of credit 3 is to assure with the seller that they will get the pay-4 ment in the sales contract for presenting the comply- Republic of China ( herein "P.R.C") can be seen as one 21 of the largest customers in using letter of credit [ 2 , p. 22 1068]. In P.R.C, the widespread in using the letter of 23 credit is not only affect the domestic business but also 24 their foreign partners. The operations of procedures 25 relating to the fraud in the letter of credit has been 26 criticized for years and most of the critiques is origi-27 nated from the actions of the applicants in China us-28 ing the Chinese rules to quit the reimbursement obli-29 gation under the letter of credit 2 . It was not until late 30 2005 that the regulations for letter of credit are issued 31 in P.R.C. 32 This article will invest in seeking and explaining the 33 nature of letter of credit as well as classify its sources 34 and regulations that govern the letter of credit. In the 35 latter part, the author will explain the regulation of let-36 ter of credit and the fraud rule in P.R.C, and last part, 37 the author will consider the situation in Vietnam by 38 giving the opinion about Case Law. the demands of the letter of credit a . In a classic let- 48 ter of credit, the bank of the buyer will be required to 49 release a letter of credit in favor of the trader. The pur-50 chaser will intruct the bank to draft a letter of credit 51 with exact every single document that the buyer needs 52 to obtain goods. The sole concern of the banks is  International parties have to draft a term within their 85 financial contract to invoke UCP to govern their letter 86 of credit. There are different opinions regarding to the 87 a Article 2 of The UCP 600 provides: Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honor a complying presentation b UCP means Uniform Customs and Practice for Documentary Credits -UCP 600. The ICC described Uniform Customs and Practice for Documentary Credits (UCP) are considered as the most outstanding private regulations that ICC has ever developed for trade. See more at http://store.iccwbo.org/icc-uniform-customs-and-pract ice-for-documentary-credits legal status of UCP. Most of the scholars agree with the 88 main view which UCP is not a statute which has the 89 law enforcement, UCP is only a set of international 90 practices which is recognized by most of the countries 91 in the world. For instance, in the Marine Midland 92 Grace Trust Co. v. Banco del Pais, the court stated 93 that "American law suggests that the UCP should not 94 be construed in the same strict manner as a statute 95 but as a contractual document prepared by business-96 men. " 8 . Or in the United Kingdom, as Lord Justice 97 Megaw, Lord Justice Shaw and Lord Justice Waller 98 stated "it has recently been observed that the Code 99 does not have the force of law. " 9 .

100
The general rules of the letter of credit 101 The foundation of the letter of credit law is the inde-102 pendent principle which make three contractual ar-103 rangements described above are independence from 104 each other 10 . The independent principle is embraced 105 in Article 4 of the UCP 600 7 . Article 4 acknowledges 106 the letter of credit is self-reliant from the sale contract 107 between purchaser and trader even though it is estab-108 lished base on the selling agreement. c 109 Under the independent principle, the main concern 110 of the bank is limited to payment obligation for the 111 presenter, once the documents tendered conform the 112 specifications of the letter of credit then the bank must 113 pay [ 11 , pp. 392-393]. The issuing bank must honor 114 the documents even though there are problems or 115 conflicts happened within the sale contract between 116 the purchaser and the trader [ 12 , p. 957]. Issuing 117 bank can only refuse to grant money once the doc-118 uments submitted do not fit the requirements of the 119 letter of credit. Otherwise, the issuer must pay even if 120 there are breach of warranty, applicant goes bankrupt 121 or even the underlying contract is cancelled [ 13 , pp. 122 186-188]. Alongside with the independent principle, 123 principle of strict compliance also operates the letter 124 of credit and is considered as an essential rule of let-125 ter of credit. Under this principle, the presenter has 126 to prepare documents with every detail fit to the pro-127 visions described in letter of credit, for instance the 128 c UCP 600, Article 4 ofUCP 600 provides: a. A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honor, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary. A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank. b. An issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract, proforma invoice and the like.  The independent principle ensures to the beneficiary 142 that he will be paid as long as he provides the comply-143 ing documents. However, there is one loophole that 144 the independent principle will be taken advantage, the    too low, the applicant may take advantages from the 179 fraud rule to prohibit the issuer from paying the pre-180 senter. The interference of the courts to the payment 181 of the letter of credit is also a problem, if it keeps hap-182 pening, the trust of business in letter of credit will be 183 devastated 17 . The fraud rule must serve its functions 184 for the merchants as well as is workable for the courts. Co., 19 in 1986. In the sale contract, the payment be-206 tween parties was secured by a letter of credit worth 207 ¥216 millions. The plaintiff (Yuegang) claimed the 208 feedstuffs of the machines delivered by the defendant 209 Japanese Technology & Science Co., did not meet the 210 standards as mentioned in the sale contract 2 . The 211 plaintiff then brought the action to the court and re-212 quested for an embargo to defer the reimbursement 213 under the letter of credit. d An embargo was granted 214 by the Court 19 .

