Hello, my dear readers! Good afternoon. How are you and I hope your day has been going well. Today, we are taking our time to carefully break down the concept of letters of credit into simple and clear terms. C’mon let go!! ( In IG content creators’ voice)
1. What is a Letter of Credit (LoC)?
Imagine you want to buy something from someone in another country, let’s say Canada, but you don’t fully trust each other yet. A Letter of Credit (LoC) is like a promise from a bank that makes sure the seller gets paid and the buyer gets the goods they paid for. The bank acts as a middleman to keep everything fair and safe.
2. How does it work? Step by Step:
• Seller Demands an LoC
When a seller (exporter) and buyer (importer) agree on a sales contract, the seller often asks for a LoC to make sure they’ll get paid. This is like the seller saying, “o boy, i can only send the goods if I know a bank guarantees I’ll get paid.” The seller is also referred to as the beneficiary
• Buyer Applies for an LoC
The buyer goes to their bank (called the issuing bank) and asks them to issue an LoC in favor of the seller. The buyer submits an application and documents to the bank, and the bank checks if the buyer is trustworthy (this is called creditworthiness).
• Issuing Bank Sends the LoC
Once the bank approves, it sends the LoC to the seller’s bank (called the advising/ confirming bank). The advising bank checks if the LoC is real and tells the seller, “hey, the LoC is ready! You’ll get paid once you send the goods and provide the right documents.”
• Seller Ships the Goods and Provides Documents
The seller ships the goods and collects important documents like:
Shipping receipt (proof the goods were sent)
Invoice (how much the buyer owes)
Insurance certificate (proof the goods are insured)
Certificate of origin (where the goods came from)
Inspection certificate (proof the goods were checked) among others depending on the transaction.
• Bank Checks the Documents
The seller gives these documents to the bank. The bank checks if the documents match the terms of the LoC. If everything is correct, the bank pays the seller (or the seller’s bank). These documents are like a “proof package” showing the seller did their part.
• Bank’s Absolute Obligation to Pay
This is where it gets interesting. Once the LoC is issued and the documents are correct, the bank must pay the seller, even if the buyer and seller are fighting about something else (like the quality of the goods). Any disputes between the buyer and seller are their problem to solve. The bank’s job is just to pay based on the documents.
Denning M.R. in Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. & Umma Bank (1978) 1 Lloyd’s Rep. 166 at 170 opined that “It has been long established that when a letter of credit is issued and confirmed by a bank, the bank must pay it if the documents are in order and the terms of the credit are satisfied. Any dispute between the buyer and seller must be settled between themselves. The bank must honour the credit“. This principle of English law has been accepted by the Nigerian Courts. See Nasaralai Enterprises Ltd v Arab Bank (Nig) Ltd (1986) LPELR-1942(SC) Pp 23 – 23 Paras A – E); Sterling Bank v Shining Star (Nig Ltd) (2022) LPELR-57076(CA) Pp 73 – 74 Paras B – A). Once the payment has been confirmed, the buyer gets the goods.
Principles of law from the 2025 case of Owigs and Obigs (Nig.) Ltd. v. Zenith Bank Plc (2025) 2 NWLR (Pt. 1977) 451 as it relates to LoC.
Facts of the Case
The appellant entered into a banking relationship with the respondent, which agreed to provide export finance facilities if the appellant secured contracts backed by acceptable letters of credit. Based on this, the appellant engaged Eglone Group Asia Pte Ltd to broker foreign contracts for the supply of solid minerals. It was agreed that the appellant would pay a 4% commission per contract and a 2% default fee if there was a performance failure. Consequently, Eglone secured two contracts with Chinese firms for the export of tin ore, tantalite ore, and columbite ore.
Thereafter, the appellant obtained draft letters of credit from the Chinese companies’ bankers, Industrial and Commerce Bank of China (ICBC), and submitted them to the respondent for confirmation. However, despite previously negotiating the details with ICBC, the respondent refused to confirm the letters. As a result, the contracts were canceled, and the appellant was liable to pay penalty fees to Eglone. Subsequently, the respondent deducted these fees from the appellant’s bank account.
Following this, the appellant, feeling aggrieved, sued the respondent at the High Court of the Federal Capital Territory. After the case proceeded to trial, the court found that the respondent was not negligent and dismissed the appellant’s claims. However, the appellant appealed to the Court of Appeal, which found the respondent negligent, set aside the trial court’s judgment, and ordered a refund of $4,486.04 in penalty fees, along with a cost award of N300,000 in favor of the appellant.
Despite this victory, the appellant was dissatisfied with the Court of Appeal’s decision regarding monetary damages and further appealed to the Supreme Court. In the end, the Supreme Court dismissed the appeal by a 4-1 majority, with Ogunwumiju, J.S.C. allowing the appeal in part.
Principles:
1. What is UCP600 and its relevance in Loc?
The Uniform Customs and Practice for Documentary Credits (UCP 600) is a set of rules created by the International Chamber of Commerce (ICC) to standardize how LoCs work in international trade. It doesn’t have the force of law on its own. Instead, it’s a voluntary set of guidelines that banks and businesses agree to follow. The UCP 600 becomes part of a Letter of Credit transaction when the parties agree to include it in their contract
The legal framework for LoCs comes from the contract between the parties (e.g., the sales contract, the LoC itself) and the laws of the country where the transaction takes place. The UCP 600 supplements this legal framework by providing detailed rules for how LoCs should be handled. However, it doesn’t replace the law
In Nigeria, the Central Bank of Nigeria (CBN) adopted UCP 600 on July 1, 2007, replacing the older UCP 500. All LoCs issued after this date must follow UCP 600 rules, while LoCs under UCP 500 remain valid until they expire.
