The Roles of Independence Principle and Preferential Transfers in Tension between Documentary Credit and Bankruptcy: With a Focus on the U.S. Case Law

The insolvency of the applicant in documentary credit transactions could lead to complexity and tension between laws of documentary credit and bankruptcy. The question posed here is: What are the effects of the insolvency of the applicant on rights and obligations of the issuer and the beneficiary? This is a significant question which results in creating a conflict and tension between the principle of independence in letter of credit and preferential transfers in bankruptcy in the event that the applicant becomes bankrupt. To deal with this problem, general principles in the field of commerce, such as efficiency and reinforcement of credit, could be taken into account. On this basis, it is necessary to adhere to the principle of independence; nevertheless, this principle should not be given a weight beyond principles of commerce. This article aims to examine situations in which the above-mentioned tension is raised by placing a particular emphasis on the U.S. case law. It would seem that in the case of standby letter of credit, the applicant’s insolvency could lead the issuer, depending on circumstances, to be reluctant to honour the letter of credit and pay it to the beneficiary.