215
The letter of credit specialists were extremely disap-216 pointed with the decision. Fraud was not cited in the 217 case. The main allegation of the plaintiff was about 218 the condition of goods, which was breach of warranty, 219 so that the fraud rule should not be brought to the 220 table. Wistfully, the Yuegang case is a presentation 221 of the Courts' view in P.R.C in the early years [ 2 , p.  e Article 92 of CPL of P.R.C provides: If, as the result of an act of one of the parties to a case or for some other reason, it appears that a judgment may be impossible or difficult to execute, a people's court may, at the request of the other party, issue a property preservation ruling. In the absence of such a request, a people's court itself may also, if deemed necessary, order property preservation measures to be adopted. When taking measures for property preservation, a people's court may order the applicant to provide security. If an applicant fails to provide security, the application shall be rejected. On receiving an application, a people's court must, if the case is urgent, make a ruling within 48 hours. If it rules for the adoption of property preservation measures, execution of these measures shall commence immediately.
f Article 94 of CPL of P.R.C provides: Property preservation shall take the form of sealing up, confiscation, the freezing of assets or other methods prescribed by law. If deciding that assets are to be frozen, a people's court shall immediately notify the party whose assets are to be frozen. g The English translation of the 1989 Summary is taken from Summary of the National Forum on the Adjudication of Economic Cases Relating to Foreigners and People from Hong Kong and Macao in the Coastal Region. "In view of the practice at home and abroad, if suf-Based on these new provisions, the courts in P.R.C, 262 especially those in high levels, when handling with the 263 cases related to the letter of credit including frauds, 264 can recognize the importance of the extraordinary 265 characters of the letter of credit and grant their judge-266 ments with cautious when they are asked to enjoin a 267 payment for the letter of credit. However, the 1989 268 Summary was underestimate because it does not have 269 the enforcement of law and is only a policy statement 270 of SPC of P.R.C 2 .  The 2005 Rules is basically a group of interpretations 291 of legal rules. The Supreme People's Court of P.R.C 292 has prepared specific instructions for several situa-293 tions including specific cases to particular rules or 294 peculiar guidance in special fields that law has not 295 reached. The whole 2005 Rules covers the entire letter 296 of credit field, but its main target is the fraud rule. It 297 is mainly focus on problem-solving rather than issu-298 ing a statute for letter of credit. Notwithstanding, the 299 2005 Rules was not considered as law but in realistic 300 awareness, it is law since it has the enforcement of law 301 and the courts keep citing it in their decisions [ 2 , p. 302 1068]. that those who try to manipulate the banking system 353 by using the invalid underlying contract and letter of 354 credit for funds will be suspend by the courts if their 355 intentions are revealed. Concerning there are people 356 always trying to manipulate the system [ 21 , p. 9] and 357 new fraud would not be listed in subsection (i), (ii) or 358 (iii), the subsection (iv) is included. This subsection 359 works under the name of security faucet to prevent 360 any further dishonest acts in the future 2 . 362 Having fraud rule embodied in the domestic law is 363 not only to protect the defrauded parties but also to 364 save innocent parties in the letter of credit transac-365 tion. However, fraud rule could not be invoked once 366 the documents tendered by a holder in due course. 367 One benefit of using the letters of credit is the ben-368 eficiary can receive money from a third party which 369 is normally the beneficiary's local banks. These bank 370 are known as intermediate banks [ 2 , p. 1080] which 371 do negotiation or purchasing the documents that ben-372 eficiary presented or taking the right of proceeding 373 the letter of credit under the name of warranty and 374 providing loans to the beneficiary. When fraud is in-375 volved, the innocent parties such as issuing bank, ap-376 plicant as well as the third parties will bear the loss. If 377 third parties are not protected, the economy benefits 378 of the letter of credit will be influenced since there will 379 be fewer local banks willing to take the risks of negoti-380 ating the letter of credit, which leads to the reduction 381 of sellers using this instrument. With these reasons, 382 innocent third parties should be exempt from the ex-383 ercising of fraud rule. Article 10 under the 2005 Rules i 384 declares about the immune parties along these lines: 385 "A people's court shall make a ruling to suspend the 386 payment or a judgement to permanently stop the pay-387 ment under a letter of credit when fraud is established, 388 unless one of the following has happened: 444 j Article 2 of UCP 600 provides: A confirming bank undertakes to reimburse another nominated bank that has honored or negotiated a complying presentation and forwarded the documents to the confirming bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not another nominated bank prepaid or purchased before maturity. A confirming bank's undertaking to reimburse another nominated bank is independent of the confirming bank's undertaking to the beneficiary. p. 1083]. In turn, under the guidance of Article 10 of 445 2005 Rules, when a negotiation bank honors the doc-446 uments with good faith means that they do not have 447 any ideas about the fraud within the transactions, and 448 with that explanation, they can be exempt from the 449 fraud rule. As a consequence, once the negotiation 450 bank is noticed about the fraud included in the trans-451 actions but still negotiates the documents then the ne-452 gotiation bank should not be protected. 