When an LC Makes Payment Subject to Buyer–Seller Disputes

Intro

One of the core principles of a documentary credit is that payment depends solely on complying documents, not on disputes arising from the underlying commercial contract.

From time to time, however, beneficiaries encounter LCs that attempt to dilute this principle by inserting clauses linking payment to buyer–seller disputes.

The following Q&A addresses such a case and explains why these clauses are incompatible with established LC practice under UCP 600.

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QUESTION

Dear Mr. Old Man,

I have a question for you.

An LC issued by Bank A states in field 47A (Additional Conditions) the following clause:

“The issuing bank is not obligated to pay in the event of a commercial dispute between the buyer and the seller.”

Does this clause contradict UCP 600?

How can such clauses be restricted?

Thank you.

Best regards,

PT

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ANSWER

Dear PT,

Thank you for your question.

Yes, this clause is fundamentally inconsistent with the nature of a documentary credit under UCP 600.

A Letter of Credit is an independent (abstract) payment undertaking. Under UCP 600 Article 4, a credit is separate from the underlying sale or other contract, and under Article 5, banks deal with documents, not with goods, services, or performance related to those documents.

By stipulating that “the issuing bank is not obligated to pay in the event of a commercial dispute between the buyer and the seller,” the issuing bank effectively makes its payment obligation conditional upon matters outside the documents. This directly contradicts the autonomy principle of the LC and undermines the very purpose of using a documentary credit.

How such clauses can be restricted or mitigated

1. Do not accept the credit as issued

The beneficiary should request an amendment deleting this clause before shipping the goods. Proceeding under such a credit exposes the beneficiary to payment risk unrelated to document compliance.

      2. Advising bank’s role

The advising bank should clearly draw the beneficiary’s attention to this clause and explain that it materially weakens the issuing bank’s payment undertaking under UCP 600.

      3. Risk assessment by nominated banks

Nominated banks may reasonably decide not to negotiate, discount, or add confirmation to credits containing such clauses, as the payment risk becomes dispute-based rather than documentary.

      4. Practical consideration

Where an issuing bank includes clauses that materially dilute its payment undertaking, the advising bank should treat this as a red flag and advise the beneficiary to exercise caution when accepting credits issued by that bank.

In short, an LC that allows payment to be denied due to buyer–seller disputes is no longer a true documentary credit, but a conditional promise dependent on matters outside the scope of document examination.

I hope this clarifies the issue.

Best regards,

Mr. Old Man