In the case under review, the appellant argued that the Court of Appeal misinterpreted UCP 600 by ruling that anticipated profits and default charges were not actual losses and couldn’t be claimed as special damages. However, the appellant failed to show which part of UCP 600 was misapplied or violated by the court. After reviewing all 39 Articles of UCP 600, the Supreme Court found no evidence to support the appellant’s claim, meaning the Court of Appeal’s decision was consistent with UCP 600 rules.
2. Do confirming banks in Locs have legal relationships with the beneficiaries?
No. The bank does not have a direct legal relationship with the beneficiary (seller). This means that the seller cannot sue the confirming bank directly if something goes wrong. The confirming bank’s responsibility is to the issuing bank (the buyer’s bank), not the seller.
If there’s a problem, the seller must go to the issuing bank. The issuing bank pays the seller first, then deals with the confirming bank if needed. Akinsanya v. UBA (1986) 4NWLR (Pt. 35) 273.
3. Is an LOC contract from the contract of sale or other contracts on which it is based?
Yes. The principle of independence in LOCs means that the LOC is entirely separate from the underlying contract between the buyer and the seller. According to Article 4(a) of the UCP 600, banks deal strictly with the LOC itself and the documents required under it, not with any disputes or obligations arising from the underlying contract.
This means that even if the contract between the buyer (applicant) and the seller (beneficiary) is breached, disputed, or even declared unenforceable by a court, the bank must still honor the LOC as long as the beneficiary presents the required documents correctly. The applicant (buyer) cannot refuse payment under the LOC by claiming that the seller failed to fulfill their part of the contract.
Because of this autonomy principle, banks discourage including references to the underlying contract (such as invoices or contract copies) in the LOC. If disputes arise over contract performance, the only option for the buyer is to pay the seller once the LOC terms are met and then seek legal remedies separately.
4. Are there exceptions to the autonomy principle?
Yes. While the autonomy principle ensures that Locs remains independent from the underlying contract, certain exceptions have been recognized. These exceptions allow either the issuing bank or the applicant (buyer) to withhold or challenge payment under an LOC in specific circumstances.
One key exception is fraud, where the bank or the applicant may refuse payment if the beneficiary engages in fraudulent activities. Similarly, illegality applies if the transaction violates legal principles, following the rule that no claim can arise from an unlawful act. Another exception is recklessness, which allows a bank or applicant to challenge payment if the beneficiary’s actions amount to gross negligence or misrepresentation.
Additionally, the nullity exception arises when documents presented under the LOC are entirely false, fabricated, or worthless, making them legally ineffective. Unconscionability is another exception, preventing a beneficiary from claiming payment if their actions, though not fraudulent, are so unfair or unjust that a court intervenes. However, proving unconscionability requires a high standard of proof.
In the case under review, the appellant argued that the respondent, as the confirming bank, was responsible for breaching the underlying contracts between the appellant and third parties. However, the court rejected this argument, emphasizing that contracts under an LOC are autonomous, meaning that obligations between the bank and its customer remain separate from the buyer-seller contract. Since there was no finding that the respondent actually breached a contract, the appellant’s claims for damages, including default payments and loss of profit, could not stand. Furthermore, under contract law, only a party to a contract can lawfully terminate it, reinforcing the independence of the LOC from the appellant’s other agreements. This brings us to the next point: privity of contract.
5. How does Privity of Contract relate to Locs?
The doctrine of privity of contract means that only the parties to a contract have rights and obligations under it. In the context of LOC, this means the issuing bank (Zenith Bank in this case) is only responsible for fulfilling its commitment to issue and confirm the LOC as agreed with the applicant. The bank has no liability for damages arising from the underlying contract between the applicant and third parties because it is not a party to those agreements.
Even if the applicant suffers losses due to issues in the underlying transaction, it cannot hold the bank responsible, as the bank’s role is strictly limited to processing payments based on compliant documents, not ensuring the contract between the applicant and third parties is performed correctly. Courts have upheld this principle in several cases, making it clear that banks are not accountable for contract disputes beyond their obligation to honor the LOC. Babatunde v. B.O.N. Ltd. (2011) 18 NWLR (Pt. 1279) 738. A. I. Investment Ltd. v. Afribank Nig. Plc (2013) 9 NWLR (Pt. 1359) 380
B. B. Apugo & Sons Ltd. v. O. H. M. B. (2016) 13 NWLR (Pt. 1529) 206. Edilcon Nig. Ltd. v. UBA Plc (2017) 18 NWLR (Pt. 1596) 74
In conclusion, a letter of credit is simply about trust and security in business. It reassures sellers that they’ll get paid and gives buyers confidence that they won’t lose money unfairly. That’s why it’s such a powerful tool, especially in international trade, where people are dealing with strangers across different countries. It keeps things fair, removes uncertainty, and helps businesses grow without the fear of being cheated. In a world where trust can be risky, a letter of credit steps in to keep things running smoothly.
Thank you for reading. See you next month.
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