Reconciling the old theory and the new evidence.

• Author: Corre, Jacob I.
• Position: Response to article by Ronald J. Mann in this issue, p. 2494

Comments on Ronald Mann's `The Role of Letters of Credit in Payment Transactions'

Ronald Mann's thorough research and rigorous analysis provide compelling evidence that the commercial letter of credit does not further the fundamental purpose traditionally associated with it.(1) Equally persuasive are his hypotheses about the functions that letters of credit actually serve in the real world. The objective statistics are startling. An overwhelming majority of letter of credit seller-beneficiaries make at least initial presentations to issuing or correspondent banks that by the express terms of the letter of credit do not entitle the seller to payment.(2) Without a waiver from its customer, the issuing bank is legally entitled to, and surely will demand, strict compliance with these terms.(3) It is only the voluntary foregoing by the buyer-applicant of its own unambiguous formal power, which is essentially always forthcoming, that enables the seller to draw on the letter of credit. Thus, the normal course of a letter-of-credit transaction at least initially places the seller at the mercy of the buyer.

Given these empirical findings, it is difficult to believe that the persistent use of letters of credit in commercial transactions has anything to do with their theoretical potential to ensure that the seller actually gets paid. It is difficult to believe, but not impossible. Mann recognizes that his evidence does not conclusively refute the traditional view that the principal function of the letter of credit is to assure payment. At least one plausible conceptual account of the letter of credit remains that is consistent both with the new, surprising empirics and the old idea that the commercial letter of credit is primarily an atomic element of the payment system. The traditional view does not depend on the legal enforceability of letters of credit because one does not need legal rights to feel assured of payment.

The account that I propose begins by identifying and contemplating the consequences of a likely disjunction in the locus within the firm (particularly the seller's firm) of the agency costs generated in the issuance of letters of credit, on the one hand, and in the performance of the conditions required before the seller is entitled to draw on the letter of credit on the other. Imagine a straightforward, very large one-time sale of a commodity by a seller who routinely does business around the world, and a buyer located in a country where the seller has little or no experience. The seller is represented by a firm-specific marketing representative who, lacking sufficient information about the buyer's reliability, demands a letter of credit. The seller wants the letter of credit only as a means of assuring payment. The buyer agrees. The terms of the letter of credit could, in theory, be worked out by the agents who struck the deal themselves. Alternatively, the parties, after agreeing on a particular issuing bank, might simply adopt and adapt a form of letter of credit routinely utilized by the bank; indeed, the bank might insist that the letter of credit be based on such a form. They could hand the matter over to lawyers, in or out of house, and the bank's lawyers will probably need to look at the resulting papers before the bank commits itself. The letter of credit that the bank finally issues will contain specific terms, ordinarily requiring that a particular set of documents evidencing shipment of the goods be presented to the bank in a particular manner within a particular time frame. Information as to precisely...