453 However, this definition of good faith could not be 454 applied when it comes to the position of confirming 455 bank. Confirmer is in the same spot with the issuer 456 from the perspective of beneficiary and third-party 457 presenters, they must honor the documents tendered 458 if the documents on the face comply the requirements 459 under the letter of credit 7 . If the confirming bank 460 turn the documents presented down because there are 461 frauds within the transaction, they might find them-462 selves being dragged into a litigation by the presen-463 ter. Accordingly, if the confirmer chooses to honor 464 the documents presented on the face conforming the 465 obligations of letter of credit even though fraud is in-466 volved and they notice it, the confirming bank must 467 be secured by the rule of fraud because of its ex-468 traordinary condition. So in this circumstance, the 469 "good faith" cannot be defined as "without notice of 470 fraud" but "without collusion" with the fraudster [ 2 , 471 p. 1083]. 473 Under the Article 9 of 2005 Rules k , "[t]he applicant, 474 the issuing bank or any other interested parties may 475 apply to a competent people's court for a ruling to sus-476 pend the payment under the letter of credit […]" 20 . 477 Once fraud is found in the transactions, the applicant 478 as the party standing in the priority position could 479 bring the action to the court and ask for an injunction. 480 The issuing bank is also listed as one of the parties ap-481 plying for court remedies under the Article 9, how-482 ever, according to Xiang Gao 2 , this is simply strange 483 and illogical. Normally, the international practices 484 and rules allow the issuer continues to honor the doc-485 uments tendered as long as it conforms the obliga-486 tions of letter of credit. Once fraud is found, the issuer 487 can refuse to do so. And it is much more econom-488 ical for the issuing bank to just turn the documents 489 down than going to the court to ask for an injunction.  When handling the letter of credit, the courts must see 630 the letter of credit as a special tool unlike the other ne-631 gotiable instruments. Since the law of letter of credit is 632 a complex area, the courts must be very careful in issu-633 ing their judgements. It is very dangerous for the po-634 sitions of Vietnamese banks in international trading 635 if the applicants try to quit their payment responsibil-636 ities by using the injunctions. At the same time, the 637 Vietnam Legal Framework will be under pressure by 638 international letter of credit experts if the courts keep 639 interfering with the payment obligations of the banks. 640 The court in issuing their judgements must recognize 641 the international practices of the letter of credit, not 642 "what is reasonable, fair, or equitable?" 23 .

643
The proposal for the letter of credit law in 644 Vietnam 645 The UCP 600 is accepted in Vietnam 22 , hence, the 646 courts and merchants in Vietnam can consult the 647 UCP rules about definitions of the letter of credit and 648 obligations of parties and etc. However, relying only 649 on the UCP for the letter of credit is not a good idea 650 because the UCP 600 is not complete. Once the let-651 ter of credit contains the governing clauses using the 652 UCP 600, the litigation might be raised relating to sev-653 eral problems such as the rights and obligations of the 654 parties once the documents presented involve frauds 655 or remedies. The courts must look for an appropriate 656 body of law 24 .

657
The legal framework of Vietnam should recognize the 658 fraud exception of the letter of credit to keep up with 659 the developing of the trade activities in Vietnam. The 660 fraud exception will uphold the courts when dealing 661 with specified cases related to the letters of credit and 662 the frustrations of the courts will be solved when most 663 of the provisions are combined at one set. There are 664 few countries tried to embody the fraud rule into the 665 domestic law such as the United States and the P.R.C. 666 In the United States, in the early years, the legal schol-667 ars and experts in banking in the United States needed 668 a case study to build the fraud rule structure. And 669 Sztejn 25 is a milestone to help developing the struc-670 ture of the fraud regulations in the letter of credit 671 law. It was drafted in the Uniform Commercial Code 672 (U.C.C) and most of cases related to fraud rule have 673 followed its rules in United States and throughtout 674 common law world [ 14 , p. 676]. Referring to the 675 law of letter of credit of US is remarkable because 676 the United State is one of the biggest financial cen-677 ters in the world, whereas the United States owns an 678 enormous case laws which is very useful to consult.