Ercüment Erdem Att. Nezihe Boran Demir

Bank Letters of Credit

September 2017

Introduction

In financing transactions, creditors, especially commercial banks, aim for repayment of loans through the smoothest manner possible. In order to secure the extended loan amount, creditors obtain security packages generally from borrowers, their shareholders or group companies to secure the extended loan amount. Within the security package, it is the intention of the lenders to receive securities that are time and cost efficient at the time of enforcement or foreclosure. Bank letters of credit are one of the most preferred securities, which include undertakings to pay the given amount without the need to conduct any further proceedings. This Newsletter will mainly focus on the definition and the legal nature of bank letters of credit, validity requirements, and validity formalities and, finally, a general overview to the types of bank letters of credit, in practice.

Definition and the Legal Nature of the Bank Letters of Credit

Due to lack of any regulations under Turkish law with respect to bank letters of credit, the legal nature of such has been argued under the doctrine and in the decisions of the Court of Appeals. Although there are scholarly views that assert that the legal nature of bank letters of credit are a type of surety or sui generis transaction, the majority of the scholars, and the Court of Appeals, are of the opinion that bank letters of credit are a type of guarantee.

Since there is no definition as to bank letters of credit in the legislation, and in practice bank letters of credit are mostly unlike each other, it is hard to form a strict definition[1]. Accordingly, a general definition would be helpful to capture various bank letters of credit that are issued, in practice. Certain scholars simply describe bank letters of credit as a guarantee granted by banks[2]. Other scholars define in a more specific way bank letters of credit as a type of agreement whereby, upon request of the customer, the bank guarantees to a third party, who is willing to transact with the customer of such bank, to pay the undertaken amount upon occurrence of the determined event regardless of the fulfillment of the customer of its obligations in its relationship with the third party[3]. In order to understand bank letters of credit, which are a type of guarantee agreement, the elements of guarantee agreement should be reviewed.

Elements

Directing the Addressee to a Course of Action

The bank, as the issuer of the bank letters of credit, and with an aim to direct the guaranteed person (i.e., addressee) to a course of action, should undertake to compensate the consequences (such as loss of profit, suffered damages) of the act of the guaranteed person. Such course of action could be to perform an act, or non-performance of an act. Turkish law enables the guarantors to guarantee all of the obligations of a third party, including performance or non-performance obligations. The aim of the bank to direct the guaranteed person to act in such a manner would characterize the relationship as a guarantee[4].

Undertaking a Risk

The guarantor undertakes to compensate certain risks. With a guarantee agreement, the risks of an obligor of an underlying agreement that may arise upon occurrence of a detrimental event, or non-occurrence of an economically beneficial event for the creditor of the underlying agreement, would be secured. In order to be secured by a bank letter of credit, such a risk should be independent from the relationship between the beneficiary and the addressee; it should further be objectively realizable and, finally, it should be determinable.

In terms of the determinability of the risks undertaken by the bank letters of credit, such risk should be calculable instead of referring to a certain monetary amount. The parties to a guarantee should specify the underlying relations that may give rise to risks. In this sense, such a requirement makes the parties unable to secure bank letters of credit all of the existing and future risks that may arise between the beneficiary and the addressee. This is due to the fact that the legal grounds for such risks are undeterminable. In the event of new and additional obligations of the addressee, the previously issued bank letter of credit would not cover such recent amendments. Therefore, the parties thereto should enter into an additional guarantee relationship for the new obligations[5].

Undertaking an Independent Obligation

In respect of bank letters of credit, the undertaking of the bank to the addressee would be independent from the underlying relationship between the beneficiary and the addressee. Although bank letters of credit are dependent on economic terms, i.e. determination of the monetary amount from the underlying agreement, they are not dependent in legal terms. In other words, such independency means that the existence and the validity of bank letters of credit are not dependent upon the existence or the validity of any other agreement. It is worth mentioning that the aforementioned independency feature of the guarantee relationship should not mean an abstract acknowledgement of debt (soyut borç ikrarı). This would be an overreaching interpretation. Turkish law recognizes two kinds of securities as being accessory and non-accessory securities. A guarantee is a non-accessory security, which is an independent form of security interest, where the validity of the non-accessory security is not dependent upon the validity of the underlying relationship[6].

Consideration

There are several discussions under the doctrine as to whether or not bank letters of credit are types of transactions with consideration. One scholarly view asserts that the guarantee agreement is an agreement that creates a burden on the one side, thus it is a transaction with no consideration. On the other hand, another scholarly view asserts that there is no obstacle to make a guarantee agreement in return for consideration. In respect of bank letters of credit, bank issues security in return for a commission fee. However, it is arguable that such commission is not paid by the security holders as consideration, but by the person to whose benefit the security is provided[7].

Formalities for Bank Letters of Credit

As mentioned, above, there are no regulations under Turkish law regarding the content or the requirements of bank letters of credits. In this sense, the decisions of the Court of Appeals are crucial. According to the decisions of the Court of Appeals[8], bank letters of credit are not subject to any formal requirements, and consolidation of the intentions would be sufficient to create the guarantee.

The fact that bank letters of credit are not subject to any legal requirements and, therefore, would be proved with any type of evidence, creates certain problems that the parties face, in practice. Thus, a precedent to issue bank letters of credit, in writing, has been established in order to avoid these problems. In the written document, the details of the beneficiary and the addressee, the date and the amount undertaken should be specified, together with the signature of the guarantor, i.e., the bank[9].

General Overview on Types of Bank Letters of Credit

As stated, above, bank letters of credit are not similar to each other, and may be issued for different purposes in different ways. In practice, letters of credit are mostly used for tenders. These types of bank letters of credit would be comprised of temporary letters of credit, performance bonds, and advance payment bonds. Depending on the existence of the term of a bank letter of credit, there are two types of letters, those being the deferred letters of credit, and on-demand letters of credit. Based on the form of the payment demand, the letters of credit would be bank letters of credit, payable upon first demand, and conditional bank letter of credit. In the absence of any regulation, the types of bank letters of credit would increase.

Conclusion

Considering the advantages of bank letters of credit, in practice, it is a commonly preferred security in financial transactions. Under Turkish law, there is no legislation that regulates the content and the requirements of bank letters of credit. However, it is a commonly accepted view that bank letters of credit are types of guarantees. Therefore, the elements of a guarantee relationship would also be referred for the bank letter of credit. Since the legislation is silent in terms of the formalities of bank letters of credit, it is generally accepted to issue the guarantees in written form.

[1] Merve Yalcinkaya, Description of the Attributes of Bank Letters of Credit, Legal Relationships between the Parties, and conditions of Validity, Journal of Bank and Finance Law, 2016, İstanbul, p. 645.

[2] Vahit Dogan, Bank Letters of Credit, Ankara, 2002, p. 32.

[3] Unal Tekinalp, Fundementals of Banking Law, C.I., Istanbul, 1988, p. 372.

[4] Dogan, Ibid, 34.

[5] Yalcinkaya, Ibid, 648.

[6] Dogan, Ibid, 38.

[7] Yalcinkaya, Ibid, 651.

[8] One decision would be the decision of the11th Civil Chamber dated 27 December 1990 under Docket No. 1989/4046 and Decision No. 1990/8459.

[9] Yalcinkaya, Ibid, 659.